Tax Amnesty for Prosperity

Spearhead Analysis – 06.04.2018

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

“We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”. [Sir Winston Churchill]

Tax and Amnesty schemes are meant as a quick fix with expectations of large gains through granting one-time exemptions. Such schemes have been introduced by different counties over the years and one of the more successful one was launched in 2016 by Indonesia.  After much speculation the Prime Minister of Pakistan finally announced the much anticipated Tax Amnesty Scheme yesterday. 

As per the Federal Board of Revenue (FBR) Active Taxpayers List there are some 1.26 Million taxpayers who filed income tax returns for the tax year 2017. Around 160,000 taxpayers become non-filers during the same year. Out of the registered tax payers only around 700,000 actually paid taxes, with most of them without an option as their taxes were deducted at source. Within a population of roughly 220 Million, as per the last Census results, this is a minuscule part and one that is not sustainable. In contrast to Pakistan around 4.7 per cent of the population pay taxes in India, 58 per cent in France, and 80 per cent in Canada. Unfortunately, for Pakistan the people think that they do not have to pay taxes, a mindset that has evolved over the last many years and pervades the other regional economies as well. Rampant corruption, lack of infrastructure development, dismal social sector facilities, and low education levels have all contributed towards convincing the people that their ‘hard earned’ money if given to the Government would be squandered for the personal gain of the ruling elites. Additionally, the lack of will within the government to implement an effective tax system has spawned from a need to enhance their personal gains at the expense of the State. The problem has been exacerbated by the policy of contracting Debt to meet deficits, rather than relying on enhancing revenue generation through increased opportunities, structural economic reforms and an expanded tax base.

The PML-N Government has continued to pile on the Debt during its tenure, hitting the US$90 Billion mark. A false sense of security was created by buffering reserves through the borrowings, and there has been no effort to contain the rising deficits. Ill-conceived infrastructure plans focused on roads, bridges, rail and metros have consumed Billions of Rupees, while the debt has kept piling on. The Circular debt alone is almost at the Rs.1 Trillion level, after assurances at the start of their tenure that this debt had been eliminated. In a word, we are back to where we were 5 years ago, with serious macroeconomic vulnerabilities, a devaluing currency, falling reserves, rising deficits, and a high probability of having to approach multilateral agencies for assistance.

The difference this time around is that relations with the US have soured and that could have a big impact in terms of being able to gain funding from multilateral agencies. In addition, the potential inclusion of Pakistan on the Financial Action Task Force (FATF) ‘Grey List’ would be another impediment that could hamper trade and the inflow of funds, and enhance the cost of business transactions. With around 85 days left for the present government, the much anticipated Amnesty Scheme has finally been announced as a means for Pakistan to overcome its financial inefficiencies. The timing of the scheme is somewhat surprising, as it is at the fag end of the governments tenure. Perhaps, when all else failed and the PML-N government wanted to exit on a high note, it felt this scheme would help bolster reserves providing them with a positive for their upcoming election campaign. The pragmatic approach would have been to have launched such a scheme at the start of their tenure to reap the maximum benefit for the country, with a longer Amnesty window. As it is, the scheme appears to be a last knee-jerk reaction when all else has failed and the nation has been buried under piles of debt and deficits. At a time when the FATF is breathing down our necks, this is a scheme that is allowing people to ‘whiten’ their ‘black’ money by paying a nominal tax and the almost 10 per cent sudden devaluation of the Rupee in the past three months, appears to have been an orchestrated move as part of the Amnesty scheme.

PMN-N Manifesto

After a meeting of the Economic Advisory Council (EAC), the Prime Minister announced a five-point Tax Reforms Package to meet the objectives of the PML-N government’s manifesto:

  1. CNIC numbers to be converted to NTN numbers to monitor tax compliance of all citizens.
  2. Income tax brackets and percentages to be revised.
  3. Undeclared assets held locally or abroad to be declared after payment of nominal penalties with the grant of a one-time exemption from accountability laws.
  4. Tax to be collected on all property transactions to be made uniform.
  5. Government to monitor citizens’ financial records and issue notices if they find evidence of tax evasion.

In addition, in a separate interview Mr. Miftah Ismail stated that the Government would be launching a Bond, where people could invest their foreign currency and get a return of 3 per cent per annum with repayment of principal amount at maturity at the exchange rate in effect at that time.

Under the proposed scheme the following tax brackets have been amended and the maximum bracket of 30 per cent has been brought down to 15 per cent:

  • Annual Income up to Rs.1.2 Million – No Tax
  • Annual Income between Rs.1.2 Million to Rs. 2.4 Million – 5 per cent Tax
  • Annual Income between Rs.2.4 to Rs.4.8 Million – 10 per cent tax
  • Annual income above Rs.4.8 Million – 15 per cent tax.

While it is being proposed that the CNIC numbers will now become the tax numbers and that everyone will have to file a tax return even if it is a NIL return, implementation of this policy is likely to pose a serious issue with a largely uneducated population ill-equipped to file a return. Not sure how the Labourers and Domestic Servants holding a CNIC would file a return.

The announced Amnesty Scheme will be given a one-time exemption from accountability and other laws and includes the following concessions:

  • People with undeclared income earned before June 30, 2017 on assets within the country will be able to bring it into the tax net by simply paying a 5 per cent penalty.
  • Foreign exchange held abroad could be brought into the country by paying a 2 per cent penalty.
  • Fixed assets will incur a 3 per cent penalty, to be evaluated at the market value of the asset, which cannot be less than the cost of its acquisition.
  • Foreign liquid assets like cash, securities and bonds held abroad and in local dollar accounts may be declared with a 5 per cent penalty.
  • Dollar account holders in Pakistan who have purchased dollars with undeclared funds can also regularise them on 2 per cent payment.
  • All remittances less than US$100,000 per year per person will continue without any questions from any agency about the source of funds and enjoy tax exemption. All remittances greater than that amount will enjoy tax exemption but may be scrutinised by the Federal Board of Revenue.
  • New foreign exchange accounts can only be opened by tax filers.

For property transactions the following amendments have been proposed:

  • Maximum 1 per cent tax (local and provincial) for registration of property and at federal level Adjustable Advance Income Tax of 1 per cent.
  • FBR rate on property being abolished from 1st July 2018 and provinces being requested to abolish the DC rate.
  • No purchase of property over Rs.4 Million possible for non-filers of tax returns from July 1, 2018.
  • To avoid under-invoicing, the government will hold the right to buy any property that a citizen holds by paying 100 per cent over its declared price – this will hold for six months from the registration of the property starting fiscal 2019. The rate will fall to 75 per cent in fiscal 2020, and 50 per cent in fiscal 2021 to deter under reporting.

Pakistan has signed and ratified the OECD’s Multilateral Convention on Mutual Administrative Assistance in Tax Matters. This has established an exchange of information mechanism for tax purposes with more than 100 countries, including tax havens and would enable regulators to seek information on banking and other details of residents from these countries for taxable periods 2018 onwards and for tax matters involving intentional conduct which is liable to prosecution, for earlier taxable periods as well. Pakistan is also commencing automatic exchange of financial accounts information under the OECD’s umbrella from September 2018 onwards, which will expose Pakistanis’ hidden offshore accounts and assets to government and help contain cross border tax evasion.

The government will monitor the financial transactions to discourage tax evasion. In addition, the Foreign Assets Declaration and Repatriation Ordinance is not valid for the following categories:

  • Money laundering
  • Drug smuggling
  • Terror financing

It is also not open to public office holders/ people in service of Pakistan including their spouses and dependent children.

The punitive measures for those who fail to comply will be decided on by parliament and the main purpose of the Ordinance is to expand the tax net, with an expectation that around 30 Million tax payers would be inducted into the system.

The reforms are being introduced under Executive Powers through an Ordinance, to be ratified through the Parliament. The Ordinance has a validity period of 120 days and the scheme has a validity of 85 days as of yesterday. It is pertinent to note that while responding to questions the PM stated: “If someone does disagree with the reforms, they can challenge it in court and then the court can rule on these reforms as it sees fit.” A road that the government should not be taking. The scheme should be launched with fool-proof guarantees and assurances that the exemptions would not be questioned under any circumstances now and in the future. He did reiterate: “We will use the cover of the law and parliamentary process to close any loopholes that exist in this scheme. The parliament will also be responsible to create the laws that will decide punishments for various forms of tax evasion.”

To gauge the success of such schemes the example of Indonesia can be studied. They launched a Tax Amnesty programme that ran from July 2016 to March 2017 (almost 9 months as opposed to 85 days for Pakistan), which was labelled as one of the most successful Amnesty programmes in terms of asset declarations. As per data from Indonesia’s Tax Office, around 965,983 people participated in the program, out of a total population of around 260 Million. Despite the success of the programme tax evasion has remained rampant in Indonesia with the government relatively helpless in collecting the optimal level of tax revenue. Out of the million or so people who participated in the Amnesty programme only 200,000 were deemed as new tax payers, while the remaining 765,000 odd people were already tax filers who availed the scheme to declare their undeclared assets.

The fact that out of an adult population of approximately 165 Million, only about 35 Million are registered taxpayers in Indonesia implies that there is a huge pool of people who fail to fulfill their tax obligations. With estimates that only 12 Million Indonesians pay their annual taxes, the figure is woefully low, but far higher than Pakistan. Perhaps that is what prompted the PM to quote the figure of 30 Million potential tax payers for Pakistan.

Indonesian Finance Minister summed up the Tax Amnesty results as follows: “I find the number of participants in the amnesty program small – both regarding taxable objects in the nation’s small and medium sized enterprises (SMEs) sector and non-SMEs sector. Hence, too many people have not joined the amnesty programme.”

  • A total of approximately US$366 Billion worth of assets were declared to Indonesia’s Tax Office under the scheme, a figure that equals nearly 40 per cent of Indonesia’s Gross Domestic Product (GDP). About 75 per cent of these funds were assets stashed domestically, while 25 per cent assets were held abroad.
  • In terms of asset repatriation only US$11 Billion worth of assets were repatriated into the specific investment instruments against a government target of US$75 Billion.
  • In terms of redemption payments, the Indonesian government collected US$8.5 Billion.

There was an apparent reluctance to repatriate wealth to Indonesia perhaps related to Indonesia’s relatively high tax tariffs and fears of another Asian Financial Crisis. The Government in Pakistan has introduced lower tax rates to overcome this problem but needs to assure the people that the funds can be deployed productively within the country and that opportunities for investment would be available.

It is believed many of those who joined the amnesty program did so out of concern of being caught in 2018 when the Organization for Economic Co-operation and Development’s (OECD) Automatic Exchange of Information initiative is implemented to enhance tax transparency.

There is an expectation that with the tax amnesty program Indonesia’s tax revenue may grow up to 10 percent (year-on-year). However, it is important for the government to set an example and limit corruption cases to encourage people to bring in the funds for productive use.

Reservations are being expressed by different quarters about the announced Amnesty scheme in Pakistan. As per some rough estimates money held aboard by resident and non-resident Pakistanis ranges between US$150-200 Billion. This is apart from the undeclared assets within and outside the country, which would be much higher. There is therefore a sizeable opportunity to enhance the tax base of the country. It is expected that:

  1. People might adopt a ‘wait-and-see attitude’ to be sure that the amnesty package would be ratified with the required legal cover and whether it is challenged in court.
  2. The scheme may not be of interest to non-resident Pakistanis as their earnings there would already be declared and they would not have a problem justifying it in Pakistan if they were to return.

There are expectations that around US$5 Billion could enter Pakistan under the scheme.

The scheme is a move in the right direction, but one that should have been introduced much earlier and for a longer duration. If backed by solid legal ratification, it could encourage people to bring in their funds and declare their assets ahead of the FATF grey list and the OECD tax treaty. It remains to be seen how serious the government is in its resolve to actually implement the scheme and provide genuine opportunities for productive use of the funds. There could be potential backlash towards the scheme internationally, specially the United States as they want to restrict Pakistan financially. If the purpose is short-term to bolster reserves or a personal agenda, the success would be severely limited like all the earlier efforts of the government towards fiscal reforms and we might find ourselves standing in a bucket trying to lift ourselves by pulling on the handle.