Suggested framework for income tax law

Building the forex reserves Debt Reduction and Management Committee Suggested framework for income tax law

By Prof. Dr. Khawaja Amjad Saeed
June 04 - 10, 2001

Constituents:

This article consists of seven parts as per following details:

Particulars

*Terms of Reference (TOR) of the Committee for revising income tax law
*Chief Executive's Agenda
*Public perception of Income Tax Law
*Canons of Taxation
*Income Tax as part of Current Revenue
*TOR — Review and Suggestions
*Some Specific Suggestions

Terms of reference of the committee for revising income tax law

Terms of Reference of the Committee for revising income tax law are as under:

* Rearrange the scheme of the Income Tax Ordinance, incorporating the tax reform measures with a view specially:
* Ensuring uniformity of tax treatment as for as possible for various categories of taxpayers;
* Reducing dependency on withholding tax;
* Encouraging voluntary compliance backed by strong audit;
* Minimize tax exemption;
* Reviewing the appellate hierarchy and grievance redressal system and incorporate appropriate provisions in the law;
* Remove distortions anomalies to make the law coherent and consistent;
* Improve language of the law with a view to removing ambiguities where the intent of the law is not clear;
* Update the provisions of the ordinance in the light of case law.

Chief Executive's agenda:

General Pervez Musharraf, Chief Executive of Pakistan, announced the following seven point agenda on October 17, 1999:

* Rebuild National Confidence and Morale;
* Strengthen Federation. Remove inter-provincial disharmony and restore national cohesion;
* Revive Economy and restore investors' confidence;
* Ensure Law and Order and dispense speedy justice;
* Depoliticize state institutions;
* Devolution of power to grass root level;
* Ensure swift and across the board accountability.

Good governance was mentioned as the pre-requisite to achieve the above objectives.

Due consideration has been given for carefully studying the foregoing Terms of Reference and the above agenda of the Chief Executive and this write-up has been developed with a positive response for favorable consideration.

Public perception of income tax law

On the basis of meeting business community, tax payers (existing and potential), representatives of trade and industry, tax practitioners and other stakeholders, some of the basic points representing public perception are as under:

* Tax rates are too high and very few are willing to get themselves registered as Income Tax assessees.
* Discretionary use of powers of the income tax authorities is by and large not exercised with a bonafide attitude.
* Honest tax payers have to undergo great hardships and have little confidence in the income tax machinery.
* With the exception of few, there is hardly any positive correlation between the remuneration drawn by the income tax authorities and the life style of the income tax authorities.
* Procedures involved in the income tax assessment are time consuming and cumbersome.
* Vested interest enjoy tax exemption under the Second Schedule annexed to the Income Tax Ordinance, 1979.
* Instead of treating assessees at par and following the golden principle of public finance i.e. 'Taxation of All', some privileged classes enjoy exemptions from income tax.
* Forms for filing income tax return are too complicated and people get fed up in providing these details. Idealism is followed rather than recognizing grass root realities.
* Adhocism continues to be the guiding principle, rather than announcing fiscal policies in a long term perspective.
* Several schemes such as self-assessment announced in the past were more self-harassment than self-assessment. 'Ifs' and 'Buts' have defaced the self-assessment scheme — shattering the confidence of the assessees.
* No code of ethics in written and transparent shape exists for assessees and income tax authorities.
* Hardly any respect exists for honoring the honest tax payers. Lips service announcements in the past in his respect has further eroded the confidence of stakeholders.
* Quality Human Resource Development of income tax authorities in a transparent and result oriented manner appears to be an agenda of the future.
* The decision in appeals against the order of income tax authorities take too long.
* The rise of information technology and working out logistics to interweave it in the assessment/appeal procedures is the crying need of the hour.
* Potential assessees wish to pay income tax but are scared of the harassment inflicted upon them due to current practices resorted to by the income tax authorities.

All in all, the public perception of operationalization of income tax law appears to be very poor. The system screams for significant improvements. In its present shape, it does not appear to be acceptable.

Canons of taxation

Throughout the world, free enterprise economy is being encouraged to grow and develop. Some strongly believe that Adam Smith is reborn. Consequently, there is a dire need to refresh ones mind in respect of Adam Smith's canons of taxation so that, while developing new income tax law or undertaking major revision in it, the spirit of the above canons is genuinely reflected.

Pertinent excerpts from Adam Smith's four celebrated canons of taxation are quoted below:

Canon of Equality

"The subjects of every state ought to contribute towards the support of the government as nearly as possible in proportion to their respective abilities that is in proportion to the revenue which they respectively enjoy under the protection of the state."

Canon of Certainty

"The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor and to every other person. Where it is otherwise, every person subject to tax is put, more or less, in the power of the tax-gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of each aggravation, some present or perquisite to himself."

Canon of Convenience

"Every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it."

Canon of Economy

"Every tax ought to be so contrived as both to take out and to keep out of the pocket of the people as little as possible, over and above what it brings into the public treasury of the state."

However, later economists have added few more canons to Adam Smith's four canons briefly quoted above. Amongst these are the following:

Canon of Elasticity

This means that the tax system should not be rigid.

Canon of Simplicity

KISS model be followed i.e. Keep It Simple Sir.

Income tax as part of current revenue

Based on figures released in Pakistan Federal Revenue Budget for 2000-2001, the position of income tax forecast for 2000-2001 is as under:

Income Tax in the perspective of Current Revenue 2000-2001

Particulars	.	.	.	Billion Rs.	% of Revenue
1. Indirect Taxes	.	.	.	298	50
Composition	Billion	% of Income	% of Current	.	.
.	Rs.	Tax	Revenue	.	.
Sales Tax	172	58%	29%	.	.
Custom Duty	73	24%	12%	..	.
Federal Excise	53	18%	9%	.	.
.	298	100%	50%	.	.
2. Direct Taxes	.	.	.	138	23
Composition	Billion	% of Income	% of Current	.	.
.	Rs.	Tax	Revenue	.	.
Taxes on Income	124	90%	21%	.	.
Wealth Tax	10	7%	1%	.	.
Other	4	3%	1%	.	.
.	138	100%	23%	.	.
3. Non Tax Revenue	.	.	..	121	20
4. Surcharges	.	.	.	38	7
Total Current Revenue	.	.	.	595	100

The present Government has announced that there will be three major taxes at the Federal level namely, Sales Tax, Custom Duty and Income Tax. In this respect, welcome announcements were made for abolishing Wealth Tax w.e.f. July, 2000 and tapering of the Federal Excise in a phased manner.

In the light of above, substantial improvement in the income tax law is the crying need of the day.

Tor — review and suggestions

Four point Terms of Reference (Part — I) was announced. Each of the TOR is now reviewed with suggested framework for consideration by the Committee:

TOR # 1

Rearrange the scheme of the Income Tax Ordinance, incorporating the tax reform measures with a view specially:

(a) Ensuring uniformity of tax treatment as for as possible

Suggestions:

* There is an urgent need for implementing the golden principle of public finance by extending the income tax regime to all tax payers irrespective of caste, creed, nature of business, etc. This will require change in the Constitution of Pakistan by extending the powers of Federal Government to collect income tax on income originating from agriculture activities.
* The current practice of provinces is to impose tax on land and not on the income. This should be withdrawn and vested with Federal Government.
* Some relief to senior citizens of Pakistan with over 65 years of age has been extended in the past with an upper limit of Rs. 200,000/-. This should be dropped and uniformity should be extended. Persons over 65 years will become more productive agents than the kind of discouragement which at present exists and thus uniformity of tax treatment will be ensured.
* The scope of potential income tax assessees was very well spelled out through Finance (Supplementary) Act 1997. Categories included in this respect were: telephone subscribers, owners of motor vehicles, owner of a house or a residential plot of 250 Sq. yards or more or has undertaken foreign travel during the income year — Haj/Umrah/Ziarat excepted. The urgent need is to draw up a practical action plan to implement the spirit of the above. The Income Tax authorities must rise to the occasion and respond to it in a positive manner.

Reducing dependency on withholding tax;

Suggestion:

* It is unfortunate that current data in respect of tax collection are not available from Central Board of Revenue. However, based on last efforts made by us, Direct Taxes, Annual Report for 1995 was available. Our analysis of tax collection is tabulated below:

Particulars	Rs. Millions	%
1. Deductions — Withholding	40	65
2. With the return	9	15
3. Demand	13	20
.	62	100
Source: Direct Taxes: Annual Report 1995, Islamabad: Central Board of Revenue, October, 1995.

It appears that the withholding tax constituted 65% of the direct tax collection. Withholding tax regime was extended because there is very poor income tax culture in Pakistan. It was, therefore, rightly decided that the above withholding tax regime must continue. It is generally felt that, at present, 75% to 85% of income tax constitute withholding tax. This is through deduction of tax at source, payment of advance income tax and through other legislated measures of deducting income tax based on prescribed scales. These scales continue to be revised upward by every government in power. Instead of tapering off the withholding tax regime, there is a need of proper monitoring to ensure that the employees and other business community people are duly educated to deduct appropriate amounts as prescribed by the law. Stock exchanges, trade associations, chamber of commerce and industry and other business bodies should be approached to ensure that withholding taxes are properly deducted and promptly deposited in the coffers of the state. Any departure in this respect should be handled with heavy penalties to set the tempo for corrective action. Our view is that if this area is given due attention, vast scope exists for mobilizing huge income tax revenues which hitherto have been the victim of negligent regime. An institutionalized approach in this respect is the call of the day.

Encouraging voluntary compliance backed by strong audit;

Suggestion:

* An aggressive and open policy for encouraging self-assessment regime without 'ifs' and 'buts' should be operationalized. Now that the national survey has been carried out in the major cities/towns of Pakistan, the Government should carry out a socially backed drive for encouraging voluntary compliance.

Minimize tax exemption;

Suggestion:

* Rather than giving tax exemptions a good idea to follow the principle of Lafer's Curve i.e. Reduction in rate of taxes should be backed up by higher number of income tax assessees — thus harvesting from the elasticity principle. In this perspective, there is a need to substantially water down the income tax exemptions, if not totally eliminate these, under the Second Schedule annexed to the Income Tax Ordinance, 1979. However, the only exception which may be made is for the poor pensioners (civil and military both) who have already suffered from the onslot of low interest rates on their saved wealth and on account of continuous rise of inflation. This will also avoid the possible social upheaval which may follow if their pensions are subjected to income tax. Income of widows may also be included in the income tax exemption regime.

Reviewing the appellate hierarchy and grievance redressal system and incorporate appropriate provisions in the law;

Suggestions:

* The following chart indicates the overall position at a glance relating to appeal before income tax authorities:

Against the order of	Time for filing the appeal	To whom the appeal is to be preferred
Deputy Commissioner	30 days	Appellate Additional Commissioner
Appellate Additional Commissioner	60 days	Appellate Tribunal
Appellate Tribunal	90 days	High Court (only against a point of law)
High Court	60 days	Supreme Court

The following notes are also pertinent in respect of above:

* If order is against the interest of tax department, the I.A.C. can revise the order.
* Within 90 days, revision application be submitted to C.I.T., if appeal is not pending before A.A.C.
* The decision of the Appellate Tribunal is final on a point of fact.
* In case of a point of law only, assessee or C.I.T. may appeal to High Court against the order of the Tribunal.
* An appeal is to be preferred to Supreme Court if High Court certifies that case is a fit one for appeal to Supreme Court.
* The time for filing the appeal appears to be reasonable. However, there is a need for prescribing maximum time for which the appeals must always be decided. This will also ensure speedy justice.
* Moreover, appeal fees may also be reduced to ensure cost effective justice.
* It is advisable that the Fellow Members of the Institute of Cost and Management Accountants of Pakistan may also be declared eligible for appointment as Accountant Member of the Income Tax Appellate Tribunal.

TOR # 2

*Remove distortions anomalies to make the law coherent and consistent

Suggestion:

*The experience gained by assessees, trade bodies and various income tax authorities can be of great advantage in identifying the anomalies and for removing distortions to make the law coherent and consistent. It is hoped that the Committee would have accumulated enough material during their interface with the stakeholders.

TOR # 3&4

* Improve language of the law with a view to removing ambiguities where the intent of the law is not clear;
* Update the provisions of the Ordinance in the light of case law.

Suggestions:

* The Secretariat of the Committee may undertake this homework and reflect the same as part of their contribution in revising the income tax law. The specialized staff of CBR can be of great help. Moreover, the published work of S. A. Salam and Co., Lahore in respect of case law need to be carefully consulted for reflecting the same in implementing the spirit of above Terms of Reference.
* It is our great desire that substantial revenues under the head of income tax law should be collected as that we can not only meet the annual current expenditure of the federal budget but also should be able to finance reasonable portion if not significant one, for financing Federal Annual Development Plan (ADP). In this respect humble suggestions are as under:
* There is a dire need to increase the number of income tax assessees in Pakistan. Credible figures are not available. However, based on the budget speech of the Federal Finance Minister delivered on June 17, 2000, the following numbers were revealed:

Total number of income tax assessees 1.8 million — many believe that this was announced on the higher side as the actual number of income tax assessees is around 1.4 million. This represents hardly 1% of the total population of Pakistan. This ratio is 25% in Hong Kong and 52% in Singapore. Based on the press statement of one of the Former President of Lahore Chamber of Commerce and Industry, the number of potential income tax assessees is around 10 million. However, based on a discussion with a high profile Federal Minister of former PPP regime, this figure is around 7.2 million. He based this forecast on the basis of information made available to him by the officials of CBR. There is a dire need that at least, while benefiting from the national survey already undertaken and implementing the true spirit of the TOR, strategic initiatives should be undertaken to increase the number of income tax assessees to at least 3 million in the short run and 5-7 million in the long run. The implementation of this suggestion will result in wiping out budget deficit and will also enable us to strengthen the foundations of laying down sovereign economic policies with home grown approach.

* The announcement of specialized assessment for cement and textile sectors made in the Federal Budget of 2000-2001 is in the right direction. It is in fitness of things that practising Cost and Management Accountants must be associated with this work so that possibilities of tax evasion may be identified and true taxable profits may be computed. This is also likely to result in collection of higher income tax from the above two sectors.
* Steady and sustained drive for documenting the economy must continue and synergy should be drawn in this respect from the national survey already conducted.
* In a review article published by Newsweek last year, it was stated that annual income tax paid by Barrister Khalid Ishaq of Karachi in one year was more than the total income tax paid by the entire members of the suspended Parliament of Pakistan. This speaks of the extremely poor leadership of the parliamentarians as example setters of paying correct income tax. Rules must be prescribed that, to be eligible to contest for the Parliament, one must have been an income tax assessee for a period of at least 3 years.
* The complicated and intricate system of computing the income tax relating to salary, taxation of perquisites, computation of income tax, etc. should be replaced through a simple approach.
* A comprehensive plan of training the income tax manpower as well as educating the potential assessees should be developed with strengthening the moral frontiers. The divine value system included in Al-Quran should be hammered home. This includes;

Dos

* Do justice: between a person & God and between a person & a person
* Do good to others
* Extend charity to the kindred

Do Nots

* No act of obscenity
* No coercion
* No wickedness

The above is a translation from Sura Al'Nisa.

* There is a need to help develop self accountability as encouraged in Islam. The belief in Hereafter an accountability in the grave and on the day of judgment should be reinforced in all messages to all stakeholders. In this respect the following verse of Sura Yasin of Al-Quran should be popularized through education and training of all concerned:

"On the day of judgment, your mouth will be sealed, your hands will talk to us and your feet will stand testimony as to what you used to do in life".

Some specific suggestions

Miss Nishimizu, World Bank Vice President, speaking at a News Conference on March 14, 2001 in Islamabad, when asked what was the most important outcome of the meeting of the Pakistan Development Forum (PDF), said, 'we told them that reducing poverty, good governance and reviving the economy should be taken into consideration more importantly than anything else'.

The above statement requires substantial in income tax so that poverty alleviation schemes can be initiated, good governance can be extended in income tax regime and through revising the income tax law the confidence of the tax payers may be increased — bolstering steps for revival of the economy of Pakistan.

* At present, minimum tax rate for salaried and non-salaried tax payers is 5% and the maximum is 35%. This is spread on 5 slabs, which may be reduced to 4 with a minimum of 5% and a maximum of 25%. However rebates available may be withdrawn.
* No change is suggested in the minimum threshold for becoming an assessee under income tax law. Any upward increase in this respect will reduce the number of income tax assessees who will slip out of the income tax net.
* There is an outcry by the Privatization Commission to reduce the income tax rate for banking companies which at present is 58%. This may be considered in view of motivating foreign investors to bid for the nationalized commercial banks. It is very difficult to remove the distinction between a registered firm under Section 68 of the Income Tax Ordinance and un-registered firms. An effort was made to withdraw the registration of firms in the PPP regime in earlier 1970s, but the then democratic government, under pressure from the business community, reinstated the registration of the firms. In view of the business culture in Pakistan, tax avoidance under the garb of registered firm through beefing up the number of sleeping/silent partners is likely to continue. Therefore, the right approach is to continue with the present system but the rates of super tax for registered firms included in the First Schedule annexed to the Income Tax Ordinance 1979 should be reviewed for a steady upward revision. Any effort to withdraw existing registration of firm under the above Ordinance will have destabilizing effect in business community.
* The income tax law should require mandatory maintenance of accounts by all tax payers. Employment will be generated for commerce/business graduates including professionally qualified chartered accountants and cost and management accountants and this would be a supportive step in right direction for documenting the economy.

Conclusion

While the patriotic citizens of Pakistan and the brave and chivalrous armed forces of Pakistan present a strong deterrent with nuclear backed technology, there is a great need for strengthening and fortifying the financial defence of Pakistan. This requires substantial reduction in current expenditure, operationalizing self-reliant approach and optimal domestic resource mobilization. The sooner the strategy is implemented the better it will be in the interest of our Country. Therefore, it is high time that all creative and innovative efforts are made to revise the income tax law in the Country, redress the grievances of income tax assessees and also strengthen institutionalized efforts of revamping and substantially improving the income tax department to achieve the above goals. Everybody must contribute to the above strategic goals.

*Chartered Accountant, Cost & Management Accountant, Former Pro Vice-Chancellor, University of the Punjab, Lahore.