THE self-assessment system provides incentives to taxpayers to assess income, expenses and tax by themselves.
However, quite often they under-report their income or claim excess deductions if they find such a taxation system without the backing of strong tax investigative department.
Needless to that that the self-assessment system is supported not only by a criminal investigation system but also audits, administrative penalties, additional tax, etc.
Since the system of self-assessment was introduced much earlier in advanced economies, the tax criminal investigation system is highly developed. For instance, in Japan, the self-assessment system has been applied to all major sources of tax revenue — individual and corporate income tax, and inheritance tax since 1947. In Pakistan, the self-assessment system became operational from the tax year 2003.
In Pakistan, the Directorate General of Intelligence and Investigation, Inland Revenue was created in 2011 to carry out investigation of tax fraud cases pertaining to individual income tax, corporate tax, general sales tax (value added-tax) and federal excise duty.
In addition, the directorate has also been assigned to perform other duties such as netting potential tax payers, creating linkages with all major national, provincial, regional data base, cross matching for the purposes of countering non-reporting and under reporting, complaints handling, preliminary investigation to determine the possible loss of revenue or the real revenue potential and gathering discreet information on all tax related issues, non-reporting, under reporting, tax evasion, connivance between tax evaders and tax collectors, fiscal fraud, and revenue leakages.
The department lacks much of the requirements needed to carry out effective tax investigation. Almost all the directorates of Intelligence and Investigation at Lahore, Karachi, Faisalabad and Islamabad have an insufficient number of tax investigators.
As tax investigation is an exhaustive work and time consuming, so it requires a greater number of investigators with requisite capabilities and skills for tracing desired information from searching voluminous business documents, and preparing relevant documents. For instance, in Japan, average 154 tax investigators were involved in one raid in fiscal year 2011.
Here it is worth-mentioning that there are different types of tax criminal investigations systems in developed countries. Japan’s ‘raid’ type system is one example and US ‘non-raid’ type mode is another and plea bargaining is widely accepted in the criminal procedure. The difference stems from each country’s culture.
Participation of such a large number of officials in the investigation process is important. It gives transparency to the process because connivance for some personal gains at the expense of the investigation is almost impossible amongst so many people.
It also makes the process more efficient and effective. A few individuals cannot carry the whole process which includes searching various places and records, questioning people, preparing relevant documents etc. Since many investigators are involved in the process, chances of finding important and relevant information are enhanced.
As these directorates are in a formative phase, they lack the desired level of legal backing. In Japan, the tax investigation system is very strong and enforced with full legal force. In the fiscal years 2009, 2010 and 2011, some total of 213, 196 and 195 cases of individual income tax, corporate income tax, consumption tax, withholding tax and inheritance tax were initiated and out of these, number of cases indicted was 149, 156 and 117, respectively.
More importantly, the amount of tax evaded was ¥25, 475 million, ¥21,315 million and ¥15,686 million, respectively. To add to this, the department is empowered to obtain information relevant to fraud cases from any source, including banks, directly.
Access to premises for the purpose of investigation is a very sensitive matter.
In most countries, such raids have been made conditional. For instance, the tax investigation department of Japan cannot carry out raid on the homes, offices of persons having a relationship with the taxpayer without obtaining a search warrant from the District Court.
Organisation of the system also affects its overall working. In Japan, the Criminal Investigation department consists of two components – the Information Group and the Enforcement Group. The Information group gathers information from third party informers, tax offices and other departments of Regional Taxation Bureaus. Then this group reconnaissance the information in order to make sure that the case is tax fraud and meets the conditions for a criminal investigation. If the case qualifies, it is forwarded to Enforcement group that, after obtaining search warrant from District Office, carries out raids at various places concerned with the taxpayer.
It is important to lay down some conditions to categorise a case either for examination (audit) and or for tax criminal investigation to minimise harassment in the business environment.
For instance, in Japan, two conditions (though not documented) - intention of the taxpayer and income evasion equal to or more than ¥100 million - are required to be met for a case to qualify for a criminal investigation. After the conditions of criminal investigations are met and the evidence supports the case, the department reports it to the prosecutor‘s office.
The investigation continues for months to gather relevant evidence in support of the case. For instance, on an average it took eight months from a raid to reporting to a prosecutor’s office in Japan in 2011. However, in case the conditions of an investigation are not met, the criminal investigation is discontinued and the case is reported to the Regional Taxation Bureau to carry out administrative assessment of taxpayer’s obligation.
Another important element is the prosecution process annexed with the investigation. In case the prosecution process is lethargic, the very objective of creating deterrence against tax fraud through the investigation may not be achieved. In view of time value, the state may be deprived of revenue necessary for economic growth and development for a longer time period.
Hence, the important lessons drawn are: enhancing work force in the field directorates; equipping tax investigators with necessary legal and administrative strength; ensuring adequate involvement of the board in potential cases; improving the prosecution system etc. However, raiding or searching premises might be conditional to minimise harassment as well as giving some confidence to the taxpayer. Above all, there must be balance between audit, administrative penalties and investigation to help the self-assessment system work smoothly without revenue leakages.