In the current budget, the government has proposed to levy a wealth tax by proposing to enact a new law.1 The object of the tax is to provide financial assistance, social protection and a safety net of measures for economically distressed persons and families. The step is being taken pursuant to the principles of policy as provided in the Constitution of Pakistan 1973,2 to provide for financial resources for running an income support fund for the distressed classes of people.3
The proposed law provides for a levy of tax on the net moveable wealth of the individuals.4 The proposed tax will be collected on the value of net moveable assets and shall be chargeable for every tax year with effect from the tax year 2013.5 The proposed tax shall be chargeable at the rate of 0.5% of the net moveable assets exceeding one million rupee.6
The proposed levy has raised many questions, first being the nature of levy, that is, whether the proposed tax is a wealth tax or transfer tax or an additional income tax and its impact on the markets and individual household.
For example, transferor-based taxes are generally levied separately on inter vivos transfers like gift tax and on transfers at death like estate tax, or together in a single integrated tax.7 Recipient based taxes are levied on inter vivos transfers ie, gift tax, on transfers at death ie, inheritance tax, and on an integrated basis accessions tax.
Where the government is seeking to address the additional tax capacity afforded by wealth it ordinarily allows top marginal income tax rates to be reduced without sacrificing overall tax progressivity. In the alternative, a wealth tax may add to the overall progressivity of an income tax without having to increase marginal rates.8 Hence, there is no room for justifying the net wealth tax with the support of the theory of ability to pay tax. A wealth tax base9 separate from an income tax base can help to ensure that taxes not collected on the latter, because of avoidance or evasion, might be collected on the former.10 This may be particularly true with regard to income from asset appreciation that has accrued but that is not taxed owing to the “realisation event” of the nature of most income tax systems.11
The distinction between transferor-based and recipient-based taxes is not black and white. In the case of transferor-based taxes, the existence of various exemptions, exclusions, and deductions based on the status of the recipient can make the tax liability similar to that under a recipient-based tax. In the case of a recipient-based tax, administrative techniques of collecting the tax at the level of the transferor can make it procedurally similar to a transferor-based tax.
It is evident that the present levy corresponds to the status of a wealth tax or it may be considered as an income tax. If it is an income tax then the problem of double taxation can also arise. In a tax design there are three key constraints namely, efficiency, administrative costs and the political constraints. Even for tax reforms there are three main criteria. Welfare criteria is the first one12 which is a standard criterion generally used in tax reform. The other two include equality of opportunity and paternalism and these are very important from the wealth transfer taxation perspective. Generally the objective of government is to choose a tax structure that maximises social welfare, taking account of how individual behaviour will respond to the tax system obviously keeping in mind the need to raise revenue to finance expenditure on public services.13 The point here is that one person’s tax liability relative to another person’s is directly related to their (relative) well being,14 and on the principle of equality no discrimination is to be made.
We are also confronted with the issue of taxable capacity, usually the responses to such issues are not direct, for example, and UK’s well known Meade Report on Tax Reform15 argues that wealth and consumption both are relevant for measuring taxable capacity. The proposed law on which we are debating is silent on a number of issues and it appears that the decision to levy this tax is simply based on the notion of levying a sort of charity contribution on a class of population without considering that whether or not it will bring in efficiency and it all leads to the question that how the issues of horizontal and vertical equity are going to be resolved.16
The proposed levy brings with it a number of issues. Among them are the following which require our attention:
(i) Tax payer’s physical presence or residence;
(ii) Entities and resident and non-resident owners;
(iii) Exemptions
(iv) Valuation
(v) Double taxation
(i) Physical persons or residence
If we take the welfares approach literally,17 all sources of well-being should count regardless of their source. We may refer to this as a strict welfares approach,18 and a number of special problems may arise in this context.
For example, physical persons are taxed either as individuals or, if they are married, minors, or themselves have minor children, as part of a family group. The proposed law on this aspect of the issue is silent.
(II) ENTITIES AND RESIDENT AND NON-RESIDENT OWNERS In most jurisdictions, only physical persons (individuals and families) are taxed.19 This means that, if all wealth is to be included in the base, that which is held indirectly through legal persons or other entities it must be attributed to the physical person taxpayer.20 Moreover, attribution is necessary to prevent the double taxation of capital owned by entities. This involves determining who is the holder of the ownership interest and valuing the interest. The proposed law does not specify how these issues are to be settled!
Ownership interests in entities other than companies, partnerships, or other typical methods for organising a joint business enterprise may be even more difficult to ascertain, and valuation of those interests, particularly if not publicly quoted, may also be difficult.21 The proposed law does not provide any directions in this regard and these issues can cause misadministration and corruption.
For example, taxing persons holding wealth indirectly through equity-type interests in entities requires identification of the owner, as well as the determination of the nature of the interest, and the same is quite difficult. It may lead to litigations and delays making the effort of taxation worthless.
Similarly the family trusts, and entities like that also pose problems of identification and determination of interest. These entities are often set up by individuals to hold and manage wealth.22 The trust is a creation of law.23 The basic legal concept of the trust is the separation of the ownership interests in property into a legal title, held by one or more trustees, and an equitable title, held by one or more beneficiaries. The legal title gives the trustees control over the property, while the equitable title gives the beneficiaries rights to the benefit of the property.24
Benefits may favour some beneficiaries over others and may change over time. It is often true that no particular beneficiaries or beneficiary has the full right to enjoy all the benefits of the property, nor are the shares of the respective beneficiaries fixed. This can make determining the attributes of ownership of the underlying wealth exceptionally difficult.25 The proposed law is silent even on this subject.
Foreign laws can be relevant to the structure of the ownership interests of residents. For example, a resident of a foreign country can set up a Cayman Islands trust or a Liechtenstein Stiftung.26 In addition to the considerable administrative problems that could arise, the legal question of ownership of the corpus of a trust would still is important to the country of residence.27
Another consideration is that if both physical persons and entities are taxed, double taxation can occur unless ownership interests in taxable legal persons are themselves exempt.
(III) EXEMPTIONS The agencies and instrumentalities of government are normally exempt from net wealth taxation; such entities are already publicly held, and levying a tax on such assets would not advance any of the stated goals of wealth taxation.28
An argument can be developed that charitable activities be encouraged, and an exemption from wealth taxation may serve as a reasonable tax subsidy.29 However, exemptions may spread far beyond such limited parameters.
(IV) TAX BASE If most jurisdictions tax domestic assets (together with world-wide assets of residents) then taxing assets can also form part of international co-ordination of the net wealth tax and relief will be allowable for foreign wealth tax paid on assets located abroad, as that is necessary to avoid double taxation. We do not find any such elaboration in proposed law.
(V) EXEMPTIONS Many assets are often exempted from the tax base for particular taxpayers. Statutes frequently provide a zero-bracket amount to exclude taxpayers who do not have sufficient wealth to warrant taxation.30 Different jurisdictions have enacted various exceptions for different reasons. For example, in France, goods necessary for the practice of a profession are exempt, presumably so as not to burden the means necessary to an individual for the production of her or his livelihood. 31 No such consideration has been made in the proposed law.
(VI) VALUATION Valuing net wealth often poses serious practical difficulties. Some jurisdictions, such as Germany, have a general valuation law that is used for all taxes.32 Other jurisdictions, such as France, have different rules for income taxes and for wealth taxes.33 The value of immovable property, for example, can be estimated using the same rules as for real property taxes or stamp duties. This can of course lead to large inequities if the value for purposes of the other tax is distorted.
Because of the difficulty of performing a valuation, it is often provided that for certain kinds of assets a valuation remains in effect for a specific number of years, or there may be a formulary adjustment of the valuation for a specified period.34
Perhaps the most difficult valuation problems are likely to arise from the varying forms of interests found in companies, partnerships, trusts, and other entities.
(VII) DOUBLE TAXATION Net wealth taxpayers whose world-wide net wealth is subject to tax may be subject to double taxation.35
(VII) LEGAL ISSUES It is not evident, what is the exact nature of the levy, nevertheless it may be stated that in case it is a wealth or wealth transfer tax, federation is no more empowered to legislate on this subject as these areas included in concurrent legislative lists now do fall within the domain of provinces. However, in view of Supreme Court’s distum36 the present levy may fall within the domain of income tax and the issue of double taxation would obviously emerge.
To sum up it may be stated that proposed legislation is purposeless and wanting in many areas and requires a serious review.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)
1. The Income Support Levy Act, 2013 (hereinafter referred to as the proposed Act)
2. See article 29 through 40 of the Constitution of Pakistan 1973.
3. See the object and reasons for enacting the Income Support Levy Act, 2013. It has been stated that proceeds from this levy will not go to the federal fund but would be directly transferred to the National Income Support Program for the needy and the existing support has been increased by 20 percent ie from Rs 1000 to Rs 1200 per month per person.
4. See clause (b) of section 2 of the proposed Act. The net moveable wealth means the amount by which the aggregate value of the moveable assets belonging to a person as declared in the wealth statement for the relevant tax year, is in excess of the aggregate value of all the liabilities owed by that person on the closing date of the tax year: Explanation.- For the purpose of this clause,- (i) where liability claimed relates wholly and exclusively to an immovable asset, it shall not be claimed and allowed while computing the net moveable wealth. However, where the liability claimed relates wholly and exclusively to a moveable asset, it shall be claimed and allowed as a straight deduction while computing net moveable wealth; and (ii) where the gross wealth of a person, declared in the wealth statement includes both moveable and immovable assets and the nature of assets to which the liability relates is not determinable, the liability to be allowed while determining the net moveable wealth shall be calculated by the following formula:- (A / B) x C Where – A is the gross value of moveable assets; B is the gross value of both moveable and immovable assts; and C is the gross value of debts owed.
5. See section 3 of the proposed Act.
6. See section 9 of the proposed Act.
7. The former UK Capital Transfer Tax, which was in effect from 1975 to 1986, was levied on a cumulative basis on all transfers during lifetime and at death. See, M.R. Moore, United Kingdom Inheritance Tax, 34 European Taxation 421 (1994). An integrated tax was established in the United States in 1976. See generally Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976 525-32 (1976). The US tax is still in effect.
8. The progressivity effects of wealth taxes have been the subject of much scholarly debate, most particularly in the United States. In that country, before the considerable increase in reliance on the income tax as a revenue source during the Second World War, the estate tax provided up to half the amount of revenue, as did the income tax, contributing substantially to the progressivity of federal taxation. See John E. Donaldson, The Future of Transfer Taxation: Repeal, Restructuring, and Refinement, or Replacement, 50 Wash. & Lee L. Rev. 539, 544 (1993). By the 1980s, the relative amount of contribution to total revenues by the estate tax had declined dramatically. Id. In 1994, estate and gift tax revenue represented 1.2 percent of federal revenue ($15.2 billion) in the United States. In France, the wealth tax yields F 9 billion out of total revenue of F 1,400 billion. See Le Monde, April 21- 22, 1996, at 6. According to one scholar, this drop has ensured that the estate tax no longer materially contributes to the progressivity of the federal tax system. Id. See also Joel C. Dobris, A Brief for the Abolition of All Transfer Taxes, 35 Syracuse L. Rev. 1215 (1984). According to one study, no country currently derives significant revenues from taxation of wealth. Henry J. Aaron & Alicia H. Munnell, Reassessing the Role for wealth Transfer Taxes, see 45 Nat’l Tax J. 121, 133 (1992). A strong wealth transfer tax system runs counter to deep-seated human motivations, making it unlikely that any jurisdiction would ever enact a wealth tax with sufficient revenue implications to add significantly to progressivity. Edward J. McCaffery, The Uneasy Case for Wealth Taxation, 104 Yale L. J. 283, 294 (1994). See also Charles O. Galvin, To Bury the Estate Tax, Not to.
9. The tax base for taxes on wealth includes either the world-wide net assets owned by, transferred to, received (depending on the type of tax) or given away by a taxpayer who has a sufficient connection with the jurisdiction, or those assets situated in a jurisdiction regardless of the taxpayer’s connection with it.
10. See, eg, Harry L. Gutman, Reforming Federal Wealth Transfer Taxes after ERTA, 69 Va. L. Rev. 1183, 1185-86, 1189-97 (1983); Henry J. Aaron & Harvey Galper, A Tax on Consumption, Gifts, and Bequests and Other Strategies for Reform, in Options for Tax Reform 106, 111-12 (Joseph A. Pechman ed., 1984).
11. See Paul B. Stephan III, Commentary: A Comment on Transfer Tax Reform, 72 Va. L. Rev. 1471, 1479 (1986).
12. Welfarist criterion is the standard criterion used in tax reform in many countries. For reference see, James E Meade, The Structure and Reform of Direct Taxation, Routledge, First Edition, (2012).
13. Better-off individuals bear progressively higher tax bills with the degree of progressively depending on the size of behavioural responses as well as aversion to inequality by government as reflected in the rate at which marginal utility of consumption diminishes. And these are the efficiency and equity considerations. The marginal utility of consumption is marginal social utility as judged by government in its notional calculations of social welfare.
14. This approach is typically called welfares and, in our perspective levels of individual well being count in determining social welfare.
15. Id. n 7.
16. See Business Recorder’s editorial dated June 13, 2013. The editorial states: The intentions may be good, even noble, but the fact remains that assets are being taxed and not income. This may not be congenial to raising the investment to GDP ratio from 14 to 20 percent. To say that it may be treated as a ‘religion card’ but it needs to be reminded that there is an order by the honourable Supreme Court that Zakat, which is a compulsory religious levy, cannot be mandatorily collected by the government. We are also reminded of the Iqra surcharge or Education Cess on all imports that the late Dr Mahbubul Haq had imposed in one of the budgets that he presented, with an assurance that collection under this head of account will not go to the federal fund but will be spent on education. An equally noble cause indeed as helping the needy, but what happened later on is something best not dwelled upon.
17. Kaplow, Louis & Steven Shavell, Reply to Ripstein: Notes on Welfares versus Deontological Principles, Economics and Philosophy, Volume 20, 2004, page 209.
18. A comprehensive survey of the optimal taxation of bequests can be found in Cremer and Pestieau (2006). Our discussion draws heavily on that.
19. This is also the general rule followed in the Nordic countries. In fact, Germany’s law is the exception.
20. For example, in France, wealth held by physical persons through companies, associations, and foundations is included in the physical person’s tax base.
21. The general matter of valuation is considered infra at secs. II(B)(3) & III(F). See also infra text accompanying notes 51-67 concerning legal forms of organising business enterprises.
22. These entities can also be used for regular, for-profit business purposes. However, in these cases it is typically not difficult to ascertain who the investors are and to attribute wealth directly to those investors. See Richard K. Gordon & Victoria P. Summers, Trusts and Taxes in Civil Law Emerging Economies: Issues, Problems, and Proposed Solutions, 5 Tax Notes Int’l 137, 142-43 (1992).
23. See generally the historical discussion in George G. Bogert, Law of Trusts and Trustees, Section 3 (2d rev. ed. 1984).
24. See, eg, Restatement (Second) of Trusts § 2 (1959); 1 Austin W. Scott & William F. Fratcher, The Law of Trusts §§ 2.3-2.6, at 40-48 (4th ed. 1987-89).
25. Id.
26. Commercial Code arts 552, 558 (LIE).
27. See generally Convention on the Law Applicable to Trusts and on Their Recognition (1984).
28. See, eg DEU VStG §§ 3(1)(1), 3(1)(1a), 3(1)(2), 3(1)(2a). These do not include legal persons owned by the state but that do not act in a governmental or sovereign function.
29. This argument can be made to advance exemption for all forms of taxation of socially beneficial not-for profit enterprises. See Yishai Beer, Taxation of Non-Profit Organisations: Towards Efficient Tax Rules, 2 British Tax Rev. 156 (1995). Other arguments also exist, including that an exemption from taxation for all not-for-profit enterprises (meaning those that cannot distribute earnings to owners) can help compensate for difficulties not-for-profit entities experience in raising capital. See Henry Hansmann, The Rationale for Exempting Non-profit Organisations from Corporate Income Taxation, 91 Yale L. J. 54 (1981) (although the arguments advanced are addressed to income taxation, they largely also apply to wealth taxation).
30. For example, taxable assets are to exceed the threshold of one million rupees.
31. Id.
32. See DEU VStG § 4.
33. Id.
34. Id.
35. Double taxation can be eliminated either by unilateral relief or by tax treaties. For example, under treaties, immovable property is normally taxable in the country in which the property is situated. An important difficulty in relying on treaties is that there are relatively few that cover net wealth taxes. But in the proposed law moveable assets are being taxed and the net work of tax treaties will bring a zero sum game as regards foreign entities and entities owned by resident; in foreign countries are concerned.
36. Elahi Cotton Mills v Federation, PLD 1997 S.C. 582.
Zafar Azeem, "Taxing the taxed: Income Support Levy Act, 2013," Business recorder. 2013-06-20.Keywords: Economics , Economic system , Economic issues , Economic policy , Economic growth , Tax policy , Tax Ordinance , Social protection , Business enterprise , Taxation , Taxes , Pakistan