This is the third in a multi-part series of articles on Income Disguise, Anti-Money Laundering Act (AML), and recent amendments to Income Tax Ordinance 2001 through Finance Act 2021. The purpose of this discourse is to identify the gaps in our financial and tax system that are bridging must be in place to implement an adequate system of punishing those who are actually involved in income obfuscation. If these loopholes are not closed, the productive effect of the legislation is lost and the regular complaints of harassment and arbitrariness arise as usual.
In the recently introduced provisions of the Finance Act 2021, the term “concealment of income” includes all measures under Section 111 of the Income Tax Ordinance of 2001. Anyone charged under this section is considered to be hidden income. I believe that, other than the tax professionals who are actively involved in this business, very few people are aware of the nature of this provision, the manner in which it is applied, and the practical problems that can arise if this provision is rigorous legally prescribed senses are applied.
Section 111 of the 2001 Income Tax Ordinance can be simply referred to as the section that authorizes the tax officer to inquire about the source of any asset or expense owned by that person. This provision is included in the tax laws of all countries and a similar section has been in our tax laws since 1922. The 2021 Finance Act only reaffirms the position that has always existed.
In very simple terms, this section states that if someone owns an asset, be it in Pakistan or outside Pakistan, or has had an expense such as an expensive wedding party, then that person must identify the source from which that asset or expense is funded were. After determining the source, the tax office is entitled to check and inquire whether the taxable income was collected in this way. If the person cannot explain this source, the consequences are:
• Taxing the value of such assets or expenses as that person’s income;
• imposing a penalty of 100% of the amount of tax evaded;
• Prosecution according to § 192A EStV, 2001 and
• Forfeiture of assets under the AML procedure when the value of these assets exceeds 10 million rupees.
Very few people can sleep well if they are involved in an act that may lead to proceedings under Section 111 of the 2001 Income Tax Ordinance. However, in Pakistan, as I will explain in the following paragraphs, we have the taxation system in which practical and reasonable application of these provisions is practically impossible. Both the big political case and the case of a member of the judiciary relate to this issue. This is enough to see the importance of this issue in Pakistan. The problem that has arisen in the implementation of this law in Pakistan, which has made the actual investigation virtually impossible, is identified in the following paragraphs.
Section 111 of the ordinance relates to “assets or expenses”, the other side to “income”. In order to determine the source of any asset or expense, it is imperative to identify the income from which those assets or expenses were generated. If there is no proof of income, there can be no proof of assets or expenditure. Proof of income does not imply taxation of income; it means aggregating the income from all sources and comparing them with their use for the creation of an asset or the incurrence of an expense. In Pakistan, this matching is available and required by regulation by a document called the “Wealth Statement”. In theory, it is an ideal document and implies that all sources of wealth can be identified if all of the wealth statements are examined. However, this theory is seriously damaged by two main mistakes and actions that we have undertaken for political and economic purposes. These are:
-
In Pakistan, agricultural income is not taxed by the federal government, so the federal government record cannot identify the source if it is from agricultural income. The law provides that if an individual wishes to claim an asset or an expense from agricultural income, that amount must be balanced with the provincial agricultural income tax paid by that individual. This is an ideal precaution. Let me confess, however, that we are not transposing the legislation and there are very few cases where such a reconciliation is actually verifiable. One of the reasons why such income cannot be verified is the presumed nature of the agricultural income tax. In short, the agricultural income window needs to be monitored if Section 111 of the 2001 Income Tax Ordinance is to be implemented. It is therefore recommended that adequate means are used to enforce asset equalization for assets or expenses above a certain limit. Changes to the agricultural income tax law in the provinces. If this politically sensitive issue is not taken seriously, the practical implementation of the tax laws, as the government is striving for, cannot take place. This is an economic issue in the country that is generally derailed for political reasons.
-
The second question concerns the “presumed tax” without any concept of imputed tax. In Pakistan there are sources of income such as “exports” that are taxed on a presumed basis. This means that a certain percentage or amount that is not income will be deemed a tax liability in relation to income from that source. Obviously, this amount does not reflect the actual income from this source. Since assets and expenses consist of income (source), no real identification of the source of income can be made. An exporter’s tax liability is 1% of the export proceeds. Real income can be Rs 10 or Rs 50, or even a loss. In the current regime, there is no record of an exporter’s actual income (nor is there an obligation) to identify an exporter’s assets or expenses. In other words, in a practical sense, it is quite possible that an exporter cannot determine the origin of his house from this tax return, because no national tax register shows an amount as this person’s assessed income. There are two answers to this problem. First, the abolition of all alleged taxes and the introduction of a zero tax rate or a reduced tax rate if a benefit is to be granted. That was my approach when I was at FBR. Without this measure, there can be no exercise or enforcement law for “inexplicable assets”. The second approach, which is actually a transitional measure, is to reintroduce the concept of imputed income to make it easier to identify a nominal source. For example, it can be said that for exports, the credited income is 25 times the tax paid on exports. This is not an ideal system; however, it is much better than the current unguided practice. The concept of imputed taxation existed in the 1979 Income Tax Ordinance, which was repealed and which was unnecessarily deleted in the 2001 Income Tax Ordinance. This needs to be reintroduced.
The purpose of this discussion is to make the tax administration accept that proper implementation of the law is only possible if the inherent gaps in the existing system are bridged. There is always a time to start correcting things. Unfortunately, I think we have reached that position. There seems to be government willingness to deal with income obfuscation, but first the gaps need to be bridged. There is no point in investigating, investigating, investigating, punishing and confiscating the assets on the grounds that it is income from hidden income when there are many windows open in the law that make the law impractical .
Copyright Business Recorder, 2021