The Government has presented to the National Assembly a bill on a voluntary tax compliance scheme (VTCS) for traders. This is the outcome of extended deliberations with the trading community following the imposition of 0.6 per cent withholding tax on various bank transactions on non-filers in the Budget of 2015-16. The key objective is apparently to facilitate the conversion of existing traders, who are non-filers into return filers.
There an estimated over 2.2 million traders today in Pakistan. Their net trading margin is as much as Rs 4.9 trillion. This is equivalent to almost 18 per cent of the national GDP, making it the largest sector in the economy. It is estimated that 56 per cent of the traders are located in the urban areas. Punjab has the largest number of traders, with a share of 62 per cent. The average annual turnover per trader is approximately Rs 9 million.
A conservative estimate of the revenue potential from the domestic trading sector is Rs 150 billion. However, the estimated number of traders who file returns currently is well below 300,000. Therefore, the greatest scope for increasing the number of taxpayers is from this sector.
The VTPS scheme has been labelled as an `amnesty` scheme in the media and criticised accordingly. It does provide immunity from audit for four years, 2015 to 2018, subject to the fulfilment of some conditions. This facility is available to both existing and new taxpayers.
There are two visible benefits of participation in the VTPS. First, the effective tax payment is lower for all new taxpayers, given the turnover, in relation to the tax liability under the normal provisions of the Income Tax Ordinance. If the taxable income of a typical trader is on average 6 per cent of the turnover, then the savings in tax payment, by filing a return for the first time with turnover of Rs 50 million, is as much as 55 per cent. The income tax law of India presumes that net income of a trader is 8 per cent of the turnover. If this is the case also in Pakistan, then the VTPS enables the trader to save as much 72 per cent in the payment of income tax.
Second, the benefit to a new taxpayer is exclusion from coverage of the withholding tax of 0.6 per cent on banking transactions. Both the benefits are substantial and it is expected that the VTPS will be successful in inducing almost one million traders to file returns for the first time. This will more than double the existing number of income taxpayers in Pakistan.
However, there are some defects in the design of the scheme. First, there should be a minimum tax payment for participation in the scheme from 2015 onwards by a new taxpayer. This can be fixed at Rs 30000. This minimum tax payment has been set currently only for existing taxpayers.
Second, the VTPS builds in a degree of inequity in the treatment from 2015 onwards between existing more honest and new return filers. Depending on turnover, the latter taxpayer will pay as tax 0.1 per cent to 0.2 per cent of turnover from 2016 onwards. If an existing taxpayer is paying a higher percentage of turnover as income tax, then for the same turnover, the tax liability remains higher than for a new taxpayer. In fact, the existing taxpayer will have to show a growth of 25 per cent annually in tax paid to obtain immunity from audit. To ensure equity, the tax paid should remain the same if it exceeds the percentage with respect to turnover stipulated in the scheme.
Third, the tax structure with respect to turnover is clearly regressive in nature. For a taxpayer with turnover less than Rs 50 million the marginal tax rate on turnover is 0.2 per cent. This falls to 0.1 per cent in the case of a large trader with turnover in excess of Rs 250 million. Instead, the rate should be higher for larger turnover.
Fourth, the immunity from audit is for four years, 2015 to 2018. The last year of tax filing falls outside the tenure of the present Government. As such, the scheme should extend only up to 2017. The decision to continue with the scheme or not should be taken by the new Government, which is inducted into power in 2018.
The announcement of the VTPS does represent an admission by the FBR of its failure to detect tax evasion through its audit process and intelligence and the general mistrust in its use of discretionary powers. However, the scheme is a pragmatic response to the need for broadening the tax base and should be given a chance to succeed. Some of the design defects may be removed during the process of approval of the Bill in the Parliament.
(The writer is the Managing Director of the Institute for Policy Reforms and a former Federal Minister)
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