The conventional wisdom places almost the entire responsibility for this malice on the shoulders of a corrupt tax administration. Seldom, if ever, the role of the tax-payer in this sordid venture is highlighted. A skewed picture has thus emerged which has been distorting our approach to the problem, resulting in our failure to bridle this menace, what to talk of eliminating it.
This picture has been further skewed by our complete inattention to the role of another player in this game, namely the auditor, who is responsible for the vital task of scrutinising and certifying financial affairs of corporate bodies. All companies, both public and private, are legally required to have their financial statements and underlying accounting systems and records examined by a qualified auditor, so as to enable an opinion to be formed as to whether such financial statements show a true and fair view of the company’s affairs. An auditor is required to present an independent report regarding the affairs of the company.
The role of auditors has come in sharp focus with the recent collapse of Enron, an energy giant and one of America’s ten top companies. It has now been widely realized that even the US system has serious financial-reporting problems. The auditors fail to report off-the-book trading operations, mysterious accounts and sham deals. Over the past three years, scores of high-profile US companies have been investigated for financial irregularities and a number of them have had to restate their earnings. The role of the auditor is obvious.
The shady practices could not be carried on without the subsequent knowledge, nay collusion, of the auditors. Evidence suggests that financial reporting in the US, backed by audit function, has become increasingly corrupt during the last few years. However, American corporations are still considered more open and honest than most others, especially in developing countries. One can only imagine the situation prevailing in Pakistan, having a well-established and well-deserved reputation for corruption. Recently, two Pakistani banks, NDFC and Indus, sank. The auditors in both the cases were well-reputed international auditing firms. The former gave the latter clean bills of health shortly before they went down.
The ambit of auditors in examining the accounts of their clients is all-encompassing and unrestricted. The audit is conducted at the premises of a client extending over months. The auditors have access to all the account books, documents, receipts etc. of their clients. The clients are legally bound to answer all their queries and explain all transactions. The law requires the auditors to form an independent view of the financial dealings of their clients without doling out any favour. Certifying a set of accounts as above board of a company which has indulged in financial irregularities can either mean incompetence or connivance of the auditor, more likely the latter.
The auditors have global picture of the accounts of a company. The yield of all taxes, sales tax, custom duty, excise duty and income tax, depend on the same set of accounts. By certifying its authenticity, which in actuality is lacking, an auditor is abetting the evasion of all taxes. Certifying understated production, sales and imports would result in evasion of excise duty, sales tax and customs duties respectively. They all will culminate in the understatement of income or declaration of loss resulting in evasion of income tax.
The auditors are in a better position to detect irregularities in the accounts of their clients not only because they have the opportunity of extensively examining the accounts but also because they have a rightful claim of possessing greater professional expertise than a run-of-the-mill tax collector. Nevertheless no auditing firm in the entire history of the country ever pointed out evasion in one single case. The taxation authorities with much lesser expertise and time available for examination of accounts have unearthed tax evasion in scores of cases, notwithstanding their corrupt practices.
Why are the auditing firms hand in glove with the business? The answer is simple. They know which side their bread is buttered. They are there to protect the interests of their clients and have no love lost for the government and its revenues. Besides, the auditor render many non-audit services, like selling advice. In many cases they earn more by rendering non-audit services than by discharging their audit functions. Bereft of their moral duty towards the country and its welfare, as most of us are, they have no compunction in becoming the part of this abject game in which the tax payer and tax-collectors are co-players as well.
The following schedule enumerating the number of public limited companies declaring losses, not distributing dividends and those declaring losses continuously for last 5 years will illustrate the above-mentioned point.
Number of public limited companies listed in the country are 762. (SEE TABLE)
The state of affairs of public limited cos. The number of companies declaring losses is inordinately high (30 per cent in 1998) as is the number of companies not declaring any dividend (65 per cent in 1996). The state of affairs gives rise to an explicit inference that declared results, which were duly audited, do not represent the reality on ground.
Only the governmental revenues are not the victim of this complicity. Pakistani stock exchanges are in doldrums for last 5 years. Barring an occasional influx of foreign investment, share prices have shown a steady decline in the years referred to above. The KSE 100 index was 2,331 in 1994. It dropped to 879.6 in 1998 but recovered to 1,520.7 in the year 2000. The figures, dismal as they are, do not depict the real depth of the decline, because the indices were held up by a few favourites like the shares of the PSO, the PTCL and the Hubco. Thus the complicity between the deviant companies and the auditing firms acts as a double-ender cutting both revenues and investment in one stroke.
Stock Exchanges play a vital role in mobilization of savings for investment. Unless investors have reasonable return on their investments, they would be averse to invest and stock exchanges will continue to stagnate.
There is an urgent need that the oversight structure for the auditing firms is reformed. Presently, it is the Institute of Chartered Accountants of Pakistan which oversees the professional conduct of the auditing firms. The prevailing conditions indicate that this arrangement needs correction and rectification. A body formed essentially to safeguard the interests of its constituents is bound to become self-serving. A hunchback can not see his own hump. There has to be an outside agency to keep a critical eye on the performance of the auditing firms. The SEAP can be one such agency. With an appropriate amendment in Chartered Accountants Ordinance, 1961,the SEAP can be assigned the task of keeping a watch over their conduct.
One conclusion which can bear repetition ad infinitum is that moral turpitude, which is responsible for all the ills of our society including that of tax evasion, is not confined to any one group or class of people. All of us are prey to this malady. Granted that the tax administrators are corrupt, but they alone are not responsible for tax evasion. There are other operators as well who aid and abet.
Unless we widen the range of our efforts to include all the players in the game of tax evasion, we can never achieve any significant success in controlling it.