The tax gap in Pakistan is estimated to be 9.8pc of the GDP as the current tax-GDP ratio is around 12.5pc against a potential of 22.3pc as per a World Bank report. The tax gap is attributed to taxpayers’ non-compliance and limited tax capacity of the federal tax authorities.
Withholding taxes to overcome tax evasion
The Federal Board of Revenue (FBR) has incorporated one of the largest withholding tax regimes in the Income Tax Ordinance 2001, which comprises at least 64 sections and subsections; a considerable number of these provisions are either presumptive or minimum in nature. Importantly, tax paid under presumptive or minimum regime constitutes the final discharge of taxpayers’ liability. Nearly 70pc of the direct tax revenue is being generated through withholding tax regime, of which over 40pc comes from presumptive or final taxes. Only 30pc of the direct tax revenue is being received with the tax returns filed by the taxpayers.
Non-filers evidence poor tax compliance
Poor taxpayers’ compliance can be gauged from the fact that only one-third of the companies filed tax returns for the tax year 2015, as per the latest tax directory published by the Federal Board of Revenue (FBR). Compliance of non-corporate taxpayers, both individuals and associations of persons, with regard to filing of tax returns is also disappointing.
There is a huge gap between the number of persons who are actually paying taxes and those who are actually filing tax returns. For example, about 90 million persons are being charged withholding income tax on phone bills, about 18 million on electricity bills and about 41 million on interest income from bank deposits and national savings schemes but the number of personal taxpayers actually filing returns is around one million.
Tax policy of higher tax rates for non-filers
To increase the number of tax returns in a bid to reduce the gap between tax-return-filers and non-filers, the FBR has employed a specific tax policy for the last four fiscal years. This tax policy envisages differential withholding tax rates for filers and non-filers. Under this policy, non-filers of returns are subjected to a higher rate of withholding taxes on various economic transactions to create a disincentive for the non-filers by increasing their cost of doing business through higher taxation.
For instance, advance tax rates on gross amount payable for the sale of goods and for the providing or rendering of services other than transport services to a permanent establishment in Pakistan of a non-resident person by every company are 7pc and 14pc for non-filers as compared to 4pc and 8pc for filers during tax year 2018. Likewise, withholding tax rates to be applied by persons other than company on above transactions are 7.75pc and 17.5pc for non-filers against 4.5pc and 10pc for filers. Advance tax requires to be withheld on gross amount payable for the execution of contracts other than contracts for sale of goods and rendering or providing of services to a permanent establishment in Pakistan of a non-resident person at the rate of 13pc in case of non-filers and 7pc in case of filers.
Furthermore, advance tax rates chargeable on gross amount of rent, prizes and winnings and commission are 17.5pc, 25pc and 17.5pc for non-filers as compared to 15pc, 15pc and 12pc for filers. The withholding tax rate on gross sale price of property or goods sold in an auction is 15pc for non-filers as against 10pc for filers.
Last but not least, withholding tax rates applicable on gross amount payable for sales of goods, for providing of services and for execution of contracts to a resident person by every company are 7pc, 14.5pc and 12pc for non-filers as against 4pc, 8pc and 7pc for filers. Advance tax rates to be applied by persons other than a company on above transactions are 7.75pc, 17.5pc and 12.5pc for non-filers as compared to 4.5pc, 10pc and 7.5pc for filers.
Partial success of tax policy
The tax policy of differential tax burden for filers and non-filers has yielded results and the number of return filers has increased substantially over a period of three years. For example, the FBR has received 1,039,291 returns by 9 March 2017 as compared to 867,194 returns received for the tax year 2015 by the same date.
Furthermore, the number of income tax return filers has increased to 1.15 million as per the updated Active Taxpayers List (ATL) issued in May as compared with 0.993 million in the previous ATL a year ago – a growth of 16pc.
In order to implement the tax policy, the FBR issues ATL that is available on its website and the withholding agents are required to use this list to determine the status of filing of return by an individual or an entity so that the appropriate rate of withholding tax can be applied. Income tax rules provide that the ATL on the basis of returns for the latest tax period is to be issued on the first day of March following the due date of filing of returns for that tax period. It is expected that with such a tax policy in place, the FBR will force the non-filers to file their tax returns that in return will bridge the gap between the filers and non-filers