Apparently there is no logic as an
exorbitant corporate tax is being charged on the earnings
By SHABBIR H. KAZMI
July 19 - 25, 1999
While no where in the world the reserves
of corporates are taxable, in Pakistan these have become taxable from the current
financial year. This has been termed, on the one hand, an effort to squeeze tax from
already burdened tax payers and on the other hand acceptance of failure of tax collectors
to bring those under the tax net who have been rampantly evading tax. At the best this
effort would defy the process of documentation of economy in the country and encourage tax
evasion. The patience of tax payers has exceeded the tolerance limit.
According to new regulation, all companies
having reserves 50 per cent or more than paid-up capital will be liable to pay 10 per cent
tax on excess reserves. Most of the analysts term this highly ambiguous. Although the
change in the income tax law, in recent budget, was aimed at penalizing companies which do
not pay dividend despite huge earnings and transfer the earnings to reserves. The change
will adversely affect the good performing companies which also pay dividend to their
Some analysts say that the economic
managers do not understand the philosophy behind imposing tax. At present roughly 42,000
incorporated companies, both private and public limited, are in operation in the country.
This number is besides hundreds and thousand of proprietorship and partnership entities.
Out of these only 769 companies are listed at the three stock exchanges operating in
Pakistan. These less than eight hundred companies and their employees are also the main
source of revenue collection for the government.
According to Etrat Hussain, chief
executive of Paramount Leasing Company, the investors in public limited companies are
already double taxes. Corporate tax is levied on the earnings and the dividend income of
shareholders is also taxable. Now, the government wishes to collect yet another tax from
these companies. This shows complete lack of understanding about the basic concept of
transfer of earnings to reserves.
Therefore, first of all it is necessary to
understand the purpose of transferring part of income to reserves. The objective is to
accumulate money for future expansion of the operation of corporate and undertake BMR on
regular basis. Besides, to have enough funds at the disposal of the corporate to take care
of any contingency in the future. Yet another reason is to meet the statutory requirements
in case of commercial banks and non banking financial institutions (NBFIs). By taxing the
reserves the whole purpose is defeated. Above all there is absolutely no rationale in
collecting tax on the reserves part of earnings when income tax has been paid on
the total income of the corporate.
According to many analysts, the corporate
sector in Pakistan is not only over-burdened with taxes but a lot of time and energy of
the management are being wasted on compliance of instructions of tax collection agencies.
These agencies often raise inflated demands mainly to compensate for their inability to
meet the required tax collection targets.
The employees of corporate sector also
have a valid point. In the budget for the current financial year, salaries of government
servants have been increased and perquisites of salaried class of private sector have
become taxable. Most of the government employees are provided free accommodation, fully
maintained cars, drivers and attendants. Why the cost of such facilities are not being
added back to determine their tax liability? Why there is a discrimination between the
government servants and the employees of private sector? If the government is serious in
collecting tax from every citizen the parameters for calculating their tax liability
should also be same for all.
According to the head of research of a
fund manager, Theory of Finance says that if a company earns a return which is more than
its weighted average cost of capital (WACC), than it should retain a higher portion of
profit to reinvest into the business. This will ensure greater value-addition to
shareholders. However, if the company earns a return on capital which is lower than WACC
then it should distribute the profit to shareholders in the form of higher dividend. The
Theory does not say that dividend should not be paid, only the payout ratio should
commensurate with the firm's ability to earn a return equal or greater than WACC. Analysts
have generally assessed that the WACC for a medium size Pakistani Company ranges from 22
to 28 per cent. If the return on average capital (ROAC) is lower than this range then
there is a strong case for higher dividend payout. Analysts are generally of the view that
fiscal policy, i.e. taxation, is not the appropriate way to tackle the non-payment of
dividend by majority of the listed companies. They point out that it would be better if
appropriate changes in corporate laws are made which are then strictly implemented with
specific penalties on a case to case basis by the newly formed Securities and Exchange
Commission of Pakistan.