Whether they realise it or not, the Public Accounts Committee (PAC) is about to disturb a great nest of hornets this Tuesday when it takes up the question of tax exemptions and waivers granted over the past four years.Last Monday the finance minister surprised everybody by admitting to the National Assembly that the government had granted tax exemptions and waivers worth more than Rs 650 billion over the past four years. The amount is larger than the total foreign aid the country has received over the same time period, and larger than the amount borrowed from the International Monetary Fund.
Of course not all exemptions are bad. It is a normal practice in many countries to exempt charitable non-profit organisations. The list provided by the finance minister to the National Assembly includes the names of the Red Cross and the Red Crescent as beneficiaries of tax exemption, which is easily understandable.
But the list also contains names of commercial enterprises and in some cases individuals whose case for exemption is not self-evident. The power to grant exemptions from each of the four major taxes in Pakistan is enshrined in law to enable the government to fine-tune its response to the changing nature of economic challenges. But many say that the power is often misused to also grant exemptions to favoured parties.
“If an exemption is granted to an industry or a trade for reasons like encouraging investment in a particular sector, that is one thing,” says Siraj Kassim Teli, a business leader from Karachi. “But we also know that there are exemptions made for a specific party, and that is wrong.”
The numbers tell a story here. For example, a list of all exemptions granted under the income tax contains items such as pensions and donations to charitable trusts. But at the bottom of the list there is a head titled “sector and enterprise specific exemptions”.
In the fiscal year ended June 2008, the amount under this head was less than Rs 1bn. Then suddenly, the next year, this amount rose to Rs 18bn. For the next four years, sector and enterprise-specific exemptions remained in this range, adding up to more than Rs 80bn.
Other heads in the same list include 18bn exempted on capital gains every year for four years, even as the rally in the stock market kicked in this year.
Former finance minister Salman Shah calls this a patronage system where rewards are doled out to some parties in exchange for loyalty.
But when talking about the exemptions granted to stock brokers and five categories of exporters by his government, he invokes international best practices and the weaknesses of the tax machinery. He says the accounting systems maintained by the textile industry “are such that they can manipulate their results”, and given a weak tax machinery, it made more sense to simply exempt them and charge tax only on their sales receipts that are easily captured because they are processed via the banking system.
Another view holds that the power to grant exemptions has been used for political purposes from the very beginning to create constituencies by placing vast areas of the economy beyond reach of the tax authorities.
This view is held by Shabbar Zaidi, a leading tax authority and chartered accountant, who argues that large exemptions have warped the tax system over time to give traders an opportunity to remain outside the net. Traders have emerged as an important political constituency in Pakistani politics over the past two decades. “There is a whole system in Pakistan to legally conduct business, and to create assets in and out of the country, without paying taxes.”
As an example, he cites section 111 (4) of the Income Tax Ordinance, which places all foreign currency deposits beyond the scrutiny of tax authorities, thus acknowledging that “exports will be under invoiced, imports will be over invoiced, and a mechanism will exist to bring those funds home when required”.
“Those who built this system of exemptions knew what they were doing,” he says, adding that the system of exemptions is accompanied by whitener schemes, sometimes explicit, and sometimes implied.
So when the PAC picks up the issue on Tuesday, they may want to first consider how far they are really willing to take this matter. The dysfunction they have put their finger on has a long pedigree and runs deep in the veins of the body politic. In time we will see what the real intentions of the PAC are in pursuing this matter.
The amounts involved are large enough to shape the destiny of the country, and powerful and interconnected constituencies stand ready to guard their share of the rackets thus created. This dysfunction has created fabulous wealth for some, but turned our country into a permanent guest in the halls of charity around the world.