Enhanced documentation requirements: Several categories of taxpayers now file IT returns

ISLAMABAD: Several categories of taxpayers, who were excluded from the Final Tax Regime (FTR) through Finance Act 2019, would now file their income tax returns with enhanced documentation requirements, record keeping, declaration of net profits, audits and increased tax liability with major cost of doing business.

Tax experts told Business Recorder here on Thursday that through the Finance Act 2019 the mechanism of FTR has been discontinued for some important categories of taxpayers mainly contractors, commercial importers, commission agents, suppliers of goods, those earning income from profit on debt or from running of CNG stations or renting of machinery and equipment. However, the tax that is withheld from the persons previously under the FTR will not become adjustable against the tax worked out on the basis of their net profits which is the hallmark of the normal tax regime (NTR). Instead this tax will become their minimum tax liability or in other words if the tax on the basis of net profit is less than the withheld tax, the excess will not be refunded and if the tax so

worked out is higher than the withheld amount the additional amount will have to be paid by the taxpayer. This important change having substantial implications for the taxpayers under the FTR has not received the attention that it deserved due to the simple fact that it will be implemented in the Tax Year

2020, the returns for which are still to be filed. Once the taxpayers start filing their returns and the returns are processed by FBR, the unfair treatment that has been meted out to them will become apparent.

Experts said that the tax liability of the taxpayers who have been taken out of the FTR will be at least equal to what they were paying under the FTR and they will also be deprived of the benefits of the FTR. They will have to follow all record keeping requirements prescribed by law, will have to work out and declare their net profits and undergo tedious tax audits. This will not only increase the cost of doing business but also leave them at the mercy of the tax auditors taking away the certainty regarding their tax liability that they previously enjoyed under the FTR. They may have been willing to accept the withdrawal of FTR if they could visualize, at least theoretically, a possibility of reduction of their tax liability and refund of the excess tax paid.

Tax experts have also highlighted the gross discrimination and anomalies inherent in the new tax regime explained above. Taxpayers who are or were not under the FTR are required to pay minimum tax at the rate of 1.5% of their gross turnover. These are mainly the taxpayers whose business transactions are not with organized sector and not subjected to collection of tax at source and hence far less documented. It would be expected that persons operating in the organized sector and having a greater level of documentation would get a preferential treatment from FBR as compared to those who are less documented but we are witnessing the exact opposite of this legitimate expectation. This becomes obvious from the fact that the rate of minimum tax as a percentage of the gross turnover for the categories that have been taken out of FTR will be 8% to 10% for the contractors, 12% for commission agents and brokers, 15% for those having income from profit on debt, 5.5% for commercial importers, 4% to 4.5% on supply of goods, 10% for persons renting machinery and equipment and 4% for CNG stations. This would mean that a taxpayer who supplies goods or executes a contract with an entity who is not required to deduct any tax on the payments made to the taxpayer, will be paying 1.5% of his gross turnover as minimum tax, whereas a taxpayer whose business receipts come from an entity that has been made withholding agent under the law, such as a government organization or a limited company will be required to pay much higher percentage of his gross receipts as minimum tax despite selling identical goods or performing identical contractual services.

The discrimination inherent in the above change of tax regime becomes even more glaring when it is realized that some categories have still been retained in the FTR. It is not understandable that if the change from FTR was so desirable why the exporters have still been kept in the FTR? The discrimination becomes even more blatant when we see that the CNG stations have been removed from FTR and the tax withheld by Gas distribution companies and DISCOs from their monthly bills is now the minimum tax but petrol pump operators are still under FTR.

Through the Finance Act, 2020 tax deductible on certain payments to non-resident persons has also been made the minimum tax. Experts have pointed out that Pakistan has tax treaties with almost all the countries to which the non-residents receiving payments from Pakistan belong. All tax treaties provide for taxation of these non-resident persons on the basis of net income and law provides that in case of a conflict between the domestic law and the tax treaty, the treaty overrides the domestic law. Therefore, it will not be possible to make the tax withheld from the non-residents as the minimum tax and the change will be ineffective and will not yield the desired results and only cause unnecessary litigation with non-residents and a bad name for Pakistan.

Tax experts are therefore of the opinion that the change from FTR to the new regime must be withdrawn to prevent unnecessary hardships for the taxpayers or alternately if the FTR has to be discontinued at all costs then the tax withheld must be made adjustable instead of being the minimum tax. In case the tax withheld is more than the tax payable on the taxable income the excess may be made refundable.

Sharing background of the issue, experts explained that the Income Tax law in Pakistan has adopted two methods of taxation of the taxpayers. The first method is the classical method of assessment of income and the payable tax and is known as the Normal Tax Regime (NTR) and the second that was introduced in the early 1990s is known as the Final Tax Regime (FTR). Taxpayers who fall in the domain of the Normal Tax Regime pay their taxes on the basis of their net profit. The net profit is determined by first arriving at their total revenues and then subtracting expenses incidental to the earning of the revenues and also taking into consideration various other factors such as allowances, credits, depreciation and rebates etc. that reduce their net profits and hence the taxable incomes and the tax required to be paid. In the case of the taxpayers falling under the Final Tax Regime, their tax liability is determined by withholding a fixed percentage of tax from the gross amount of certain specified economic transactions. The withholding tax collected at source becomes their final tax liability irrespective of what income or profit has been actually made as it has no relevance in determination of the tax liability. Income from contracts, supply of goods to prescribed persons, commercial imports, exports, commission income, petrol and CNG filling stations are some of the prominent sectors falling in the FTR. In most cases the tax liability worked out under the FTR is higher than what would have been payable on the basis of computing net income as under the FTR tax is collected on the gross revenues and the taxpayer does not get the opportunity to deduct allowances and expenses from his revenues to reduce his payable tax. However, the taxpayers falling in the FTR despite some initial legal challenges have accepted this mode of taxation as it allowed them freedom from quite a few hassles and irritants. They are not required to bear the costs of maintaining intricate and detailed records prescribed under the law. They also do not have to face the rigorous tax audits as the only relevant information for the tax collector in their cases is the gross receipts and the tax withheld from these receipts. Their gross receipts having already been subjected to deduction or collection of tax by the withholding agents also do not need to be verified.

From a purist point of view FTR represents a departure from pure income taxation and has been subjected to criticism by economists who have been demanding for its phasing out. However, since it provided a mechanism for the FBR to maximize its collection from these sectors and also facilitated the taxpayers, it was allowed to continue. FBR in the past tried to give option to the persons falling in FTR to opt out of this regime and come under NTR with a certain percentage of the tax withheld from them to be treated as adjustable tax against their final tax liability determined on the basis of their net profits and they could also get refund of the adjustable tax if it exceeded their tax liability determined on net income basis. However, the overwhelming majority of the taxpayers preferred to remain within the FTR due to its benefits and did not opt to ask FBR for refund due to their apprehensions of harassment by the tax collectors. Nevertheless, it is widely accepted that FTR is an ad hoc measure that has ultimately to be discontinued once the essential pre-requisites for its withdrawal such as the desired level of documentation, increase in the capacity of FBR to tax actual incomes and the willingness of the taxpayers to pay their due taxes are in place.

Copyright Business Recorder, 2020