Appraising the Pakistan Tax

System
M Munir Qureshi

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 The Principles of Taxation: Equity.
The tax payable should accord with ability to pay or taxable
capacity.
– Vertical Equity & Horizontal Equity.
– Vertical equity is the idea that taxpayers with a greater
ability to pay taxes should pay larger amounts.
– Horizontal equity is the idea that taxpayers with similar
abilities to pay taxes should pay the same amounts.

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How Equitable is the Pakistan Tax System ?

• The Pak tax system has been largely dependent on Indirect

Taxation. Even today, the total Indirect Tax Collection (Sales
Tax, F.E.D & Customs Duty) is much greater [61%] than the
total Direct Tax collection [39%].

• Thus, Regressivity has been a dominant feature in our tax

system- which is not a good thing.

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 Rs 847 Bill

Customs Duties,
132.2, 16%
Direct Taxes,
Federal Excise,
333.4, 39%
71.6, 8%

Sales Tax,
309.2, 37%

Source: FBR Revenews Rs in bill

Sources of Revenue

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 The Certainty principle.

• The taxpayer should know exactly what is being taxed, how

much he has to pay, and how and when he has to pay it,
meaning that the law should be clear and unambiguous and
the tax authorities interpretation of it should be readily
available.

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 How Certain is the taxpayer in Pakistan of his
obligations under the law?
• Pakistan has had three direct tax statutes since 1947 and
one of the reasons given for repeal has been a lack of
clarity due mainly to the many amendments made over
time. There has also been no system of “Advance Rulings”
to enable a taxpayer to know his liability under the law in
advance of filing a Return.
• The Tax Ordinance of 2001 is an attempt to introduce
greater clarity by using simple, easily understood drafting.
Furthermore, it is now possible for a taxpayer to ask for an
‘Advance Ruling’ on any aspect of his tax obligations.
• A number of ‘Tax Amnesty’s’ allowed in Pakistan since 1947
has to some extent conditioned the taxpayers to expect
their repetition in the future as well and this goes against
the principle of ‘certainty.’

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 --------contd

• In the case of Indirect Taxation the attempt to

replace G.S.T by V.A.T is proving problematic
mainly due to problems with adequate
taxpayer knowledge with regard to proper
documentation of the stage wise transactions.

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 Principles of taxation: Convenience.
• The tax should be payable in a manner and at a time convenient to the taxpayer.
• In Pakistan, in the case of direct taxation, there has been a system of periodical
Advance payment of tax, payment of tax with the Return of Income and, since the
1990’s, tax withholding when goods are imported/exported , when certain
payments are made and salaries disbursed. There is also the system of
“presumptive tax payment” in the case of certain transactions (contracts/imports)
in which the payment made deemed to be final discharge of direct tax liability.
• The general perception of taxpayers is against the system of tax withholding esp
presumptive taxation in which there is no ‘adjustment’ of the tax paid at the time
of assessment.
• However the system of tax payment has had a beneficial effect on mobilization of
revenues. It has also reduced refund claims esp in the case of commercial
importers and also the attendant corruption.
• The trend now is to reduce tax withholding and esp presumptive taxation.

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 The Principles of taxation:Economy.
• Enforcement and collection costs should be reasonably
proportional to the receipts. This concept is also referred to
as ‘Administrative Efficiency.’
• In Pakistan total tax collection cost as a percentage of revenue
is well below 1% which is much less than the cost of collection
in advanced countries. The low cost is mainly due to low
compensation packages for tax personnel and the low level of
advanced technology put to use to assist tax collectors esp in
the I.T area.

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 ----Contd
• The yield from taxation should be sufficient for the provision
of essential public services and for funding a strong program
of economic development.
• In Pakistan revenue collection has increased in recent years
esp with the introduction of low tax rates and universal self
assessment.
• However the Pak tax system is still grossly deficient in terms of
the “t2gdp:”

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 FBR’s Revenue Performance

• In the legacy system it took us 43 years to collect the first Rs. 100
billion (1947-48 to 1990-91);
• Within the next four years, this amount was doubled and crossed
Rs. 200 billion in 1994-95;
• Another seven years, the collection crossed
Rs. 400 billion in 2001-02;
• In the next five years CBR exceeded the target of
Rs. 835 billion for 2006-07.
In 2007-08 & 2008-09 FBR Collection exceeds Rs [1] Trillion.

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t2gdp:

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Pakistan Budget Deficit

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 Tax Principles: Broad basing.
• Taxes should be spread over all sectors / sections of the
population, as uniformly as is practicable.
• In Pakistan, Taxes have a very narrow base. In the case of
Direct Taxation only 2% of the population [just over 3 mill]
pays income tax.
• The number of registered sales tax payers is less than
100,000.

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 Tax principles: Neutrality.
• Taxes should not favor any one group or sector over another
and should not be designed to influence individual decision
making.
• In Pakistan in order to promote industrialization and the
geographical dispersal of Industry a large number of fiscal
incentives [ tax expenditures] have been put into play and
these have facilitated the growth of the manufacturing sector
esp Textiles, Sugar, Cement, Steel, Pharmaceutical, Chemicals.

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 Types of Investment Incentives

• Incentives related to rural industrialization.

• Concessions for industrial estates.
• Industry specific incentives.
• Incentives for undertaking in Export Processing Zones.

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 Promotion of Rural Industrialization
1. Complete exemption of imported machinery from custom duty, sales tax and
import surcharge, if such machinery is not locally manufactured. Import license
fee is also being reduced from 6% to 2% for these undertakings.
2. Public institutions will acquire necessary technology from abroad for transferring
it to rural enterprises along with technical assistance and marketing expertise.
3. Debit-equity ratio for imported machinery in a project has been fixed to 70:30
while for local machinery it is 80:20.
4. Availability of tax holiday for maximum of eight years on average.
5. Private power plants are exempted from corporate taxes, import duties and sales
tax in all these areas.
6. Besides, encouraging power generation by rural entrepreneurs the excess
electricity will be purchased by WAPDA.

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 Concession for Industrial Estates

1. Hundred percent exemption from custom duty for approved industrial estates
located in Hub, Mianwali, Bhakkar, Khushab, Tharparkar and Dadu (excluding
Taluka Kotri).
2. 50% exemption from leviable custom duty for estates located in Islamabad,
Rawalpindi, Gujranwala, Sialkot, Faisalabad, Lahore, multan, ferozewala, Taluka of
Kotri and Hyderabad.
3. 75% of the leviable custom duties are exempted for approved industrial estates
located in all other areas except Karachi.
4. All of the industrial estates enjoying the scheme of income tax rebates on export
earnings and on value added items. The rebate on such export earnings has
increased from 25% in 1960-61 to 50% in 1976-77, 55% in 1979-80 and 75% in
1990-91.

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 Industry Specific Incentives
1. Plant and machinery not manufactured in Pakistan and imported for
establishment of key industries like biotechnology, electronics,
fertilizers, fiber optic and solar energy are completely exempted from
the whole of the custom duty and sales tax thereon.
2. These industries are also available four years tax holiday through out
Pakistan.
3. Raw material and components used in the manufacturing of capital
goods and machinery for initial installation, Balancing Modernization or
Replacement (BMR) are exempted from the whole of custom duties
thereon.

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 Incentives for Export Processing Zones
An Export Processing Zone has been set up in 1980 at Karachi, under EPZA Ordinance,
on 500 acres area to attract foreign investment in export-oriented industries. The
concessions and other facilities offered by the Government of Pakistan for EPZs include:

1. Duty free import and export of goods in and from the zone.
2. Special income tax exemptions up to 75% of the normal corporate rate
after the expiry of tax holiday period.
3. Five years tax holiday for all undertakings.
4. Availability of infrastructural facilities like, water, gas,
telecommunication etc, in the zone.

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 Contd_

1. Removal of the restriction on imports from the zone into

tariff area.
2. Pakistanis working abroad are equally eligible for
investment in the zone while resident Pakistanis can invest
up to the limit of 40% of the total investment.
3. Warehousing facilities for goods that are in transit.

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 Taxation Policy & the geographical dispersal of
industry

• The ‘Tax Holiday’ has been used to encourage new

industrial projects to move to areas that are
otherwise not attractive. The objective is to reduce
disparities in the degree of industrialization that is
seen as an essential first step in accelerating the pace
of economic development.

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Tax principles -Promotion of distributive justice.
• The tax system must facilitate reduction in inequalities in income
distribution.

• The Pak tax system is clearly deficient in this regard as is evident from a
Gini Index ranking of 41 and the increase in poverty levels over time
[presently 34%].
• The progressive tax rate structure has not proved to be adequate in this
regard and this is mainly because of the extremely narrow tax base so that
direct tax policy affects very few people.
• The repeal of the Wealth Tax Act has also impacted negatively on the
reduction f income inequalities.
• The burgeoning informal sector has also reduced the efficacy of tax policy
initiatives.

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 Distribution of Income in Pakistan
» 1980 1987 2006
• % share of GNP going:
• To poorest 20% 7.0 6.1 5.7
• To richest 20% 45.4 49.8 55.0
• To poorest 40% 19.1 16.1 14.0
• To Top 5% 31.7 35.7 45.0
• Rural rich 40.8 42.2 45.0
• Urban rich 48.1 45.3 50.0
• Rural poor 8.5 7.8 6.0
• Urban poor 6.8 7.8 8.5

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 Distribution of Income in Pakistan- the Gini
Index
• This Index measures the degree of inequality in the
distribution of family income.The Index is calculated from the
Lorenz curve, in which cumulative family income is plotted
against the number of families arranged from the poorest to
the richest.The Index is the ratio of (a) the area between a
country’s Lorenz curve & the 45* helping line to (b) the entire
triangular area under the 45% line.The more nearly equal a
country’s income distribution, the closer it’s Lorenz curve to
the 45* line & the lower it’s Gini Index.

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 Curtailing the size of the informal sector.
• For a developing country with a very large informal sector,
tax policy must aim to reduce the size of the parallel
economy.
• Tax policy has not been successful in this regard as is evident
from the fact that the black economy has continued to
increase by leaps and bounds in recent years so that presently
it may be equal in size to the formal economy. However the
latest income tax statute expressly promotes documentation
by mandating maintenance of records by all taxpayers and if
the requirement is rigorously enforced it could have a salutary
effect over time.

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 _Contd
• The Tax System reform & re-structuring currently underway
emphasizes automation, setting up of data base of vital
economic data & the use of specialized technology & software
to collate the data.
• These may well be the most important steps taken -in
conjunction with the compulsory maintenance of prescribed
accounts- to reduce the size of the informal sector & enlarge
the tax base thereby augmenting revenues meaningfully.

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 Tax Principles -Facilitating F.D.I

• Stimulating FDI mainly thru large TNC’s

requires cost minimizing devices that impact
favorably on :
• i. the rate of return ;
• ii. The price of capital goods;
• iii. The tax treatment of generated income.

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 _Contd
• Stimulating FDI mainly thru large TNC’s requires cost
minimizing devices that impact favorably on :
• i. the rate of return ;
• ii. The price of capital goods;
• iii. The tax treatment of generated income.

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 _Contd

• Foreign investors look for:

• i. Locational advantages like market size, access to raw
material, availability of skilled labor & a conducive, safe
environment.
• ii. Incentives offered by the host countries thru their fiscal
policies.
• TNC’s evaluate fiscal incentives offered only after they are
satisfied with the locational advantages.

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 -Contd
• Pakistan offers a range of fiscal incentives to foreign investors
including guaranteed repatriation of profit, a foreign tax
credit, across the board tax holiday in specified areas [energy
sector], liberal exemptions/allowances and deductions against
income in the case of different manufacturing enterprises.
• Although the adverse security situation has restricted FDI it
has not stopped completely but for future inflows a dramatic
improvement in the security situation is essential along with
significant improvements in infrastructure esp provision of
electricity.

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 Tax Principles -Good Tax Compliance
• An effective tax system will have good
compliance levels.
• In Pakistan just over 3 million direct tax payers
and 100,000 registered sales tax payers are
required to file periodic Returns / Statements.
About 75 – 80 % do so voluntarily. Considering
that the tax base is very narrow, this is not a
satisfactory compliance rating.

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Tax Principles -Taxpayer facilitation.
• A good tax system must have in- built mechanisms for
taxpayer facilitation.
• Tax statutes and rules are complicated and there is a body of
‘case law’ that also has a bearing on tax liability. The govt
must facilitate taxpayers so that they are fully aware of their
rights and obligations under the law. Before 2002 there not
much attention was paid to this aspect. However, with the
enactment of the I T Ord’2001 the situation has changed and
under the functional division of work in the new statute, tax
facilitation is recognized as an independent obligation of FBR.

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 Tax Principles -Low level of
Litigation.
• A good tax system should have a low level of
litigation.
• Before the enactment of the I T Ord of 2001,
the litigation level was very high. However the
new statute has brought in it’s wake, universal
self assessment ‘ for ALL entities.’ Thus in
most cases the Returns are accepted as filed.

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 Tax Principles-Limited Support
Staff.
• A modern tax system employs limited support
staff.
• In Pakistan, FBR has a total strength of some
22,000 with about 1500 officers and 20,000
support staff. In the recent past the support
staff strength was 30,000 plus. This is a lop
sided arrangement and goes against the
requirements of a good tax system.

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 Tax Principles -Use of modern
technology.
• A good tax system will use modern technology
as a ‘force multiplier.’
• In Pakistan we have only limited access to the
latest, state of the art, technology and
sophisticated data processing systems based
on such technology. A beginning has certainly
been made in the wake of post re-structuring
reforms, but a lot more needs to be done.

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 Tax Principles -Alternate Dispute
Resolution.
• In order to quickly resolve taxpayer and tax
assessor disputes, a good tax system will have
mechanisms to resolve such disputes without
going to the formal appellate fora.
• In Pakistan we do have an Alternate Dispute
Resolution system (ADR) but it’s performance
has not been satisfactory and taxpayers do not
appear to have much confidence in it.

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 Tax Principles -Integrity.
• In a good tax system the integrity of tax
personnel must be beyond reproach.
• In Pakistan corruption levels have been rather
high. In order to deal with the problem
effectively, the compensation package for ALL
tax personnel has been revised and take home
pay has been doubled. Action has also been
taken under E & D Rules in specific cases of
corruption. However, more needs to be done.
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 Tax Principles -Deterrence to tax
evasion.
• A good tax system will have laws, rules and a
system of sound tax administration acts as a
powerful deterrent to tax evasion.
• In Pakistan the huge Informal Sector is proof
that the average citizen does not think much
of the ability of FBR to nab tax evaders.
However the new law does have provisions
that make it better able to deal with tax
evaders.
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