Tax Reforms in Pakistan Historic & Critical View Huzaima Bukhari & Ikramul Haq Tax Reforms in Pakistan Historic & Critical View Huzaima Bukhari and Ikramul Haq PAKISTAN INSTITUTE OF DEVELOPMENT ECONOMICS ISLAMABAD 2020 The views and thoughts expressed in this publication are those of authors and thus may not be considered as of the Pakistan Institute of Development Economics as publisher. This scholarly work has been published online by PIDE in good faith for the collective benefit of academia and policy circles. © Pakistan Institute of Development Economics, 2020. ISBN 978-969-461-147-1 Pakistan Institute of Development Economics Islamabad, Pakistan E-mail: [email protected] Website: http://www.pide.org.pk Fax: +92-51-9248065 Dedicated to millions of Pakistanis who pay income tax at source, and may or may not be liable to tax under the law, yet are dubbed as “tax cheats” by the tax authorities, lenders, donors, media and many others! (v) Tax Reforms in Pakistan C O N T E N T S Dedication (iii) Forward (xiii) Preface (xvii) PART – I Issues Chapter I: Issues in tax system 1 Chapter II: Confiscatory taxation 21 Chapter III: Collection dilemma 27 Chapter IV: Overcoming fragmented tax system: need for National Tax Agency 33 Chapter V: Black economy, tax losses, new paradigm 39 PART – II Past Legacy & Current Challenges Chapter VI: Fiscal Management: issues & challenges 45 Chapter VII: Imprudent policies sans reforms 73 Chapter VIII: World Bank & tax reforms 89 Chapter IX: Lack of initiatives & innovations 103 Chapter X: Hideous legacy of unpaid refunds 117 Chapter XI: Tax base & filers 123 PART – III Solutions Chapter XII: Productive tax reforms 133 Chapter XIII: Need for Taxpayers’ Bill of Rights 139 Chapter XIV: Need for new income tax law 149 Chapter XV: Case for harmonized sales tax 157 (vi) Chapter XVI: Need for National Tax Tribunal 187 Chapter XVII: Taxes for growth and prosperity 195 PART – IV Annexures Annexure-A: Historic Tax Collection Data of 1948-49 to 2019-20 199 Annexure-B: Sales Tax Base & Collection 207 Annexure-C: Tax Collection/Tax Potential 225 Annexure-D: Blueprint of Harmonized Sales Tax (HST) 225 Annexure-E: National Tax Appellate Bill, 2021 225 Annexure-F: Tax Directory Analysis by FBR 225 Epilogue 233 Bibliography 237 Subject Index 239 (vii) Tax Reforms in Pakistan Forward FORWARD The False Narrative of Tax Cheating For at least 3 decades, policy discussion and debate has been dominated by tax issues. The narrative has been fully accepted and shouted from pulpits that Pakistan is a country that neither collects enough taxes nor is there a tax paying culture here. The related narrative on corruption begin very high in Pakistan has served to paint the country as totally immoral as well as with a state that is bordering on failure. This is despite the fact that many of our comparator countries like Bangladesh, Indonesia, Malaysia and others are not doing much better than us. Huzaima and Ikram have relentlessly written about the problems in taxation over the last 3 decades highlighting all the failures in law, policy and administration. In this collection of their writings is chronicled a compendium on these issues that should hopefully will be used by researchers and tax practitioners to delve deeper into the subject of our failures in revenue mobilization. It is probably fair to argue that the many failures in tax policy, law and administration has led to the narrative now well established and backed by donors and our policymakers of pointing fingers at the poor taxpayer. The Inability to Frame a Law On September 13, 2001, General Pervez Musharraf-Shaukat Aziz government at the behest of the International Monetary Fund (viii) Forward Tax Reforms in Pakistan (IMF)1 promulgated a new income tax law. The new law repealed the time-tested Income Tax Ordinance, 1979 after 22 years when it attained acceptability and stability after authentic judicial pronouncements. They point to the Income Tax Ordinance of 2001, drafted by an Australian Assistant Professor (Lee Burns) was hurriedly signed without even removing typographical errors because of the pressure of an IMF Stand-By Arrangement. It is an extremely good example of how policy has been and continues to be made in Pakistan- junior consultant and donor pressure and you have a law. Was there an adequate review or debate? The tax-watching duo are convinced there was not. They also note that the 2001 ordinance required a large number of revisions to make it work but still leaving it open to court challenges which persist till today. However, it is sad that three elected parliaments since then have not found the time to straighten out the legal underpinnings of the income tax law. This apathy on the part of elected representatives is highlighted by Supreme Court in CIT v Eli Lily (Pvt) Ltd (2009) 100 Tax 81 (S.C. Pak) as under: “Since the creation of Pakistan, we have not been able to frame any Income Tax Act duly debated in the Assembly. Both the Ordinances were promulgated during the Martial Law Regime otherwise the Constitution has prescribed a four-month life of an Ordinance in case the Ordinance is not be placed before the Assembly and it shall be enacted as an Act then the Ordinance will automatically cease to exist. This aspect also reveals that the Constitution has cast duty upon the legislative body to frame the laws within the parameters prescribed under the scheme of the Constitution….The fact that the Ordinance in question was issued and various amendments were incorporated before and even after the enforcement of the Ordinance 2001 raises the controversy that the Ordinance in question was promulgated without meticulous debate on the subject due to which assessees and concerned departments were compelled to agitate the issues in different courts.” 1Undoing the legacy of military dictators, The News on Sunday [Political Economy], October 8, 2017: https://www.thenews.com.pk/tns/detail/564159-undoing- legacy-military-dictators. (ix) Tax Reforms in Pakistan Forward The Income Tax Ordinance, 2001, as Huzaima and Ikram show is a badly drafted and complex law which has been poorly amended over 2500 times since 2002. It has been generating enormous litigation since its inception. Since the Parliament and the Federal Board of Revenue (FBR) have failed to remove the inbuilt contradictions, revenue worth billions of rupees is lost till today. Supreme Court in (2009) 100 Tax 81 (S.C. Pak) pointed out: “It appears that the Ordinance was drafted in post haste and the draftsman omitted to incorporate this important provision. This observation is supported from the fact that the Ordinance was subjected to speedy, successive and large-scale amendments, particularly at its very inception. It may be seen that section 238 provided that the Ordinance shall come into force on a date to be appointed by the Federal Government by notification in the official gazette. Accordingly, vide notification (SRO No. 381(I)/2002) dated 16.6.2002, the Ordinance came into force with effect from the first day of July 2002, but with more or less 1000 amendments inserted by the Finance Ordinance, 2002, as calculated by the learned counsel for the respondents…..Had the un-amended provision of subsection (1) of section 239 continued on the statute book, no difficulty would have arisen regarding the treatment of assessment orders passed in respect of the assessment year ending on 30th June 2003. In such eventuality, the assessments up to the said period would have been governed under the repealed Ordinance, while the assessments of the post enforcement period of the Ordinance of 2001 would be governed under the latter Ordinance.” Despite these sharp admonishments by the Supreme Court no effort has been made to revise the law. Interestingly enough, Huzaima and Ikram are the only researchers to focus on this subject. I am afraid even academics are seriously remiss in producing enough material to help develop a much needed revision of the law. Simplicity of Taxes and Better Administration Not Killing Transactions Public finance theory has long argued that tax policy can distort incentives to save invest and trade the foundations of any economy. (x) Forward Tax Reforms in Pakistan Bad tax policies have been seen in history to have curbed economic growth and development. Rather than carefully develop such a policy with adequate legal basis, the hunger for revenues leads to more and more ‘tax measures’--new taxes added on to existing measures regardless of their consequences for the economy. Sadly, even the IMF makes such recommendations. Thus, for example energy and imports are often taxed more than once. Despite hearty affirmations for an open economy, tariffs continue to be used for revenue purposes and often surcharges are added to further fragment the tariff structure. Tax administration has serious issues as the book shows. Instead of a serious effort to reform it, proposals such as giving bonuses to a broken system have led to a doubling of FBR salaries with little change in the fundamentals of policy, law or administration. Recognizing the weakness of tax administration, withholding income taxes have been applied to all manner of transactions such utility bills, school fees, bank transactions, telephone bills etc. Business, utilities banks and even schools have become tax collection agencies adding to their costs of doing business. Now as our authors show some 70% of taxes are collected though these transaction taxes collected for FBR by service providers and businesses. The adverse effect on the economy has never really been fully understood nor debated. Bad Policy Leads to Uncertainty and Excessive Documentation The thirst for taxation has driven the economy to the ground.