Need for new income tax law – I

When the then government of General Pervez Musharraf decided to promulgate a new income tax law in 2000, many opposed it strongly. The main objection was that his regime had no mandate to enact any such law. The rule, “No taxation without representation”, was stressed by his critics. This cardinal constitutional rule is embodied in Article 77 of the Constitution of Islamic Republic of Pakistan but being usurper, the military dictator was least pushed about it. Strangely and disturbingly, even the elected representatives since the exit of Musharraf have been showing apathy towards enacting the tax laws that conform to fundamental rights and public policy guidelines contained in the Constitution.

During the Musharraf era, it was argued that the dictator lacked the mandate to enact the Income Tax Ordinance, 2001 repealing the Income Tax Ordinance, 1979, which was also promulgated by a military dictator, General Zia-ul-Haq. It was demanded that he should leave this work for the future elected government. Unfortunately, the law was promulgated and thereafter all popularly-elected parliaments did not bother to review it.

We do not enact tax laws through consultative process, which is a prerequisite of democratic polity. Tragically, the repealed Income Tax Ordinance, 1979 was also by a military dictator, and the existing one, the Income tax Ordinance, 2001, is reminiscent of undemocratic rule of General Musharraf.

The Supreme Court of Pakistan aptly observed in CIT v Eli Lily (Pvt) Ltd (2009) 100 Tax 81 (S.C. Pak): “Since the creation of Pakistan we have not been able to frame any Income Tax Act duly debated in the Assembly. Both the Ordinances were promulgated during the Martial Law Regime otherwise the Constitution has prescribed a four month life of an Ordinance in case the Ordinance is not be placed before the Assembly and it shall be enacted as an Act then the Ordinance will automatically cease to exist. This aspect also reveals that the Constitution has cast duty upon the legislative body to frame the laws within the parameters prescribed under the scheme of the Constitution”.

The Income Tax Ordinance, 2001 is highly complex and badly drafted law. During the last 16 years, despite the fact that over 2500 amendments, it has generated enormous litigation. The apex court noted in (2009) 100 Tax 81 (S.C. Pak):

“The fact that the Ordinance in question was issued and various amendments were incorporated before and even after the enforcement of the Ordinance 2001 raises the controversy that the Ordinance in question was promulgated without meticulous debate on the subject due to which assessees and concerned departments were compelled to agitate the issues in different courts”.

We have been pointing out since its inception, various errors of drafting and concepts (see Law & Practice of Income Tax, Volume I, pp 1-14) but the Federal Board of Revenue (FBR) did not bother to consider these and ultimately lost revenue of billions of rupees when Supreme Court vindicated our viewpoint in (2009) 100 Tax 81 (S.C. Pak) as under:

“It appears that the Ordinance was drafted in post haste and the draftsman omitted to incorporate this important provision. This observation is supported from the fact that the Ordinance was subjected to speedy, successive and large scale amendments, particularly at its very inception”. It may be seen that section 238 provided that the Ordinance shall come into force on a date to be appointed by the Federal Government by notification in the official gazette. Accordingly, vide notification (SRO No. 381(I)/2002) dated 16.6.2002, the Ordinance came into force with effect from the first day of July 2002, but with more or less 1000 amendments inserted by the Finance Ordinance, 2002, as calculated by the learned counsel for the respondents… Had the un-amended provision of subsection (1) of section 239 continued on the statute book, no difficulty would have arisen regarding the treatment of assessment orders passed in respect of the assessment year ending on 30th June 2003. In such eventuality, the assessments up to the said period would have been governed under the repealed Ordinance, while the assessments of the post enforcement period of the Ordinance of 2001 would be governed under the latter Ordinance”.

In para 53 of (2009) 100 Tax 81 (S.C. Pak), the Supreme Court has categorically held that “there is a need to review the language, content and scope of the power to amend and further amend an assessment, the power to revise an assessment and the power to rectify mistakes envisaged in these sections so as to make it in line with the legislative intent of consolidating the law relating to income tax so as to make it easily comprehensible to the convenience of the taxpayers”. This judgement was passed on June 22, 2009 and till today, neither FBR nor the Parliament has implemented the command of the Supreme Court, which is binding under Article 189 of the Constitution. The FBR has lost and is still losing cases involving substantial revenue because of conflicting and confused provisions of the Income Tax Ordinance, 2001, but tax bureaucrats are least pushed to request the Parliament to amend the law as suggested by the apex court or enact a new one that is more suitable to our conditions.

The time has come that the Parliamentary Standing Committee on Finance initiates the process of drafting and adoption of a new income tax law rather than further amending the Income Tax Ordinance, 2001 as it is simply impractical. Services of experts should be elicited for this task. We can never ensure tax culture unless the rich and mighty are taxed according to their ability (all the presumptive and minimum tax regimes, concessions and exemptions given in the existing law should be abolished), taxpayers should be given rights through legislation (Taxpayers’ Bill of Rights) that taxes collected would be spent for public welfare and not for the luxuries of the ruling elite and that their cases shall be adjudicated expeditiously through an independent tax appellate system. Efforts are needed to have an income tax law:

(a) ensuring taxation on the basis of ability to pay as enshrined in Article 3 of the Constitution;

(b) providing uniformity of tax treatment as far as possible for various categories of taxpayers;

(c) reducing dependence on withholding taxes;

(d) encouraging voluntary compliance through deterrent provisions;

(e) minimizing tax exemptions;

(f) reviewing the existing tax appellate system; replacing it with National Tax Court completely independent of FBR and Ministry of Law; and

(g) removing distortions and anomalies to make the law coherent and consistent;

New approach

It is an inescapable conclusion that income tax law, as it exists, is a most undesirable piece of legislation. Direct tax system intends to achieve the twin aims of maximizing revenue as well as utilizing revenue for achieving socio-economic objectives. In actual practice, our tax system has failed to achieve either of these objectives. In fact, the complex regime of incentives and disincentives built into the direct tax law cannot but lead, per se, to difficulties in enforcement and to the opening of opportunities for tax-dodgers/evaders. At the operational levels, this has resulted in undue bureaucratization, corruption and harassment of the citizens. Time has come to resolve these contradictions and completely convert the direct tax regime into a simple tax law. The new approach should aim at generating resources besides achieving some limited but important economic objectives like promotion of savings, encouragement of new investments and conservation of energy.

Equity in taxation For any meaningful change, solutions have to be found for those issues that have been sidetracked for years. One problem that affects personal taxation significantly relates to presumptive taxes, minimum taxes, tax brackets, exemption limits, tax rates and fairness of the system of indexing for inflation. On the eve of each year’s budget exercise, these issues are raised but avoided rather than solved by an appeasement policy of giving tax amnesty, increasing exemption limits, raising deductions, rearranging tax brackets and making some minor changes in tax rates. The case for adjusting the structure of personal income tax to inflation, to retain the same levels for taxation and collections in real terms, should receive the first priority in any future tax reform to enhance the credibility of the system.

Broadening tax net We, in Pakistan, have been running after small fry to broaden the tax net. For example, a widow or pensioner is subjected to 10% flat tax on income earned from Bahbood Certificates and pension accounts. They also pay advance adjustable income tax on mobile phone use even if income is below taxable limit. Such erratic taxation is highly lamentable. Salaried persons having no other source of income have to pay advance tax not only from salary but also even when paying fees of their children and mobile bills. They have to file tax returns and then claim refund of excess payments made to FBR. This exercise generates tremendous unproductive and wasteful workload without any significant gain to the revenue. It strengthens the feeling that the government, unable to tackle the hardened tax evaders (for example, sharks in real estate speculative business and at the stock exchanges), is unduly harsh on salary and wage earners. A feeling goes around that they are made to bear the major burden of taxes. The consequence is that ordinary people who generally think of themselves as honourable and honest end up in participating or advising others to practice evasion of taxes!

Administrative reforms The administration of a tax system is highly complex. No doubt, a proper bureaucratic input is vital for making the system successful but it is equally necessary to take all the stakeholders on board and the laws are made and implemented through consultation and consensus rather than by means of irrational policies and illogical measures. Unfortunately, this aspect of the problem, which deserves utmost priority, has been neglected for no ostensible reasons. All the tax reform committees and commissions have failed to consider this matter important enough to merit full-scale attention. Even if they recognised it as a problem, they decided to leave it for the relevant quarters. The undeniable reality is that no agenda for rationalization or simplification of tax reforms can improve tax compliance without improving public perception regarding the efficiency, technical competence, integrity and ability of the tax authorities to relentlessly pursue and punish tax evaders without any political and other interference. There is always talk of giving “market” wages to officers, but nobody has even thought of improving the overall working conditions of tax departments and professional skills of tax collectors. If one goes to a tax office as a taxpayer only then one would feel the taste of inhuman and insulting treatment, an ordinary citizen receives daily. Does it really need enormous money to extend respect and courtesy to taxpayers they deserve? Does this issue relate to market wages or foreign funding or advice?

Tax reform not a time-bound but a continuing exercise The exercise relating to tax reforms cannot be a time-bound affair and does not mean merely making changes in the law. Reforms can be successful only if simultaneous analysis is made of the whole system, that is, tax structure, tax administration, state of economy, taxpayers’ attitude, revenue needs of the country and so many other allied aspects. Measures that are necessary to make a tax system successful relate to: –

1. devising and running an efficient and truly independent justice system;

2. provision of expert legal advice for drafting of laws;

3. designing of tax forms and procedures;

4. improvements in the management of tax department;

5. a broad-based personnel policy;

6. training of tax administrators, especially for undercover operations;

7. educating the taxpayers and making them realise that it is their moral duty to pay tax;

8. development of work ethics;

9. provision of healthy working conditions; and

10. efficient redressal machinery for the problems of taxpayers.

Relatively successful reforms in Indonesia, Jamaica, Malawi, etc., were carried out in three to four years and these involved substantial preparation and transition arrangements, including extensive consultations with all parties affected by tax reform. In Pakistan, the five-year (2006-2011) foreign-funded Tax Administration Reform Programme (TARP) extended for one more year (2012) failed to achieve anything, rather it has multiplied the problems of tax machinery as well as taxpayers. Tax reform programmes and strategy involve continuity in key decision-makers and major educational campaigns concurrent with the introduction of tax reform proposals to familiarise taxpayers with the new requirements. In Pakistan, we merely made it a bureaucratic exercise which was bound to fail.

The Royal Commission on Taxation in Canada (the Carter Commission) and the Musgrave Commission in Columbia are said to have done the finest work up to that time in applied public finance because of their comprehensive analysis, rational approach and recommendations which could not have been possible, if a short timeframe had been prescribed.

In order to initiate a public debate, we are presenting a draft of ‘Income Tax Act, 2017’. It can serve as a starting point of debate in the Parliament. All concerned-members of House Standing Committees, tax administrators, trade and professional bodies, taxpayers, tax professionals and public at large-can examine this draft and suggest improvements as well as highlight its shortcomings and deficiencies. A meaningful public debate on this draft can pave the way for better income tax legislation in the country. However, it all depends on the attitude of the elected members, who hardly take any interest in enacting such laws that can make a difference in the lives of ordinary people. They are keener to safeguard their vested interests (amendment in law to ensure that Nawaz Sharif remains head of party even after disqualification by Supreme Court is the most recent example).

We hope that some elected members may get inspired and opt to present it as a private member’s bill in the house before the next budget. It can generate meaningful debate in the Parliament as progressive income taxation is at the heart of establishing a true social democracy. FBR will certainly not like this draft as tax bureaucrats want complex laws and cumbersome procedures that give them unbridled powers and discretion-their strength and capacity to extort money (not tax but bribes) depends on complex and complicated laws. They resist any such change. It is now the duty of elected members to take initiative and enact fiscal laws through consultative process.

Salient features of the proposed Income Tax Act 

I. Integration of all components

There are four authorities responsible for enactment and implementation of taxes on income, Parliament, Federal Government, Federal Board of Revenue and the Inland Revenue Authorities. The role of each one of them should be clearly defined.

II. No delegated powers 

There should be no delegation of powers to any administrative authority in the fiscal law, except to make rules. The notorious SRO system should be disbanded completely as it is against Article 162 of the Constitution of Pakistan.

III. Tax rates should not be subject to annual Finance Bill Income tax Rates should be at least for five years so that people can make long-term planning of their affairs. The base of income and the range of tax rates should be made adequately wider so that there is no need to change it every year. The progressivity of the tax rates is essential to meet the constitutional requirement of ensuring economic justice and social disparities. Tax rates should also be rationalized in order to make them equitable for all classes of persons.

IV. Tax on undisclosed income The tax on undisclosed income must not be charged by clubbing it with the declared income. It should be taxed separately at a fixed rate. However, it is proposed to have a National Deposit Account in which any amount can be deposited without giving explanation for its source. No money can be withdrawn from it for 3 years and it would not carry any interest either. Thereafter, when money is withdrawn the same shall become taxable in that year.

V. Income from capital gains and long-term sources Income from capital gains and other long-term sources should be separately taxed. It should be delinked from the taxation of annual income.

VI. Distribution of income within a family In respect of deductions, a minimum 20% of the income, if transferred to members of a taxpayer’s family, must be exempted. It can be made taxable in the hands of the members of the family. This will provide for faster and equitable distribution of wealth amongst the members of the family and greater family stability in the society.

VII. Penalty and prosecution Penalty and prosecution provisions must continue and the income-tax authorities should be given wider powers to enforce the provisions of law. No degree of liberalization or reduction in the rates of tax can take away the lure of not paying taxes. Tax is like any other expenditure and every one would like to save the maximum on this.

VIII. Payment of tax The entire amount of tax should be made payable by the assessee either by deduction at source or by advance payment of tax before the end of the year. The base for deduction of tax at source may be made very wide but option must be given to the assessee to declare that his income is below the taxable level to receive income without any deduction of tax. Penalty and prosecution provisions can be strengthened against giving a false declaration.

IX. National Court of Federal Taxes There may be a National Court of Federal Taxes subordinate only to the Supreme Court. It should be the final authority as regards the interpretation of all federal tax laws. It should only refer important questions of law to the Supreme Court. This would relieve the High Courts of very heavy burden of tax cases.

X. Rules of interpretation The Act should contain the rules for interpretation of the statutes. Much of tax litigation has arisen because of different rules of interpretation being applied by different authorities and by the same authorities at different times. The rules of interpretation of tax laws should be applied uniformly and decisively.

Draft of proposed Income Tax Act

CHAPTER I

PRELIMINARY

Part 1 – Enactment

1. (1) This Act may be called the Income tax Act, 2017.

(2) It extends to the whole of Pakistan.

(3) Save as otherwise provided in this Act, it shall come into force on the 1st July 2017.

(4) The Income tax Ordinance, 2001 is hereby repealed.

(5) If any difficulty arises in giving effect to the provisions of this Act, the federal government may, by general or special order, do anything not inconsistent with such provisions which appear to be necessary or expedient for the purpose of removing the difficulty.

(6) The Federal Government shall cause every Rule made and every notification or circular issued under the Act to be sent to the Parliament Secretariats within one month of its issue.

(7) Where both Houses of Parliament agree in making any modification in the Rule, circular or notification or both the Houses agree that the Rule, circular or notification should not be made or issued, the Rule, circular or the notification shall thereafter have effect only in such modified form or be of no effect, as the case may be, so, however, that any such modification or annulment shall be without prejudice to the validity of anything previously done under the Rule, circular or notification.

(8) No suit shall be brought in any civil court to set aside or modify any proceeding taken or order made under this Act, and no prosecution, suit or other proceedings shall lie against the Government or any officer of the Government for anything done in good faith or intended to be done under this Act.

Part 2 – Definitions 

2. In this Act, unless the context otherwise requires-

(1) “agricultural income” means agricultural income as defined below:

(a) any rent or revenue derived from land which is situated in Pakistan and is used for agricultural purposes;

(b) any income derived from such land by-

(i) agriculture; or

(ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by him fit to be taken to market; or

(iii) the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by him, in respect of which no process has been performed other than a process of the nature described in paragraph (ii);

(c) any income derived from any building owned and occupied by the receiver of the rent or revenue of any such land, or occupied by the cultivator, or the receiver of rent-in-kind, of any land with respect to which, or the produce of which, any operation mentioned in paragraphs (ii) and (iii) of sub-clause (b) is carried on:

Provided that the building is on, or in the immediate vicinity of, the land, and is a building which the receiver of the rent or revenue or the cultivator, or the receiver of the rent-in-kind by reason of his connection with the land, requires as a dwelling-house, or as a store-house, or other out-building;

(2) “amalgamation”, “company”, “director”, “dividend”, “manager”, “managing agent”, “principal officer” and “public sector company” have the meanings respectively assigned to them in the Companies Ordinance, 1984;

(3) “assessee” means a person in whose name a proceeding under the Act has been initiated or is intended to be initiated;

(4) “Taxation Officer” means any authority who is vested with the relevant jurisdiction under the Act;

(5) “average income-tax rate” means the rate arrived at by dividing the amount of income-tax on Gross Annual Income as per the rates in the First Schedule by such Gross Annual Income;

(6) “Board” means the Federal Board of Revenue established under the Federal Board of Revenue Act, 2007 (Act No. IV of 2007);

(7) “business” includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture;

(8) “capital asset” means property of any kind except-

(a) stock-in-trade, consumable stores or raw materials held for the purposes of business or profession,

(b) movable property excluding jewellery held by an individual or a Hindu Undivided Family, and

(9) “charitable purpose” and “charity” shall have the meaning assigned to them in the Trust Act of 1882;

(10) “cooperative society” means a co-operative society registered under the Co-operative Societies Act, 1912 (XI of 1912), or under any other law for the time being in force in any Province for the registration of co-operative societies;

(11) “fair market value” of an asset means the price that the asset would fetch if sold in the open market on the relevant date;

(12) “firm”, “partner” and “partnership” shall have the meanings respectively assigned to it in the Partnership Act, 1932 (IX of 1932);

(13) “income” includes any receipt in cash or in kind or by settlement through account, whether due or not, which is assessable under the Act and shall include

(a) gifts received,

(b) value of any assets received by way of inheritance or under will or on death of any person in any manner, which exceeds Rs one million, and

(c) goodwill;

(14) “legal representative” shall have the meaning assigned to it in clause (11) of section 2 of the Code of Civil Procedure 1908 (V of 1908);

(15) “non-resident person” shall be one as defined in the Foreign Exchange Regulation Act of 1947 and as a person who is not a non-resident shall be treated as a resident person;

(16) “person” includes –

(a) an individual,

(b) a Hindu Undivided Family,

(c) a company,

(d) a firm,

(e) an association of persons or a body of individuals, whether incorporated or not,

(f) a local authority,

(g) every artificial juridical person, not falling within any of the preceding sub-clauses, and

(h) federal government, provincial government or any person, body or institution, responsible for paying any sum under the Act;

(17) “prescribed” means prescribed by the Board;

(18) “profession” includes vocation;

(19) “public servant” has the same meaning as given in section 21 of the Pakistan Penal Code (XLV of 1860);

(20) “transfer” has the same meaning as given in the Transfer of Property Act, 1882 (IV of 1882) and shall include –

(a) the transfer of a capital asset by a person to a firm or association of persons or body of individuals in which he is or becomes a partner or member, by way of capital contribution or otherwise and

(b) the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or association of persons or body of individuals;

(21) “year”, save as otherwise provided in any provision of this Act, means the financial year, and where a new business or profession is set up, or a source of income newly comes into existence on a date within the said financial year, the year shall be the period beginning with that date and ending with the financial year or earlier.

(To be continued)

(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences)