A MAJOR tax reforms package has been announced and promulgated by the government. The first is the Foreign Assets Declaration Repatriation (FADR) Ordinance and the second is Voluntary Declaration of Domestic Assets (VDDA) Ordinance.
The first question is why the path of ordinances has been chosen rather than including the tax reforms in the Finance Bill, as part of the forthcoming Budget for 2018-19. Ordinances are temporary in nature and the desired responses may not be forthcoming in view of the resulting uncertainty.
A major concern is that the reforms in the FADR Ordinance may run afoul of the Financial Action Task Force thereby weakening, if not potentially jeopardising, our stand with them that we have done enough not to be included in the grey list.
Thus, not surprisingly, the FATF has already expressed its concerns on the failure to share the contours of the scheme with it before the formal pronouncement.
The underlying complacency of the approach and the cavalier attitude towards such a delicate matter is worrying, indicating why even our Chinese friends ultimately chose to side with the rest of the international community at the recent meetings of the FATF.
The impact could be ever greater difficulty in borrowing from the international capital market or from multinational commercial banks.
Further, since the OECD Convention, perceived to carry risks for Pakistanis holding assets in these countries, does not cover real assets (e.g. property) which make up the largest proportion of investments in value terms, the announced package is not likely to elicit the anticipated response.
There is also the proposal that the FBR would be empowered to question the source of funds in case of remittances exceeding $100,000 received by an individual during a financial year.
In our view, the timing of this proposal is fraught with danger since this will incentivise disintermediation, with a significant chunk of the remittances moving out of the formal banking system to the hawala/informal foreign exchange market. This could result in the widening of the Current Account Deficit, something we can ill-afford at this time.
On top of this, if only declaration and no repatriation is required, then the scheme will not contribute in any way to improving the balance of payments position of the country.
The claim of the announced scheme is that it will not provide protection to cash and assets acquired from money laundering, terrorism and trafficking in drugs.
It is not clear how the government will be able to identify such financial/real assets because if it already knows which individuals and entities had derived their earnings from activities that would be categorised as money laundering or trade in drugs then the obvious follow up question would be why no criminal proceedings were initiated or action taken against them earlier; and if the credentials of the remitters (i.e. their source of funds) would be subjected to investigation either before or after the declaration/receipt of the funds then why would they transfer their money and pay the tax on foreign assets to make them legitimate.
Turning to the VDDA Ordinance, an unprecedented and extremely large reduction in tax rates is proposed to expand the tax base and improve compliance by getting more filers of tax return.
The exemption limit has been trebled and the maximum tax rate has been halved. The potential revenue loss is at least Rs80 billion, unless the response is overwhelming.
Also, the big tax break has the perverse consequence of giving larger tax savings as a percentage of income to persons with higher incomes.
A comparison with the income tax system of India is useful.
The exemption limit in India is Rs250,000 ($3,900) only and the maximum tax rate is 30 per cent. Yet, the number of return filers is 29 million, almost twenty five times the number of filers in Pakistan.
Actually, with a rate for non-filers much lower than the rate for the highest slab of 15pc, successful broadening of the income tax base will require a major improvement in the quality of tax administration and use of collateral evidence.
Otherwise, the reduced tax rate will not be effective if the probability of getting caught and penalised is perceived to be low. The overall impact will leave a big hole in revenues which the FBR will have a huge problem in filling up.
The proposals regarding property taxation need to be whetted and accepted by provincial governments. Capital Value taxation of properties is in the provincial domain, as per the exception to Section 50, explicitly stated in the Federal Legislative List-Part-I of the Constitution.
In particular, the feasibility of effective application of the law of eminent domain on property needs to be carefully examined.
There is a real danger that this will be difficult to administer and could lead to a severe disruption of the property market, without adequate checks over the potential abuse of discretionary powers.
A better strategy to achieve the stated objective, to capture the accurate value of the transaction, would be to update the DC rate for properties more frequently.
Finally, there will be a lot of heartburning and resentment at the amnesty on offer on domestic assets.
Those who were liable for the highest marginal rate of income tax (30pc) would especially feel cheated because the rate for ‘whitening’ is an abysmally low 5pc. It would have perhaps been more palatable (with no penalties) to the honest taxpayers if this whitening had been made permissible at the tax rate for the highest slab or at least the highest marginal rate of 15pc being proposed under the package.
To conclude, the realisation of the underlying objectives of this audacious package, while addressing the caveats that we have listed above, will depend heavily on the quality of tax administration that will both execute and preside over its implementation.
The authors are former federal minister and governor of the State Bank of Pakistan.
Published in Dawn, Aprill 10th, 2018