Wednesday, June 6, 2007

Issues in Tax Management

Issues in tax management

By Mohiuddin Aazim
May 28, 2007 Monday
In 10 months of this fiscal year, the Central Board of Revenue (CBR) has collected Rs656.5 billion against the target of Rs645 billion. The CBR officials believe that the full year collection would also exceed the annual target of Rs835 billion. The government is expected to set the next year target at Rs1 trillion.In Islamabad, economic managers are busy giving final touches to budget proposals for FY2008. The government does not want to introduce any new tax on the eve of elections. But it is looking for ways to broaden the tax base. The CBR has put forward a number of proposals to increase tax collection without levying new taxes.It has instructed tax collectors to bring all those in the sales tax net who are required to pay the tax but are not registered. The CBR has also advised the collectors to use third party information to see who could be brought into the net and to verify whether those already in are paying the taxes honestly. It has sought a report on the subject by June 15.The tax collectors have powers to compulsorily register those providing excisable services, including airlines, banks and financial institutions, foreign exchange companies, money changers, cable operators, and service-providers of vehicle tracker and burglar alarm systems.The CBR and Securities & Exchange Commission of Pakistan (SECP) are also planning to task chartered accountants to issue a separate audit report of companies verifying that they are paying federal and provincial taxes.The revenue collectors have identified various areas where tax evasion is high and the proposed ways to plug it. “Still we are not sure if political expediency would overrule our professional advice,” remarked a senior CBR official. He said that the third quarterly report of CBR issued last week, contained “professional advice on critical issues in tax policy and management”.The 70-page report sheds light on developments in the revenue collection in nine months to March 2007. It reveals that although the CBR met revenue collection target set for July-March FY07, a decline in import-related taxes and additional payments to the power sector squeezed potential tax collection by Rs60 billion.It says the CBR may have to absorb similar shocks in the last quarter of the fiscal year as well but the full year target of Rs835 billion remains within the reach. It claims that even the overall tax to GDP ratio is expected to improve further. (In the last fiscal year it stood around 9.8 per cent).Discussing the role of CBR in increasing tax-to-GDP ratio, the report points out that the policy of facilitating various segments of the economy “needs to have appropriate controls”. The rest of the report elaborates this point effectively.Experts say that one of the reasons for a low tax-to-GDP ratio is a mismatch between the contribution of various sectors of the economy towards GDP and their respective tax contribution. For example, in FY06, agricultural tax revenue totalled Rs874 million or 2.4 per cent of the provincial taxes of which it is a part, whereas the share of agriculture in GDP was 21.6 per cent. And in the first half of this fiscal year, tax collection from agriculture sector stood at Rs268 million or 1.6 per cent of total provincial taxes. The CBR attributes agricultural tax evasion to the fact that it is out of the purview of the federal taxes.What else encourages tax evasion, according to the CBR report, is a law that allows a person to pay income tax only on non-agriculture income, if his agriculture income exceeds Rs80, 000. “Experience shows that the income from other sources is also reported under agriculture income to avoid taxation.”The provincial governments of the Punjab, Sindh and the NWFP collect an insignificant amount of agricultural income tax as presumptive tax. And Balochistan has no contribution at all, says the report. The only federal tax paid by agriculture sector is in the form of indirect taxes on agricultural inputs like fertiliser and pesticides.The report points out that tax contribution of textile sector is also far less than desired. In FY05 the industry paid Rs13.8 billion as indirect taxes whereas CBR paid Rs40.7 billion as refund and rebate. Thus, net tax contribution of the industry was minus Rs26.9 billion.The report links this situation partly to zero-rating of exports for sales tax and partly to the wide-ranging tax exemptions and concessions “granted by the taxation system due to pressure by the strong textile lobby”. In case of income tax, the industry only pays withholding tax 0.75-1.5 per cent at the export stage. Tax collection through this mode is also unimpressive, the report claims.It reveals that the levy of three per cent sales tax on domestic sales of textiles fetched an insignificant amount of Rs4.4 million only against the potential of Rs1.9 billion. Similarly, a one per cent income tax on textile retailers fetched only Rs7.7 million. “At this stage it is pertinent to determine whether the textile sector is paying any amount under sales tax or income tax on its domestic supplies that are not zero-rated,” the report suggests. (CBR estimates that 80 per cent of textile produce is exported and 20 per cent sold in the local market).An official of the All Pakistan Textile Mills Association said the textile industry is paying all the taxes that it is required to pay. “As for the tax on domestic sales of textiles, we would certainly support CBR’s efforts to realise the tax potential,” said Mushtaq A. Vohra, member, managing committee.Market sources say that the CBR can reconcile its data on tax paying retailers with that available with the city governments to plug tax evasion. “In Saddar Town (Karachi) some 4000 retailers have got licenses from the city government to do business in and around the Empress Market alone. I know for sure that hardly 10 per cent of them are registered with CBR,” said a businessman based in Saddar. “Now, if the CBR reconciles data with the city government it would be easier for them to see who is evading taxes.”The CBR report has devoted a special section for iron and steel industry. After analysing the tax trends from various angles, the report says that the tax contribution of this industry has been insignificant in relation to its size. The industry as a whole paid Rs24.5 billion tax in the last fiscal year including income tax of only Rs800 million.The report points out that whereas the tax contribution of Pakistan Steel Mills has remained consistent with its production, this has not been the case with private sector’s iron and steel producers. The report also accuses those located in Lahore and Gujranwala of not paying “their due share of taxes”.The representatives of iron and steel industry have reacted strongly to the CBR findings. In a meeting with a senior CBR official immediately after the release of the report, they said they would oppose any change in the tax regime based on the so-called findings of CBR.“We are neither involved in under-invoicing nor in tax evasion,” a participant of the meeting was quoted as saying. “The CBR figures on tax collection indicates that their own system, perhaps, is not functioning properly.”The report also analyses tax collection from major sectors of the economy i.e. agriculture, mining/quarrying, manufacturing and services. The study shows that the Revenue Productivity (RP) is the lowest and that of the manufacturing is the highest. (Revenue Productivity is an indicator that measures the relation between the extent to which a sector can be taxed under a given tax rate and the potential base and its actual contribution to revenues).Though the tax contribution of manufacturing sector remains the highest as measured through the RP and that is because of better tax compliance by some selected sub-sectors and is not spread evenly across the components of the manufacturing sector.The report points out that food and beverages sub-sector has 10 per cent share in manufacturing and contributes two per cent to the GDP. But its revenue productivity is only two per cent in direct taxes and 27 per cent in indirect taxes.All types of food, agricultural or marine, including fruit juices and cereals are exempt from sales tax and customs duty at domestic and import stages. Only the processed food and beverages are liable to tax.The rationale behind tax exemption on food industry is to keep food prices in check. But the CBR report indirectly suggests that the government may withdraw tax exemptions on this industry and find ways of providing direct relief to the poor through social safety nets.