Introduction
The tax method is administered by The Central Board of Revenue (CBR) & its subordinate departments. Each of the six principal taxes has a different history & different set of issues. For a large number of income tax payers the core of the business method is pre-audit & assessment by a tax official. So this method gives considerable discretion to tax officials, with potential for abuse. Moreover, this method is also not tenable as the number of taxpayers increase. The document is focused on a total overhaul of the method & organization of income tax. Sales tax is recent & its method & organization is adjusted to the needs of an expanding tax base. These are based on self-assessment & selective audit. Similarly, in customs the accent is on accelerating & broadening the changes begun in recent years. Before long, central excise will be subsumed in sales tax.
During the nineties, despite plenty of changes in the tax regime and introduction of withholding and presumptive taxes, Federal Government tax to GDP ratio has varied narrowly around eleven percent. The tax base has grown but still remains narrow and skewed. The number of income tax filers is around a million. At less than one per-cent of the population, it is a lower proportion than in plenty of developing countries.
Pakistan's fiscal crisis is deep and cannot be basically resolved. Taxes are insufficient for debt service and defense. If the tax to GDP ratio does not increase significantly, Pakistan cannot be ruled effectively, essential public services cannot be delivered and high inflation is inevitable.
The Reforms to improve our taxation technique need to be focused on human resources, business method and organization, corruption and information management. An effective revenue organization must be comprised of trained and dedicated persons with integrity, transparent processes, a comprehensive information technique, and taxpayer schooling. The paper recommends self-assessment, selective audit, and expansion and upgrading of information management, emphasizes reduction of discretion and direct contact between tax collector and taxpayer.
Pakistan's Taxation System
Federal taxes in Pakistan like most of the taxation systems in the world are classified into two broad categories, viz., direct and indirect taxes. A broad description regarding the nature of administration of these taxes is explained below:
Direct Taxes
Direct taxes primarily comprise income tax, along with supplementary role of wealth tax. For the purpose of the charge of tax and the computation of total income, all income is classified under the following heads:
• Salaries
• Interest on securities;
• Income from property;
• Income from business or professions
• Capital gains; and
Analysis of Existing Taxation System
Income Tax
In the last decade income tax, together with sales tax, has become the principal source of revenue for the federal government. Th report said that taxpayers distrust public institutions and the tax-to-Gross Domestic Product (GDP) ratio had declined in recent years. But in fiscal 2009/10 (July-June), tax-to-GDP ratio is expected to rise to 9.3 percent from 8.8 percent in 2008/09.. The inflation adjusted annual increase in income tax revenue was 10.7 percent between 1990-91 and 1999-2000, which compares with the real increase in non-agricultural GDP of 4.2 percent. 1 The revenue is raised at a cost that amounts to less than 1 percent of the revenue collected.2 Despite these reassuring statistics, there is widespread disaffection with the functioning of the income tax department and its performance. There are several factors that have resulted in this state of affairs. Some of these are rooted in the income tax legislation, others are an outcome of the constitutional structure of the country, others are the result of a complex web of lobbying and political compromises, and still others are dictated by the revenue crunch that is faced by the country.
The number of active tax-filers in Pakistan is about 1.05 million, which is 0.07 percent of the population. The number of persons in the registers of the income tax department is about 2.0 million, out of which about 1.2 million have been assigned national tax numbers. The percent of population on national tax register is 1.4 percent of the population which compares with 2.2 percent in India, 13.6 percent in Argentina, 53 percent in France and 82.5 percent in Canada. The cross-country comparison is usually not very useful because of considerable differences in 'the economic structures, tax laws and administrative procedures'.
Among tax filers the number of companies was 18,000 in 1997, which paid 53 percent of the total tax revenue. The salaried taxpayers, who numbered 410,000, contributed about 7 percent of the total revenue. The number of taxpayers who filed under the self-assessment scheme was 359,000.3
In any given year only a very small percentage of salaried taxpayers are assessed for income tax purposes, as is the case of taxpayers who qualify under self-assessment scheme. Effectively only about 250,000 or 25 percent of tax-filers are subject to any degree of tax assessment. This includes all company cases, which are subject to 100 percent tax audit unless the entire income of a company is subject to presumptive tax. These taxpayers are not chosen on the basis of their risk profile nor because there is a prima facie inconsistency in their accounts but because these are the residual group once the salaried persons and self-assessment group are effectively excluded for detailed audit. The 250,000 audits/assessments are handled by an officer cadre in grade 16- 18, who number about 650. This means a workload of about 400 audits/assessments per officer per year. Therefore, it is not surprising that an overwhelming number of tax audits are conducted in haste and are perfunctory.
For income tax purposes, the population of the country could be categorised as: (1) cases with no incomes or whose incomes are below the income tax threshold, (2) cases which fall within the taxable bracket but are exempt from payment of income tax under Schedule II of ITO, 1979, (3) cases which fall within the taxable bracket but have successfully avoided entering the tax net, (4) cases which are within the tax net but under-report their incomes, (5) cases which are within the tax net and correctly report their incomes but where there is the possibility of differences with the tax department on the extent of their taxable income.
A measure of the extent of tax evasion is provided by the value of assets declared under the recent tax amnesty scheme. Under this scheme, assets of Rs120 billion were declared, which could not be explained through known income sources. A tax at the rate of 10 percent on these assets raised Rs12 billion in revenues. Assuming that 10 percent was a low tax rate and that under normal course of events a marginal tax rate of 20 percent would have applied, the extent of tax evasion could be taken as Rs24 billion. If these assets had been created within the last 10 years, the annual tax evasion would amount to Rs2.4 billion. This is about 2.27 percent of the income tax revenue raised in 1999-2000.
While property and commercial surveys, if conducted frequently can identify individuals and businesses that are outside the tax net and also limit the scope of tax evasion, these do not address one important source of tax leakage, namely 'flight of capital'. If tax that is evaded and reinvested back in the form of domestic assets is easily detected through surveys, tax evaders could start investing in foreign assets. The extent of this leakage may already be significant and could gain momentum if local avenues of evading taxes are effectively plugged. This is a strong case for detecting evasion primarily through effective tax audit and supplementing it with regular surveys to identify non-filers and cases of under-declaration and false declaration. If tax evasion is detected at the audit stage, than it can be caught before it finds its way out of the country. The reforms I am suggesting focus on tax administration and tax processes. A good tax system requires a good tax policy but more importantly, an administrative system that can put these policies into practice. Tax reform efforts in the past have concentrated primarily on issues of policy; the issue of improvement of tax administration and of processes has not been given the importance it deserved. The core subject of this reform effort is the improvement in tax administrative structure and simplification of processes. We begin by looking at the organisational structure of the tax department.
Sales Tax
The sale tax is evolving into Pakistan's key revenue earner is beyond any doubt. What is even more impressive is the growth of sales tax revenue during the latter half of the nineties. During this period, real sales tax growth was 2.9% per annum faster than the growth of direct taxes, a true testimony to its buoyancy. Although the performance of the sales tax has been impressive, it still remains short of the potential achieved by high performing developing countries, where its contribution to the GDP ranges between 4% and 9%4. The Proposed Reforms shall be driven by four broad objectives:
• To increase the long-term revenue generation capacity of the administration
• To lower compliance costs of taxpayers through process reform
• To reduce the misuse of discretion by reducing the points of contact between the taxpayers and the tax officials.
• To create an impartial and judicious adjudication system, which gives relief when faced with excesses
Customs
Pakistan Customs is one of the oldest organizations of the Federal Government. Customs regulatory framework was first consolidated under the Sea Customs Act 1878. Over the years, as international trade grew, Customs administration gained importance, both as a major source of federal tax revenues and as a regulator of the economy. Nevertheless, the Customs administration and its regulatory framework did not fully keep pace with the developments in international trade and the requirements of domestic economy. The Sea Customs Act, 1878 was replaced by the Customs Act, 1969, but it did not contain any substantial changes. Pakistan was one of the first few developing countries to join the Customs Cooperation Council (now called World Customs Organisation) and adopt the internationally applied classification system (then referred to as Customs Cooperation Councils Nomenclature). However, Customs procedures, in general, did not keep pace with the changing requirements of international trade. The customs operations initially revolved around imports by sea and were codified and published in a document called Appraising Manual. It contained operating procedures, which envisaged 100% scrutiny of import and export documents and examination of all goods, imported or exported. This document spelt out standard operating procedures (SOPs) for various Customs tasks. With the passage of time, the use of this document as a reference guide diminished; now it is hardly available.
Essentially, Customs procedures are based on a manual system with multiple checks and verifications of every transaction, hallmarks of a defensive and time-consuming system. These procedures were devised at a time when the volume of international trade and the number of import and export transactions were small and import tariffs were prohibitively high. The analysis of Customs business processes highlights that they involve numerous steps, handling officials, signatures and verifications, and are cumbersome and irritating. A summary of the basic characteristics of Customs business processes is presented below:
• The existing business processes of Customs are fundamentally manual, devised to handle a small volume of transactions. Besides being tedious and time consuming the lend themselves to collusive malpractice.
• Clearing agents carry documents from desk to desk for completing various steps in each process. They move with documents from one official to the next, as they follow the process.
• Existing work methods and processes allow excessive interfacing between Customs employees and clearing agents/clients. The clearing agent has become an integral part of the processes.
• A large number of Customs officials are involved in completion of business processes and various steps, verifications and signatures for completing processes are rather large.
• The client has to travel considerable distance to complete formalities as Customs offices are awkwardly and distantly located.
