In the name of Allah, the most gracious and most merciful.

1. In the name of Allah, the most gracious and most merciful.

2. Pre Budget Seminar Organized by Income Tax Bar Association Karachi Presentation by Abdul Qadir Memon April 11, 2005

3. At the outset, I would like to take this opportunity to express my gratitude to the ITBA CPE Committee for extending me this invitation to share my proposals for the forthcoming Budget – 2005 with this august gathering. By the Grace of Almighty Allah, the world at large is recognizing the action and policies of the present government. The economic managers and business leaders all over the world are showing great faith and confidence in the present team.

4. The macro indicators like arrest of investment stagnation in Pakistan, effort to revive sick industrial units, accumulation of foreign exchange reserves, market driven policies, privatization & liberalization, stable foreign exchange rates, formation of Task Force on Corporate Tax Policy by SECP etc. are showing accomplishment of many milestones.

5. The credibility of Government of Pakistan has enhanced many folds globally. The honourable Prime Minister, Ministry of Finance and the team members of the Central Board of Revenue deserve lot of appreciation on not only achieving the above goals but striving hard to bring positive Reforms, through Tax Administration Reform Program (TARP), CARE, STREAM, establishment of LTU, MTU etc. The introduction of Dispute Resolution Committees, withdrawal of frivolous appeals/review of applications and abolishment of mandatory payment before filing of appeals are all steps towards removal of irritants and obstacles in the way of our journey to success.

6. Ladies and gentlemen it is my observation that in past we did not witness any meeting with the business and professional leaders in which the government and its team members were not criticized for their failure to remove irritants and anomalies from the fiscal statutes, to create conducive investment environment in the country and to curtail discretionary powers of the revenue officers from the taxation laws.

7. Now at least one cannot recall any meeting in which the government and team members of CBR are not praised. What a great change. I mean the government is making headway towards removal of such obstacles as pointed out by the honourable Prime Minister time and again.

8. You and I would agree that despite all reforms and achievement of macro economic targets, 1/3rd of our population is still living below the poverty line, although international assistance is available. Our Tax - GDP ratio is still one of the lowest in the world as majority of people in Pakistan are not having proper drinkable water and 59% of the total educated citizens of Pakistan are unemployed.

9. According to UNDP’s Human Development Report, we rank a poor 135th on human development index. So the problem of a common man is yet to be resolved. This is the moment where we have to think, what is wrong with the present system. Are we contributing our due share for the betterment of the society?

10. While some responsibility for our present economic ills undoubtedly can be attributed to the policies or lack of policies of the present and past governments, yet it would be unfair to place the whole of the blame on the government. You and I know ladies and gentlemen that government could and would have achieved very much more if it had received the full cooperation of the public in the past. It was rightly said by an eminent political leader and I quote:-

11. “A nation’s strength ultimately consist in what it can do on its own and not in what it can borrow from others.” My Budget proposals are influenced by the views of Mr.Adam Smith, pointed out in the eighteen centuries, in his classic The Wealth of Nation that every state should bear in mind the following four objectives while levying taxes that:-

12. 1. The taxes must be equitable and fair as between the different classes of society; The convenience of the taxpayer; 2. The Government must economize and levy only the minimum tax, which is necessary for the national good; and 3. The certainty and clarify.

13. For a successful journey towards lasting economic growth and to make our country a better place to live, it is incumbent upon the Government to immediately provide due attention and take appropriate steps for expansion of tax base, reasonable reduction in the tax rates (according to capacity to pay tax), creation of conducive investment environment, curtailment of undesirable discretionary powers from various tax laws, simplification of rules & regulations, removal of irritants and impediments for seeking justice are important steps for Government to take for achieving the above four objectives.

14. I am hopeful that following recommendations, if approved by this august gathering and implemented sincerely by the government; will help to enhance economic activities, restore the confidence of the taxpayers on the government, accelerate foreign and local investment and establish credibility of the taxation system of Pakistan.

15. Pakistan is undertaking a massive tax reform. Recently the Chairman, Central Board of Revenue while addressing the members of Pakistan Textile Association on 21st March, 2005 stated and I quote:- “All these reforms being implemented at a cost of dollars 150 Million, were aimed at transforming the CBR into an organization fully equipped to take on the challenges of the New World Trade Order.” Unquote

16. The lesson taught by the experience of tax reform in many developed countries is that tax changes have very important economic effects. They affect not only taxable income or tax revenues, but also labor supply (especially, secondary earners), savings, investments, and entrepreneur ship and the willingness to take risks. Particularly, the effect of a cut in marginal tax rate is considerably big.

17. It is interesting to note that none of the reform guidelines mentions any “ideal” level of taxation. It is necessary to focus on three important principles of tax reform, that is to broaden the tax base while keeping the marginal tax rate low, to promote economic growth, and to simplify the system.

18. In my humble view the challenge the government faces is not how to increase current tax revenues, but how to widen the tax base to prevent tax-revenue erosion in the future. On the subject of revitalizing the Japanese economy and put it on a new growth path Mr.Iwamoto said and I quote:-

19. “It is necessary to conduct tax system reform, including tax cut. Investment and consumption should be stimulated. It is necessary to cut corporate taxes at first, and after that to broaden the tax base of income tax while reducing the marginal tax rate. To broaden the tax base, the argument should focus on the inequalities of tax burden, such as “Kuroyon,” by keeping track of income more clearly.”

20. So my first and foremost budget proposal is Reduction in Tax Rates. The old fashioned fiscal theory that tax rates must be high to provide larger revenue for State has long been discarded. The modern fiscal policy pursued by the most progressive countries is to make revenue grow, not by increasing tax rates but by enlarging the tax base. The major impediment in expansion of tax base in the country is high rates of taxes whether direct or indirect.

21. Out of 145 countries of the world, the corporate rate of tax in 138 countries is lower than Pakistan. In almost 83 countries rate of tax ranges between @ 10% to 30% and 39 countries levy corporate tax @ 31% to 35%. On 28th April, 2003 the Saudi Shura Consultative Council slashed the rate of tax from 45 percent to 25% on foreign companies’ profit, to attract more foreign investment. President George W.Bush is pressing the Congress to approve new tax cuts.

22. The Finance Minister of France promised tax cuts for corporate and individuals taxpayers. On the other hand in Pakistan the rate of withholding tax has been rising progressively. In 1995, the rate of withholding of tax at the time of import of goods was raised from 2% to 4% of import value and currently it is 6% of the import value.

23. The Karachi Declaration of ICC Regional FDI Conference held in Karachi in February 2002, in fact, recommended the reduction of corporate income tax to 16%. As for other countries, it is noteworthy that Singapore decided in 2002 to bring corporate and income tax rates to 20% within three years from current 24.5% and 26% respectively. This will bring Singapore’s direct taxes in line with arch rival Hong Kong, where corporate tax rate is 16%.

24. The Worker’s Welfare Fund and Workers Profit Participation Fund are no longer providing any benefit to the workers. On the contrary the contributions to these funds have taken the shape of unnecessary additional levy for the taxpayer and requires to be withdrawn. The law abiding citizens are paying greater cost than evaders. Therefore, in the overall interest of the country and to continue the journey of economic progress, it is strongly recommended to reduce the tax rates as follows:

25. The rate of Income Tax for the corporate and non-corporate sectors be reduced by 10%; The rate of withholding tax on supplies to be reduced to 2% and the sub-section 2 of section 153 be substituted in line with the recent judgement reported as 2005 PTD 194 (SC) as follows:- “the gross amount payable for sale of goods shall exclude the sales tax if any payable in respect of the sale.”

26. The present statutory limit of exemption under the Income Tax law be increased from Rs.100,000/- to Rs.200,000/-; and The Workers Welfare Fund and Workers Profit Participation Funds Laws be abolished.

27. The second important task is to broaden the tax base. As per data available the tax payers are less than 1% of the total population. The drive that the Collectorate of Sales Tax (Enforcement) launched last October to identify new taxpayers is reported to have led to the detection of 18,224 cases which need to be registered as taxpayers under the Sales Tax Act. These include different categories of 14,933 distributors, agents and dealers; 2,681 wholesalers; 23 car dealers; and 3,000 retailers is commendable.

28. However, I feel complete details and data base of all the owners/ holders of the property (including residential, commercial, industrial), cars, club membership, utilities (including residential, commercial and industrial), vehicles, buses, credit cards, international passports, investment in fixed deposits, bank accounts, national saving schemes and stocks be prepared and on the basis of above information a complete profile may be generated.

29. The taxes must be equitable and fair between different classes of society. All the segments of the society including agriculturists should be brought in the tax net. The rule of law should be for everybody and not for the weaker ones. A very big segment of the high placed people is owning enormous wealth, lucrative occupations and enjoying highly luxurious living.

30. I believe that assessing the income from four main crops – cotton, rice, sugarcane and wheat – may not be difficult because these are generally sold to registered dealers whether they are ginners, millers, crushers or arthis. Their receipts should be considered authentic documents and taxpayers should be encouraged to obtain them and submit them with their returns.

31. Since there is an enormous amount of money to be made on sale/purchase of houses, it is only fair that like any other commercial activity it should bring the government its due share of revenue on house sales in the form of capital gains tax. All the more so because most of those earning fat profits on property sales are not genuine homeowners but speculators, who are there in the market only to earn profits.

32. The government may consider to tax the windfall on sale of immovable properties by amending the Constitution of Islamic Republic of Pakistan. Proposal It is proposed that effort should be made to reduce the number of exemption and incomes be brought within tax ambit.

33. Simplification of documents is third and very important area for brining tax reforms. Mr.Musgrave, in his book on page 158 stated and I quote that:- “One of the strong motivations behind the recent reforms has been to bring about simplicity in tax systems. In the context of tax reform proposals in the United States of America, it has been commented: “what reason is there to expect that good taxation - taxation that is equitable as well as efficient-should offer a haven of simplicity in an increasingly complex world?” This is a non-trival question for developing countries as well.

34. Day before yesterday Government has unveiled simple and self compliant draft proposal of Federal Excise Act, 2005 to replace sixty years old complex and cumbersome Central Excise Act, 1944. Government is genuinely making effort to simplify the documents. However I think that taxation laws including forms, statements and other necessary documents may be simplified and must not be as complicated & cumbersome as to cause needless inconvenience and hardships to the taxpayer.

35. This is also an impediment in expansion of tax base in Pakistan. There are also a number of short comings in the existing Return forms and statements. I therefore desire that such forms, statements, including acknowledgement receipts of the return etc. be designed in consultation with the mercantile, tax and accounting associations etc.

36. At a workshop held in Islamabad on Saturday under the joint sponsorship of the Ministry of Industries, Production and Special Initiatives and the World Bank, representatives from the government and industry deliberated upon the subject of improving investment environment in Pakistan.

37. They identified poor law and order situation and the high cost of doing business as the major reasons why foreign investments are not coming in at the desired level. It may be recalled that according to the special task force that prepared a draft industrial policy, made public in January; Pakistan will need nine percent increase in investments in the next 20 – years, 11.5 percent in ten years and 16 percent in five years in order to catch up with other countries of the region. It is therefore evident that there is a lot of catching up to do.

38. Royalties Royalty under clause (g) includes consideration for “the disposal of any property or right refereed to in sub-clauses (a) through (e).” The gross consideration for royalty income of a non-resident person is taxed at 15%, which is the final tax. To equate the consideration received for disposal of the property or right generating royalty income with the royalty income itself is not equitable.

39. Royalties The gross consideration received on disposal would be taxed at 15% without taking into consideration the cost of acquisition of the property or rights. This is contrary to the provisions relating to disposal of capital assets. Any expenditure incurred to earn royalty should be allowed as expenditure.

40. Enhancement in cost of private vehicle for tax depreciation Sub-section (13)(a) of section 22 of the Income Tax Ordinance,2001 provides that for the purposes of this section the cost of a depreciable asset being a passenger transport vehicle not plying for hire shall not exceed one million rupees.

41. Enhancement in cost of private vehicle for tax depreciation Enhancement in cost of private vehicle for tax depreciation Proposal Section 22(13)(a) of the ITO 2001 should be amended by increasing the cost restriction on private vehicles from Rs.1 million to Rs.1.5 million.

42. Employee Training Facilities Section 27 provides that a person shall be allowed a deduction for any expenditure (other than capital expenditure) incurred in tax year in respect of: a) any educational institution or hospital in Pakistan established for the benefit of the person’s employees and their dependents; or

43. Employee Training Facilities b) any institute in Pakistan established for the training of industrial workers, recognized, aided or run by the Federal Government or a provincial Government or a local authority. c) ………………………………………………….. As the above two objectives require expenditure of capital nature the restriction on its allowability is against the very purpose of this provision. No such restriction was imposed in the sub-section 23(i)(xiii), (xiv) and (xv) Repealed Ordinance.

44. Employee Training Facilities Proposal The section 27 be amended so as words and brackets (other than capital expenditure) be removed.

45. Admissibility of Bad Debts Sub-section (1) of Section 29 provides that a person shall be allowed a deduction for a bad debt in a tax year, if the following conditions are satisfied:- (a) the amount of the debt was- (i) previously included in the person’s income from business chargeable to tax or; (ii) in respect of money lent by a financial institution in deriving income from business chargeable to tax;

46. Admissibility of Bad Debts (b) the debt or part of the debt is written off in the accounts of the person in the tax year; and (c) there are reasonable grounds for believing that the debt is irrecoverable. In this section a distinction has been made between bad debts of money lending and non-money lending business. Bad debts relating to principal amount have been made admissible only if that bad debt was earlier included in his income from business chargeable to tax.

47. Admissibility of Bad Debts Proposals i) Scheduled banks, approved leasing companies and approved modarabas be added with financial institution for admissibility of bad debts. ii) Law should be amended to cover all transactions undertaken under the Ordinary course of business. iii) Clause (c) of sub-section 1 may be deleted.

48. Long-Term Contracts In the provision of sub-section (2) of Section 36, it is important to note that under sub-section (2) of Section 36 for the purposes of determining income on incomplete long-term contracts, the percentage of completion shall be determined by the ratio which the contract costs incurred up to the end of the tax year has with the estimated total cost as “determined at the commencement of the contract”.

49. Long-Term Contracts I feel that considering contract costs as a variable “at the commencement of the contract” for estimating the stage of completion is not appropriate, given the practical considerations whereby with the ongoing progress of the contract, it is invariably desirable to re-estimate the entire costs of the contract until its completion.

50. Long-Term Contracts Proposal That the word “commencement of the contract” in sub-section (2) of the said section of the Ordinance may be substituted with the words “commencement of the year”.