Minimum & Banking Transactions’ Tax

The following article has been published in Daily Nation, dated 27th July 2015

(E-Paper (Print Edition)http://nation.com.pk/E-Paper/lahore/2015-07-27/page-9)

(Onlinehttp://nation.com.pk/business/27-Jul-2015/minimum-banking-transactions-tax)

Minimum & Banking Transactions’ Tax

By: Omer Zaheer Meer

With the stated aims of supporting the entrepreneurship culture, facilitating businesses and increasing the numbers within the ambit of formally documented economy, one would expect steps by policymakers to incentivize the masses to this effect. Notwithstanding several positive developments, some recent steps have actually served in contradiction of the above aims of the incumbent Government.

Before diving into the specifics let’s briefly discuss some important building blocks. First of all, most of the modern economies have moved away from been solely or greatly based upon agriculture or manufacturing to a greater focus on service sector, then be it financial, IT, educational, telecommunication or other services within this sector. Even those with a large base of agriculture or manufacturing have modernized to include service industry as a significant part of their overall GDP. It is therefore essential for a successful modern economy to promote service sector with the underlying GDP growth and employment opportunities acting as prime motivators. Similarly in a country like ours where, as per some studies, the black monies and illegal economy outweigh the documented formal one, reforms are required to incentivize people to come within the ambit of documented economy.

With the above been clarified let us move onto some extremely important issues with serious ramifications for our economy. First up a minimum tax on service companies has been levied from fiscal year 2015-16. But what does a minimum tax mean? For our tax dilettante readers, it means that the advance tax paid by service companies will not be refunded in the event of them ending up in losses at the financial year end. This is not only unjust but would have serious negative implications for the service sector growth. Moreover it also has the potential to entice this sector towards “creative accounting” to avoid paying any more taxes then the minimum they have to since they will not be getting any refunds due to them in the past in their hour of need.

This “creative accounting” argument was actually floated as an initial reason for attempting to introduce the minimum tax on service sector several years ago under pressure from international lenders. This was done in a controversial manner despite an existing section of the Income Tax Ordinance 2001 already dealing with the minimum tax on companies. The matter led to serious misgivings from the tax payers and after long heated debates the last finance bill included a proposal to restore the original position before the controversial insertion in section 153. The original position was that any tax paid in advance was adjustable against the final tax liability. Unfortunately at the last moment the policy makers again succumbed to certain pressures and instead introduced the minimum tax. In doing so the long term impact on tax net and GDP growth was ignored in favor of the short term cash accumulation to meet annual targets.

Several responsible officials have shared in private that this amendment was based on the underlying assertion that all mobile companies, a sub-sector within the service industry, were preparing falsified accounting records to avoid due tax and thereby causing losses to the national exchequer. Even if we accept the notion, this observation was based upon a sub-sector only and it was therefore inherently unjustified to “punish” an entire sector for that. Moreover this was equal to declaring that since some- murderers are able to deceive with the judicial system therefore all accused from now on would have a body part amputated as a presumed minimum punishment. Not very just, is it?

Instead an overhaul of the system with effective implementation along-with introduction of stringent penal clauses would have served the purpose more effectively. Last but not the least, even the existing audit provision, if implemented properly was sufficient to deal with the problem. We therefore propose and expect the policy makers to review this matter positively with a strategic view of expanding the GDP and broadening the tax-base rather than diminishing it. Volume over margin is the way forward for a progressive taxation regime.

Next up is perhaps the most controversial issue of the imposition of advance tax on banking transactions by non-filers. After a lot of uproar from the business community, the negotiations with finance ministry officials resulted in the concession that the levy of 0.6 percent withholding tax was reduced to 0.3 percent till end of September 2015. Any non-filers after that date would be liable to the rate of 0.6 percent again. However, a section of business community has rejected this and is planning to force a change by strikes and protests.

While the underlying aim seems fairly positive in that the non-filers are incentivized to come within the ambit of documented economy, there are certain qualifications to that. Firstly many individuals particularly salaried ones get their tax deducted at source and as such do not file income tax returns. This is despite them paying more than their due shares of taxes if all the indirect taxes on their consumption are taken into account. A lack of awareness and the bureaucratic difficulties within our taxation apparatus are the biggest reason for this trend. Secondly the lack of trust in the authorities and Governments by the business community is a big barrier.

Some of the concerns leading to the lack of trust are seemingly genuine and warrant corrective actions. A case in point is the undue relief given to influential tax payers while the ordinary one having to waste material resources in order to get their genuine rights like refunds due to them. Moreover the undue nuances caused to even genuine businessmen by certain elements within the taxation apparatus cements the belief that it’s beneficial to stay out of the system to avoid these troubles. Moreover taxing every transaction over Rs. 50,000 at 0.6%, when aggregated, takes the total cost to inexplicable levels making it attractive to avoid banking channels for those not bound to. The crux is that trying to impose a reform like taxing banking transactions without addressing the inherent limitations and problems of the taxation system may not be the most effective way to address the issue of widening the tax-net and should be re-considered.

The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced fellow Chartered Certified Accountant and anti-money laundering expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or omerzaheermeer@hotmail.co.uk

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Finance Act 2015-16: Dissecting major reforms – II

The following article has been published in Daily Nation, dated 21st July 2015

(E-Paper (Print Edition)http://nation.com.pk/E-Paper/lahore/2015-07-21/page-9)

(Onlinehttp://nation.com.pk/business/21-Jul-2015/finance-act-2015-16-dissecting-major-reforms-part-ii)

Finance Act 2015-16: Dissecting major reforms – II

Prof Dp

By: Omer Zaheer Meer

We’ll continue to discuss some important reforms carrying on from where we left in the first part on the above topic on 13th July and conclude the write-up today. The need for a structural overhaul has been lauded for years now. While many concrete proposals for reforms continue to fall on deaf ears, a few have been implemented in the finance act. This indeed is commendable and something to expand upon.

In our budget proposals we have suggested the relevant authorities to allow the use of CNIC as both the NTN (National Tax Number) and STRN (Sales Tax Registration Number) on these pages. Section 181 has now declared that for individuals the CNIC will be used as the NTN. Although it is only for individuals as of now but it is a step in the right direction. By removing the hurdles in tax registrations by allowing the above mentioned proposal not only can the FBR expand the tax-net but also assist in promoting the entrepreneur culture by removing unnecessary formalities.

Similarly another positive reform has been introduced in section 114 of the Income Tax Ordinance 2001. The requirement of obtaining prior approval from the Commissioner for filing a revised return is now dispensed away with if the revised return is filed within 60 days of filing of the original return. This would remove the long-standing complaint of many tax payers faced when a genuine mistake resulted in tax losses to them.

Yet another change introduced via Finance Act 2015-16 is regarding the income earned from property. Now, any expenditure incurred whether wholly or exclusively for the purposes of deriving rental income including the administration and collection charges shall be admissible as allowable expense with a cap of 6% of rent chargeable. While it’s a positive move it is certainly not sufficient considering the levels of inflation increasing the repairs and maintenance as well employee costs.

Moving onto another significant change we’ll briefly discuss Section 37A and Division VII of Part 1 of the First Schedule dealing with Capital Gains Tax on securities disposed off. A revised status of tax on Capital Gains on disposal of ‘securities’ under section 37A has been prescribed as below:

         Holding period                            Tax Year

                                                            2016     2015

  • < 12 months                               15%      12.5%
  • 12 months to < 24 months          12.5%   10%
  • 24 months to < 48 months            7.5%     0%
  • > 48 months                                  0%        0%

This revision is multi-dimensional. Firstly the rates have been revised upwardly while at the same time the holding period for taxable gains has also been increased. This enhancement of holding period will effectively apply retrospectively as gains for holding period between 24 to 48 months which were exempt from tax prior to Finance Act 2015 will now fall under taxable incidence. The motivation for this is to incentivize investors to hold onto their investments for longer while at the same time trying to balance off avoiding disillusioning the small investor. How much has the finance ministry succeeded in this will only be reliably known with the passage of time and the results of the stock markets.

Next up is an extremely important issue with serious ramifications. Minimum tax on service companies is that hotly contested issue. Under pressure from international lenders, Government of Pakistan decided to introduce a controversial insertion in section 153 few years back. The way this was done raised serious questions as there were arguments that despite an existing section dealing with the issue the insertion was done against the prescribed way and even leaving the existing provisions intact, hence creating a gulf of confusion. Furthermore a series of conflicting SROs were then issued further complicating the matter.

As per the insertion introduced, despite the existing section 113 dealing with minimum tax on service companies, the corporate service companies were made liable to a minimum tax. What this meant was that even if any company in the sector incurred losses they’d not be able to claim a refund of any tax already paid by them. The reason this is problematic is that service companies particularly during startup years are susceptible to losses. This led to calls of review and resulted in Clause 79 in Part IV of the Second Schedule being added to clarify the matter and declare that minimum tax would not be liable on service companies. The implication was in effect from tax year 2012 onwards.

The initial proposal in finance bill 2015 was to clarify the matter since 2009 but instead the government decided to introduce the minimum tax on service companies from tax year 2015 onwards while the clause 79 mentioned above was also deleted. This has led to serious reservations by corporate sector and is part of the package being negotiated between finance ministry officials and traders.

Furthermore a minimum tax of 2% has been levied on land developers. This 2% shall be levied on the value of the land as notified by the authorities for stamp duty. This would increase the revenues for the exchequer and can be seen as an indication of the policy direction.

We hope that the policy makers would also consider our other proposals in future budgets for the betterment of economy and that these write-ups have been enlightening to our readers. We shall continue to apprise our readers on relevant developments in the future too.

The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced fellow Chartered Certified Accountant and anti-money laundering expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or omerzaheermeer@hotmail.co.uk

Finance Act 2015-16: Dissecting major reforms – I

The following article has been published in Daily Nation, dated 13th July 2015

(E-Paper (Print Edition)http://nation.com.pk/E-Paper/lahore/2015-07-13/page-9)

(Onlinehttp://nation.com.pk/business/13-Jul-2015/finance-act-2015-16-dissecting-major-reforms)

Finance Act 2015-16: Dissecting major reforms – I

By: Omer Zaheer Meer

The finance bill for financial year 2015-16 was passed by the National Assembly with some amendments and released as the Finance Act 2015-16. The opposition’s walkout on 23rd June 2015 allowed the finance ministry officials an easy outing with the Treasury benches rendering their support for granting the approval to the finance bill. There have been positive developments in some areas while much is left to be desired in others. The honorable finance minister explained his constraints in his budget speech when the original finance bill was floated, pointing out to the strong lobbies with vested interests and that the incumbent Government is undertaking reforms in a phased manner. We’ll discuss some major reforms, their impact on businesses and economy as well as the reaction of the impacted segments towards them in this write-up.

This is first of a two part write-ups on the above titled subject aimed to enlighten our readers on some of the least understood aspects of the finance act.

First up is the reduction in tax rate for companies which has been reduced for the tax years 2016, 2017 and 2018 to be 32, 31 and 30 percent of taxable income respectively. This is the fulfillment of the commitment by the incumbent Government to reduce the tax rate for corporate sector to 30 percent by 2018. The move is seen positively and welcomed by the corporate sector. Lowering the tax incidence on corporate sector is viewed as an incentive for this segment.

Interest Free Loans for Solar Tube Wells upto Rs.1 Million for setting up new solar tube wells or replacing the existing tube wells with solar tube wells shall also be provided to small farm owners having landholdings of less than the 12.5 acres economic threshold. This is a positive step aimed to address both the energy crisis impacting the agricultural sector as well as providing some relief to the small farmer as most of the other measures for the agricultural sector seems to be aimed at benefitting large landowners and investors.

Next up is perhaps the most controversial and discussed about yet least understood reform of the imposition of advance tax on banking transactions by non-filers. A lot of hue and cry including strikes by traders has resulted in the original levy of 0.6 percent withholding tax halved to 0.3 percent till end of September 2015 by way of an ordinance promulgated by the President of Pakistan. The original reform required all banking companies to collect advance tax at the rate of 0.6 percent on all transactions from an account either by way of sale of any instrument including demand draft, pay order, etc. and/or transfer of any sum through cheque and other similar manners or clearing interbank transfer through cheques etc which meant that all debits (amounts taken out) of an account shall be liable to this tax.

There are a few important qualifications to this advance tax though. Firstly this is only applicable to non-filers. Secondly the provision will apply only where the sum total of payments for all transactions in an account shall exceed Rs 50,000 in a day. Also this tax will be adjustable against the tax liability if the person files his/her return of income. Furthermore, the onus is on the account holders to inform their banks/financial institutions about their status of being a filer sans which collection will become applicable on their accounts.

Last but not the least, this provision is in addition to the existing provisions of Section 231AA of the Income Tax Ordinance where in all cases (being a filer or non-filer) a collection of tax is made on cash transactions. This effectively means that the new tax will apply to non-cash transactions of non-filers whereas section 231A and 231AA shall continue to apply on cash transactions. The rate of withholding tax on cash withdrawals under section 231A (in case of non-filers) and section 231AA (in case of both filers and non-filers) has been increased from 0.5% to 0.6%.

If we look at this reform from an objective perspective, though cumbersome administratively it incentivize businesses and individuals to come within the ambit of filing tax returns. The objective is to broaden the tax net. However the structural inefficiencies, rampant corruption within most tax authorities and a regressive taxation system all act as a deterrent against becoming a filer. This reform alone does not address all these issues and therefore this context can help us better appreciate the negative reaction from masses particularly businesses instead of simply dismissing their concerns as the prevalent tax avoidance culture.

Another interesting reform is the imposition of a one-time “super tax” for tax year 2015 for the rehabilitation of temporarily displaced persons on all those with income of Rs. 500 million or more as below:

  • (i) banking companies at 4%
  • (ii) all other taxpayers at the rate of 3%

This is an example of a reform pursuing the progressive tax regime by taxing those with higher income to the advantage of the downtrodden sections of the society. If the entire taxation system is revamped with a focus on direct taxation pursuing a progressive tax regime many of the ills facing our revenue generation and thereby economy can be rectified.

We’ll continue with some more interesting amendments, issues and structural reforms introduced by the Finance Act 2015-16 in the second and last part of this writeup.

The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced Fellow Chartered Certified Accountant and Anti-Money Laundering Expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or omerzaheermeer@hotmail.co.uk

Budget, Taxation and Reforms – Blue Chip July 2015, 11th Anniversary Edition

The following article has been published in the renowned “Blue Chip” journal as an exclusive Op-Ed on Economy in its 11th Anniversary Edition published in July 2015.

Online Version Link: Blue Chip Article on Economy

Budget, Taxation and Reforms

Prof Dp

By: Omer Zaheer Meer

There were many positive indicators announced by the honorable finance minister, Mr. Ishaq Dar in his latest budget speech. The first one was the growth rate of 4.24% in 2014-15. Despite missing the target growth rate of 5.1% in last fiscal year, it is still a healthy sign when compared to the mere 3% from 2008 to 2013. The significant drop in inflation from 12% to 4.6% was also phenomenal. Fiscal deficit is expected to be brought down to the level of 5% of GDP from the previous level of 5.5%. However, all these were largely due to the significant reduction in global oil prices and the resulting deflation effects rather than the structural reforms and/or economic policies of the policy makers.

Furthermore, the foreign remittances to Pakistan showed an extravagant increase of 16.14%, which is the highest in the region and should be exceptional by any standards. However it would warrant further examination into the origins of the funds as the controversial law sanctioning no tax or questions about origins on foreign remittances has long made the foreign remittances route a heaven for money laundering and legitimizing black money. While legitimate foreign remittances are a great support for developing economies like Pakistan’s, the use of the above mentioned law for legalizing the black money actually costs more to the economy in terms of the lost revenue and the impact of black businesses on related industries.

In view of the above, it was rational to expect the shortcomings to be addressed in the budget including structural reforms in the taxation system pursuing a progressive regime, introduction of economic reforms and improvements in controversial laws hampering the economy. Whether that was the case is examined below along-with some recommendations

As for the reforms in the taxation system, the proportion of indirect and direct taxes has not changed substantially. This alone though is not sufficient as indirect taxes lead to a regressive system where not only are the rich and poor paying equal amount but unequal proportion of their incomes as taxes but it also causes inflation. This results in higher production costs, which leads to declining exports due to the loss of cost competitiveness and missed opportunities.

The government, in its defence points out to the existing trust deficit between the taxpayer and the taxmen which has created a tax avoidance culture in Pakistan. However there is a reason that all developed economies rely more on direct taxes to negate the disadvantages of indirect taxes which far outweigh the benefits to the national exchequer. The approach of using indirect taxes to fill-up government’s coffers has serious negative ramifications.

To make this clear, take the example of fuel. Upto 30% had been routinely charged as an indirect tax on every liter compared to only 13% in the USA. There are several types of indirect taxes levied within Pakistan including customs duty, sales tax, federal excise duty, petroleum levy, gas infrastructure cess, natural gas surcharge, e.t.c. All this focus on indirect taxation leads to inflationary pressures in the economy as increased prices translates into increased cost of production, services and living. The resulting impacts are hyper-inflationary in nature as there is a multiplicative rather than an additive element in the inflation passed-on at every level.

Furthermore the pay-rises are not proportionate to inflation. Only a 7.5% increase has been proposed in the federal budget. This forces people towards unfair means or rely on expensive credit in order to make their ends meet. Similarly finance requirements of businesses also increase. The resulting hyper-inflationary environment and decreased purchasing power leads to higher interest rates which negatively impacts the businesses as many otherwise viable projects become non-feasible. The declining business output results in lower employment opportunities which coupled with the limited money-supply puts recessionary pressures on the market. This ultimately results in the devaluation of the currency which in turn translates into increased foreign debt. As a result, financing costs of the foreign debts increases leading to a higher proportion of GDP being spent on debt financing. All this combined with hyper-inflation drags the already weak economy further back in Pakistan’s case.

It is therefore recommended that the policy makers should seriously consider pursuing a progressive tax regime where wealthy segments of the society are taxed more. Moreover large landowners and the various exempt sectors must be brought within the tax-net and the revenues raised should be utilized to subsidize the weaker segments of society and to support reforms. For example, it’s been suggested to the authorities before that the agriculture sector should be taxed at a reasonable rate, 5%-7% for landowners with holdings over 12.5 acres and the revenue raised should be used to subsidize the water and electricity for the agriculture sector. This would enhance the yield and therefore the GDP. To summarize, the proportion of direct taxes should be increased and reliance on indirect taxes should be minimized. While some exemptions have been withdrawn in the finance bill which is commendable, more needs to be done in this regard.

Also some structural reforms in the taxation system can go a long way to assist the authorities in meeting their revenue targets. One good step is the current budgetary proposal to allow computerized national identity card (CNIC) number to be used as the National Tax Number (NTN). However the proposal for using the CNIC number as Sales Tax Registration Number (STRN) for all citizens has been ignored. Together both these steps could not only make it extremely easy for any Pakistani to start a business having the requisite tax registrations and thereby promoting a culture of entrepreneurship but would also help broaden the tiny existing tax base as the number of filers and ultimately taxpayers are forecasted to increase with the increasing documented nature of the businesses.

Another key reform could have been to decrease the tax rates to make it more feasible to pay taxes with stringent penalties and cost of avoidance acting as a deterrent. The increase in the tax base would more than compensate for the loss from lower rates. Currently Pakistan has one of the lowest tax bases and tax-to-GDP ratios in the region. If implemented this proposal can turn this around and increase them both substantially.

In addition, to restore the faith of the taxpayers a multi-dimensional tax reforms agenda which has been constantly recommended by this writer must be implemented, where:

  • Taxpayers are encouraged and incentivized for paying taxes.
  • Taxpayers are facilitated by making the process easier and fairer, focusing on maximum automation in order to stem out corruption.
  • Instead of increasing the tax rates the tax net is constantly widened.
  • More focus is given to direct taxation.
  • Meaningful tax rebates and reliefs are introduced for the less able sections of the society.
  • A system of proportionate taxation is adopted with more affluent contributing more to the treasury.
  • Certain exempt sectors are brought into the tax-net (subsidies can be given for assisting any under-pressure areas/products).
  • Tax rebates and incentives are introduced to encourage foreign/local investments in key sectors with tax-breaks for transfer of technology, e.t.c. as may be required in a particular sector.
  • Tax money is actually spent on public welfare and infrastructure projects, which will improve the spending capacity and the business environment in Pakistan.
  • The massive corruption in public contracts/projects, now routinely in the range of 40-50% of tender values, is eradicated for better and efficient use of public money through revamping the pay and accountability structures.

Similarly the controversial law allowing foreign remittances to be brought to Pakistan without having to declare the source of origin or pay any taxes has more disadvantages than the benefits it brings. Let’s elaborate this further. As mentioned before, Pakistan saw an increase of 16.14% in foreign remittances from $12.89 billion to $ 14.97 billion in the last fiscal year. What’s interesting is that the remittances in the entire region have seen a much humble growth. Also, the work profile and the resultant pay scales of ex-pats Pakistanis have not been changed drastically. Furthermore, the inflation and cost of living has actually declined for the relatives of ex-pat Pakistanis as per the figures revealed by the finance ministry. Considering all this and the various studies conducted in the past, it can be safely said that a huge chunk of the foreign exchange remittances are actually the black money laundered and then brought back to legitimize the funds and that too tax-free. Now infamous model Ayan Ali is a case in point. We don’t know for sure how many Ayans are currently doing what she was caught for. It is therefore high time that the finance ministry officials give this a serious thought and atleast consider introducing checks about origins of finances to control and curtail the illegal economy hampering Pakistan’s economic development rather than actually assist it for some short-term gains at the cost of longer-term losses.

Pakistan has been blessed with all kinds of terrains and weathers, fertile lands, valuable natural resources, a high proportion of population been young and hardworking with cheap labor availability. A fairer system of taxation coupled with some key reforms culminating into a fairer economic policy can provide the necessary environment to harness the economic potential of Pakistan.

The key reforms outlined above, if properly implemented with a focus to rely on and develop indigenous capabilities, can resolve the current enigma facing the treasury. With the above actually implemented, there is no reason, why Pakistan cannot stand on its own feet and become an economic hub not only for the region but the whole world. Let us hope that our representatives give this all a serious thought while passing the amendments to the federal budget.

The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced fellow Chartered Certified Accountant and anti-money laundering expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or omerzaheermeer@hotmail.co.uk