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In its latest working paper titled, “Unlocking Pakistan’s Revenue Potential” published in August, an International Monetary Fund expert has discussed Pakistan’s tax revenue generation capacity.
The paper concludes that the country has the potential to nearly double its tax-to-GDP ratio over the long term, while increasing it to 14-15pc over the medium term from a low 12.4pc of GDP, the average level of developing countries.
While assessing revenue potential, the working paper made certain factual, contextual and interpretational mistakes. For example, the paper asserted that income tax rate in case of individuals is 20pc in the following words:
Although Pakistan has the potential to increase its tax revenue, it should be realised that the way forward is sensible taxation without hurting business growth
“Although the statutory CIT and PIT rates declined from 45pc in 1990 to 31pc and 20pc, respectively, by 2016, Pakistan’s low level of direct taxes is mostly a result of weak compliance and enforcement and abundant concessions and exemptions.”
However, para (1) and (1A) of Division I of Part I of the First Schedule to the Income Tax Ordinance, 2001 clearly indicate that the marginal rate of tax in the case of salaried persons is 30pc and that of non-salaried persons is 35pc.
In the existing law, under normal tax regime, the maximum income on which tax is not payable is Rs400,000. The IMF working paper recommends it be reduced as below:
“In the case of PIT, with the tax exempt income threshold set at almost four times per capita income, a significant share of employed people do not pay any income tax at all.
“Accordingly, reducing the tax exempt income threshold, widening tax brackets, adopting more progressive and lower tax rates, and rationalising concessions and exemptions would not only reduce distortions and increase revenue yield, but also improve the fairness of the tax system.”
This observation does not take into account the country’s scio-economic conditions and the needs of a common person.
In Pakistan the average household size is of 5-6 persons. In most of the cases, there is only one bread earner. Even if we consider five people in one household, Rs400,000 per annum means around Rs220 per person per day. It is hardly sufficient to make both ends meet. Almost the entire amount is spent on consumable items which are also subject to at least 17pc sales tax.
One of the functions of the income tax is to distribute resources from the rich to the poor. To reduce the threshold for charging tax below the annual earning of Rs400,000 would do exactly the opposite.
Another aspect is that such individuals also pay income tax in the form of the withholding tax in a number of ways, which is otherwise not due from them. They deserve relief, not more tax.
‘Withholding tax becomes an indirect tax when it is treated as a final tax and is passed on to the ultimate consumer’
It is also incorrect to claim that the number of taxpayers in Pakistan is very low. Theere are more than 45 withholding taxes which are paid by millions of common citizens. Most of these WHT have no nexus with the income earned or capacity to earn. For example even one rupee of interest/profit is chargeable to tax and so is the income from services, contracts, dividend, gain from sale of securities, etc. Even widows and orphans pay tax on all of their income, be it as low as one rupee.
Barring rare exceptions, 124m mobile phone users pay income tax at source. A country where 50pc people live on or below the poverty line, this number is not less, it is excessive.
Similarly every commercial electricity user pays income tax at source. Most of the persons in the first instance should not have been subjected to tax, or if subjected to tax, should get refunded. But the government never returns this money back and retains it unlawfully. It is a classic case of fiscal tyranny by the state machinery itself.
No one takes suo moto notice Pakistan is a case of wrong distorted, senseless taxation and over-taxation. Those who should pay taxes are not brought into tax and those who should not pay taxes are made to pay taxes. Most of them do not even know that they are paying income tax at source.
Another ugly aspect of the vast, indiscriminate withholding tax regime is that almost all the businesses are made withholding agents and the tax department is mainly involved in the monitoring of collection of tax at source, levying penalties and default surcharges, making the cost of doing business very high.
Withholding tax becomes an indirect tax when it is treated as a final tax and is passed on to the ultimate consumer as an indirect tax. For example, in the case of contracts and services, income tax is collected at the time of making payment. The providers of the service, or the contractors, build this tax in the price they charge.
Another aspect of this issue is that big infrastructure development projects are executed by the government itself and the tax collected from the contractors is in fact paid by the government itself in the form of ‘cost of the contract’ and the contractor gets tax-free profits. Two-third of income tax is collected at source.
There are a number of minimum taxes which are levied without any reference to the income. Taxpayers are forced to pay minimum tax even in cases where they are suffering a gross loss. Since they are forced to pay the government out of the capital of the business without earning a penny, it cannot be called an income tax.
Sales tax on petroleum products (e.g. more than 35pc on diesel) along with petroleum development levy, etc; prevent passing the benefit of falling oil prices to the Pakistani businessmen.
Although Pakistan has the potential to increase its tax revenue, it should be realised that the way forward is sensible taxation without hurting business growth. The sole objective should not be the collection of tax, it should be collection of tax based upon the principle ’from each according to his capacity to pay’. The next step is to revisit the existing withholding tax regime to make it more rationale and income based.
The author is an FCCA and Advocate High Court.
Published in Dawn, Business & Finance weekly, September 12th, 2016
