Bridging the tax gap

Updated 24 Sep 2018


Tax experts say Pakistan has the potential to generate Rs8 trillion in tax revenue every year. Before becoming prime minister, Imran Khan also vowed to raise Rs8tr in tax revenue to avoid further loans.

The possibility of increasing tax revenue from current Rs 3.8tr to Rs8tr cannot be ruled out given the size of the tax gap, which is estimated to be 9.8 per cent of GDP. The tax gap is the difference between the actual tax collection and the amount that would have been collected if every taxpayer was fully compliant.

To realise such a gigantic tax revenue target, the government has to work earnestly on rationalising tax policy, strengthening the enforcement mechanism and removing pitfalls in the tax litigation system.

Several provisions in Income Tax Ordinance 2001 are difficult to interpret and not easily implementable

Inadequate tax policy can be one of the top reasons for the wide tax gap. In 2017-18, the magnitude of tax expenditures was as high as 4.4pc of GDP, amounting to about Rs540 billion. Tax expenditures are special provisions in the tax code, such as exemptions, deductions and credits that benefit specific groups of taxpayers.

Rationalising tax expenditures will help broaden the tax base essential for progressive and equitable tax regime. The second element of tax policy that needs proper attention is the simplification of tax provisions. Several provisions in Income Tax Ordinance 2001 are difficult to interpret and not easily implementable. For example, provisions of Section 65B provide tax credit against tax payable under the normal, minimum and final tax regimes by a taxpayer company making investment in the purchase of plant and machinery for expansion, extension, balancing, modernising and replacing the already installed plant and machinery in an industrial undertaking.

These are not easily implementable for being in conflict with the provisions of Section 113(1)(d), which says that the companies have to pay minimum tax regardless of the application of credits or rebates, and Section 169(2)(d), which provides that tax deducted under the final tax regime should not be reduced by any tax credit.

As a result, tax authorities remain reluctant to process claims of investment tax credits against tax payable under minimum and final tax regimes. Moreover, it is also not clear from the provisions of Section 65B whether the companies making such investments through musharaka agreements are entitled for investment tax credits and tax refunds under the said provisions.

Additionally, the withholding tax regime needs to be revisited to make the tax system more equitable and pro-economic growth. Reliance must be on direct tax collection by enhancing the number of direct taxes and reducing withholding taxes gradually.

Strengthening enforcement is inevitable to create deterrence against tax evasion and fraud. Results of the recently announced tax amnesty scheme show tax evaders and money launderers could not be handled with kid gloves and benign tax policies. Not many people stepped forward despite being provided with a golden opportunity to declare concealed income and foreign and domestic assets by paying tax at significantly reduced rates. In the United Arab Emirates alone, Pakistanis own around $150bn worth of properties and assets.

To bridge the tax gap, the authorities have to focus on major segments of the economy, including real estate, services, hospitality and food, non-traditional and newly emerging businesses and professions, bulk trading like vehicles and other luxury items and brokerage houses. Each of these segments requires specialised taxation through the creation of specialised zones in field formations. These zones could be assigned sector-specific cases of taxable persons.

For example, real estate zones could be assigned the cases of taxable persons concerning housing societies, including cooperative and departmental housing societies, private housing schemes, real estate projects launched by builders and developers, real estate companies, housing authorities, marketing companies engaged in the real estate sector, owners and sponsors of plazas and complexes, investors in real estate schemes, societies, projects and complexes, major property dealers, brokers and commission agents involved in the real estate sector.

Ever-expanding commercial activities offer a tremendous scope for broadening the tax base, which is inevitable to reduce the tax burden on a small number of taxable persons.

Under the withholding tax regime, there are persons who are liable to deduct or collect taxes, but they don’t do so. Some withholding agents collect taxes but don’t deposit revenue in the national exchequer. Some withholding agents don’t deposit the full amount of the tax withheld. Unregistered persons are being wrongly treated as filers at the withholding stage by withholding agents as filers subject to low rates whereas non-filers at higher rates.

Similarly, at the time of the withholding of tax, a wrong withholding provision is being applied to evade the higher rate of deduction or collection. In order to prevent revenue leakages in the withholding tax regime, the authorities need to segregate all withholdees into registered and unregistered taxpayers and check the application of correct withholding provisions. The registered withholdees should also be segregated into filers and non-filers. The tax authorities should then generate and transmit withholding alerts to withholding agents.

Notwithstanding the sanctity of taxpayers’ rights, transparency, fair play and professional conduct, which are integral components of any responsible tax regime, the tax system must be capable of implementing laws and regulations in an efficient manner. Stringent actions as provided in tax statues need to be taken for the recovery of settled tax demands and checking of fictitious tax registrations. For effective enforce­­­ment, services of well-qualified inspectors and auditors must be utilised.

At the same time, well-maintained, updated and information technology-enabled regional database is inevitable for enforcement against various hazards. Effective coordination among various stakeholders working for inland taxes is essential to avoid duplication, unnecessary paperwork and correspondence.

Lastly, litigation has been on the rise. From 2014 to 2016, the combined pendency of litigation cases in the Supreme Court and high courts increased from 304,813 to 312,478. As many as 59,177 and 658,089 fresh tax litigation cases were instituted in the Supreme Court and the high courts during the same period. Re­­ducing tax litigation and ensuring speedy and affordable justice require that business practices be standardised. This will help the tax authorities seek guidance from these standards while finalising assessments.

The writer is additional director for Intelligence and Investigation (Inland Revenue) at the Federal Board of Revenue. Views expressed in this piece are his own.

Published in Dawn, The Business and Finance Weekly, September 24th, 2018