ReportNo. 7196-BD Bangladesh An Agendafor TaxReform (In Three Volumes) Volume Ill: Direct Taxation:Policy and Administration Decenber15, 1989 Public Disclosure Authorized PublicEconomics Division CountryEconomics Department Policy,Planning and Research FOR OFFICIALUSE ONLY Public Disclosure Authorized .J Public Disclosure Authorized Docwnen of the WordmSan Thisdocument has a restricteddistribution and may be usedby recipients Public Disclosure Authorized only in the performanceof their officialduties. Its contents may not otherwise be disclosedwithout World Bankautdhorization.--' BANGLADESH CURRENCYEgUIVAUENTS The estimatedvalue of the BangladeshTaka (Tk) is fixed in relation to a basket of referencecurrencies, with the U.S. Dollar 4 -. serving es the interventioncurrency. 1989 US$I - Tk 33 Tk I - US$ 0.030 'Weightsand Measures 1 Crore - 10 million FISCAL YEAR July 1 -- June 30 FOROMCLAL USE ONLY BANGLADESH:AN AGENDAFOR TAX REFORM VOLUMEIII Table of Contents Page No. CHAPTER5: DIRECT TAXATION: PERSONALAND COMPANY INCOMETAXES ..............................................1 I: INTRODUCTION................................... ............. 1 II: PERSONAL INCOME TAXATION. 1 1. Basic Tax Rules. 1 2. Tax Incentivesand Exclusions. 3 InvestmentAllowance. 3 Interest and Dividends. 3 Capital Gains. 4 Gifts and Inheritance. 4 CharitableContributions. 4 GovernmentSalaries .4 Income from Other Sources. 4 3. Tax Liability. 4 4. An Assessment of Personal Income Taxation. 7 A. Filing Threshold. 7 B. IncentiveAspects. 8 C. Revenue Aspects. 9 D. Equity Aspects.11 5. Recommendations .. 11 A. Include Employment-RelatedAllowances in the Tax Base and Replace the Current Filing Thresholdby a Conventional ExemptionLimit .11 B. Eliminatethe Special Exemptionfor Interest and Dividendsand Introduce a WithholdingTax on Interest and Dividends Paid by Financial as well as Non-financialCorporations, Irrespective of the Size of Income or Asset Holdings.16 C. Tighten the Scope of Investment Allowances......................................... 18 D. IncludeRealized Capital Gains in the Tax Base, Irrespectiveof How the Proceeds are Used, if the Initial Investmentfrom which the Capital Gains Arose was Deducted as an Investment Allowance.......................................... 20 This documenthas a restricteddistribution and may be used by recipientsonly in the performance of their officialduties. Its contents may not otherwisebe disclosedwithout WorldBank authorization. PagzeNo. E. TransitionalMeasures ..... ...........................20 F. Tax LiabilityUnder the Revised System . 21 III. COMPANY INCOME TAXATION .. 23 1. Basic Rules and Tax Rates .23 2. InvestmentIncentives .24 3. Assessment.24 4. Revenue Aspects.26 5. Resource Allocation.28 A. Neutralitywith Respect to Project Selection.28 B. Neutralitywith Respect to Financing.29 C. Tax Holidays vs. Accelerated DepreciationAllowances .30 6. Recommendations.30 Short-Term.31 Long-Term.31 Appendix 5.1: Revenue Impact of EliminatingEmployment- Related Allowances and Switchingto ConventionalExemption .34 Appendix 5.2: Calculationof the Marginal Effective Tax Rate (METR).36 Appendix 5.3: Taxation, the Cost of Capital and the Cash Flow Company Tax .39 Appendix 5.4: Revenue Implicationsof Restructuring Company Tax Incentives.43 - ii - PAge No CHAPTER 6: DIRECT TAXATION:THE AGRICULTURALSECTOR .....................45 I: INTRODUCTION .................................................45 II: LAND DEVELOPMENTTAX .........................................45 1. History................................................... 45 2. Post Independence......................................... 46 3. Experience................................................ 48 4. Progressivity.............................. .............. 52 5. Revenue................................. 59 6. AdministrativeCost ................................. 60 7. ComparativeEvidence ................................. 61 III: PROPERTY TRANSFER TAXATION................................. 63 1. Description................................. 63 2. ComparativeEvidence ................................. 65 3. Incidence................................. 67 IV: THE TAXATION OF AGRICULTURE................................. 68 1. Direct Taxation................................. 68 2. IndirectTaxation ................................. 69 3. ImplicitTaxation ................................. 71 V: RECOMMENDATIONS................................. 73 A. The Short-Term................................. 73 B. Medium-to-LongTerm ................................. 73 C. Revenue-Sharing................................. 74 I ~~~~~~~-iii- Page No. CHAPTER 7: DIRECT TAXATION ............................................. 75 Administration 75 I: Introduction . .75 1. Background .. 75 2. Existing Organizations .. 75 A. National Board of Revenue.75 B. Auxiliary Organizations.78 C. Field Level ExecutiveOrganizations .81 D. Field Level Appellate Organizations.83 3. Workload and Manpower.83 A. Workload.83 B. Manpower.93 C. Norms .95 II: Recommendations.96 1. Objectives.96 2. Tax Arrears.97 3. National Board of Revenue.97 4. Auxiliary Organizations.100 5. Field Level Organizations.109 A. Senior Commissioner .109 B. Commissioners.109 C. AssessingOfficers .112 D. AppellateOrganizations .117 6. Financial Implicationsand Revenue Effects. 121 7. Timeframe for Implementation. 125 8. Miscellaneous. 125 9. Avoidable Paper Work . 127 10. Computarization. 129 11. Morale and Motivation of Officers. 130 12. Timeframefor Implementation. 131 Appendix 7.1: Extracts from Budget Speeches for FYs 87, 88 and 89 Regardingthe Voluntary DisclosureScheme . 132 Appendix 7.2: Workload of Officers of Taxes Department,Dhaka (South)Zone . 134 Appendix 7.3: Governmentof the People's Republic of Bangladesh. 137 - iv - Page No. Appendix 7.4 The Experiencewith PreemptivePurchase of Property in India .....................................139 Appendix 7.5: Computerizationin the Income Tax Department in India .....................................142 -v- List of Table. Pare No. Table 5.1: ComparativeCharacteristics of Income Taxation (in Selected Asian Countries)* ............. ***.. 2 Table 5.2: Revenue Contributionof Personal Income Tax Table 5.3: ComparativeTax Liabilitiesfor Selected Income Levels (Levels of Income)o .....**a* ............... Table 5.4: Interest and Income Elasticitiesof Bank Deposits.............. 19 Table 5.5: IndustryGroup Eligiblefor TaxlHolidays.......................25 Table 5.6: Marginal Effective Tax Rates on Capital Investmentsfor Selected Countries ...............-............ .* ...... ..........o......27 Table 6.1: Land DevelopmentTax Rates 1976, 1982, 1985 ....... ...........49 Table 6.2: Land DevelopmentTax and Non-JudicialSt.amp Tax Revenue: Nominal and Adjusted by the GDP Deflator, 1976177-1985/86 (Taka coe .....................................SO**5 Table 6.3: Expected Revenue Yield from the 1982 Rate Structures Land DevelopmentTax .......................... 53 Table 6.4: Fragmentationof Holdings in Bangladesh,1977 .................*57 Table 6.5: AgriculturalProperty Taxation in Selected Countris............62 Table 6.6: Non-Judicial Stamp Tax............................. Table 6.7: Immovable Property Transfer Taxation in Selected Table 6.8: Tax Burden of Indirect and Direct Taxation by Income Class ......... ..... .*....o...e.........................70 Table 7.1: Number of IncomeTaxpayers.....................................76 Table 7.2: Head-vise Collectionof Direct Taxes for the FinancialYear 1983/84 to 1987/88.................... Table 7.3: Workload and Disposal of Salary, Company Self Assessment Penalty Cases Year 1985/87 (endingJune 1987).................. 87 Table 7.4: Category-viseWorkload and Disposal of Current and Arrear Income Tax Cases for the Year, 1986/87..........................88 - vi - List of Toble. Paae No. Table 7.5: Commissioners'Zone-vise Number of Self AssessmentCases and Collection for the FinancialYear 1984/85....................88 Table 7.6: Final Collectionof Income Tax (Classified)for the year 1986187 ......... Table 7.7: Statementof Appeal Case vith AJCTe .........................89 Table 7.8: Statement of Appeal Cases in the Three Branches of the Taxes appellate Tribunal,Bangladesh Showing Pending Cases as of August 7, 1985, Institutionand disposal of the Cases in 1985/66 and 1987/88and Pending as of July 1, 1988........**9*90 Table 7.9 Bangladesh: Arrears in Collection of Taxes (Millionsof Taka) ................... Table 7.10: Bangladesh: Breakdown of Arrears in Collectionof Taxes by Size of Arrears, June 30, 1986 (Millionsof Taka)...............92 Table 7.11: Bangladesh: Breakdown of Arrears in Collection of Taxes by Public and Private Sector, June 30, 1986 (Millionsof Taka)....93 Table 7.12: SanctionedStrength of Direct Taxes Field Organization.........94 - vii - Chapter 5: DI_CT TAXATION: PESONL AND C 'MfINCgnE IAS I. InTRODUCTION 5.1 Direct taxation which is derived almost exclusively from income accounts for approximatelyone-fifth of tax revenue Revenue arising from personal and company income accounts for 15 percent of total tax revenue or about 1.2 percent of GDP. It is estimatedthat more than three-quartersof this comes from company taxation. The tax is levied almost entirely on the non-agricultural sector vhilch accounts for some 50 percent of GDP. Furthermore, tax concessions of various kinds, further described below, ensure that less than 0.5 percent of the populationis liable for personal income tax. 5.2 Comparativedata (see Table 5.1) show that the share in