Seminar in Economics Policy

TOPIC: Potential for increase indirect taxation in Pakistan for next decade.

Submitted to: Dr.Rafique

Submitted by:
QURAT-UL-AIN SABIR (53084) SYED TAQI HAIDER( )

Potential for increase indirect taxation in Pakistan for next decade

The term indirect tax has more than one meaning. In the colloquial sense, an indirect tax (such as sales tax, value added tax (VAT), or goods and services tax (GST)) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). The intermediary later files a tax return and forwards the tax proceeds to government with the return. In this sense, the term indirect tax is contrasted with a direct tax which is collected directly by government from the persons (legal or natural) on which it is imposed. Some commentators have argued that "a direct tax is one that cannot be shifted by the taxpayer to someone else, whereas an indirect tax can be. An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products. Examples would be fuel, liquor, and cigarette taxes. An excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately the manufacturer transfers the burden of this duty to the buyer of the car in form of a higher price. Thus, an indirect tax is such which can be shifted or passed on.

Indirect tax policy consideration

Consumption taxes have grown to be a major source of tax revenue for governments around the globe. Tax authorities worldwide are gradually migrating the overall tax burden from direct tax to the less visible indirect taxes and are the sole big reason of increasing inflation. In a recent survey, consumption taxes constituted approximately 30 percent of total taxation in OECD countries while in some countries these constituted more than 50 percent of the total tax revenue. As the honorable chairman of proposed FBR has excise and customs are dying levies, hence, 1990 which is about to be replaced with value added tax in near future and a committee is working in CBR over this law. As now that consumption taxes are taking more prominent role, currently our government is also more focused on deriving maximum benefit from these taxes like consumption tax policies, legislation and auditing are all under increased scrutiny by government and tax officials. Currently, Pakistan is moving ahead in the right direction recommended by the World Bank which covers four broad measures to progressively reform taxation in general. 1. Consolidation of the number of taxes

2. Cutting back on special exemptions and privileges 3. Simplifying filing requirement 4. Broadening the tax base by keeping rates moderate in the developing countries However, the recommendation of something more in the light of directions given by working party No. 9 of OECD double taxation treaties of indirect taxes. Government must prepare such treaties with an aim to avoid double taxation, promote harmonization of rules, mutual co-operation, simplification of administration and above all certainty for business. CONSUMPTION TAX POLICIES At the moment a consistent indirect policy keeping an eye over literacy rate and geographical segregation of urban and rural population is not reflective from any document. CBR is not the only institution which is responsible for reduced tax to GDP ratio. Other institutions are also responsible for this reduced tax to GDP ration owing to the low literacy rate. There is a dire need to increase the literacy rate not only to increase the tax to GDP ratio but also the civic sense. Efforts must not only be concentrated towards illiterates, CBR must work with ministry of education to include the concept of tax, need for imposing tax, types of taxes in Pakistan, basic tax calculation of direct and indirect taxes etc in the appropriate portion of syllabus at various classes or stages at school and college level and do not limit it like a 30 marks portion in B. Com. From the administrative front, recommend replacing the use of designation of collectors, assistant collectors, Inspectors, commissioner, taxation officers with assistant manager, manager, senior manager like tax facilitation manager, tax audit manager and taxpayer care manager. This will have a deep impact over the mind set of tax machinery. The training at DOT must not concentrate only on law but the difference between wrong decisions, that is, an order of an economic manager and finance manager also need to be crystal clear in their mindset by experience sharing. Moreover, there must be a process of consultation within tax machinery for complex issues and not just throwing the ball for appeal forums. The three dimensional strategy of Excise Tax and five dimensional strategy of Sales tax needs to be principally based instead rule based facilitation to bring certainty in Business Planning and removal of unnecessary doubts about the discrimination and transparency issues. Such conflicting rule based facilitation with dimensional tax legislation makes the excise and sales tax law the most difficult piece of legislation to comprehend.

The fact that strategies are hard to apply and hard to manage, however, principle based strategy is much easier to apply then a rule based strategy. TAX ON TAX and RATES OF TAX Tax on tax issue is not limited to section 148 of Income Tax Ordinance, 2001 but has its roots in Sales Tax and Excise tax also. On the excise front, excise tax machinery now days taking a view that according to section 12(4), excise tax needs to be inclusive for the purpose of determination of value for the purpose of duty under section 12. Although various precedence in field at the moment, however, things need to be cleared with efficient advice mechanism for machinery by the CBR as it deteriorates the image. Section 2 (46) value of supply, clause (a) and (d) clearly enunciates the fact that sales tax needs to be levied on value inclusive of all taxes specially federal excise. Such tax on tax needs to be removed and have a considerable effect over consumer price and sensitive price index issued by state bank of Pakistan. A levy needs to be independent in order to calculate its impact tax on tax is clearly an impediment for the tax administration owing to the variability in tax rates. It is worthwhile here to note that rates of tax coupled with tax on tax varies the prices considerably when the items covered in sensitive price index are now manufactured and becomes the indispensable part of life of urban population. Removal of tax on tax and reduction in tax rates of indirect taxes, especially 15% rate of sales tax will greatly relieve the SPI which is continuously moving upward. EXCISE TAX Rule 40A (4) of Federal Excise Rules, 2005 [FER, 2005] and section 12(2) of FEA, 2005 are highly debated in the professional circles of banking industry. Some professionals believe rule 40A (4) of FER, 2005 read with section 12(2) of the FEA, 2005 creates two fictions while others believe in three in respect of chargeability of excise duty on normal rates irrespective of following. 1. Provided free of charge 2. At discounted rate or 3. Normal rate. A clarification needs to be issued to avoid plethora of cases in this regards. These will also bringing certainty. However, banks are at safer side owing to precedence available in this regard.

According to section 7 of Federal Excise Act, 2005, there are only some manufacturers which are authorized to claim input under Sales Tax Act, 1990 on payment of excise tax. This list needs to include other manufacturers also to move in the direction of burying this law and increased consolidation towards sales tax and administration. As we know that the sales tax on services is moving in the right direction and constitutional impediment was overcome through effective arrangement, however, this may not a long term solution. RECORD KEEPING The strategy for prescribing the necessary records should be principle based instead of existing rule based methodology. In a principle based methodology, the taxpayers can effectively be categorized as large, medium and small. Large taxpayers normally maintain detailed records not only for tax purposes but for effective data mining to ascertain their business share in the market and effective marketing plan for future potential. CBR should prescribe the postulates of their documents instead of the document itself. Medium taxpayers are requested to closely align their documentation according to law while the prescription of document method needs to be left for small taxpayers. Currently, there is no time limit needs to be prescribed in section 22 of Sales Tax Act, 1990 like section 17 of Federal Excise Act, 2005. In this regard, I would like to quote the recent judgment of Honorable Supreme Court whereby fixed asset and scrap are liable for output sales tax at the point of sales. Unfortunately, none of the appellant tried to took the direction from Honorable Supreme Court for CBR in respect of inconsistent treatment of input and output of fixed asset. Moreover, the constraint of minimum ten years record keeping requirement under section 230(6) of Companies Ordinance, 1984 has not been brought to the lime light as there is not notification available under section 22 of Sales Tax Act, 1990 which clearly specifies the holding period of records. However, from the face of the judgment, in some cases much more than ten years have elapsed and in the absence of any prescribed time limit in fiscal laws, the Companies Ordinance, 1984 becomes the base law for such companies. Lets hope for a good review petition taking appropriate direction from the courts as it can not provide for the deficiency in law in view of Article 4 of the constitution, while exercising powers under Article 199 of the constitution. strongly request CBR to resolve this matter amicably and neither revenue should discuss the fact that liability arise because of taxpayers incorrect interpretation nor taxpayer will argue that their understanding is based on varying notifications in the field

AUDIT Moreover, the existing audit section needs to be rephrased under one chapter which may include audit management, taxpayers obligation, authorized representative obligation, modus operandi of audit, modus operandi of audit decision, postulates of an audit order and time frame to conduct & complete the audit. From the corporatization front, Section 96, 97 and 98 of Income Tax Ordinance, 2001 relating to promotion of corporatization is neither harmonized with sales tax nor with excise tax specifically stress over sub-section (2) of section 49 of Sales Tax Act, 1990 which needs to be suitably amended in order to avoid the timing difference and problems currently being faced by the taxpayers. TAX REFUND INFORMATION SYSTEM It is really applaud able that CBR is making experience adjustment starting from STARR, RCPS and now CREST, however, taxpayers are still suffering. This is just because of lack of efficient IT policy which do not use appropriate system analysis methodology. suggest that CBR must consider accepting the refund related reports in MS Excel format apart from any new software; hence, the most distinguishing feature of any new software is its capability of importing such MS Excel report. By this way the taxpayers will be relieved from current practice of hectic data entry into STARR then RCPS now CREST. Moreover, CBR may stick to its current practice of refund claim during current year but must allow adjustment of refund against various different taxes during same fiscal year income, sale, excise and custom. A detailed modus operandi may be formulated which may include notifying different departments etc. This will have a considerable impact not only over the working capital cycle of business in avoiding liquidity crunch and taking unnecessary high cost loans but also help CBR in showing true revenue collection less tax refundable. GROUP RELIEF would like to suggest that Group relief needs to be incorporated into the Sales and Excise Tax Acts whereby intermediate supply related transactions falling within the ambit of Sales Tax needs to be zero rated while intermediate goods used by another group needs to be exempted from excise tax. SHARIAH COMPLIANT FINANCIAL PRODUCT Shariah Compliant Financial Product instead of Islamic Banks deliberately as Securities and Exchange Commission of Pakistan is currently working over a framework whereby NBFC will also be able to undertake and offer Shariah compliant financial product resembling to their current financial product. The sales tax treatment of Shariah compliant financial products is somewhat uncertain and produces anomalous results. These anomalies can put the providers of Shariah compliant financial products at a commercial disadvantage.

Conventional financial institutions are at ease to structure the transaction, for instance, consumer finance, and hire purchase etc in such a manner that it does not fall within the ambit of Sales Tax Act, 1990. It is suggested that Shariah compliant financial products need to be brought out specifically from the preview not by implication which is the current state. This will bring the Shariah compliant financial product providers at par with conventional financial products providers and remove uncertainty. there are many new investments are in the offing and waiting for clarity. RECTIFICATION OF ERROR OR MISTAKE BROUGHT TO THE NOTICE Currently, Sales Tax Act, 1990 do not contain any specific provision parallel to section 221 of the Income Tax Ordinance, 2001. Although the concept is present in various section but in the absence of such specific provision claim of refund under complex situations remain unresolved for instance correction of errors, revision of return, issuance of debit and credit note etc. Apart from refund claim, appeal stages also feel handicapped when any mistake was brought to their notice. CUSTOM TARRIF Rationalization of tariff after the WTO regime and continual Free Trade Agreements make this an unobservable secondary issue and this is also realized by CBR, hence, honorable chairman of CBR has stated that it is a dying levy. It is suggested that tariffs needs to be suitably amended which promote investment in manufacturing and IT sector not only to become the regional hub, not only relying over textile export but a diversified product base exporter resulting in increased GDP, facilitation of transfer of modern technology including research not just technological equipment. Moreover, CBR may not be able to reap any benefit from IT related efforts in customs unless and until there databases are attached through a key field to fetch the data and are connected through a secure intranet with the use WAN. Must appreciate the efforts of CBR who is trying to provide developed countries facilities in a developing country but it must adopt the practice and thoughts as tactical cum strategic economic managers not finance managers. On productivity front of masses, I would like to end up on the borrowed phrases from the preamble of History of Ibn e Khaldoon. if the government gives top priority or keeps an eye over facilitation and judicial system then the boldness, sense of honor and self respect remains the personality trait of the masses. However, if the government takes help from chastisement and conquest then boldness, sense of honor and self respect gradually extinct from the personality masses and the ability of guardianship and striving to repel an assailant would become almost absent. In other words, this procedure conquers their personality traits and sooner or later they become lazy and good for nothing that is non-productive

Tax offers Pakistan escape from poverty

Pakistanis were thrilled to hear United States Secretary of State Hillary Clinton during her recent visit chiding the Asian country's business elite for their tax-shy habits. During her October 28-30 visit, she met business leaders in Lahore, capital of the Punjab, Pakistan's most populous and most prosperous province, for plain talk. Addressing a conference in the Governor's House, where captains of industry were assembled, she stunned her audience by setting aside diplomatic niceties to hammer home a straight and searing message: At the risk of sounding undiplomatic, Pakistan has to have internal investment in your public services and your business opportunities ... The percentage of taxes on GDP [gross domestic product] is among the lowest in the world ... We [the United States] tax everything that moves and doesn't move, and that's not what we see in Pakistan ... You do have 180 million people. Your population is projected to be about 300 million. And I don't know what you're gonna do with that kind of challenge, unless you start planning right now. Middle Pakistan cheered her candor and echoed her concerns. The US regards Pakistan's national security as inextricably linked to its economic security. The US Congress's Enhanced Partnership with Pakistan Act (EPPA) of 2009, which President Barack Obama signed into law on October 16, attests to this new US vision of Pakistan. The EPPA (otherwise known as the Kerry-Lugar Bill) will provide Pakistan with US$7.5 billion in economic aid over the next five years. This is the single-largest aid package the US has offered to any ally, although Pakistan has long been one of the largest recipients of US aid, which puts it next only to Egypt and Israel (listed alphabetically). According to the US Congressional Research Service (CRS), Pakistan received $15 billion in US economic and military assistance in the 1947-2004 period. Islamabad, however, has garnered far more indirect benefits from its relationship with the United States, especially since the 9/11 terror attacks there. A Pakistani lawmaker valued the indirect benefits at a remarkable $50 billion. Irfan Siddiqi, a conservative journalist who opposes the EPPA, reported that $85 billion had flowed into Pakistan since 9/11. A major illustration of these benefits is remittances by Pakistani expatriates, which stood at close to $1 billion in 2001, and have now risen to $12 billion a year. Yet these benefits are vertical in growth, which hardly trickle down to the average Pakistani. What makes this vertical accumulation even worse is its immunity to taxation. As a result, it does little to help the government escape from the trap of an enduring fiscal deficit - a gap between the government's annual revenue and its expenditure - and

increase what little it has to invest in what Clinton calls "public services". Pakistan has been financing the fiscal deficit with external and internal borrowings. In 2008, the fiscal deficit climbed to almost $9 billion (722.5 billion rupees), which came to 5% of Pakistan's gross domestic product (GDP) of $160 billion. The financing of this gap drains the government of every ounce of its fiscal energy. The result is extensive cuts in its public expenditure, at a time when governments around the world are stoking public spending to keep afloat. In 2008, the government budgeted 646 billion rupees (US$8 billion) for public sector development (PSD), which includes spending on defense, economic development, education, and healthcare. Public healthcare claimed a laughable allocation of $79 million for a nation of 180 million people, that is 43 cents per person per year. The untaxed vertical growth, a severe fiscal deficit, and reduced public expenditures are what fuels poverty in Pakistan. As of 2009, 40% of the national population lives below the poverty line, which in Pakistan is liberally defined as a food intake that is equivalent of the daily need of an adult's caloric consumption. In other words, if a person secures the daily diet of required calories, she/he is "unpoor;" if they fall short, they are "poor". Even by this liberal definition, 72 million Pakistanis, according to the Pakistan Planning Commission, still live below the poverty line. Some independent observers, such as banker and economist Shahid Hasan Siddiqi, believe that 50% of the national population (that is, 87 million Pakistanis) is at risk of slipping below the poverty threshold. The Mahbubul Haq Development Center counts 73% of the population living below the poverty line. Many blame the regime of former president Pervez Musharraf for reducing the definition of poverty to make it appear there were fewer people than there actually were. Prior to October 2006, the Musharraf government reported 33.6% of the population as poor; as of that month, it claimed the rate was down to 23%. Poverty varies across Pakistan. The most deprived parts include rural areas, followed by Balochistan and the Pakhtunkhwa, which border Afghanistan. Rural Pakhtunkhwa is the worst hit by privation. The Federally Administered Tribal Areas (FATAs), 97% of which are rural. are little better off. According to the World Food Program, the entirety of the FATAs are food-insecure. Poverty among 3.3 million residents of the tribal areas is as high as 90%. The Awami National Party, which leads the coalition government in the Pakhtunkhwa, has worked out a long-term economic construction plan for the seven tribal agencies, which will cost $12 billion. Pakistan, however, needs $50 billion nationwide - $5 billion a year for 10 years - to make a meaningful dent in the existing level of poverty. To raise this kind of money, the country has to mobilize its own resources by having taxable income-earners (individuals and companies) pay their fair share. Yet Pakistan has

been grossly undertaxed, largely thanks to military regimes - of Ayub Khan, Zia ul-Haq and Musharraf. These regimes did not rely on tax revenue to stay afloat. Instead, they traded in their geopolitical utility to keep them in cash. They each, therefore, went easy on the urbanindustrial elite and large landholders in exchange for their support in grabbing power. As a result, the tax-GDP ratio under these governments, which Clinton lamented, hovered around 10%. The ratio increased to 14% in the 1990s, when democratically elected governments of the Pakistan People's Party (PPP) and Pakistan Muslim League (PML) were at the helm. The late prime minister, Benazir Bhutto, during her second term in office (1993-1996), took the national housekeeping far more seriously. She went after the "untouchables", such as the All Pakistan Textile Mills Association (APTMA), to persuade them to open their checkbooks to the treasury. She would use chalk and board, according to Mirza Ikhtiar Baig, an aide to Bhutto, to convince naysayers among textile barons to contribute to the national till. Yet the textile sector, which had a projected income of $11 billion in 2007-08, has almost been tax-exempt. Many believe that textile tycoons constituted some of the power behind Bhutto's ouster in 1996. In general, those who form the top of the economic pyramid in Pakistan are resistant to paying their fair share in taxes. Large landholders are especially notorious in evading the taxman. In the 1990s, the government took on the landowning classes and had legislation passed to tax their income, the first time the taboo on taxing farm income was broken. Although the legislation was toothless, it was symbolically potent. The landowning classes, who ride on their landownership into the legislative chambers, were thus cut down by their own power after for long taking tax-exemption as their entitlement. A case in point is Sardar Farooq Legari, whose estates extend from the Punjab to the Pakhtunkhwa. In 1994-95, he reported "zero income" while he was still the sitting president of Pakistan. Imran Khan, leader of the Pakistan Tehrik-e-Insaf (Pakistan's Justice Movement) shamed the entire landed class by revealing that a practicing lawyer, Khalid Ishaq, paid more in taxes in 1992-93 than all 273 members of the National Assembly combined - 85% of whom were large landholders. This shaming, however, did not work on lawmakers who kept evading taxes. In 1994-95, celebrated journalist-writer M Ziauddin conducted a thorough investigation into the taxable farm income and tax-paying behavior of wealthy farmers. He found that all landlords in the country pitched in just chump change of 2 million rupees in taxes in 1996 against their annual income of 600 billion rupees. On this scale, Ziauddin concluded that the landowning classes had been evading taxes of 100 billion rupees a year. This is a blatant case of tax theft, which has spawned its own vicious knock-offs, one of which is "black money" (that is, totally untaxed wealth). In 1996, an economist estimated that black money in Pakistan grew as large as to form 40% of GDP. If left alone, tax

evasion in the above-ground economy or underground economy increases the budget deficit and forces governments to shift the tax burden to consumers or to increase money supply. In either case, it is a whammy for the poor. In the 2008-09 budget, Pakistan has set itself on the course of widening the tax net. In terms of the tax-GDP ratio, the current budget features a relatively high ratio at 14%. The tax base also is on the rise. In 1994, it consisted of an overwhelming majority of the working middle class of 800,000 tax payers, who have now grown to more than 2 million. The government, thus, can over the next 10 years raise $50 billion - $5 billion a year - to rein in poverty. At the current exchange rate, $5 billion comes to 345 billion rupees. Economist Shahid Hasan Siddiqi believes that Pakistan is undertaxed by 400 billion rupees a year. Its tax revenue should be 1.6 trillion rupees as against the projected 1.25 trillion rupees for 2008-09. The government can close this gap by eliminating tax exemptions. It is unfair for a country like Pakistan to give a two-year tax holiday on capital gains, which, according to Siddiqi, costs the government 112 billion rupees a year. Yet the stock market capitalization has more than doubled from 2,100 billion rupees to 4,600 billion rupees within the past three years. This means that the government's tax holiday is encouraging surplus wealth away from productive enterprises to unproductive ventures such as the stock market. Similarly, agriculture's contribution to GDP (of $160 billion) is 21%; but its share in tax revenue is just 1%. At least an additional 100 billion rupees can be raised by bringing farm income to tax. Siddiqi also lists the most profitable industries such as textile, cement and sugar, which are near tax-exempt or pay very little in taxes. They can be readily targeted for at least another 100 billion rupees. Similarly, the corporate sector is ridiculously undertaxed. The country's 768 top corporations posted taxable income as low as 8,300 rupees ($100 at the current rate) a month; while 2,341 corporations claimed to be in the red. Another 1,193 big companies reported 33,400 rupees a month in taxable income. In parallel, the banking industry that has been swimming in profits - with takings of 123.6 billion rupees in 2006 alone - yet have had their tax rate reduced to 35% from 38%. Economist Mahnaz Fatima decries the government for slashing the tax-GDP ratio to 13.5% in 2006 from 17.2% in 1995. Siddiqi argues that a tax-GDP ratio of 15% can raise the projected tax revenue of 1,250 billion rupees to 1,650 billion rupees, yielding additional 400 billion rupees. Last but not least, the government needs to widen its tax net to black money. Although it has attempted to net the untaxed and black money in its 2008-09 budget, that is not nearly enough. To have a stolen pile in untaxed wealth laundered white for 2% of giveaways in

taxes will only invite public wrath. Given the dire straits in which Pakistan finds itself, such wealth ideally should be confiscated or mercilessly taxed up to 85%. Any of the preceding measures, jointly or severally, can help the government raise $50 billion over the next 10 years to combat the severity of poverty in the country. Clinton's call for an increase in tax-GDP ratio to help Pakistan meet its challenges ahead couldn't be more appropriate.

Indirect Taxation playing havoc rolls in Pakistan

The Federal Board of Revenue (FBR) says if the half-yearly target (about 45% of the revenue target of Rs 1380 billion) is not met, the government would be forced to levy new taxes or enhance the rate of some prevalent ones. The nation has already received the Eid gift in the shape of substantial hike in POL prices, coupled with an 18 percent power and a 26 percent gas tariff increase. All these jolted the entire nation, especially the business community. These measures have been announced when the industry is on the verge of a collapse. The expected increase in the cost of doing business, after these steps, will be the final deathblow for the entire economy. The government, instead of reducing wasteful expenses is increasing the prices of inputs utilized by the business houses, without realizing its impact on the common mans life. Businessmen can no longer recover the cost of various inputs from the end users the purchasing power of the masses is fast-diminishing. The untapped avenues of resource mobilization the introduction of progressive taxes and the increase in production are totally being ignored by the government. The result is overall industrial recession, closures of more and more units, rising unemployment and poverty. The businessmen have rightly stressed upon the government to explore avenues for broadening the tax-base, instead of putting more pressure on the existing taxpayers. There is no dispute over the fact that the government needs more financial resources to steer the country out of poverty and bring economic stability in the country. But it does not imply that the government should spend all its energies on exploiting the existing tax bases. Rather it should take measures to expand the tax-base as there exist enormous opportunities to broaden the tax-net by eliminating tax-exemptions. For example, agriculture accounts for 22 percent of the GDP, but contributes just 1 percent to the tax revenue, while this sector has the potential to generate sufficient chunk of tax-revenue. It is the most ignored sector.

Total investment in this sector60% of total population depends on itis 1% of GDP. Had the State invested substantially in agriculture, we could have increased our GDP growth rate to 7% to 9%. Resultantly tax from this sector alone could have been between Rs. 1.5 to 2.5 trillion. The right strategy would be more and more growth in agricultural sector, including agrobased industries. Tax will be a natural outcome of accelerated growth in economy. Expecting, or forcing, extraordinary growth in tax collection in an ailing economy can only be counter productive. The business houses are already facing multiple problems. The government, instead of giving those bail-outs, is increasing 18 percent power tariffs, 26 percent gas tariffs and 2 percent FED. Foreign direct investment (FDI) has already posted a decline of 53 percent and exports have fallen by 9 percent in the first four months of the current financial year. It is a fact that our economic managers and tax collectors have utterly failed to remove the fiscal imbalances. Their tax policies are based on collecting taxes at the source and without bringing the mighty sections of society within the tax ambit or to collect what is actually due from them absentee landlords are not paying a single penny as income tax. The lack of a judicious balance between direct and indirect taxes and the levy of regressive taxes in the garb of income tax and petroleum development surcharge has pushed an overwhelming majority of Pakistanis towards the poverty line. In reality, the persistence of large fiscal deficits, among other reasons, remains one of the primary causes for the rise in public debt and a major source of macro-economic imbalances. It is now reported in the Press that the government may suffer fiscal deficit of 6% of GDP during the current fiscal year. The FBR relies heavily on import-based taxation that results not only in huge current account deficits, but also an unprecedented surge in imports of luxury goods. We should tax the import of such luxury goods heavily and give relief to the local industry. Instead of exporting yarn, we must concentrate on producing value-added textile products. The FBR collected tax revenues to the tune of Rs 1130 billion in the fiscal year 2008-09, yet it was just 8.8% of the GDP. On the one hand we are not exploring the actual potential of taxes of Rs 4000 billion and on the other, whatever is collected is wasted by the ruling elite. Due to the huge fiscal deficit, the government borrows more and more money. The IMF and the World Bank then impose their conditions.

The government must collect taxes of Rs 4000 billion by bringing all persons, having a taxable income, within the tax net. There should be no exemptions. Serious efforts should be made to use taxation as a catalyst for economic development and industrial growth. We need progressive taxes incidence of which is on the rich segments rather than regressive taxes like Value Added Tax (VAT). Indirect taxation is playing havoc with society. The burden of such taxes is to be borne by the end users. VAT being a regressive tax takes a larger portion of the meager income of a poor man but a thin slice of the rich mans cake. Our rulers, at the behest of IMF and World Bank, are keen to levy more regressive taxes, knowing very well that VAT will not hit them. This tax is passed on to the consumers. They are not ready to pay income tax, wealth tax, estate duty, capital gain progressive taxes on their colossal incomes and wealth. If these taxes are imposed and collected, we can easily collect Rs 4,000 billion and there will be no need to burden the masses with VAT and other regressive taxes at the exorbitant rate of 16%. The contribution of income tax [although a major portion of it is now composed of indirect levies or expenditure taxes], as a percentage of GDP, is continuously declining; it is merely 2.2% in 2008-09, 2.4% in 2007-08, 2.8% in 2006-07, 3.01% in 2005-2006, whereas in 2004-2005 it was 3.15% [FBR YEAR BOOKS 2004-05 to 2006-07 and Economic Surveys of Pakistan 2007-08 and 2008-09]. These figures establish, beyond any doubt, that rich segments of society are paying negligible tax. The sole reliance on indirect taxes that constitute over 80% of the total collection proves beyond any doubt that the tax system is directly contributing to the rising cost of doing business and abject poverty. People, who possess enormous income and wealth, are not being subjected to income taxation (wealth tax and other progressive taxes like capital gain tax, gift tax and estate duty were abolished to favor the rich). Thus, the very purpose of the redistribution of wealth as the main object of taxation is being defeated. Undoubtedly, the prevalent economic and tax policies are detrimental for business and industry. Those who possess more economic power (income and wealth) should contribute more to the public exchequer and vice versa. It is tragic that in a country where billions of rupees are earned by the rich absentee landlords, as rent of land and orchards, enormous money is made in speculative transactions; the tax-to-GDP ratio is pathetically low at 8.8%. The priority of the government should be improving productivity and economic growth that will ultimately result in more revenue generation. At present, our economy is faced with a dilemma, where it can neither afford to give any meaningful tax relief package to the common people, trade and industry [due to the huge

fiscal deficit] nor can it achieve a satisfactory level of economic growth [due to the retrogressive tax measures]. This is a vicious circle that the government needs to break. It must come out of this tangle to make Pakistan a competitive economy where investors, both domestic and foreign, find satisfactory conditions to live and invest.

Taxation System
Federal taxes in Pakistan like most of the taxation systems in the world are classified into two broad categories, viz., direct and indirect taxes. A broad description regarding the nature of administration of these taxes is explained below: Direct Taxes Direct taxes primarily comprise income tax, along with supplementary role of wealth tax. For the purpose of the charge of tax and the computation of total income, all income is classified under the following heads: 1. Salaries 2. Interest on securities; 3. Income from property; 4. Income from business or professions 5. Capital gains; and 6. Income from other sources. Personal Tax All individuals, unregistered firms, associations of persons, etc., are liable to tax, at the rates rending from 10 to 35 per cent. Tax on Companies All public companies (other than banking companies) incorporated in Pakistan are assessed for tax at corporate rate of 39%. However, the effective rate is likely to differ on account of allowances and exemptions related to industry, location, exports, etc. Inter-Corporate Dividend Tax Tax on the dividends received by a public company from a Pakistan company is payable at the rate of 5% and at the rate of 15% in case dividends are received by a foreign company. Inert-corporate dividends declared or distributed by power generation companies is subject to reduced rate of tax i.e., 7.5%. Other companies are taxed at the rate of 20%. Dividends paid to all non-company shareholders by the companies are subject to with holding tax of 10% which is treated as a full and final discharge of tax liability in respect of this source of income. Treatment of Dividend Income Dividend income received as below enjoys tax exemption, provided it does not exceed Rs. 10,000/-.

1. Dividend received by non-resident from the state enterprises Mutual Fund set by the Investment Corporation of Pakistan. 2. Dividends received from a domestic company out of income earned abroad provided it is engaged abroad exclusively in rendering technical services in accordance with an agreement approved by the Central Board of Revenue. Unilateral Relief A person resident in Pakistan is entitled to a relief in tax on any income earned abroad, if such income has already been subjected to tax outside Pakistan. Proportionate relief is allowed on such income at an average rate of tax in Pakistan or abroad, whichever is lower. Agreement for avoidance of double taxation The Government of Pakistan has so far signed agreements to avoid double taxation with 39 countries including almost all the developed countries of the world. These agreements lay down the ceilings on tax rates applicable to different types of income arising in Pakistan. They also lay down some basic principles of taxation which cannot be modified unilaterally. Customs Goods imported and exported from Pakistan are liable to rates of Customs duties as prescribed in Pakistan Customs Tariff. Customs duties in the form of import duties and export duties constitute about 37% of the total tax receipts. The rate structure of customs duty is determined by a large number of socio-economic factors. However, the general scheme envisages higher rates on luxury items as well as on less essential goods. The import tariff has been given an industrial bias by keeping the duties on industrial plants and machinery and raw material lower than those on consumer goods. Central Excise Central Excise duties are livable on a limited number of goods produced or manufactured, and services provided or rendered in Pakistan. On most of the items Central Excise duty is charged on the basis of value or retail price. Some items are, however, chargeable to duty on the basis of weight or quantity. Classification of goods is done in accordance with the Harmonized Commodity Description and Coding system which is being used all over the world. All exports are exempted from Central Excise Duty. Sales Tax Sales Tax is levied at various stages of economic activity at the rate of 15 per cent on: all goods imported into Pakistan, payable by the importers; all supplies made in Pakistan by a registered person in the course of furtherance of any business carried on by him; there are an in-built system of input tax adjustment and a registered person can make

adjustment of tax paid at earlier stages against the tax payable by him on his supplies. Thus the tax paid at any stage does not exceed 15% of the total sales price of the supplies.

Pakistan Budget 2009-2010 and IMF consolidations.

The budget for the fiscal 2009-10 is due to be announced in June this year. It remained a question whether the resolution of annual budget is to gain political mileage or to reveal an economic action plans for next year? This question becomes much relevant in upcoming budget in view the garb of economic restructuring plan of IMF for Pakistan. Budget document presents the government action plan of priority and allocation of funds and the question that confronts us is how to strength the policy that should not undermine the sovereignty on decision making functions of the country. There should be priority on the national issues and allocation of funds for various key sectors and the role and extent of IFIs. Critics are fast to note that this budget is no exception, at present, just after the approval of second tranche of $800 million of $7.6 billion loan of IMF.

Measuring the im plementation of IMF conditions is not straightforward. Presently, the governments central challenge in this first budget would be putting downwards pressure on inflation, reducing fiscal deficit and increase tax to GDP ratio. It is apprehended that if the target of fiscal deficit which is core area of IMFs medicine to poor state is not materialised by the government, then the future trenches after June 30, 2009 under 23 months Standby Arrangement loan of $7.6 billion may be delayed. Keeping in view the shortfall of the projected revenue for current financial year, it is unlikely that such reduction in deficit can be achieved. As a result of talks with IMF for next tranche, other targets such as expenditure of Rs3.064 trillion, debt servicing Rs751 billion, defence expenditure Rs380 billion, development expenditure Rs616 billion and

tax revenue of Rs1.879 trillion is already fixed for next financial year. So fixing up these macro targets already tuned the budget of 2009-2010, barring a miracle any way. Since 1998, Pakistan had a long and difficult relationship with the IMF and it remained concerned with macro economic issues of Pakistan, which naturally gives leverages to influence the monetary policies and budgets. As per agreement with the IMF we are under obligation for a new value-added tax laws for full implementation. This new VAT system will replace the existing general sales tax (GST) regime. From a macroeconomic perspective, a particular area of interest for policy makers is whether the existing overall tax to GDP ratio is appropriate, and whether the existing composition of tax revenue is viable. For the past three decades, IMFs favorite policy advice area is tax reforms, now with great emphasis on the value added tax (VAT). Under the given tax structure it is believed that it will be regressive and put more burden on poorer than rich classes of any country. Though it is also be considered as most efficient way of raising revenue but we should be mindful that it would be also at risk of evasion and tricks may be lesser but still. There is a potential chance that under VAT sales is underreported, ghost traders can evade VAT as other taxes, unregistered groups will be beneficiary, and VAT with a relatively high registration threshold will exclude smaller businesses for which this is likely to be more of a risk. If this tax is not charged at the borders, then there is a brighter chance form accumulation of profits by importers without any tax. It will also increase administrative cost of the tax collection. The policy makers seeking to reform tax structure must comprehend that a misguided tax reform would do more harm than good to the general public. Rationale of VAT must have some merit for replacing a sales tax or excise duty, it will improve the horizontal equity of the sales tax and replacing a corporate profits tax with a VAT will make revenues more stable but with the caution that what works with Europe, may not work with other states keeping in view the week tax structure. Unlike sales tax VAT often may not be itemised on retail receipts, leaving a smaller room for consumers to know that they are paying VAT. Since it is passed through to consumers like a sales tax, replacing a corporate profits-tax with a VAT, will make already-unfair tax systems even more regressive to consumers. If we look at Pakistans present tax structure in international perspective, we would know that already it has narrow tax base while having tax evasions too. It caused lower tax to GDP ratio which is now declined to 9.5 per cent which in 1980s and 1990s remained at 12 and 13 per cent respectively. It is lower even in the region where average is about 15 per cent to GDP. In EU it is ranging between 24 to 44 per cent. Now the authorities in Pakistan targeted its raise to 15-18 per cent through tax reforms in coming 5 years. A revised target of 1 trillion is already set for the next financial year by Federal Board of Revenue. What we need is to link our tax base with our per capita income which is also lowest in the region. Keeping this fact in view, how much exploitation of present sectors of tax-base can be made, is not a difficult riddle. Naturally we need to enhance the tax net base, though there is stronger view that existing bases should be exploited, which will easily generate 400 to 500 billion rupees, but this takes a whole restructuring of the tax system. It is also said that if potential in the existing tax base gets exploited, Pakistan will

easily be able to generate Rs300 to Rs400 billion and can generate revenues of over Rs100 -150 billion if tax exemption is revisited but it would need an investment in restructuring of the tax system to work, for already exploited areas. The tax area would enhance capacity through investment in traditional tax sectors. Agriculture sector accounts for 22 per cent to GDP but contributing in tax revenue only 1 per cent. In given structure it is the biggest sector of tax evasion, as often the income of non-agriculture can be exposed as agriculture income which substantially increases nonformal sectors of economy. Agriculture tax will give a financial cushion immediately to tax gap in present circumstances. Just focusing on indirect taxes will not give revenue recovery in the long run. In the past the promises of brining Agriculture sector in to tax net have been made but did not work. Now it has been warned by IMF that there is no escape, if Pakistan wants to continue with IMF program, it has to go for agriculture tax. The IFIs surely wants us to improve tax revenue, and it is not their issue, if it is done by increasing tax more on indirect source on already well exploited sectors or to take some superficial measures on administration level for reducing the tax evaders.