In Pakistan, tax collection as a percentage of gross domestic product (GDP) is considerably low when compared to similar economies. The ratio is low for both direct and indirect taxes. In 2012-13, tax-GDP ratio for direct and indirect taxes collected by the Federal Board of Revenue (FBR) was 3.2pc and 5.3pc, respectively. Overall the ratio was 8.5pc.
There are numerous reasons for low tax-GDP ratio in the country. Some of them are discussed hereunder:
1. Tax Evasion
The extent of tax evasion in Pakistan could be estimated by looking at the tax gap. The operational definition of the tax gap is the difference between potential and actual tax revenue, where the potential tax revenue is the amount of tax the government would collect if every person liable to pay tax fully pays his due tax and complies with tax law. There is an enormous revenue loss due to exemptions, allowances and deductions from income tax, sales tax and customs duty, which was Rs. 887.5 billion or equal to 3.9pc of GDP in fiscal year 2012-13.
Generally, the tax incentives (exemptions) are provided to the investors to boost economic growth and create jobs. But, slow GDP expansion over the last five years or so has demonstrated the ineffectiveness of tax incentives in accelerating the pace of growth.
Likewise, the tax amnesty schemes, introduced from time to time, frustrate the FBR’s efforts to curb tax evasion. These schemes adversely affect documentation, distort uniform collection of taxes and ensure horizontal and vertical equity, violating the two golden principles of good taxation.
Such schemes widen tax policy gap as they raise expectations of taxpayers for more such packages in the future. Furthermore, as the amnesties provide immunity from tax audit, they further hinder the process of tax compliance. There are more than one form of tax evasion such as none or under-reporting of tax liability.
Inadequate staff, scarcity of physical and financial resources and/or poor working capacity of the tax officials may result in weak enforcement. And tax-evaders exploit weaknesses in the enforcement mechanism to their benefit.
In order to improve revenue performance, it is necessary to bridge the tax policy gap as well as tax gap arising from weak enforcement. Minimal use of exemptions is needed to refine the existing taxes and to provide level playing field for all sectors of economy. At the same time, it is crucial to strengthen the current enforcement mechanism by enhancing administrative efficiency and capability as well as improving taxpayer compliance through taxpayer services and education.
In addition, regular and effective examination of records could be a deterrent against tax evasion and underreporting. At the same time, appropriate training of the relevant staff could improve recovery out of demand created from examination of records. The effective use of relevant information could help bridge the tax gap besides encouraging documentation.
Listening to public opinions and suggestions could improve mutual understanding and trust between taxpayers and tax officials, and this has to be addressed at each level of tax management.
Last but not least, it is imperative to impose stipulated penalties on taxpayers who violate provisions of law. At the same time, strengthening the tax investigation system is fundamental in creating deterrence against tax evasion and bridging the tax gap.
2. The Black Economy
The unreported economy or the black or underground economy comprises those activities that evade the payment of taxes and thus violate the fiscal rules. It includes income which should be reported to the authorities but is not. The size and growth of black economy adversely affects various economic and tax reform policies, the budget deficits, debt burden, etc. Revenue loss estimated due to undocumented economy is massive.
3. Sales Tax Frauds
The taxpayers exploit the multiple sales tax regimes to evade taxes through fraudulent schemes. VAT/GST fraud is a matter of serious concern for the tax administration of both developing and developed countries and Pakistan, too, is no exception to that. It’s an issue of growing concern that has put a question mark on the superiority of VAT over other forms of consumption taxes such as retail sales tax.
The issue of sales tax fraud in terms of size and frequency is a matter of grave concern for the tax authorities in Pakistan. GST fraud exists in a number of forms, some prominent of them are:
a. Registration of dummy units
In some cases, the businesses got sales tax registration by submitting documents of employees. Under such circumstances, the actual beneficiaries of refunds or input tax adjustments remained underground. Whenever records of such dummy units are subjected to examination, tax demand so created could not be collected as the amount is assessed against the poor employees rather than rich, real owner of the business.
b. Fake import of goods declarations
There are cases wherein invoices were being issued on the strength of fake /non-verifiable import of goods declaration (GDs) in the sales tax returns. Thus the whole amount of input tax adjusted by the buyers proved to be illegal and recoverable. In fact, goods were being supplied to unregistered persons and invoices generated on the strength of fake GDs were being utilized for input tax adjustment.
c. Flying invoices
It is found in certain cases that the registered persons supply taxable goods to unregistered persons but succeed to obtain invoices from registered units involved in supply of different goods. These flying invoices are being used extensively to claim input tax or sales tax refunds.
d. Fake bank accounts
The registered persons claiming input tax on invoices more than Rs. 50,000 are required to make payments through banking channels. The tax fraudsters opened bank accounts sometimes in connivance with the bank officials utilizing documents/signatures of persons other than actual beneficiaries and this enables buyers to ensure compliance of section 73 of the Sales Tax Act 1990.
e. Suppression of taxable supplies
Sales tax is an indirect tax. The businesses are supposed to shift the burden of this tax to final consumers of goods and services. In many cases, the registered persons, though charge sales tax on all supplies, they don’t declare true turnover in the sales tax returns and thus evade sales tax. In other cases, many businesses declare turnover just below threshold required for sales tax registration and thus continue to operate in an undocumented economy. These businesses actually capture large share of market due to less product prices as compared to those operating under the sales tax net.