Tuesday, May 19, 2009
By By our correspondent
KARACHI: The Overseas Investors Chamber of Commerce and Industry (OICCI) have recommended mandatory documentation of all sectors of the economy including real estate, agriculture, capital markets and manufacturing.
In their budget proposal for 2009-2010, the OICCI said that by making documentation mandatory, the government will be able to substantially increase the tax revenue as about 40 to 50 per cent of the total manufacturing in Pakistan is done by the medium and small scale manufacturing sector operating in the unorganized sector. Salient features of the proposals are as follows:
Reduce Rate of Corporation Tax to Below 30%: Pakistan has one of the highest rates of corporate tax in the region. This discourages investors from coming in the country as regional competitors not only offer lower rates but also better security and infrastructure facilities. It is, therefore, recommended that the corporate tax rate be gradually reduced from 35 to 28 per cent over the period of 2 to 3 years to make it compatible with other countries in the region.
Rebates and Tax Credits to Encourage Reinvestment of Capital: Through such measures the effective rate may be reduced with corresponding economic benefits. In Pakistan all such benefits, except accelerated depreciation have been removed. It is imperative to re-introduce rebates and tax credits to encourage re-investment of capital in the business.
Outsourcing of Audit Function: An audit can never be a tax collection measure, especially where there is inelasticity in constituents and delinquents are effectively outside the tax net. Moreover, the high levels of compliance set for tax payers usually result in harassment rather than having any value addition. A process of independent audit outsourced to professionals can be implemented as an interim measure to build confidence levels.
Cascading in Import Duty Structure: Throughout the world subsidiary and allied industries flourish when a sustainable base for the primary manufacturing sector is provided. However, it has been observed that over the past decades, cascading adjustments for local industries have been fundamentally disturbed. The current duty structure encourages the import of finished goods rather than manufacturing even in those cases where reasonable manufacturing facilities are available in Pakistan. FBR and the National Tariff Commission (NTC) need to undertake a long term holistic exercise for the development of an industrial and manufacturing policy for the country to encourage the manufacturing sector.
Zero Rated Import of Plant Machinery & Equipment, Spares and Raw Materials Not Locally Available: Up front duties and taxes on the import of Plant Equipment & Machinery, Spares and Raw materials not locally available hamper industrial growth by limiting the amount of Foreign Direct Investment (FDI) and suppressing the export potential of industries by raising costs. Zero rated import of all plant equipment and raw materials which are not locally manufactured will result in foreign direct investment, local skill development and incremental revenue to the government from alternate revenue sources such as sales and corporate taxes which would more often then not offset the revenue lost by the government.
Quantitative Ceiling on Imports for Afghanistan (ATT): Agreement of a quantitative ceiling for imports for Afghanistan (Afghan Transit Treaty) and streamlining of exchange control mechanism is required so that administrative and economic barriers are placed to control smuggling.
Consolidation of All Labor Levies with a Rate of 2 to 3% (WWF and WPPF): In Pakistan, the corporate tax rate is 35 per cent. An additional 2 per cent Workers Welfare Fund (WWF) and 5 per cent Workers Profit Participation Fund (WPPF) is levied. This effectively makes the rate equal to 42 per cent which is one of the highest corporate tax rates in the world. Government should consolidate of all labor levies with a rate of 2 to 3 per cent in line with regional standards; or allow companies to utilize the contribution for the welfare of labor in the form of providing health, education and housing for their factory employees or in the areas their factories/industries are located.
Presumptive Tax Regime be Eliminated Sector by Sector or for Documented Companies: An effective tax system requires identical procedures for the same kind of business, without any discrimination between sectors. PTR has been made inapplicable for the manufacturing sector. It is recommended that this practice should be extended to other sectors which are properly documented and should eventually be abolished completely. Continuation of PTR is a major bottleneck in the sustainable growth of Tax to GDP ratio.
Overall Rate of Indirect Taxes Needs to be Reviewed and Reduced: At present effective indirect tax rate is 28 percent (16 % GST + 12 % FED). This high level of taxation encourages a substantial part of the manufacturing base to operate in the unorganized sector. There is a need to review the issue of overall incidence of indirect taxes so that possibilities and comparative advantages of evasion are reduced and minimized. It is also recommended that the rate of Value Added Tax (VAT) be brought down to 10 per cent over a period of two years encompassing all sectors and segments of the economy specially the services sector.
Overhaul or Introduction of Sales Tax on the Whole Supply Chain: Sales tax of 2 per cent at the import stage has been levied on all products. The rationale for this levy is that in the case of imported products, the subsequent supply chain is unorganized and therefore, tax on the whole chain of value addition needs to be collected at the import stage. Additionally, there is no contribution by the medium and small scale manufacturing sector which is responsible for 40 to 50% of all manufacturing taking place in Pakistan. Such an instance, therefore, highlights the need for overhaul or introduction of sales tax on the whole supply chain.
Promotion of Retirement Benefits: There should be encouragement for promotion of retirement benefit schemes complemented with schemes for investment by such funds in investments required for industrial growth.
Special Benches For Tax Cases: Delay in ultimate decision by the appellate authorities and their quality is a hurdle in the development of a tax base. To improve quality and capacity of the first stage of appeal, it is recommended that special benches for tax cases be set-up. It has been noticed that even after judgment is received, execution is delayed. This needs to be reviewed. 13. Allowability of NPL for Banks: Debts considered as Loss under the Prudential Regulations as issued by SBP (as applicable at that time) be allowed as deduction (Pre-7th Schedule). The amendments in the Prudential Regulations (Post 7th Schedule) revived the Forced Sale Value (FSV) of collateral which was not accounted for before. Now the State Bank of Pakistan for its own purposes has allowed credit for proportion of FSV.
Allocation of Expenses Should be Streamlined - Banks: There are inconsistencies in the treatment of allocation of expenses for income exempt from tax. This issue attains importance for banks as there is substantial investment in shares where capital gain is exempt from tax. It is suggested that the matter of disallowance of allocation of expenses against exempt income should be streamlined. Specific rules need to be introduced to the effect that allocation of expenses has to be made on the basis of amount invested in exempt securities rather than earning there from.
Transitional Provisions for Banks and Provision for Consumer Loans: Unabsorbed depreciation and written down value for assets on finance lease outstanding as at December 31, 2007 should be allowed over a five year period. Furthermore, there is a need to revise the limit of 3 per cent for consumers' loan for all the years prior to Tax Year 2009. In the Seventh Schedule such deductions be allowed as are approved under the Prudential Regulations.
Clarification for Reinsurance Premium: Finance Act, 2008 has introduced withholding tax on Reinsurance Premium. Such withholding is not applicable where the recipient is protected by the Double Taxation Treaty (DTT). A clarification needs to be issued that where there is DTT protection and the re-insurer is not in Pakistan, either directly or through agent, provision relating to withholding shall not apply; In all other cases, standard requirement of information will apply.
Withholding for Insurance Companies of Recipient: In the case of banking companies subject to Seventh Schedule, an exemption has been provided to banks from withholding as recipient as such entities are all in the organized sector and are subject to advance payment of tax. Same principle requires to be adopted for the insurance sector.
Tax on Transfer Pricing: Since the introduction of the Income Tax Ordinance, 2001 there are very few cases where tax proceedings have been finalized under the new provisions of the Ordinance. All the cases from Tax Year 2004 to Tax Year 2008 are effectively exposed to action by tax officers on the matter of Transfer Pricing. However, fiscal issues relating to non-arms length consideration are a matter of determination of fact rather than application and interpretation of any law. The OECD model also supports the same principle. It is suggested that agreed upon processes be undertaken to prescribe the procedures for implementation of fiscal measure for taxing non-arms length transactions.
Resolution of Input Tax Adjustments: In Pakistan, credits for input taxes are treated as inadmissible whilst determining the overall tax liability in many cases. This results in higher rates for sales tax and federal excises. This problem emanates on account of improper implementation rather than any provision of law. It is required that implementation issues in the admissibility of input tax in sales tax be resolved and proper guidance on that matter be obtained from other countries where such systems are already in operation.
Federal Excise Duty: In Pakistan, input tax for Federal Excise Duty (FED) for many sectors is not allowable under the law. This places the said tax outside the ambit of VAT regime. It needs to be decided by the government whether such a levy is to be operated as VAT or a straight indirect tax. If the second option is to be implemented, that rate of tax will have to be reduced. OICCI considers that implementation of a full- fledged VAT with same rate, is a better option.
Franchise Fee: Royalty payments have been subjected to FED. The term used in the law is Franchise fee which is at time distinguishable with royalties in strict commercial and practical sense. This has lead to serious issues of interpretation and misapplication in many entities. It is, therefore, recommended that FED procedures for franchise fees be streamlined and the same be brought in line with SBPs regulation. Such measures will resolve the issue correctly as most of the organized entities remit such fees through SBP and there are well laid down procedures for the same.
Capacity Building of Personnel - Group Taxation: Over the last two years, positive provisions have been introduced in fiscal laws for promoting the formation of holding companies and introduction of group taxation. However, like any other fiscal measure, problems are being faced in the implementation of group taxation as the issues are unique and new. Therefore it is recommended that capacity building at FBR and SECP by way of training and study of such measures in other countries be undertaken to take full advantage of such a positive provision.
No Taxation on Inter-Corporate Dividends: Group taxation requires elimination of inter-corporate dividend taxation. This matter has been taken care of in the present law. However, over the last two years virtually no group structure has evolved on account of problems relating to inter-corporate dividends. No industrial group will endeavor to switch to holding company structure unless there is a clear position with regard to no taxation on inter-corporate dividend. 24. Stock Options: In order to promote proper disclosure and taxability of stock option, it is recommended that stock option given by MNCs for Pakistani employees be treated similar to stock option given by Pakistani companies. Moreover, stock option should be taxed as capital gains.
By By our correspondent
KARACHI: The Overseas Investors Chamber of Commerce and Industry (OICCI) have recommended mandatory documentation of all sectors of the economy including real estate, agriculture, capital markets and manufacturing.
In their budget proposal for 2009-2010, the OICCI said that by making documentation mandatory, the government will be able to substantially increase the tax revenue as about 40 to 50 per cent of the total manufacturing in Pakistan is done by the medium and small scale manufacturing sector operating in the unorganized sector. Salient features of the proposals are as follows:
Reduce Rate of Corporation Tax to Below 30%: Pakistan has one of the highest rates of corporate tax in the region. This discourages investors from coming in the country as regional competitors not only offer lower rates but also better security and infrastructure facilities. It is, therefore, recommended that the corporate tax rate be gradually reduced from 35 to 28 per cent over the period of 2 to 3 years to make it compatible with other countries in the region.
Rebates and Tax Credits to Encourage Reinvestment of Capital: Through such measures the effective rate may be reduced with corresponding economic benefits. In Pakistan all such benefits, except accelerated depreciation have been removed. It is imperative to re-introduce rebates and tax credits to encourage re-investment of capital in the business.
Outsourcing of Audit Function: An audit can never be a tax collection measure, especially where there is inelasticity in constituents and delinquents are effectively outside the tax net. Moreover, the high levels of compliance set for tax payers usually result in harassment rather than having any value addition. A process of independent audit outsourced to professionals can be implemented as an interim measure to build confidence levels.
Cascading in Import Duty Structure: Throughout the world subsidiary and allied industries flourish when a sustainable base for the primary manufacturing sector is provided. However, it has been observed that over the past decades, cascading adjustments for local industries have been fundamentally disturbed. The current duty structure encourages the import of finished goods rather than manufacturing even in those cases where reasonable manufacturing facilities are available in Pakistan. FBR and the National Tariff Commission (NTC) need to undertake a long term holistic exercise for the development of an industrial and manufacturing policy for the country to encourage the manufacturing sector.
Zero Rated Import of Plant Machinery & Equipment, Spares and Raw Materials Not Locally Available: Up front duties and taxes on the import of Plant Equipment & Machinery, Spares and Raw materials not locally available hamper industrial growth by limiting the amount of Foreign Direct Investment (FDI) and suppressing the export potential of industries by raising costs. Zero rated import of all plant equipment and raw materials which are not locally manufactured will result in foreign direct investment, local skill development and incremental revenue to the government from alternate revenue sources such as sales and corporate taxes which would more often then not offset the revenue lost by the government.
Quantitative Ceiling on Imports for Afghanistan (ATT): Agreement of a quantitative ceiling for imports for Afghanistan (Afghan Transit Treaty) and streamlining of exchange control mechanism is required so that administrative and economic barriers are placed to control smuggling.
Consolidation of All Labor Levies with a Rate of 2 to 3% (WWF and WPPF): In Pakistan, the corporate tax rate is 35 per cent. An additional 2 per cent Workers Welfare Fund (WWF) and 5 per cent Workers Profit Participation Fund (WPPF) is levied. This effectively makes the rate equal to 42 per cent which is one of the highest corporate tax rates in the world. Government should consolidate of all labor levies with a rate of 2 to 3 per cent in line with regional standards; or allow companies to utilize the contribution for the welfare of labor in the form of providing health, education and housing for their factory employees or in the areas their factories/industries are located.
Presumptive Tax Regime be Eliminated Sector by Sector or for Documented Companies: An effective tax system requires identical procedures for the same kind of business, without any discrimination between sectors. PTR has been made inapplicable for the manufacturing sector. It is recommended that this practice should be extended to other sectors which are properly documented and should eventually be abolished completely. Continuation of PTR is a major bottleneck in the sustainable growth of Tax to GDP ratio.
Overall Rate of Indirect Taxes Needs to be Reviewed and Reduced: At present effective indirect tax rate is 28 percent (16 % GST + 12 % FED). This high level of taxation encourages a substantial part of the manufacturing base to operate in the unorganized sector. There is a need to review the issue of overall incidence of indirect taxes so that possibilities and comparative advantages of evasion are reduced and minimized. It is also recommended that the rate of Value Added Tax (VAT) be brought down to 10 per cent over a period of two years encompassing all sectors and segments of the economy specially the services sector.
Overhaul or Introduction of Sales Tax on the Whole Supply Chain: Sales tax of 2 per cent at the import stage has been levied on all products. The rationale for this levy is that in the case of imported products, the subsequent supply chain is unorganized and therefore, tax on the whole chain of value addition needs to be collected at the import stage. Additionally, there is no contribution by the medium and small scale manufacturing sector which is responsible for 40 to 50% of all manufacturing taking place in Pakistan. Such an instance, therefore, highlights the need for overhaul or introduction of sales tax on the whole supply chain.
Promotion of Retirement Benefits: There should be encouragement for promotion of retirement benefit schemes complemented with schemes for investment by such funds in investments required for industrial growth.
Special Benches For Tax Cases: Delay in ultimate decision by the appellate authorities and their quality is a hurdle in the development of a tax base. To improve quality and capacity of the first stage of appeal, it is recommended that special benches for tax cases be set-up. It has been noticed that even after judgment is received, execution is delayed. This needs to be reviewed. 13. Allowability of NPL for Banks: Debts considered as Loss under the Prudential Regulations as issued by SBP (as applicable at that time) be allowed as deduction (Pre-7th Schedule). The amendments in the Prudential Regulations (Post 7th Schedule) revived the Forced Sale Value (FSV) of collateral which was not accounted for before. Now the State Bank of Pakistan for its own purposes has allowed credit for proportion of FSV.
Allocation of Expenses Should be Streamlined - Banks: There are inconsistencies in the treatment of allocation of expenses for income exempt from tax. This issue attains importance for banks as there is substantial investment in shares where capital gain is exempt from tax. It is suggested that the matter of disallowance of allocation of expenses against exempt income should be streamlined. Specific rules need to be introduced to the effect that allocation of expenses has to be made on the basis of amount invested in exempt securities rather than earning there from.
Transitional Provisions for Banks and Provision for Consumer Loans: Unabsorbed depreciation and written down value for assets on finance lease outstanding as at December 31, 2007 should be allowed over a five year period. Furthermore, there is a need to revise the limit of 3 per cent for consumers' loan for all the years prior to Tax Year 2009. In the Seventh Schedule such deductions be allowed as are approved under the Prudential Regulations.
Clarification for Reinsurance Premium: Finance Act, 2008 has introduced withholding tax on Reinsurance Premium. Such withholding is not applicable where the recipient is protected by the Double Taxation Treaty (DTT). A clarification needs to be issued that where there is DTT protection and the re-insurer is not in Pakistan, either directly or through agent, provision relating to withholding shall not apply; In all other cases, standard requirement of information will apply.
Withholding for Insurance Companies of Recipient: In the case of banking companies subject to Seventh Schedule, an exemption has been provided to banks from withholding as recipient as such entities are all in the organized sector and are subject to advance payment of tax. Same principle requires to be adopted for the insurance sector.
Tax on Transfer Pricing: Since the introduction of the Income Tax Ordinance, 2001 there are very few cases where tax proceedings have been finalized under the new provisions of the Ordinance. All the cases from Tax Year 2004 to Tax Year 2008 are effectively exposed to action by tax officers on the matter of Transfer Pricing. However, fiscal issues relating to non-arms length consideration are a matter of determination of fact rather than application and interpretation of any law. The OECD model also supports the same principle. It is suggested that agreed upon processes be undertaken to prescribe the procedures for implementation of fiscal measure for taxing non-arms length transactions.
Resolution of Input Tax Adjustments: In Pakistan, credits for input taxes are treated as inadmissible whilst determining the overall tax liability in many cases. This results in higher rates for sales tax and federal excises. This problem emanates on account of improper implementation rather than any provision of law. It is required that implementation issues in the admissibility of input tax in sales tax be resolved and proper guidance on that matter be obtained from other countries where such systems are already in operation.
Federal Excise Duty: In Pakistan, input tax for Federal Excise Duty (FED) for many sectors is not allowable under the law. This places the said tax outside the ambit of VAT regime. It needs to be decided by the government whether such a levy is to be operated as VAT or a straight indirect tax. If the second option is to be implemented, that rate of tax will have to be reduced. OICCI considers that implementation of a full- fledged VAT with same rate, is a better option.
Franchise Fee: Royalty payments have been subjected to FED. The term used in the law is Franchise fee which is at time distinguishable with royalties in strict commercial and practical sense. This has lead to serious issues of interpretation and misapplication in many entities. It is, therefore, recommended that FED procedures for franchise fees be streamlined and the same be brought in line with SBPs regulation. Such measures will resolve the issue correctly as most of the organized entities remit such fees through SBP and there are well laid down procedures for the same.
Capacity Building of Personnel - Group Taxation: Over the last two years, positive provisions have been introduced in fiscal laws for promoting the formation of holding companies and introduction of group taxation. However, like any other fiscal measure, problems are being faced in the implementation of group taxation as the issues are unique and new. Therefore it is recommended that capacity building at FBR and SECP by way of training and study of such measures in other countries be undertaken to take full advantage of such a positive provision.
No Taxation on Inter-Corporate Dividends: Group taxation requires elimination of inter-corporate dividend taxation. This matter has been taken care of in the present law. However, over the last two years virtually no group structure has evolved on account of problems relating to inter-corporate dividends. No industrial group will endeavor to switch to holding company structure unless there is a clear position with regard to no taxation on inter-corporate dividend. 24. Stock Options: In order to promote proper disclosure and taxability of stock option, it is recommended that stock option given by MNCs for Pakistani employees be treated similar to stock option given by Pakistani companies. Moreover, stock option should be taxed as capital gains.
