New Tax Model

Viqar A. Khan
FCA

Viqar A. Khan is a Chartered Accountant and  a tax specialist. He has been writing in newspapers for a few years now.

His clear, crisp line of thought and precise expression make reading a pleasure. 

Preamble

In early 1998, Mr. Moin-ud-Din Khan the then Chairman, CBR, realizing the anomalies in our fiscal policies passed on an article authored by myself titled ‘Safety Valve’ to the Prime Minister through the then Finance Minister. The theme of the article was that cheap money laundering schemes and expensive normal tax regime cannot go hand in hand for an indefinite period. Everyone in the decision-making chain subscribed to the basic theme. As a consequence, I was mandated by the CBR to critically analyze the federal revenue laws and give a ‘new tax model’ for Pakistan so as to enable the government to increase the revenue from Rs. 300 billion to Rs. 600 billion in three years.

As mandated, the basic concept of the ‘new tax model’ in its final form was presented to the CBR in March 1998. I had stated that the new tax model was a jigsaw puzzle in which all the pieces had been locked. I warned that selective application of its different aspects would make the entire concept ineffective. Bureaucracy prevailed. It has been selectively applied in the budgets for the financial years 1998-99, 1999-2000 and 2000-2001.

 The following fundamental concepts have been ‘taken’ from the ‘new tax model’ and enacted into law by the provincial and the federal governments upto the Finance Ordinance, 2000:

• Application of broad based G.S.T. scheme.

• Turnover tax on retail outlets being final discharge of their tax liability.

• Abolishing CVT.

• Rationalizing tax rates for the corporate and the non-corporate sector.

• Monthly payment of income tax alongwith the sales tax returns by the unorganized sector. Filing of annual income tax returns dispensed.

• Small companies in the corporate sector to be treated at par with the unorganized sector with regard to application of tax laws. Companies eligible for self assessment scheme.

• Reduction in registration charges of immovable property.

• Abolishing money laundering schemes in December 1999.

• Abolishing wealth tax.

 Unfortunately, these measures would not give the desired results since selective application has resulted in the implementation of ‘form’ while the ‘substance’ has been left out. I have tried to convey these views through several articles in leading newspapers of the country.

A presentation of the ‘new tax model’ was made to the then Federal Finance Minister, the then Chairman CBR and members of CBR and officials of the Finance Ministry on the 1^st of August 1998. The then Finance Minister specifically instructed that each Member of CBR give his comment on his respective subject on the relevant provisions dealt with, in the ‘new tax model’. The bureaucracy prevailed once again. What to talk of the comments which were due from the members of the CBR, the presentation was not even ‘minuted’.

Other Articles by Author

Kargil

Creating willing tax payers

State of the Economy

Dancing to the Tune

The ‘new tax model’ was summarized for the print media to elicit public opinion and was carried by the Dailies “The News”, “The Nation” and “Dawn” on 8th of June, 1998, “Business Recorder” on 2nd July, 1998 and again by “Dawn” on 24th of May, 1999. The above summary was printed by “Dawn” on 24^th of May, 1999.

Complete failure of the various relief packages to take the country out of its economic stagnation should dawn a realisation on the higher ups that adhoc measures and selective surgeries for economic uplift would not prove productive. Mere good intentions are not good enough to take this country out of its economic lethargy. Good intentions have to be matched with equally good and innovative policies to give the economy a jump-start and to sustain it over a long period.

The economic managers in Islamabad envisioned such a necessity in early 1998. This resulted in a ‘new tax model’. Doing work by halves is not alien to our national character. The much publicized and initially accepted ‘new tax model’ lies somewhere in the corridors of power gathering dust. Every now and then it is pinched at and whatever appears palatable to the policy maker is selectively applied. This is done inspite of specific instructions of the author that the model is one big jigsaw puzzle. It should either be applied or rejected in toto. Selective application from the ‘model’ of ‘GST’ and ‘turnover tax’ on retail outlets would proved counter productive, unless the numerous relief’s spelt out in the ‘model’ are applied as a whole.

The  ‘new tax model’ is a economic stimulant and would be able to lift the country out of the economic oblivion in which it has been for quite some time. The ‘new tax model’ has been drafted by adhering to the parameters of broadening the base of taxation, documentation of economy, maintenance of economic growth, fair and judicious taxation, simplified and business friendly tax laws, lesser government, reduction in discretionary powers of officers, reasonable protection to local industry, zero loopholes, reduction in smuggling and parallel economy and establishing a reliable tax data base and maintaining the honour and dignity of the tax payer.

 The model explains the philosophy of tax, identifies the problem areas, comments on the utilization of tax payers’ money and elaborates on the importance of the dignity and honour of the tax payer and emphasizes the need for institutions for policy making. It is being claimed that the model  has  opened  up  the  stifled  economy  by adhering to the lofty principles of justice and fair play as explained to us by Islam. It has been ensured that the unorganized sector, being the biggest business sector contributes its fair share of tax, in return for immunity from probe by federal revenue authorities. It has further been ensured that the small corporate sector is freed from interaction with the tax collector and still it contributes its fair share of tax to the federal revenue. Taxation measures have been simplified, made business friendly and revenue generating. Burdensome taxes which caused smuggling, inhibited free flow of capital, encouraged corruption and were irritants

have either been limited in their application or have been abolished. Without resorting to penal provisions, measures have been taken to increase the circulation of money by putting a price on money laundering and keeping it alive. Measures have also been taken to create a level playing field for all. Interaction of the department with the small assessee has been minimised and it has been endeavoured to eliminate smuggling through fiscal measures and not through brute force.

 The new tax model has proposed reduction in tariff on import. Goods subject to excise duty have been limited. Wealth tax, C.V.T. and all ancillary tax levies have been proposed to be abolished. Concept of final tax liability for small assessees, they being limited companies or any other category has been introduced. Such assessees would purportedly be paying income tax on turnover alongwith the monthly payment of G.S.T. Filing of income tax returns for such assessees has been purposed to be dispensed with. Money laundering has been priced @ 15% to 20%. Taxation rates for limited companies have been staggered. 1% withholding tax on encashment of F.E.B.C.’s has been proposed for withdrawal. To create a level playing field, exemptions prescribed in direct and indirect taxes have been proposed to be phased out. It has been further proposed that G.S.T. should be the main source of revenue for the government in future. It has also been stated that the entire model is one big whole. All the proposals in the new tax model are apparently pieces in a jigsaw puzzle which have been locked and warns that selective application of different aspects would make the entire concept ineffective.

 The model prophisises that as things stand today even a complete amnesty would not be able to invoke public enthusiasm since the trap of perennial levy of wealth tax is already laid out and alternatively there are cheap money laundering schemes at hand. It further emphasis that disjointed fiscal measures which are not part of the whole would not prove effective over the long run. The planners of today have to visualize Pakistan fifty years from now and devise policies with that end in mind. In the great scheme of things an honest businessman has to feel justly appreciated and rewarded while a dishonest businessman/bureaucrat should get ample stick. This is the message that has to be given to the nation. To build a nation economically, we need to provide a haven to the existing law abiding entrepreneur while at the same time we have to ensure that he contributes his share towards the economic well-being of the nation.

 The model emphasises the principles of openness and advocates discussion and consensus from the broad  spectrum  of  the tax payers prior to implementation of tax levies. The latitude given to the non corporate sector of 20% tax irrespective of scale of operations has to be rationalized with the 30%-55% tax of the corporate sector. The rhetoric of documenting the economy has to be followed by concrete actions because there has to be cohesion between words and deeds. If the policy maker takes the local entrepreneur into confidence, rationalises the tax structure both direct and indirect in harmony with the business community taking the next fifty year view of the nation, gives constitutional guarantees to the continuity of policies then our country would become a haven. Instead of flight of capital our own people would want to retain or even bring back the money which they have stashed away.

Pakistani tax payer is unwilling because he gets an extremely poor service from the state. Due to the human instinct of self preservation, blatant evasion of taxes has become socially acceptable. In the current maze of things the tax payer and the tax collector with the notorious participation of the tax lawyer have colluded to deprive the state. The system has been beaten. With the result that the tax payer and the tax collector being the principal beneficiaries have thrived while the state hangs on the precipice of bankruptcy. This is what we have achieved!

 The utilization of tax payers’ money has to be in consonance with the rhetoric of the government that it is poor. State wealth has been looted in an extremely callous manner without regard to the consequences as to the effect it may have on our very existence. We have been burdened with so much loan, the utilisation of which is highly questionable, that our independence has been mortgaged to the forces of imperialism. Now we expect the tax payer to pay for the misdeeds of the public functionaries. Is this fair?

 The model emphasises the maintenance of honour and dignity of the tax payer. It advocates the need for creation of an environment in which the tax payer after payment of fair tax considers himself a free man as opposed to hiding his identity and endeavouring to become invisible for fear of enhanced future taxation which he does today.

 Policy measures should evolve from institutions, the make-up of which should be apolitical. They should have continuity of thought and leadership. It is an irony of our nation that we bank upon individuals rather than institutions. Individuals are made into institutions. The nation is made hostage to their whims. Our intellect level may be high but we have to realise that weaknesses in our fundamental values and moral construction exist, that enabled foreign forces to rule us for a hundred and fifty years. Only when we realise our weaknesses would we be able to take corrective measures.

 In human dealings wherever we tend to drift from the path of justice and fair play the instinct of self preservation is activated. In such a situation it is very difficult to penetrate the defences that have been erected. It is naive to think that over a protracted period of time, the subjects of a state can be coerced into paying tax, which to their minds is not being utilised the way it is intended to be.

 The new tax model spells out a four year phased implementation period for the new concept encompassing all the federal revenue laws.

 Customs duty

Customs duty for taxable items has been proposed to be reduced from 45% in the first year to 35%, 25% and 18% in second, third and fourth years. The base rate of 18% is the effective tax rate if import duties are levied on all items except defence equipment and slightly higher than the cost of smuggling. This is a measure to eliminate the menace of smuggling through fiscal measures and not brute force. Customs duty on goods which are also produced locally should be fixed in consultation with local manufacturers keeping the interest of end user in view to enable optimum utilization of resources and to channelize our scarce capital towards internationally competitive production.

Exempt items except defence are proposed to be taxed @ 5%, 8%, 10% and 18% during the four years phased implementation to bring them in line with the taxable items. The model appreciates that it would amount to taxing commodities and agricultural inputs but considers it inevitable. Being an agricultural country, and abundance of land and water, we have no business in importing agricultural produce. Our policy makers should take stock of the situation.

 Sales tax

Sales tax at import stage which is currently levied @ 15% is proposed to be reduced to 10%, 5% and NIL in second, third and fourth years so as to bring the total taxes payable at the port of entry at parity with the cost of smuggling. In the new scenario, the government would be losing 18% customs duty to smuggling when such goods are retailed compared to the government losing 72% at present on the highest duty bracket. The collection of sales tax for goods to be retailed shall only be delayed since it shall be collected in the form of G.S.T. However, loss of sales tax on capital goods is expected to be around Rs. 6 billion. It has been justified since the payment of this tax is financed with burdensome loans increasing the capital cost of the project, increasing the cost of the end product, adding to inflation, reducing the profitability of the project thereby reducing tax revenues to the government over a long run.

 Other import duties

Flood relief surcharge, iqra surcharge and the like have been proposed to be abolished since they are a thorn and erode the confidence of the public.

 Excise duty

It has been proposed that excise duty be retained only on 11-items out of the hundred odd items thereby retaining 82% of the revenue and losing 18%. The loss comes to approximately Rs. 12 billion. Excise duty in its current form has been retained as a revenue earner and a regulatory duty. However, it has been proposed that beyond the implementation period of the model, this duty be applied as a regulatory duty only e.g. on tobacco, liquor etc. Such a step would free our industry from the shackles of multiplicity of taxes and lay a foundation for the implementation of G.S.T.

 G.S.T.

All produces of goods and services are proposed to be covered under the normal sales tax regime of 12.5% i.e. claiming input output tax. At the retail level for goods, it has been proposed that G.S.T. be levied @ 2% on selected products in the first year, @ 3% on increased products in the second year, @ 4% on all products in the third year. Such G.S.T. being unadjustable. From the fourth year, it is proposed that the normal G.S.T. regime of 12.5% be applied on all products. For services, it is proposed to levy 2%, 5%, 8% and 10% non-adjustable G.S.T. However, the retailers of goods and services have the option for the normal G.S.T. regime from the first year. It has also been proposed that a nominal G.S.T. be levied on immovable assets, vehicles and stocks to enable the government to generate resources from tax havens of black money.

Income tax

It has been proposed that the corporate sector be stratified on the basis of paid-up capital, assets and turnover. The smaller companies be subjected to the same treatment as given to the unorganized sector while the bigger companies be subjected to the rates of taxation as currently existing. It has been proposed that the unorganized sector be given immunity from all the federal revenue laws in respect of those assessees covered under G.S.T. and consequently paying income tax on turnover. The rate of income tax on turnover be determined in close consultation with the representatives of each class of business. It is to be paid on a monthly basis alongwith the payment of G.S.T. using the same form. The stamped and signed G.S.T. paid challan has been proposed to be the assessment order for the assessee hence there is no need for him to file an annual income tax return. It has been proposed that monitoring of deduction of tax on salaries be made more vigilant and they also need not file income tax returns. However, as salaried people are not covered under G.S.T. they would also not be covered under immunity.

 Inspite of the immunity, wealth statements and financial statements above a certain threshold would have to be filed to enable the assessees to launder unexplained acquisition of assets under a scheme proposed in this model hereinafter. Every outlet is proposed to be an assessee and the concept of a person being an assessee has been abolished.

 The concept of charging income tax on turnover is being frowned upon by some quarters by saying that it is actually a consumption tax and not income tax. Technically the criticism is based on sound footing. Had we been a developed country where there was complete documentation and a credit economy, the criticism would have fallen on fertile ground. All policy decisions have to be taken by staying extremely close to ground realities since following developed economies might further complicate our problems. We are a developing country, a cash economy, documentation is non existent therefore we have to have our own solutions.

 In the financial year 1995-96 the total collection of direct taxes was Rs. 78 billion, of which Rs. 59 billion (75%) were collected from the corporate sector while Rs. 19 billion (25%) were collected from the non corporate sector. The taxes collected under presumptive income and becoming the final discharge of income tax liability were Rs. 30 billion (38%). Hence the tax on presumptive income as proposed in this model is not a new concept. The only new thing about it is that it has been proposed at the retail level. This model has retained the revenue yielding ability of the big corporate sector, while it has enhanced the revenue yielding ability of the small corporate sector. Thereafter the model has concentrated on the unorganised sector that by far is the largest sector of the economy but due to the inherent weaknesses in our system the policy makers tried to rope them in through conventional means without success. The innovative measures proposed in this model should hopefully build their confidence and help increase the revenue receipts many times.

Money laundering scheme

Assets purchased beyond white money are to be laundered @ 20%. The value to be determined at a date of declaration. No penalties are proposed for non-declaration. Foreign currency remitted into Pakistan from unexplained sources by resident Pakistanis is proposed to be laundered @ 15%. It is further proposed that 1% withholding tax on F.E.B.C.’s be withdrawn.

 It is feared that a person would finance the purchase of assets through loans obtained by securing it with foreign currency or F.E.B.C.’s, thus defeating the purpose of pricing money laundering. The fears can rest since the idea is that unexplained credits in the foreign currency accounts and F.E.B.C.'s purchased from unexplained sources are to be taxed. Hence an officer would be able to place a value on the asset given as security to obtain the loan.

 Wealth tax

The contribution of wealth tax since its enactment in 1963 (35-years), is only Rs. 1.8 billion 2.28% (1995-96) of the direct taxes. Wealth is created from savings. Savings is unconsumed income that has already been subjected to tax. Why should it then be subjected to retention levy in the form of wealth tax? Why should a person be penalised for not consuming the entire income? Why should he be discouraged from building savings which would ultimately lead to capital formation? Hence, it is proposed to be abolished.

 C.V.T.

C.V.T. was initially imposed as a regulatory tax to encourage people to become assessees as it was imposed only on non assessees. Later due to the poor financial state of the government and lack of application of mind by the bureaucracy, they converted this into a revenue generating tax which was not its initial purpose. Such underhand tactics by the government erode the confidence of the tax payer and make the economy sluggish. Hence in all fairness as all people would be coming into the G.S.T. net and would hopefully be paying income tax also, the continuation of C.V.T. is not justified and hence proposed to be abolished.

 The idea is that people should declare the correct value of property. The provincial government would also be advised to lower registration charges to encourage correct disclosure. Moreover, the contribution of C.V.T. is only 0.85% of direct taxes (1995-96) amounting to Rs. 0.667 billion which would also be offset by G.S.T. Loss of revenue by the provincial governments from lowering the registration charges on property can be compensated by the federal government from G.S.T. collection. However, the loss to the provincial government would be minimised by more people having their properties registered coupled by a law to enforce registration in a specified time.

W.W.F.

W.W.F. is to remain as it is on the genuine corporate sector i.e. large companies. It is calculated as a %tage of the taxable profits of limited companies and gets entwined in the figure of income tax as far as the assessee is concerned. It does not effect the psyche of the assessee and hence it can stay for the organized corporate sector.

 Exemptions.... Level playing field.

The concept of fair play is that everyone should be given a level playing field to exhibit his business prowess. In a boxing match if you tie one persons hands and the expect him to fight, it shall be a mockery of the whole show. At present major portion of our industry is sick. Imagine a situation when our entire industry is operating at optimum level. Would we still require foreign capital for our industrial base. Lopsided financing by state run financial institutions which are heavily prone to influence and other back door methods have landed the economy with hefty unrecovered loans. Less than wise exemptions in direct and indirect taxation have contributed to the mushroom growth of sick industrial units all across the country. To woo new capital the existing entrepreneur has been sacrificed. Unwise financing to less than competent businessmen coupled with unwise exemptions has landed the economy with scores of industrial units that have become sick before take off, not to mention the old established industry which is on the verge of closure due to an unlevel playing field. 

We should cherish our old capital because it offers stability, expertise and experience. We should woo new capital but not at the expense of establish industry. Policy maker should ensure that new capital compliments the existing economic structure and does not counter it. New industry can be offered softer loans to make them competitive. On the basis of the foregoing discussion the entire exemptions both direct and indirect should be considered for being phased out across the board without exception. If exceptions are created, no matter how deserving, they shall be prone to misuse.

 Effective implementation

For the effective implementation of the new tax model, it has been emphasised that the fiscal policies of the provincial governments are in line with those of the federal government. The rhetoric of the government that it is poor is actually projected that way with regard to the daily life style of government functionaries and office bearing politicians and finally the salary package for the tax collectors shall have to be revised keeping in view the status society has given them and their need for a respectable living with honesty.

 Effect on revenue

It is claimed that inspite of the apparent tearing down of the entire revenue structure, the tax decreasing measures would cost the federal revenue about Rs. 22 billion only. Though the new tax model has not quantified the revenue increasing measures yet it is claimed that as per past experience as explained by the highest of levels in the C.B.R., the potential of raising revenue from the unorganised sector in the form as propounded in the model is about twenty times.

Advice

The political mangers have to realize that there are no quick fix remedies to uplift an economy. This model is a product of a preliminary study and certainly has its rough edges. The policy makers need to dwell on its basic theme and see if it falls within their main outlook of the economy as projected into the future. Once approved, an intensive study followed by an extensive interaction with the taxpayer would result in a finer implementable product.

 The economic managers should bear in mind that the model is a “big jigsaw puzzle”. It should either be accepted or rejected in toto. Its selective application in the hope of realising windfall revenues as warned by myself during the enactment of the budget for fiscal year 1998-99 has proved counter productive and shall continue to prove counter productive. The model has to be viewed on a larger screen so that the vision shifts from the myopic image to the “whole scheme of things”.