Overhauling Pakistan’s tax system

Rationalising taxation laws and broadening tax base should be priorities

KARACHI:

I A Mayburov (2007) defines the Tax System as ‘a system that is a principle-based integral unity of its main interconnected and interrelated elements. These elements are the regulatory legal basis of taxation, the set of taxes and fees, the payers of taxes and fees, and the mechanism of tax administration’. Considering these elements in relation to Pakistan’s tax system reveals the need for comprehensive overhaul. The budgeted revenue receipts for the fiscal year 2023-24 are Rs12.378 trillion, with tax revenue receipts budgeted at Rs9.415 trillion, constituting 76% of the total revenue receipts. Projections for fiscal years 2024-25 and 2025-26 anticipate increases in tax revenue, reflecting a strategy for growth. The challenge remains on achieving these targets, whether through traditional methods of taxing existing taxpayers or through a fundamental overhaul of the tax system. Success lies in the latter, with a focus on modernisation and efficiency.

The first priority should be the restructuring of the Federal Board of Revenue (FBR), the backbone of the tax system, addressing issues like overstaffing and the quality of personnel. Many officers, burdened by revenue targets, conduct assessments and audits that often fail in appellate forums. Policy matters should not fall under the purview of tax administrators. Automation, given the advancements in Artificial Intelligence, needs emphasis over manual processes. Crucially, the FBR’s perception among taxpayers needs improvement to address trust deficits and encourage compliance. Considering the inactive status of many potential taxpayers, a single tax collection agency for all taxes in Pakistan could enhance efficiency and effectiveness in tax administration.

The focus should shift towards broadening the tax base, a long-standing issue with limited progress. As per the updated list of FBR pertaining to the active taxpayers for tax year 2023, the active taxpayers in income tax are 3,665,612, and in sales tax are 207,194. Despite efforts, the number of active taxpayers remains insufficient. Many register to evade higher rates but declare incomes below taxable thresholds. Efforts to identify non-filers have yielded limited results, despite existing data within the FBR. Corporations, including financial institutions, shoulder significant tax burdens, raising questions about equity and sectoral contributions to GDP. If we want to check the intent of the legislators in this area, we will have to check the measures they have taken to tax those sectors that contribute more towards GDP. Sectors like retail, agriculture, real estate, gold, foreign exchange and others largely evade targeted taxation. Imposing more taxes on existing taxpayers may drive more activity into the undocumented sector, discouraging compliance.

Rationalising taxation laws should be a priority. Tax laws are meant to simplify processes, yet in our country, they often add complexity. This complexity hampers economic goals and may deter investors. New provisions are introduced without considering potential litigation costs, such as cases related to Super tax on high-earning individuals or Capital Value Tax. Tax policies must offer consistency and stability to foster business growth and economic stability. Uncertainty discourages investment and impedes economic progress. Therefore, policymakers should ensure that tax laws are consistent and provide a conducive environment for businesses to thrive in the medium to long term.

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In the fiscal year 2022-23, direct taxes constituted 32.33% of total revenue receipts, while indirect taxes made up 49.32%. For fiscal year 2023-24, the budget allocates 34.38% to direct taxes and 41.69% to indirect taxes. However, a closer look reveals that a significant portion of direct tax revenue is collected indirectly through advance and withholding taxes. Individuals with incomes below taxable thresholds are still subject to these taxes, leading to inefficiencies and delayed refunds. Simplifying the tax system by introducing flat rates for individuals and associations, akin to corporate taxes, could streamline processes. Implementing a single-digit sales tax rate without input tax allowances would reduce disputes and administrative burdens. Additionally, uniform provincial sales tax rates across provinces for similar services would eliminate competitive tax advantages, while resolving issues related to origination and destination would promote harmonisation.

According to Article 10A of the Constitution of Pakistan, every individual is entitled to a fair trial and due process. However, a fair trial becomes challenging when decision-makers lack independence. There’s a noticeable bias in decisions made by the Commissioner Appeals, especially when the FBR faces revenue shortfalls. Since this office falls under the FBR, independent judgment is compromised. This pressure then burdens the Appellate Tribunal Inland Revenue (ATIR), which must handle matters that could have been resolved earlier with independence. One solution could be to abolish this appeal forum and expand ATIR benches. Furthermore, ATIR, currently under the Ministry of Law – and hence the federal government – lacks full independence. Placing ATIR under the Supreme Court of Pakistan for oversight and allowing appeals only to the Supreme Court would ensure swift and uniform decisions. This reform aligns with Article 25 of the Constitution, ensuring equality for all citizens.

It is concluded that overhauling the tax system of Pakistan requires sincere and consistent efforts in all the interconnected elements of the tax system. The outcome of the initiatives taken in this regard would reap the results for the ailing economy which would be sustainable in the long-term as compared to the fire-fighting measures that are usually taken under lenders pressure to achieve the revenue targets.

THE WRITER IS A MEMBER OF INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN

Published in The Express Tribune, April 1^st, 2024.

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