Simplification of Pakistan’s income tax system—I

The Illusion of simplicity in a fractured ecosystem

The International Monetary Fund’s (IMF’s) recent directive to strategize the simplification of Pakistan’s tax code by May 2026 presents a critical opportunity to fix a system that has long substituted complexity for collection. However, for seasoned tax professionals and the weary documented sector, this mandate begs a fundamental question: Can genuine simplification be achieved by merely rewriting laws, or does it require dismantling the structural dysfunctions that necessitated them in the first place?

The complexity of Pakistan’s income tax regime is not merely a drafting error; it is a symptom of a deeper crisis in the country’s political economy. It reflects a fiscal ecosystem where a massive undocumented economy thrives in the shadows, leaving the State to rely on a narrow base of compliant taxpayers. To bridge the resulting revenue gap, policymakers have resorted to a labyrinth of ‘ad-hoc’ measures, non-adjustable withholding taxes, and minimum tax regimes that prioritize short-term cash flow over long-term economic principles.

Therefore, any attempt at ‘simplification’ that ignores these ecosystem realities, specifically the unchecked informal sector and the erosion of the social contract is destined to remain an elusive dream. True reform requires more than shorter statutes; it demands a holistic approach that restores the integrity of the tax system, re-establishes the principle of ‘Ability to Pay’, and acknowledges that fair tax law cannot function in isolation from the economy it seeks to regulate.

The legacy of the law: from assessment to endless amendments

The most significant attempt at simplification in recent history was the replacement of the Income Tax Ordinance, 1979, with the Income Tax Ordinance, 2001. The key principle underpinning the 2001 Ordinance was a shift from ‘assessment’ (where the tax officer determined the liability within a period of around two years) to a Universal Self-Assessment Scheme based on ‘audit’. Returns were to be accepted, subject only to ‘audit’ under specific, well-defined conditions and it was then widely propagated to be an act of deterrence rather than mere revenue generation tool.

This promise of trust was short-lived. Even before the law took full effect, legislative amendments were introduced empowering tax authorities to amend returns without conducting a full audit and that too as many times as necessary.

The rationale was to fix apparent errors, but this created an administrative grey area where the powers of direct amendment and audit are used interchangeably and often arbitrarily.

Where the cases were selected for audit, the lack of trust also fueled litigation on various questions including who has powers to select for an audit (whether the FBR or Commissioner) to even the procedural issues relating thereto such as mandatory issuance of audit report before issuance of a show-cause notice for amendment of assessment.

Further amendments to limitation periods, coupled with the exercise of condonation powers to extend the limitation beyond the statutory mandate, resulted in endless litigation.

Even where controversies were settled by the Supreme Court, the non-implementation or misapplication of those principles at the administrative level, or legislative amendments aimed at nullifying the effect of such judgments, also resulted in tax litigations.

The result?

• Endless litigation: Issues of merit take a back seat to lengthy legal debates over whether the power exercised by the tax officer was legally correct.

• Wasted resources: Higher Courts, Appellate forums, tax advisors, and departmental representatives waste valuable hours on procedural disputes, draining the taxpayer’s and the state’s resources.

The taxpayer’s nightmare: multiple proceedings on a single return: For a typical large taxpayer, the dilemma doesn’t end there. Compliance with a single annual income tax return often triggers multiple, distinct proceedings:

• Direct amendment: For issues which, in tax authorities’ view do not require detailed scrutiny.

• Full audit: For issues requiring verification, leading to an amended return.

• Withholding tax proceedings: A separate and often complex audit to verify compliance with dozens of withholding provisions.

• Advance tax disputes: Separate proceedings for perceived underpayment of quarterly advance tax.

In case such taxpayer is also registered for Federal Sales Tax and Four Provincial Sales Taxes (which is often the case with big taxpayers having businesses across the country) besides Azad Jammu & Kashmir and Gilgit Baltistan, one can imagine if a similar pattern is followed for all these jurisdictions as well, the only industry which can flourish is ‘tax compliance, litigation and advisory’ but at the cost of main business of the taxpayer.

A prevailing departmental belief that any proceeding is incomplete unless a tax demand is created assures that disputes and controversies are the norm. This forces taxpayers into an appeal process with its own complexities, coupled with the constant, coercive threat of direct attachment of bank accounts for recovery of disputed demands.

Moreover, many appeals result in the remand back of issues to the original level, subjecting the taxpayer to a second or third round of proceedings with almost similar results and having a lack of certainty on closure of particular year. In a recent meeting with a foreign client, I was embarrassed when he asked as to why his tax assessments dating back to 15 years are still not closed due to multiple rounds of proceedings.

Litigation drivers: administrative excess and lack of finality

However, the question remains: what fundamentally prompts a taxpayer to enter into a prolonged tax dispute? It is a costly, time-consuming decision driven by two main factors.

First is the perception of administrative excess, where taxpayers believe the tax demand is arbitrary, motivated solely by the department’s need to create a tax demand rather than a genuine interpretation of law, making litigation an act of defence.

This sentiment is often rooted in the high tax collection targets imposed on tax authorities; I once had a conversation with a tax collector who candidly admitted that if they find even a 1% chance to create a tax demand against a taxpayer on the basis of a possible interpretation of law, they have to do it to meet targets.

My response was that, due to the high tax incidence, taxpayers adopt a converse position, interpreting the law in the most favorable light possible. This approach, fueled by conflicting interpretations, also fuels the resulting tax litigation, which is often termed in tax policy literature as whether there is an incentive for the taxpayer to mitigate or reduce tax liability either based on a possible interpretation of law or adopting strategies based on the law.

Second is the issue of lack of procedural closure; since the power of amendment is exercised arbitrarily and proceedings are often remanded back by the appellate forums to the original level having a risk of mere repetition of original action, taxpayers are forced to seek clarity from higher judicial forums to gain the certainty and finality that the tax administration itself fails to provide.

The lack of independence, boldness, and non-specialization in initial appellate forums further compounds this, ensuring that every significant issue becomes a matter for the higher courts which have its own limitations due to a large number of other non-tax related disputes to be dealt by the Courts.

(To be continued on Monday)

Copyright Business Recorder, 2025