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Opinion

We seem to have no understanding of what ails our taxation system

Introduction I never wanted to write the following article for the simple reason that there isn’t anything good ...
02 Jun 2021

Introduction

I never wanted to write the following article for the simple reason that there isn’t anything good to present. However, I am forced to write because there is so much disinformation, misperception and constant abuse of the word ‘reform’ of tax collection in Pakistan that one must present certain ground realities to people. In my view, the biggest stakeholders in this state being the people of Pakistan, who are around 85-95 percent of the population that are deprived of primary justice ingrained in constitution of every state. This is Part-1 of the series. In the subsequent parts I will present some solutions to suggest how to get out of this mess.

The conclusion of this article is that there is effectively no ‘direct tax’ on income in Pakistan, except in a very few cases. It would amount to less than Rs 50 to 75 billion out of total collection of over Rs 4,000 billion in 2020-2021. For the sake of vested interests ‘smoke screens’ are created to confuse the stakeholders that now includes the International Monetary Fund (IMF). The system is simple and straight. Whatever is collected constitutes collection from consumers, essentially from the poor by way of indirect taxes or disguised direct taxes that are actually indirect taxes. The persons responsible for perpetuation of this state of affairs are people like us and the academia who are not asking the right questions. Everything and every word is politicized. We are PTI, PPP, PML-N, MQM, but not Pakistanis in such matters. On this subject, there is a ‘United Front’ whose only slogan is ‘status quo’ and a demand for more smoke screens. In the following paragraphs, at the cost of many risks, I have tried to filter through these smoke screens to dissect the total collection of taxes in Pakistan to let people know who is paying taxes and on what. And who is not paying and just passing it through to consumer like, for instance, an ordinary commercial importer. It is time to consolidate instead of creating further opportunities for mafias that have virtually invaded this country. If we do not correct at this stage and maintain the status quo then our future generations will question us for many crimes.

The information laid down in the following paragraphs is accurate to the best of my understanding and I have worked very hard to gather it. There may be errors, however, it is my firm understanding that the primary data is correct. It will be a service to the nation if in case of inaccuracy, the data is challenged as that would assist in refining the thought process. The conclusion of discussions in the following paragraphs before any further dilation is as under:

  1. Pakistan’s total tax collection is largely and fundamentally based on the value of imports made by the country. Depreciation of rupee is a bonus/increment to tax as we collect more than in rupees on the same value of imports. This collection has no relation with efforts and administration of FBR. The main collection depends upon the value of imports, USD parity and withholding rates. This will be proved by facts for the past five years.

  2. On the domestic side, around 70 percent of tax is collected as ‘withholding’ or voluntary paid as ‘advance tax’ without any effort by the tax administration.

  3. There is effectively no ‘direct tax’ on income earned by various persons such as importers, wholesalers, retailers and agriculturists as tax collection other than imports and that collected at source is around equal to 90 percent of taxes collected. Accordingly, in Pakistan, tax planning is nothing but to arrange a business in the manner that there is no withholding. This has led to de-incorporatization of businesses. This is the biggest disservice done to this country; Pakistan is going in the reverse direction.

  4. The aforesaid structure, as designed above, is not the result of an error or omission. It is the result of a concerted policy designed to suit the rulers who included Ziaul Haq and Nawaz Sharif. However, I have no hesitation in stating that General Musharraf (retd), Asif Ali Zardari and even the incumbent government have not been so aggressive to rectify as mafias in favour of status quo are too strong to resist. This article has been written to narrate the facts which few people would like to discuss. Nevertheless, I am confident that nobody in Pakistan or elsewhere can challenge any of the assertions made in this article. Whether or not it is self-assessment scheme designed by Dr Mahbubul Haque in the 1980s and presumptive taxation of Dr Hafiz A. Pasha in the 1990s and the Protection of Economic Reform Act (PERA) of 1992 of Ishaq Dar in the 1990s or the decision in the Elahi Cotton Mills case by the Supreme Court there cannot be any escape from an aggressive historical analysis. In my view, all these actions had negative effects on Pakistan’s taxation system. However, this is my considered opinion.

  5. In my capacity as Chairman of Federal Board of Revenue (FBR) I tried to bring in some fundamental changes but I failed due to my personal shortcomings. Nevertheless, it is my duty to highlight the issues in a manner that the country is placed on the right path;

  6. This fiscal policy supported by a weird foreign exchange regime led to the legalised cash outflow of dollars from Pakistan. This has partly stopped due to changes in the PERA; however, there have to be more transparent fiscal and foreign exchange policies. Foreign Exchange laws need a complete revamp.

It is my duty to state my conviction that Pakistan as a country that is not only facing the issue of personal corruption but also of intellectual corruption. The personal corruption is the result of policies and intellectual corruption where people are not ready to discuss facts and ground realities about the manner in which this tax system has been designed. Under this system, the rich are getting richer and the whole tax burden is passed on to the common man by way of indirect taxes. There is no distributional equity. This means justice is not there. Societies can survive in the presence of infidelities but they cannot survive in the absence of justice. We are facing the same.

Over time, Pakistan has developed an erroneous tax culture on the policy side. It will take time to rectify it and that will only happen if there is a concerted effort to identify the intellectual corruption and a national consensus developed to have a ‘direct across the board income’ based taxation on all income including agricultural income with substantial reduction in the rate of indirect taxes. I am in agreement with the IMF but with serious differences on certain policy measures. There is a need for a fundamental correction for which they are not focused as they should be. The question is whether we are trying to rescue a patient of cancer with Aspirin.

==========================================================
Total collection during the last five years
==========================================================
Tax Year                    Collection (Rupees in billion)
==========================================================
2015-2016                                            3,113
2016-2017                                            3,368
2017-2018                                            3,844
2018-2019                                            3,829
2019-2021                                            3,997
2020-2021 (July-April)                               3,781
==========================================================

Import-based taxation

Out of the total collection as referred above, now we turn to taxes collected at ‘import stage’ at ports. It is always over 45% of total collection as will be demonstrated in the following paragraphs. This is one of the highest in the world and is conceptually wrong. Almost 90 percent of the same is collected at the two ports of Karachi and in the last 40 years, Karachi has been completely destroyed on the infrastructure side not realising that easy flow of goods from Karachi is the backbone of this country. Political differences have been part of national disaster. This is certainly a separate subject.

=================================================================================
The table will be further analysed in the following paragraphs.  
=================================================================================
Year /         USD Value     Pakistan       Effective    Tax                  Tax
Period         of Import     Rupee          Exchange     Collection    Collection
              (billion       Value of       rate         at Import           as a
               USD)          Imports in                  stage:        percentage
                             Pakistan                    Income tax,     of total
                                                         sales tax,      value of
                                                         FED and          imports
                                                         Customs
                                                        (Rupees in
                                                         billion)
=================================================================================
2015-2016       45           4722            105         1282               27.2%
2016-2017       53           5584            105         1431               25.6%
2017-2018       61           6750            110         1691               25.1%
2018-2019       55           7499            135         1747               23.3%
2019-2020       44           7057            160         1755               24.9%
2020-2021
(July-April)    45           7222            160         1726               23.9%
=================================================================================

The aforesaid table reveals everything about Pakistan’s economy in the last five years. The last year of PML being 2018 was very bad from the current account balance side, however if they boast about tax collection then they should read what is written in the following paragraphs. These are facts not assertions.

It will remain so if we do not change the paradigm. This table is more than enough to identify almost 50 % of the tax collection of Pakistan. The average collection for every Rupee value of import is around 25% of the value of import and composition of the same is as under:

==========================
• Income Tax          2.5%
• Sales Tax          12.8%
• FED                 0.3%
• Customs             8.3%
==========================

This makes under-invoicing, smuggling and postings at Customs very lucrative. The question is the change that has to be made. The answer is that such collection should not be more than 10% in any case. Nevertheless this is not the subject here.

====================================================================
The aforesaid table is further classified for clarity as under: 
====================================================================
Tax year      Income tax    Sales Tax     FED     Customs      Total
====================================================================
2015-2016        177           692         13       401         1282
2016-2017        194           729         12       497         1431
2017-2018        217           853         13       608         1691
2018-2019        223           826         13       686         1747
2019-2020        206           913         12       624         1755
2020-2021        179           927         18       602         1726
(July-April)
====================================================================

As can be seen, average tax collection at import stage is hovering between 25 and 23%; however, no government can take the risk of decreasing the same as this is the main revenue source. This is no tax; it is effectively duties at the import stage which is totally inflationary and being transferred to consumers. It makes smuggling and under invoicing highly lucrative. This is what the game is. Import-based economy seeking USD after every five to ten years from aid or grant and transfers own non tax paid earnings outside Pakistan. This is quite simple and well designed. I have no objection to what is being done; however my problem lies with misstatements about the well-being of the poor, expansion in tax base and perverted nationalism.

The most important aspect of the aforesaid collection is that over the last five years and even before, the tax collection in real terms has decreased, not increased. It is the decrease in the value of Rupee against USD and almost constant and increasing value of import that has given us an increase in tax in rupee terms. This can be further clarified if we compare the year 2015-2016 with the year 2019-2021. The USD value of import has actually decreased by I billion USD and the effective tax rate at import stage has gone down from 27% to 25%; however, in rupee terms, the tax collection has increased by Rs 473 billion (1755-1282=473). This is where we have increased tax collection. I wonder who deserves the credit for this Rs 500 billion.

The question is whether Pakistan can get out of this ‘import based inflationary tax trap’ and the falsification of the assumed increase in tax collected that we see every year. In my view, there is complete misperception about the increase in the tax collection over the past years. The present government has taken a very correct and bold step to reduce the value of imports from USD 61 billion in 2017-2018 to around USD 50 billion that directly reduces the tax collection. They have got the cover by decrease in rupee parity, otherwise there would have been a decrease in tax collection by over Rs 400 billion.

In Pakistan, an increase in import and a decrease in rupee parity is a ‘blessing’ for the FBR whereas the same is a curse for the country otherwise. Who will decide that balance. This fundamental mismatch has to be handled. Let me reiterate that we do not see serious efforts in settling this primary issue of taxation. Incidence at the rate of 25% at import stage is ‘hazardous’ for the country from an inflationary viewpoint as well as corruption as such a high rate provides incentives for avoidance and evasion. It can be well imagined how lucrative an import trade can be if someone is ready to evade 25% collection at import stage or under-invoice the product to a manageable extent. This is what is being done. Mafias are protecting them.

Whilst I was Chairman FBR there was a constant fight between Customs Department and IRS departments as both wanted to take the collection at import stage to their credit. This reveals one part of the story about the fact for the persons who pay taxes in Pakistan on every product that is purchased from cooking oil, sugar, tea etc. The answer is that very few pay on a ‘net income basis’. In ‘Mumlikat Khudadad Pakistan’, there are economic reasons why smuggling is so lucrative and under-invoicing is so rampant.

Income tax collection

The story of income tax collection is even more discouraging. The facts described in the following paragraphs ranging for over five year disclose the status which is evident.

==========================================================================================================
Tax year   Imports     Witholding    Demand      With       Advance       Others      Total       Share of
           under 148   excluding     under       returns    Tax under                          withholding
                       imports       section                Section                                  tax %
                                     137                     147
==========================================================================================================
2015-2016    177         611         64           37         286           30         1205           65.4%
2016-2017    194         694         71           44         309           33         1344             66%
2017-2018    217         781         76           37         304           122        1537           64.9%
2018-2019    223         705         58           38         325           97         1446           64.2%
2019-2020    206         857         42           39         318           60         1523            69.8
==========================================================================================================

Two elements are very clear from the above table. Around 65-70 % of domestic collection is through ‘withholding taxes’. If these withholding provisions are taken out then collection will go down substantially.

Furthermore, the exact composition of withholding which is under ‘presumptive basis’ is not known, however it is my estimate that it exceeds over 60% of the total. This shows that out of the total local collection say Rs 1600 billion at least Rs 400 to 500 billion is presumed as ‘direct tax’ however the same is an indirect tax. This is an intellectual crime validated by the Supreme Court of Pakistan in the case of Elahi Cotton Mills Limited.

If we further go deep down in the ‘taxes collected through demand’ being the process where taxation officers and the field force of over 20,000 persons is involved then it is revealed that not even Rs 50 billion is realized by them from no corporates as the bulk is collected from large companies and the organized sector. This all proves without any doubt that there is no direct taxation on income in Pakistan on any business in the manner it should have been. They have got National Tax Numbers and stories of ‘harassment’ (which are true in many instances) however, for the government at large there is nothing on the table. It ends up in other pockets. This status quo has to be broken.

Now on the basis of the aforesaid facts total tax collection, domestic and at import stage is recomposed as under:

=========================================================
Domestic tax 
=========================================================
Tax year         Income tax    Sales Tax     FED    Total
=========================================================
2015-2016         1028            624        178     1830
2016-2017         1151            600        186     1937
2017-2108         1320            632        201     2153
2018-2019         1223            633        225     2081
2019-2020         1317            680        245     2243
2020-2021         1182            667        205     2055
(July -April)
=========================================================
====================================================================================
Import taxes and their role
====================================================================================
Tax year      Income     Sales    FED     Customs     Total    Grand       Import as
              Tax        Tax              Duty                 Total      % of total
                                                                          collection
====================================================================================
2015-2016      177        692      13      401        1282      3113             41%
2016-2017      194        729      12      497        1431      3368           42.5%
2017-2018      217        853      13      608        1691      3844             44%
2018-2019      223        826      13      686        1747      3829             45%
2019-2020      206        913      12      624        1755      3997             43%
2020-2021      179        927      18      602        1726      3781           45.6%
(July-Apr
====================================================================================

The aforesaid facts reveal that:

  1. There is a complete lack of dissemination of information to the general public about the sources from which taxes are being collected. Poor people are paying by way of indirect taxes, say on tea, cooking oil, sugar, gas, electricity and almost everything they consume whereas there is no effective ‘direct taxes’ on small and big retailers and agriculturists and many other fields. Our reliance on tax collection relating to imports has increased so much that no government has the resilience to cut down the prime sales tax rate at import stage which is a high source of many problems; This is a policy error. I will identify the solution in the articles to follow.

  2. The academia and economists who are required to accelerate and moderate such analyses are totally divorced from reality and there are very few voices which talk against absurdities like presumptive taxes, minimum taxation and many other subjects. In fact, a lot of persons are not aware of facts. This article will open eyes for many people about actual collection of taxes in Pakistan.

  3. General discourse we make on tax system and perceived taxes that we levy or remove including IMF recommendations has very little relevance with actual collection as collection is totally dependent on following items:

a. Value of imports;

b. The exchange rate of payment of taxes; and

c. The withholding tax rate on local supplies and other payments which are the main source of taxation. In 2019, I tried to convert those into minimum taxes to get rid of the ghost of presumptive taxes and there was a plan to gradually bring down the taxation on a net income basis. That is the only solution.

  1. There is effectively no role of tax administration in tax collection. At the most it can be monitoring of withholding and collection of Rs 100 billion out of total collection of Rs 4000 billion. All taxes in the present mode are inflationary in nature.

  2. This government has inherited these legacies and as stated above it will take time to change the status quo. The only prerequisite for the change is conviction that change is required.

In the following articles, I would be providing a plan for phasing out the intellectual corruption made in this field. There is no doubt in my mind that after the 1990s in the name of deregulation, simplification, and harassment a network of mafias has evolved that does not allow any fundamental change in the system. There is a joint venture of vested interests that needs to be dismantled.

Imran Khan is passionate about corrections. It is high time to realize the ground realities and take the risk of correction leaving aside the so-called collection from poor people in the form of presumptive taxes and sales tax at high rate, etc., which are all passed on to the consumer.

Copyright Business Recorder, 2021

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