Taxes are the primary source for the developing states to make their economy run so is the case with Pakistan. The dependency of Pakistan’s revenue on taxes is around 86 per cent, which includes both direct and indirect taxes. Generally, besides the revenue objectives of the state, taxes are imposed to counter the effects of inflation, promote the domestic industry by incentivising them and making the imports expensive, for reducing disparity in wealth distribution and so far and so forth. It has always been advised to make transactions via banking channel in order to document the economy and to ultimately discourage the undocumented sector. To bring the taxpayers into tax net has also remained the focal point of the policymakers. The legislators have tried to distinct those who are filing their annual income tax returns as Active Taxpayers then those who are not filing as Non-Active Taxpayers. Consequently, the rewards have also been aligned with respect to their status. If you are an Active Taxpayer, you have the right to enjoy the usual tax rate on withholding while if you are not, then, be prepared to have your withholding of tax at twice of the usual rate as per the insertion of the Tenth Schedule of the Income Tax Ordinance, 2001 [the Ordinance].
The Ordinance has always been favourable to those who are registered and then become active, as compared to those who are not. The cautiously drafted Ordinance still leaves the loopholes behind, is the fact that prevails. One cannot think that the Ordinance itself promotes such transactions which are to be carried out with the unregistered persons. Although there exists plenty of such cases let us examine two of the related instances having similar gaps. In fact, it has been observed that taxpayers are doing their tax planning in a way to get the best out of existing anomalies.
It is quite common in the supply chain process of Fast Moving Consumer Goods [FMCGs] that the manufacturer of the product supplies the same to the distributor. If the distributor is a prescribed person as per the criteria mentioned in section 153 of the Ordinance, then he would withhold the tax at the rate of 4 per cent, if the supplier is a company and 4.5 per cent in any other case, while making payment for supply of goods to him. If the distributor is not a prescribed person, or the manufacturer presents the exemption certificate to the related distributor of non-withholding of tax then the tax is not collected. Although there exists an issue in the first case too, generally, companies being manufacturer prefer to have transactions with persons falling under prescribed persons so let us analyse the second phase of this chain. Now, when the distributor of FMCGs supply further in the chain being company then two per cent of tax or 2.5 per cent if the distributor is not a company is deductible as minimum tax. However, the tax becomes deductible when the same is being supplied to a prescribed person under section 153 of the Ordinance, which means if the distributor supplies to a person who is per se, not a prescribed one, in other words, it has been observed that the buyer not only is a person other than the prescribed person in this case but also unregistered, then his tax would not become deductible at the rate of 2 or 2.5 per cent respectively. Rather, the minimum tax liability of the distributor of FMCGs shall be discharged under section 113 of the Ordinance at the rate of 0.25 per cent only. Thereby, earning a significant tax saving of 2.25 per cent and no cash flows are stuck out towards the tax department as a result of this handsome strategy. So, why would a person being a distributor not supply to a person other than the prescribed person in order to have such huge savings that too on the gross amount of supply?
Taxpayers are doing their tax planning in a way to get the best out of existing anomalies
Besides other instances in section 153 itself let us have a glance of section 233 of the Ordinance, wherein case of principal being a prescribed person then the tax to be collected from the payment to be made to the agent would be at the general rate of 12 per cent which shall be a minimum tax for an agent. Where in the case when the agent’s dealing is not with the prescribed person then the agent’s commission would be subject to a minimum tax liability of 1.5 per cent under section 113 of the Ordinance.
Interestingly, in both the above cases, no carry forward of the excess of minimum tax over actual tax liability is allowed when the case is of supply by the distributor of FMCGs is made to prescribed persons or commission is received from prescribed persons. The former comprises of more tax with no carry forward and the latter charges less tax with carrying forward for five years.
It is therefore recommended that some suggestive changes shall be made by doing some rationalisation in the existing provisions. Firstly, the rates of tax in case of prescribed persons shall be revised to bring them at par with the case when the transaction is executed with persons other than prescribed persons. Secondly, the rule of carrying forward of the excess amount due to the difference between actual tax liability and minimum tax liability must be revisited in transactions with prescribed persons. If these changes are not considered and suitable amendments are not made, then this could cost a lot to the national exchequer considering the concerned taxpayers are busy in exploiting the existing tax provisions. This will bring harmonisation in the tax provisions and could be an effective measure against such exploitation.
The writer is a tax expert, researcher and corporate trainer. He has studied International Taxation from the Chartered Institute of Taxation in the UK and is also a member of the Institute of Chartered Accountant of Pakistan (ICAP). He can be reached at mmuzammil309@gmail.com.