The Central Board of Revenue (CBR) chief's recent statement to go for investment-oriented tax policies is in conformation to the government policies on foreign investment. The country holds immense promise for return to investors.
A number of reforms have been introduced to improve the governance through the Income Tax Ordinance 2001.
The taxation system is one of the deciding factors for making an investment decision in any country. Open investment policies offer attractive opportunities in all sectors. In Pakistan, there are no restrictions on the quantum of equity, joint ventures with local partners, remittance of royalty, technical and franchise fee, capital, profits and dividends.
However, the tax collecting machinery creates a dangerous show making foreigners inquire whether it is a criminal act to be in a tax net in Pakistan. This speaks volume about the shyness of foreign investors in making investment despite attractive environment, especially at a time when multinational companies are striving to relocate their manufacturing and service industries in developing states.
Foreign investment has fallen sharply despite the applaud Pakistan has received from the IMF, the WB and the ADB over it's policies and its improved international credit ratings. One of the reasons is being discussed here.
Lets understand a little about the taxation system. The Income Tax Ordinance 2001 has divided the taxpayers into two categories (1) resident (ii) non-resident, based on the residential status.
An individual is a resident u/s 82 for a tax year if he was present in Pakistan for 182 days or more in aggregate or is an employee or official of the federal or provincial governments posted abroad in a tax year.
A company u/s 83 is a resident company for a tax year if it is incorporated in Pakistan and control and management of the affairs of it is situated wholly in Pakistan at any time in the tax year. A non-resident is defined u/s 80 is a person who is not a resident person for the tax year. The other major change in the Ordinance is the basis of income liable to tax.
A concept of geographical source of income has been introduced u/s 101 of the Ordinance. Any income shall be foreign source income to the extent to which it is not Pakistan source income as enumerated u/s 101. Non-residents are taxed on their Pakistan source income whereas a resident is taxed on both, his Pakistan as well as foreign source income.
Investors face difficulty in ascertaining tax components, and are interested to know in advice the chargeability to tax of their income at the time of preparing a feasibility of new projects or industries to be set-up or intends to merge with any of the projects or businesses or acquisition of a business in Pakistan.
To meet this demand in line with the international practice, the Ordinance has introduced the concept of advance ruling u/s 206 A with an object to provide foreign investors in advance the impact of income tax on their proposed plan.
According to the provision of S.206A a non-resident investor is required to apply in writing to the CBR the full and true-disclosure of the nature of all aspects of the transaction proposed or entered into by the applicant.
Based on disclosures of the nature of transactions relevant to ruling, the CBR will award an advance ruling setting out the Commissioner's position regarding the application of income tax law on the transaction referred to it.
The ruling awarded by the CBR will be binding on the Commissioner with respect to the transaction of the law in existence at a particular point of time of application. It is also provided that the ruling will have overriding effect if there is any inconsistency between a circular issued by the CBR and such an advance ruling.
This provision has been inserted by the Finance Act 2003 on June 17, 2003, but the CBR circulated a SRO 130(1) 2004 dated February 27 2004, thereunder, it has amended the Income Tax Rules 2002.
A new rule 231A has been inserted. It has devised procedure and modalities for the issuance of advance ruling u/s 206A to foreign investors who require it in preparing the feasibility report of their new projects or industries to be set-up or merged into the business in Pakistan in advance.
It is learnt that the applications for advance ruling have been moved to the CBR by non-resident companies for avoiding tax disputes in future. The chargeability of tax on the transaction by one of them is pending since last over eight months.
No doubt any ruling will impact the exchequer. The ruling sought by a non-resident will either result in exemption from tax on income, or reduced tax rate on transaction. The tax authorities, therefore, will be cautious in taking a decision on the matter and will try to involve as many tax collectors as may be possible.
Following are the few suggestions to improve the provisions of rule 231A on the ruling:
1. The rule 231A(1) requires a non-resident desiring advance ruling shall make an application to the CBR on a prescribed form. Rules should prescribe the documents to be attached with the application.
2. The rule 231A(2) provides that an application desirous of an advance ruling shall be considered by a three-member committee comprising the CBR Chairman, Member Direct Taxes and the Additional Secretary of Law and Justice and Human Rights Division. Out of three members, two are from the CBR, thereby the Board undertaking both executive and judicial powers. Under such circumstances how can a foreign investor expect a level playing field. To build confidence in the system it is necessary to replace discretion and favours with fair rules. Advance ruling can only serve the purpose if it is assigned to an independent authority. A high-powered statutory Advance Ruling Commission should be formed ensuring transparency and professionalism.
3. The rule 231A(3) provides the committee to obtain comments of the Commissioner concerned. It is suggested that a time-frame is necessary to be provided under the rule during which period the Commissioner should submit his comments to the CBR on the question of laws.
Moreover the rule 231A does not provide an opportunity to the applicant or his authorized person to be heard. Such provision will facilitate the committee to resolve their queries on the question of law specified, besides understanding the nature of the transaction quickly and will help them in giving the ruling within the shortest possible time.
4. Further the rule 231A(4) provides the committee to determine the transaction proposed or entered into by the non-resident person. It does not specify any time-limit for its determination on the issuance of advance ruling. Though the draft SRO published by the CBR included sub-rule (8) to rule 231A(1) that the application filed under this rule shall be disposed off not later than 90 days. This sub-rule has been dropped in the final SRO 130(1)/2004 dated February 27, 2004. Thereby, the CBR has assumed unlimited time. Will an investor wait for an indefinite period? The delay will distort the feasibility thus discouraging investment in Pakistan. In case ruling is delayed, the applicant may be penalized or imposed additional tax on the amount involved for the non-compliance of the Ordinance.
Although current policy offers a number of incentives but unless special care is not taken to avoid such delays and bureaucratic red tapes, the government's efforts to enhance foreign investment will be a futile exercise. The government should provide advance ruling facility within 15 days so that an investor can make a meaningful decision. It is necessary to amend the rule 231A(4).
5. The rule 231A(7) provides that the ruling shall cease to be binding on the Commissioner if the ruling is found to be obtained by misrepresentation.
The advance ruling is restricted to foreign investors only. Resident investors are not entitled to apply for such ruling. This discriminatory treatment with the local investor is not justified in view of the huge contribution to the exchequer by way of the government levies without relief and incentives that are available and enjoyed by foreign investors.
Therefore, the resident and non-resident investors be brought at par with the facility of advance ruling.
