Apr 18 - 24, 2011

Like most of the taxation systems in the world, federal taxes in Pakistan are classified into two broad categories, viz., direct and indirect taxes. Direct taxes primarily comprise income tax and wealth tax. For the purpose of the charge of tax and the computation of total income, all income is classified under the heads i.e. salaries, interest on securities; income from property; income from business or professions; capital gains; and income from other sources.

Pakistan inherited a sophisticated taxation structure at the time of its independence in 1947. The system underwent substantive changes over the years with a view to augmenting the resources as well as meeting other economic needs.

Pakistan's indirect taxation system is aggressive and biased against the poor putting greater burden on the lower income households than the upper ones.

According to a report, the poorest 10-percent of households contribute 16- percent of their income to the three indirect taxes - General Sales Tax (GST), Central Excise Duty (CED) and Customs Duty. However, the report reveals, the burden of tax progressively declines as income rises and the richest 10 percent of households contribute only about 10 percent of their incomes to the indirect taxes.

A significant percentage of the economy remains undocumented and operates outside the tax net. Not only does this act as an impediment towards broadening the tax net, it discourages honest taxpayers. Mandatory documentation of all segments of the economy is essential if the government intends to broaden the tax base and reduce burden on already taxed, experts told PAGE.

According to an Asian Development Bank (ADB) study, the taxation system of Pakistan, which was progressive till 1990, was converted into a regressive regime in 1991 with the introduction of certain withholding provisions in the Income Tax Law and VAT-type tax in the Sales Tax Act, 1990. The result is that during the 20 years period (1991-2010), tax burden on the poorest households is estimated to have increased by 27. 4 percent, while it declined by 15.9 percent on the richest households.

The study states that Pakistan's tax regime consists of four main revenue sources: GST, CED, Customs Duty and Income Tax. Its structure is dominated heavily by indirect taxes, which combine over two-thirds (68 percent) of combined federal and provincial tax receipts. If surcharges are included, it observes, the indirect taxes rise to over three-fourth (76 percent). In terms of the share of federal taxes, indirect taxes account for nearly half (46 percent), and if surcharges are included, it touches 55 percent, the report said.

According to the study, the average share of direct taxes for high income countries is 46 percent, while in the low income countries, it is 28 percent. Iran and India post direct tax shares of 40 percent and 29 per cent respectively as compared to 27 percent by Pakistan. The GST claims 9.3 percent of the income of the poorest 10 percent of households, but only 5.9 percent of the income of the richest 10 percent. In other words, the burden of GST on the lowest deciles is 58 percent higher than the highest deciles. Thus, the CED is the most aggressive tax, with the burden on the lowest deciles being 100 percent higher than on the highest deciles. The customs duties are the least regressive with the burden on the lowest deciles being 28 percent higher as compared to that of the highest deciles. The average burden of direct taxes is 0.3 percent, while the burden of indirect taxes is 13 percent. Nevertheless, the structure of personal income taxes is still progressive.

Experts are of the view that the government departments and organizations are legally obliged to provide information to the Federal Board of Revenue (FBR) for broadening the tax base under the provisions of the Income Tax Ordinance 2001.

Under the Income Tax Ordinance 2001, FBR is authorized to obtain information about citizens from any government department to verify source of income, they said, adding: "The only way to broaden the tax net is to bring more people into tax net. If every department starts providing data to the FBR as per section 176 of the Income Tax Ordinance, Pakistan will enter the regime of countries where the tax-to-GDP ratio has increased through broadening the tax base using third-party information."

They further said that under section 176 of the Income Tax Ordinance, the Commissioner may, by notice in writing, require any person, whether or not liable for tax under Income Tax Ordinance 2001 to furnish to the Commissioner or an authorized officer, any information relevant to any tax as specified in the notice. The Commissioner or authorized officer may require the persons examined to produce any accounts, documents, or computer-stored information in the control of the person.

According to them, mandatory documentation of all segments of the economy is essential if the government intends to broaden the tax base and reduce burden on the already taxed. A significant percentage of the economy remains undocumented and operates outside the tax net and this act is not only an impediment towards broadening the tax net but also discourages honest taxpayers.

Experts believe that there exist certain gaps in the taxation system that need to be addressed for the greater benefit of the country. In this regard, they proposed following measures: Documenting all sector mandatory; Offering incentives to registered entities to deal with tax compliant units only; Effective utilization of data available with FBR especially since 2007 when e-filing was introduced; Using the NADRA database to identify potential taxpayers; Reducing differential in corporate tax for small companies and large corporations; Introducing a system of independent monitoring of turnaround time of various application made to tax office; Corporate Tax Rate be reduced to at least 30 percent to make Pakistan internationally competitive.

Final tax regime (FTR): The application mechanism of the FTR and Minimum Tax Regimes should be adjusted to ensure that the effective rate of tax does not exceed 35 percent.

Over the years, Pakistan's (Income) Tax Base has been more or less stable at 1 per cent or less of the total population. In the United States, 72 million Returns of Income are filed annually with the I.R.S which, given a population of 300 million, translates into a tax base of just over 24 per cent. In Malaysia, the tax base is about 20 per cent, Turkey 5 per cent, and India 2 per cent.

Pakistan's huge and burgeoning 'informal sector' - also known as the 'black economy' and the 'parallel economy' - forms 35 to 55 per cent of formal GDP - and employing some 20 million out of the total labor force of 47 million. A strong will on the part of the government is needed to exploit tax potential available in the country.