OICCI RECOMMENDS BROADENING THE TAX BASE

AMANULLAH BASHAR
May 25 - 31, 2009

The government has made a timely decision to broaden the tax net to generate revenue and ease the burden on the already taxed, at a time when Pakistan is faced with an acute shortage of resources.

Appreciating the initiative of the government, the Overseas Investors Chamber of Commerce and Industry (OICCI) has extended its support to the move of the government to bring sectors such as real estate, services, agriculture and bourses into the tax net.

These measures, if adopted will help bolster investors' morale, increase FDI in Pakistan and provide more resources for development, without having to resort to external borrowing and aid.

As outlined in the OICCI Budget Proposals, shared with the government earlier, there is an urgent need to expand the tax base to reduce the burden on the taxpaying section, which is currently represented by a shrinking minority. OICCI had proposed mandatory documentation of all sectors of the economy and to gradually bring them in the tax net.

The announcement that has come is a step in the right direction. The long-term benefits of such a measure will undoubtedly assist in expanding the tax base and OICCI wholeheartedly supports the government in initiatives that will lead to mutual benefit of investors and the country.

This is in line with the OICCI recommendation that an effective tax system can only work where there are identical tax procedures and processes for the same kind or nature of business activities. Furthermore, there has to be no discrimination in incidence of tax in one sector over the other.

Established about 150 years ago, OICCI is the oldest of investment chambers in the country. Its primary function is to foster a conducive, open and equitable business environment in Pakistan while facilitating transfer of best global practices in the country.

Diverse both in terms of sector and geography, the 176 members of the OICCI collectively contribute more than 14 percent of Pakistan's total GNP and 33 percent of total tax receipts.

OICCI has strongly recommended for mandatory documentation of all sectors of the economy including real estate, agriculture, capital markets and manufacturing.

About 40 to 50% of the total manufacturing in Pakistan is done by the medium and small scale manufacturing sector operating in the unorganized sector. In addition the services sector, representing over 50% of the economy, remains largely undocumented and outside the tax net.

By making documentation mandatory, the government will be able to substantially increase tax revenue. This was said by the OICCI in a report related to Budget Proposals for the forth coming Federal Budget.

INVESTMENT ENVIRONMENT & TAX COLLECTION

The tax system and its hassle free implementation are key determinants of investment friendly environment. The opposite is experienced as the organized sector is subject to high levels of compliance whereas the unorganized sector appears to have an implied amnesty.

To overcome these gaps, several mechanisms have been outlined. These proposals will not only assist in reducing the burden on the already taxed, it will aid in improving the tax culture in the short run and increase the tax base in the long run.

OICCI PROPOSES:

1. Reduce Rate of Corporation Tax to Below 30% Pakistan has one of the highest rates of corporate tax in the region (Figure

2). This discourages investors from coming in the country as regional competitors not only offer lower rates but also better security and infrastructure facilities. It is, therefore, recommended that the corporate tax rate be gradually reduced from 35 percent.

Being an important stakeholder in the economy of Pakistan, OICCI apart from providing foreign direct investment, employment generation, corporate social spending and other benefits, also represents perhaps the single largest groups of taxpayers in the country.

"Reform of the tax system and broadening of the tax base has to be at the heart of any economic reform agenda if Pakistan is to achieve its full potential," said Farrukh H. Khan, President OICCI.

He pointed out that a significant hindrance faced by foreign investors in the country is the current Corporate Tax Rate (CTR) which is 35% whereas the average in the region is 30%. Even before an investor looks at risk adjusted returns, Pakistan is at a disadvantage by over 5%. An additional 2% Workers' Welfare Fund (WWF) and 5% Workers' Profit Participation Fund (WPPF) bring the rate to approximately 42%, the highest in the world. The Chamber suggests consolidation of all Labor Levies.

Rebates and Tax Credits should also be provided to reduce the effective tax rate as well as encourage Reinvestment of Capital.

For the tax system to be effective, OICCI believes there should be no discrimination between tax payers with adequate penalties for delinquents. Periodic Tax Amnesty Schemes and provisions like 'Inward foreign remittance,' however, negate this principle and hence need to be eliminated.

In addition to changes in policies, OICCI has suggested several procedural issues via the Budget Proposals. It is recommended that a system of independent audit outsourced to professionals be implemented. Special Benches for Tax cases should also be set up to improve quality and capacity of the appeal process.

Zero rated import of Plant, Machinery and items necessary for local manufacturing should be allowed to encourage industrial growth. Quantitative ceiling on imports for Afghanistan (ATT) and streamlining of exchange control mechanism is required so that those effective administrative and economic barriers are in place to control smuggling.

Presumptive Tax Regime needs to be eliminated sector by sector or for documented companies as it creates discrimination between sectors. The overall rate of Indirect Taxes needs to be reviewed and reduced as it encourages a substantial part of the manufacturing base to operate in the unorganized sector.

BOX

PETROLEUM PRODUCTS TAXED RS101 BN IN JULY-JUNE

AMANULLAH BASHAR

A total Rs 101 billion was collected as Petroleum Development Levy (PDL) on petroleum products during July 2008 to May 2009 whereas gross of Rs53 billion was paid as subsidy in the first quarter of financial year 2009.

On the back of more than 35% share of government taxes including GST plus PDL a 2.5% cut in regulated prices of POL products effective May 22nd may not come to the long awaited expectations of the POL consumers.

The petroleum consumers both in the industries and the commercial users were taken by surprise with what they called insufficient cut of 2.5 percent bringing the petrol prices down from Rs57.66 to Rs56.21 and the diesel prices from Rs.57.17 to Rs56.21 which they said will hardly provide any relief to the hard hit consumers of the price inflation.

It may be recalled that the recent directive from the Supreme Court to provide relief on petroleum products prices has put the government in a difficult spot, given rebound in crude prices and likely high revenue collection targets for next year.

Consequently, a further cut in POL prices may drag down the government's PDL and revenue targets for the financial year 2009-10, especially if the oil price stays above US$60/bbl, financial analysts remarked.

It may be mentioned that the government charges 35 percent different taxes on petroleum products. The POL consumers were expecting a further cut following the final recommendations of the committee constituted by the Supreme Court for a review of oil pricing formula even before the budget in June this year.

Meanwhile the government is actively considering levying a carbon emission tax to mitigate the impact of lower PDL revenue collection in case a further cut is allowed on POL products. However, even if the proposal regarding carbon tax is approved, the proposed carbon tax may not be sufficient to offset the impact of lower tax collection as the amount of carbon tax is likely to be smaller than the reduction in PDL.

In fact, the environmental tax is generally linked with volume of consumption and except for Australia, no other major county has levied carbon tax as far as the oil pricing structures were concerned.

It is estimated that the expected price cut on regulated products is unlikely to have a material impact on the current revenue target as only one month left before the close of the financial year next month.

However, the Court directive may warrant: a relatively low share of government taxes built into product prices meaning the government will have to settle with relatively low PDL collection during financial year 2010 which might be forcing the government to explore other sources to meet its revenue target. It is worth noticing that PDL contributed 3-4% of overall revenue collection from the year 2002 to 2007.