Budget 2012-13 proposals: SECP for gradual reduction in corporate tax rates

In order to encourage documentation and growth of corporate sector, the Securities and Exchange Commission of Pakistan (SECP) has strongly proposed gradual reduction in the corporate tax rates for private and listed companies with simultaneous increase in tax rate of Association of Persons (AOPs) in the upcoming budget (2012-13).
In its budget proposals, communicated to FBR Chairman Mumtaz Haider Rizvi, the SECP has drafted the budget proposals with the objective of documentation of economy, competitiveness of Pakistan corporate sector, increasing government tax revenue, growth of corporate sector and abolishment of the Presumptive Tax Regime. The gradual reduction in corporate tax rate triggered growth of corporate sector, an average annual increase of 3,000 new companies.
In this connection, Chairman Securities and Exchange Commission of Pakistan (SECP) Muhammad Ali has drafted viable budget proposals for documentation and growth of corporate sector. The SECP has proposed that the classification of small company be omitted considering the economic disincentive for small company to increase its turnover, paid up capital or employment. The rate of presumptive tax be increased gradually over a period of three years to make it unattractive for businesses vis-à-vis normal tax regime. The rate of presumptive tax regime for the importer of goods, should be enhanced from 5 percent to 8 % of value of goods; supply of goods from 3.5 percent of the value of supplies to 5 percent and presumptive tax on exports from one percent of the value of sale proceed to 2 percent.
The SECP has also proposed that the fiscal incentive for listed companies to distribute dividend- The rate of tax in case of company not distributing a minimum of 30% of its after tax accounting profits of the year as dividend will be 3% higher than the normal tax rate for listed company.
The Securities and Exchange Commission of Pakistan (SECP) was of the view that the proposed increase in the rate of income tax for AOPs and reduction for companies (private and listed) will encourage corporatization and documentation of the economy. Potential loss to the national exchequer will be offset against the enhanced government revenue through income tax from increasing number of companies; capital gain tax, increased collection of withholding taxes, dividend taxation, federal excise duty, increase in rate of small companies, conversion of AOPs into companies and monitoring of FBR on existing non filers.
About the revenue implications of the proposal, the SECP stated that the revenue has been worked out on the basis of Pakistan Revenue Automation Limited (Pral) data for 2011 on number of taxpayers and tax revenues collection from AOPs, Listed and Unlisted Companies and KSE data for 2011 for listed companies' tax collection figures.
The Securities and Exchange Commission of Pakistan (SECP) has also made assumptions for tax revenue projection of the said proposal. The number of business; AOPs and Non-Salaried Individuals that will convert into company for next three years will be 500, 1,000 and 2,000. It has been estimated that 3,000 new companies incorporated every year will be new entrants in the corporate tax net. Out of 45,000 non filer companies, the number of companies coming into the tax net will be 500, 1,000 and 2,000 during next three years respectively. Only 5% of new companies will come into profitability ie, 150, 475 and 1,000 during next three years respectively.
The SECP said that there would be additional revenue impact of Dividend Distribution. The SECP said that 421 companies have declared dividends for the financial year 2011 and 167 companies have declared profit of less than 30% of profits. On 30% compulsory dividend declaration, the short dividend declared is Rs 15 billion and the additional tax @3% of the profit will increase tax revenue with an amount approx. Rs 2 billion. Besides the above increase in tax revenue, the proposal would also add in the tax revenue due to proposed increase in tax rate of small companies and the presumptive tax rates.
The SECP said that the existence of numerous exemption programs and avenues coupled with tax evasion has greatly distorted the allocation of investment across sectors and asset types along with reduction in tax revenues. The extensive use of tax incentives is seldom tracked, quantified and evaluated, and the intended effects on economic growth are uncertain. Consequently, there are following important issues that must be addressed in the Pakistan corporate fiscal system:
Firstly, high corporate tax rate of 35% vis-à-vis 25% for non-corporate sector - an incentive for non corporate sector to remain undocumented and without any supervisory oversight. Secondly, the existing tax regime for small companies discourage corporate progression from small to normal company, exceeding the threshold defined for small company.
Thirdly, the existence of Presumptive tax regime (PTR)- Incentive is to avail PTR and remain undocumented instead of normal tax regime. Fourthly, large size of undocumented businesses and cash economy. Fifthly, the resistance to documentation. The SECP said that the increasing globalization of economic activity and integrated world markets has increased tax competition among jurisdictions due to capital flow towards low taxation jurisdictions. Global trend in corporate taxation reflects decline in the level of tax rates across various jurisdictions.
During last one decade, global average corporate tax rate reduced from 29.03 % to 22.96%. Statutory corporate tax rates in OECD countries have fallen significantly since 1982 when it was on an average above 40% to 25.94% in 2010. Several countries have recently reduced their corporate tax rates during 2008-10 not only to attract and retain both local and foreign investments but also to incentivise growth of corporate sector. In the Asia Pacific region the average rate is 22.78%, the SECP said.
The SECP stated that the rates for the corporate sector were exceptionally high in the past. During 1992-93, banking, public, and private companies were taxed at the rate of 66 percent, 44 percent, and 55 percent, respectively. These rates have been reduced significantly over time. Currently, there is uniform corporate tax rate of 35 percent for all three types of companies except for "small" companies that are taxed at a lower rate of 20%.
The SECP stated that the PTR not only reduces tax revenue but also distorts allocation of investment across sectors and asset types. In the present fiscal structure, following activities falls under PTR and taxes are collected via withholding: Importer of goods, are taxed@ 5 percent of value of goods; supply of goods, other than by listed companies and manufacturing companies are taxed@ 3.5 percent of the value of supplies; exporters are taxed@ 1 percent of the value of exports; interest, profit on debt in the hands of non-companies, are taxed @ 10 percent. This effectively means that all importer, exporters and traders are not subject to tax on net income basis, unless they are public listed companies or manufacturers of goods. Thus, all such activities are outside the effective equitable tax net. This PTR discourages both corporatization and manufacturing activities.
Present taxation regime incentivizes corporatization as small companies are taxed at 25%. This is a significant fiscal incentive for a "small" company that means a company registered after July 1, 2005 that fulfil the criteria of paid up capital plus undistributed reserves not exceeding Rs 25 million; number of employees not exceeding 250 during the year; annual turnover not exceeding Rs 250 million and not formed by splitting up or reconstitution of business already in existence. However, no smooth graduation is allowed for a company from small to normal company thus if a company increases, say, its employees above 250, then in principle entire net income of the company is immediately taxed @35%.
The economic disincentive exists for companies at the threshold of small company. Companies generally, fragment to meet the legal requirements. Although fragmentation disqualifies a company from the "small company" designation monitoring of the split is quite difficult. Such tax driven fragmentation is economically inefficient and a disincentive for growth in turnover, paid up capital or in employment, SECP said,
Pakistan's corporate sector contributes almost 70% of federal direct tax revenue collection. The tax collections from the corporate sector have increased at a fast pace during the past few years. Despite the gradual but steady reduction of corporate tax rates, especially for banking and private sector companies, overall collections have improved substantially and the corporate share in gross income taxes has jumped from 60% in 2004-05 to 70 percent in 2009-10.
The profitability of the banking sector has been instrumental in this revenue performance. Private companies exhibited a reasonably high growth rate but one that is lower than for public and banking companies. This outcome spotlights the need of revisiting the extent of tax compliance by the private sector. The collection of corporate taxes is mainly generated from advance taxes, payment with return and withholding taxes, the SECP added.