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Federal budget 2009 - yet another opportunity lost

By Kashif Jahangiri

Agriculture sector: Agriculture forms 20% of Pakistan's GDP. The Tax to GDP ratio of this sector is less than 1%, even after taking into account the provincial taxes.

When someone talks about income tax on agricultural income, he is condemned as someone disrespecting to the sacred cow. This holds more ground especially in these days when we are witnessing food inflation and there is talk of giving more incentives to the agricultural sector.

Someone talking about agricultural income tax is immediately shown the picture of a feeble farmer (or a tenant farmer) making efforts to make his ends meet in these challenging times. The question is: Does our agricultural sector comprise solely of subsistence level farmers - what about feudal lords with big land holdings including those who employ people as their tenant farmers? As a matter of fact, approximately 88% of farmers own less than 12.5 acres of land, while the other 12% are big land owners. We need to isolate the different categories of agriculturists; there is no need to staple the whole lot together. Income tax should be 'tax on income'; so if a farmer is at a subsistence level, he would not be paying tax but if there is someone who is cropping cash in his fields, why should he not contribute to the exchequer?

Talking of agriculture, the question is: are we an agrarian society other than for the fact that we claim to be one! In the complete definition of agriculture, the sector is not limited to farming four seasonal crops and leaving them at the mercy of weather; it also includes mechanized farming, dairy, livestock, etc. It is ironic that despite the concessions granted year on year, the agricultural sector has not grown to the extent it should have. Despite the fact that our consumption of fertilizer is higher than the world's average on a per-hectare basis, our yield per hectare is very low as compared to the international average, a few statistics are given below.

* The world average yield of wheat is around 2,720 kg per hectare, while in Pakistan it is about 2,262 kg per hectare. Even in, the average yield of wheat is over 2,770 kg per hectare, which is well over the world average, while in the UK and Germany it is around 7,800 kg and 6,500 kg per hectare, respectively. Even in Saudi Arabia, the yield is more than 4,700 kg per hectare.

* The average yield of maize in Pakistan is around 1,768 kg per hectare against world's average of 4,343 kg per hectare. In India, Maize average yield is 1,705 kg per hectare and in China, it is 5,022 kg per hectare.

Although, the average cotton yield in Pakistan (around 1,867 kg per hectare) matches well with the world's average (1,788 kg per hectare), however, there is a huge room for improvement as China's average yield of cotton is around 3,978 kg per hectare.

* The per-hectare yield for Rice in Pakistan is 2,900kg as compared to 9,500kg in Egypt and 8,220 in Australia.

* Pakistan is the sixth largest milk producing country and yet we do not exist on the dairy map of the world.

The above is largely because excessive land is held by a few feudal lords and they cannot manage their farms to the best of the available use. They would not use the mechanized farming techniques in order to exploit the poor cultivation tenant, and to enjoy the feel of being the almighty. The excessive landholdings earn enough for the feudal lord, but at the expense of the public at large. The poor cultivation tenants always struggle to make their ends meet.

In the last 60 years no effort has been made to grow corporate farming. Any move towards corporate farming will be resisted by the mighty ones as this will affect their status and land holdings.

I would propose that all provincial and local levies (such as Abiana, Malia, etc.) are removed from agricultural income and such income is taxed as normal business income. The reduction arising to the provinces on the removal of these small taxes should be taken up by the Federal Government, similar to what was done in 1999 on removal of the octoroi (choongies). Tax exemption on agricultural income should be restricted to companies in order to encourage corporate farming and, in the case of individuals, to farmers who have received formal training in farming. For other farmers, tax exemption should be available only if their produce per hectare is in excess of a given threshold. For companies, the tax exemption should be restricted to so much of the profit that is re-employed in the business and is not distributed out for at least 5 years. Dairy sector should be given tax incentives on an identical basis. Similar to inheritance tax, the constitutional bar on the taxation of agricultural income can also be dealt with through provincial income tax laws with the mode of recovery vested in FBR (similar to sales tax on services).

Capital gains on listed securities: It is interesting to note that our present taxation policy encourages investment in stocks only on a short term basis. If you invest for long term, your returns will be taxed. However, if you are a short term investor looking for a value gain only, your capital gains will be free of tax. With this policy, we hope to have a stable stock market!

Capital gains tax (CGT) exemption on shares should be rationalised and dividend distributions by companies should be exempted. CGT exemption on shares should be available only where shares are disposed of after being held for one year. This exemption should be proportionately reduced and capital gains derived on sale of shares disposed of after being held for less than 3 months should be taxed at full rate.

The above will discourage people from investing for short term and will induce them to hold shares for longer term. Consequently, it will bring only the genuine investors to stock exchange and will filter out those who are there to make money overnight. This will bring the much needed stability to stock exchange index movements which will then reflect the true state of the country's economy.

The stock pundits drumbeat that by taxing the capital gains, foreign investment will be withdrawn by the international investors and the stock market will plunge nose down. One fails to understand this logic. What do we gain if their money changes pockets for a few days in our stock market where in the end they extract out the capital of the local investors! The way our stock market works, it is certainly not a barometer of investment. In fact the stock market in Pakistan is nothing but a sophisticated casino of the West; the only difference is that income earned in a casino is subject to tax.

Consumer economy: The slogan looks very attractive but, as they say, the devil is always in the detail. This is a big ill of the previous government as they let the banks invest heavily into non-productive sector in the name of reshaping the banking sector and making Pakistan as a consumer economy. The banks found a very easy window in the shape of retail lending for non-productive assets (such as cars, etc.) as it was always easy to get hold of the asset through 'hired-ghundas' (recovery teams) in the middle of the road. The ordinary consumer was willing to borrow at a very high rate. In a 3/4 year period, the overall banking profits grew manifold as the spread was retained by the banks and very little was passed on to the depositors.

Where this philosophy very systematically diverted the investment into non-productive sector, it has become very difficult to sustain this with the increasing oil bill and with the acute shortage of gas. Another flip side of this was that it increased the interest rates as the retail consumers were paying higher interest rates as compared to industrial investors. This now needs to be checked and we need to bring the train back on its track.

I would propose that an excise duty is levied at 25% on all non-productive loans. Again, the purpose is not to generate revenue, but to correct the direction in which the investment is flowing.

Presumptive tax - the blanket is not leaving us now: Presumptive system of taxation should be done away with. Successive governments have been promising to do away with this system however the reliance has always been increasing since 1991 when this system was first introduced in the Pakistan tax law. This Retail and wholesale trading sector forms 18% of GDP and its total Tax to GDP ratio is less than 2%. This is because traders are largely taxed under presumptive tax where they are required to pay tax and sales tax at a fixed percentage applied on their gross sales. The combined percentage for sales tax and income tax varies from 0.5% to 1%.

While our fiscal policy has a basic flaw of encouraging non-documentation, our monetary policy is also running on the same path and encouraging non-documentation. We are a very small economy with the maximum currency note of worth Rs. 5,000. The US is a three trillion dollar economy and the maximum bill there is of USD 100 (maybe we are trying to equate in exchange rate terms!). In simple terms, by enabling people to carry huge volume of cash in pockets, we are encouraging a cash economy bypassing the banking system. Since the introduction of the new tax law in 2002, the number of the so-called transitional provisions (that deal with presumptive taxes) has just been increasing.

A committee comprising of professionals and industrialists should be set up to investigate the best way of moving away from the presumptive system of taxation. The findings of the committee should be religiously adhered to.

Tax exemptions - tie these with business expansion and development of human capital: As a policy, every tax exemption should be restricted to profit that is not distributed for at least 5 years and is re-employed for business expansion. The difference between accounting profit and taxable income will need to be bridged. This can be achieved by restricting the exemption on a proportionate basis (for example, if on an accounting profit of Rs. 300, an amount of Rs. 150 is distributed up as dividend, only 50% of taxable income will be exempt). Moreover, each tax exemption should be subject to the condition that the company would set up a vocational training centre with free training to the employees' families. Separately, a policy should be prepared to ensure that appropriate level of training is imparted to the students. This will be very relevant for industrial exemptions going forward, especially in the power sector.

Money whitener schemes: Under section 111(4) of the Income Tax Ordinance, 2001, the tax authorities cannot question the source of income if the amount has been remitted from abroad through banking channel. This is a big ill and needs to be cured as it results in misuse of the system. It incentivises people not to pay tax and then get their money channelised in their bank accounts from abroad. Why would I pay tax if I know there is such an easy way out!

Instead of closing this loophole, the Government decided to launch a tax amnesty scheme allowing people to declare their hidden assets by paying a one time 2% tax. Not just this, the tax law has been amended to allow FBR to launch such schemes in future as well.

From a long term perspective, one fails to understand the logic behind this. It only gives the incentive to not pay tax at a higher tax rate and wait for the next amnesty scheme and get away by paying a small amount. There should be a legal (or constitutional) bar on any tax amnesty schemes so that people have fear of law and they know that by failing to pay taxes legally due, they will always have a sword hanging above their head. Even otherwise, how can you equate a thief with someone who has been complying with the law all along with a simple stroke of pen! The open-ended money whitener scheme under section 111(4) should be put to an end.

Tax rates: Tax rates should be drastically reduced for provided income is earned as a result of actively engaging into a business. A higher tax rate should be provided for income received without engaging in an active business activity, such as, interest on investments, property rentals, etc.

This will encourage people to engage into some activity in order to earn income. An increased level of business activities will generate sales tax revenue for the government.

Sales Tax - collection and spending: Sales tax should be collected by district Governments and spent within the district. The FBR should assist in the setting up of this mode of collection. Moreover, if the amount of sales tax is visibly spent within the district, this will induce people to pay the due amount of tax. Even if the entire amount is not to be spent within the district, a large part of the collection should go directly to the district funds, instead of the provincial divisible pool. Moreover, sales tax can be best recovered by a person who is well exposed to the local market and is familiar with the norms of the market. A person from Karachi should not be expected to recover the full amount of sales tax from a market in Peshawar or in Islamabad or in Lahore.

In India and the US, sales tax is a state subject although their systems are not very good as there are differences in local sales tax laws and this situation has its own deficiencies. I would propose a unified law and system with recovery (and spending) at local level. We can have a prototype and see how it works and the improved system can then be replicated.

The writer is Director, Financial Services Tax with KPMG in Ireland and has previously been a tax partner with KPMG in Pakistan. He can be contacted on kashif.jahangiri@kpmg.ie

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