SMALL & MEDIUM ENTERPRISES NEED TAX RELIEF FOR AN EFFECTIVE ROLE
Budget 2005-06 announced exemptions from Withholding tax and Turnover tax, and the application of income tax at a reduced rate of 20% for newly incorporated small companies.
From KHALID BUTT, Lahore
May 29 - June 04, 2006
Income Tax The basic exemption limit of income tax to be increased from Rs. 100,000 per annum to Rs. 200,000 per annum in the next budget 2006-07 to enable the small and medium enterprises to play an effective role in building up the economy.
Budget 2005-06 announced exemptions from Withholding tax and Turnover tax, and the application of income tax at a reduced rate of 20% for newly incorporated small companies. It is proposed that Small Companies (registered before 1st July 2005) may also be offered the similar incentives. This will encourage corporatization among SMEs The withholding tax at 0.1% imposed in the budget 2005-06 on cash withdrawal from banks exceeding Rs. 25,000/- should be reviewed. The limit may be increased to Rs. 100,000/-. Government has granted income tax exemption to Federation of Pakistan Chamber of Commerce and Industry. It is proposed that similar tax exemption may be allowed to all chambers of commerce and industry located in small cities. It will encourage their efforts for service provision to SMEs. Tax deductions/ withholding tax at source should be reduced from 3.5% to 1% for Paper and Pulp Manufacturers. Depreciation to be provided in the books of account under the Companies Ordinance should be the same as provided under the Income Tax Ordinance, on written down value (WDV) basis. The rates of depreciation under the Income Tax Ordinance may be rationalized on realistic basis. Workers Welfare Fund is charged on income exceeding Rs. 200,000. Currently it is charged on income exceeding Rs. 100,000. Withholding tax on payment of royalty/technical fee may be reduced from 15% to 5%. Removal of condition of payment of due tax before filing of appeal under section -127 (2).
2. Sales Tax A research by SMEDA has revealed that tax rate median in the South Asian region is 10%; whereas, countries like Taiwan have lowered it to 7%. In the background of regional dynamics for attracting investment, it is proposed that sales tax rate may also be reduced to 7% without exemptions. The rationalization of tax may be done over a period of four-years by deleting sales tax on 10% items in the first year, 20% items in the second year, 30% items in the third year and finally 40% items in the fourth year. Procedure of refund may be made simple and effective as the taxpayers still complain of difficulties. There should be only one tax rate under GST on all type of transactions. GST paid on purchases or inputs should be deducted from GST paid or payable on sale. In cases where tax paid on inputs is in excess of tax payable in a particular month or quarter, the same should be carried over to next period. There is a need to simplify the Sales Tax Registration process at present it takes over a month even after the completion of requirements. General penalties in case of failing to furnish sales tax return may be reduced from existing Rs. 5000/- to Rs. 2000/-. The current penalty applied at the rate of 5% may be reduced to 2% of the amount of tax involved in cases where application is not submitted within the specified period under section 33 sub-section 3. Currently advances received against future sales are considered as sales and tax is deducted on cash basis. An appropriate amendment in the definition of "Time of supply" is proposed. Sindh High Court decided that sales tax was exempted on sold fixed assets; further Ministry of Law, Justice & Human Rights had also given its clarification. CBR has filed an appeal in the Supreme Court for clarification. It is proposed that this issue is resolved immediately. GST exemption on electricity used in the production of export goods: Sales Tax notification SRO 247(1)/2006 dated March 15, 2006 provide facility to 514 industrial units to use electricity by KESC without paying GST. It is proposed that all exporters may be allowed to benefit from these incentives.
3. Customs Import of reconditioned and new machinery has been allowed to certain sectors at zero rate i.e. agriculture, marble & granite, gem & jewellery etc. however, their spares or replacement parts are subject to 25-35% custom duty. It is proposed that machinery replacement parts may also be allowed to import at 0% duty. Tariff rates with special reference to leather & leather goods, children ready-made garments, apparel and footwear industry may be reviewed as the import influx from China is posing serious threat to local industry. Enforcement of Rules of Origin is also proposed. Smuggling is a major threat to local industry. Therefore a list of smuggling prone items may be prepared by CBR in consultation with Chambers and Associations and tax structure on all such items may be rationalized in manner that total levies do not render local industry uncompetitive due to smuggling of similar goods.
4. Sector Specific Recommendations 4.1 Dairy Sector 4.1.1 Tax exemption may be granted to dairy processing machinery. 4.1.2 For the development of model dairy farms, investment in modern technology at farm level proposed to be exempted from income tax for five years. The exemption may be subject to minimum investment and technology being used. 4.1.3 To encourage Dairy and Livestock farming, milk collection infrastructure and processing for value addition/quality improvement it is proposed to allow Dairy & Livestock related equipment, parts, including packaging materials and consumables imports at 0% Customs Duty. 4.1.4 Raw packaging material may be allowed at 0% to 5% duty with a condition to set up local manufacturing facility within 5 years. 4.2 Gems and Jewelry Sector 4.2.1 All machinery, equipment and raw material excluding precious metals may be allowed to be imported at 0% for upgrading the quality of products. Previously only custom duty is exempted 4.2.2 High rate of sales tax and levy of taxes at Provincial level i.e. Provincial Cess/fee/surcharge etc. under import entitlement/authorization against export of jewelry and gemstones makes exports more costly and as a result exporters become unable to compete in international market. It is proposed that all imports against exports must be exempted from taxes, duties, cess, fee and surcharges. 4.3 Marble, Granite & Mineral Sector 4.3.1 Removal of Customs duty and Sales Tax on spare parts, attachments, accessories and consumables will enable industries to upgrade. 4.3.2 Funds for the establishment of machinery pools (banks) in mineral bearing areas may be allocated from PSDP/ADP. 4.3.3 Funds for establishment of Warehouses or Trade Houses in Pakistan may be allocated from PSDP/ADP. 4.4 Cutlery and Stainless Utensils Manufacturers and Exporters 4.4.1 Raw materials should be allowed to be imported at 0% for this industry since raw material prices have increased by 50% rendering the sector uncompetitive. 4.4.2 25% compensation is required in air and sea freight for the industry to be able to come at par with China and Taiwan in the international market. 4.5 Leather Sector 4.5.1 It is proposed that subsidy out of EDF to the extent of 75% for the setting up of waste water treatment plants in individual tanneries/factories in Karachi and some cities of Punjab may be provided. 4.5.2 European Union may be requested to abolish import duty on finished leather being exported from Pakistan, as there is no import duty in Pakistan on such imports from these countries. 4.5.3 Exemption should be granted from the deduction of 1% withholding tax/ income tax on purchase of raw hides and skins. 4.5.4 Import of crust leather or semi finished leather from India may be allowed. 4.5.5 25% freight subsidy on air and sea shipments should be allowed to exporters of leather products as already allowed to leather garment exporters. 4.6 Hotel Industry: The Tourism/Hotel Industry in Pakistan is liable to pay different types of taxes at provincial level in addition to property taxes, Sales tax etc. Following incentives are proposed for development of this industry. 4.6.1 Hotel industry is put under category 'C' and therefore charged higher rates of taxes and duties. They may be considered as an 'export oriented industry' under category 'A'. 4.6.2 Zero duty needs to be applied on import of hotel equipment not manufactured locally for new hotel project. 4.6.3 Tax holidays should be awarded to all new projects of hotels to be constructed in the earthquake-affected areas for at least the gestation period. 4.6.4 Even though hotels have been declared as an industry in the tourism policy, the policy recommendations has not been implemented. 4.6.5 Input sales tax adjustment should be allowed against hotels' sales tax liability. 4.7 Rice Exporters/ Manufacturers 4.7.1 Earlier, Rice Exporters/ Manufacturers were allowed waiver on import duty on the purchase of Jute bags. International buyers now prefer rice packed in other packaging materials. It is therefore, proposed that sales tax and customs duty on packaging material be zero-rated (e.g., p/p bags, OPP bags etc.). 4.7.2 Further, to improve the packaging and printing materials available locally, it is proposed that Institute of Material Management and Institute of Printing and Packaging Technology may be established. 4.8 Knitwear Industry: 4.8.1 Under SRO 621(1) 05, services provided to exporters are treated as export and tax on such services are levied at the same rate as applicable to exporters. Knitting services are not included in the referred SRO. It is proposed that the may be included. 4.8.2 Availability of water at Dyeing Houses is increasingly becoming expensive. Dyeing houses in Karachi are buying water by tanker at the rate of Rs. 6/ Kg. It is proposed adequate arrangements be made to supply water at affordable rates. 4.9 Cables & Conductors Manufacturing Industry 4.9.1 Custom duty may be considered at zero rate on all basic industrial raw materials not manufactured locally including spare parts and related industrial consumable items i.e. Copper Cathode, Aluminum Ingot etc. 4.9.2 10% customs duty on all immediate industrial raw materials locally manufactured such as Aluminum Rod, Copper Rod and PVC Compounds etc. may be considered. 4.9.3 M/s Engro Asahi, the manufacturer of PVC Resin, has been granted 20% custom duty protection since 1999 for five years and extended further for next five years. In addition to this an anti-dumping duty is imposed on this product. It is proposed that 5% customs duty on all basic industrial raw materials locally manufactured including PVC resin be allowed to lower the input cost and meet the shortage of PVC Resin. 4.10 Steel Re-Rolling Industry 4.10.1 Import duty rate on finished m.s. products, i.e. m.s. bars and wire rod should be increased from 10% ad-valorem to 15% ad-valorem. However, Customs duty rate on m.s. Billets and re-rollable steel scrap should be maintained at existing scale. 4.10.2 Building contractors wishing to import structural steel are exempted from withholding tax. This makes their imports cheaper than the locally produced goods, which is a big setback for the local producers. The exemption should be withdrawn. 4.10.3 The industry of steel sector particularly steel re-rolling industry should be charged under a concessional tariff of electricity and gas. Also all government taxes in utility bills of the industry should be waived. 4.11 Surgical Instrument Manufacturers 4.11.1 A 10% research and development subsidy should be awarded to the surgical industry in order to support new product development and innovation. 4.11.2 Withholding tax on surgical industry may also be brought to 1% like other sectors. 4.12 Canvas and Tents Manufacturers and Exporters 4.12.1 Withholding tax should be collected at 0.5% on ordinary exports of other than relief agencies/ international NGO's. 4.12.2 Duty on import of paraffin wax should be withdrawn to increase the volume of exports. 4.13 Textile Sector 4.13.2 Withholding tax on import of goods may be reduced from 6% to 3.5% and on the payment of royalty/ technical fee may be reduced from 15% to 5%. 4.13.3 Instead of installing costly water treatment plants on individual basis, small and medium textile processing units maybe encouraged to install collective treatment plants on community/ cluster basis with a subsidy of fund from PSDP. 4.15 Automotive Parts and Accessories Manufacturers 4.15.1 Government may reduce custom duty on hard coke from 5% to 0%, on pig iron from 5% to 0% and fix the assessment value for cast iron scrap @ USD 200/- per ton. 4.15.2 Steel under the HSC 7207.1110 and 7207.1190 both should be at 5%. Further, all alloys and special steel to 0%. 4.15.3 Export of steel and non-ferrous scrap from Pakistan should be halted temporarily. 4.15.4 All prime materials tariff be brought down to 0% and all secondary material tariffs may also be brought at par to 5%. 4.15.
5. Government may consider 6% WH tax on sale and purchase of new cars so the prices can be lowered and same treatment is meted out to local and imported vehicles. 5. General Recommendations 5.1 Initial Tax Holiday for period of two years to be provided to new SME entrants, this will encourage SMEs registration as taxpayers in addition to simplifying the registration process. 5.2 Withholding tax on electricity bills for industrial consumers are abolished as it increases the cost of production. 5.3 Withholding tax deduction from SMEs may either be removed or the limit be enhanced from Rs. 25,000 to Rs. 100,000. This may also be treated as an alternative to formal tax registration for undocumented SMEs
6. SME SPECIFIC SMEDA has been submitting these proposals on Income Tax to CBR since July 2002. For ready reference these are reproduced. 6.1 There is a need for a separate scheme for SMEs with following features for the successful implementation of new Income Tax law for businesses that under-report their incomes. 6.1.1 The detailed Stock Report with Balance Sheet may be the only documents to be required. It means that a balance sheet declaring capital and all assets & liabilities plus a detailed stock report may suffice the documentary requirement. Any asset i.e. property, automobile or bank a/c not declared in the balance sheet and later discovered may be considered concealment. 6.1.2 To avail off the above short documentation the businesses will pay tax @3-4% of its total capital declared. However, to avail off the smaller documentation one must accept a higher tax payment . The proposed documentation though little, if once accepted will later pave the road towards complete documentation in an evolutionary manner. 6.1.3 It will also make audit exercise simpler, reliable and manageable for the auditor as one has to verify the stocks/assets during any surprise inspection, not the entire operation during the years to verify sales. 6.1.4 In case of default in making any payment of tax under this scheme the taxpayer shall be deemed to have opted for assessment under normal law, and all provisions of the Income Tax Ordinance, 2001 should apply accordingly. 6.1.5 Any SME which chooses to opt for documentation as required under the IT Ordinance 2001 may be given the same tax rebates as offered to the salaried class of taxpayers thereby creating incentive for maintaining books of accounts and also partially hedging the cost of bookkeeping . 6.2 AUDIT 6.2.1 Tax evasion can be detected primarily through effective tax audits and supplementing it with regular tax surveys to identify non-filers and cases of under-declaration and false declaration. Inadequacy of human resource and time place constraint on the ability of tax department for detailed scrutiny. Considering this, income tax department could choose to reduce the number of audits . This strategy will help in significantly improving the quality of audit and better understanding of business processes for tax department's own capacity building. 6.2.2 The business community has been demanding the reduction in the percentage of audits time and again; the announcement of the reduction in the overall percentage of audit partly because of constrains delineated above will help to regain the public trust and give CBR the much needed social mileage. 6.2.3 The entire appeal process should not exceed 2 years. Hence, a clear cut directive that the appellate for a case cannot reopen case on the same issue more than once be given. This will lead to entire appeal process be completed within the proposed timeframe of 2 years with logical transparency and equitable responsibility on each party. 6.2.4 Before embarking on the detailed scrutiny or the audit, Income Tax department may through a letter offer a taxpayer to revise its return voluntarily to avoid audit (like the pre-bargain of NAB). It is assessed that this strategy will help to significantly increase the tax collection without actually going into the audits and should be cost effective as well. However, caution is to be observed towards the delegation of authority to issue such letters as it should not become a tool for harassment and should be sent only to those who have been selected through balloting. 6.2.5 In order to gain taxpayers trust, it is suggested that audit of businesses be conducted by involving trade associations. The tax audit may be conducted at the premises of the trade associations for the demonstration and education purposes and not to penalize in the first year. 6.2.6 Balloting should be deemed an appropriate procedure for audit. No discretionary powers should be delegated to tax officials to tamper with random balloting. 6.2.7 As long as businesses are reporting growth in their incomes, taxpayers should be spared from audit or scrutiny. This will help them to focus on their business activities and establish goodwill of Income Tax department as business friendly agency. 6.3 RECORD KEEPING/ DOCUMENTATION 6.3.1 The long-term objective of documentation of economy can be achieved gradually and progressively. CBR may consider the following strategy: 126.96.36.199 Year 1: Allow businesses to opt for Balance Sheet and Stock Report only and ask no question. 188.8.131.52 Year 2: Enforce maintenance of Cash Memos along with Balance Sheet and Stock Report; they will have little option to refuse but to comply since they have submitted Balance Sheets and Stock Reports in the preceding year. 184.108.40.206 Year 3: Enforce the maintenance of Stock Registers as well. 220.127.116.11 Year 4: Ask for Day Book and complete the chain of business documentation. 18.104.22.168 Record keeping is one of the main problems that the small enterprises face. There are not only financial constraints but also problems due to absence of skills and resources. Small and medium taxpayers require massive sensitization and education on bookkeeping and filing of tax returns. 22.214.171.124 It is understood that documentation through legislation alone can not be implemented. CBR should facilitate compliance through education. For this purpose, a campaign for documentation through mass media is proposed. 6.3.2 The record retaining time limit should be reduced from 5 years to 3 years . 6.3.3 Tax officials' training in variety businesses is imperative and for this purpose various trade and industrial associations can be requested. 6.3.4 Section 175 pertaining to power to enter and search premises often leads to collision between the taxpayers and tax authorities. Hence the provision should be rationalised to create a friendlier environment between the two entities leading to increased revenue collection.