The Chief Justice of Pakistan, while hearing a case on May 05, 2009, has aptly remarked that the people of Pakistan have lost faith in the Income Tax Department. The loss of faith pointed out by the Chief Justice is not limited to the tax department only, it is reflective of general trust deficit prevailing among the people against different government departments.

Even judiciary is not immune from this deficit. Nizam-e-Adl Regulation, 2009 is manifestation of the same phenomenon. It is high time that all state departments take stock of the situation, so that hearts and minds of the people are won for strengthening the Federation of Pakistan.

‘Mistrust syndrome’ in case of the Federal Board of Revenue (FBR) manifests itself in different forms and is caused by mutually supporting factors. The main causes are ‘perception and reality of tax money being wasted by our ruling elite, complex and ambiguous tax law viewed as a trap and the working of the department itself. This article aims at providing some food for thought to improve the situation.

USE OF TAX MONEY According to J. Holmes, “Taxation is the price we pay for civilisation”. People pay taxes in the hope of living in a welfare society peacefully. Tax culture can be developed if people are made to realise the nexus between taxes paid and what they get in return. They expect that the state will protect their lives and properties. It will provide roads, hospitals, utilities, etc.

However, when the government collecting taxes is corrupt and there is bad governance, tax culture cannot be promoted. This explains why despite so many reforms tax to GDP ratio in Pakistan is one of the lowest in the world, and that in Scandinavian countries one of the highest. Rampant corruption in tax collecting and tax spending organs of the state erodes trust of the people.

While the people hesitate to pay tax as they think they do not get any thing in return, the government states low tax collection as the main reason for non-development of the country. The vicious circle continues. Trust deficit and fiscal deficits are directly proportionate to each other.

Reduction in one will reduce the other. Every government has a right to levy taxes through Parliament. But no Government can be allowed to cause misery and harassment to the taxpayer and the bitter feeling that the taxpayer has been made the victim of palpable injustice.

Analysis of cases decided by different courts as reported in PTD of February 2009, indicates that 75% decisions of the higher appellate forums and of Federal Tax Ombudsman are against the department. The same trend can be observed in each month which needs no further comment on the poor quality of assessment orders and high handedness of the departmental officers.

Late N.A. Palkhivala, eminent tax scholar of India, had once said that “Taxes are the life-blood of any government, but it cannot be over-emphasised that the blood is taken from the arteries of the taxpayers and, therefore, the transfusion has to be accomplished in accordance with the principles of justice and fair play.”

DOES THE DEPARTMENT PROMOTE TAX EVASION? Unbelievable but true. Most of the time it may be unintentional collateral damage of some policy, but sometimes it seems due to criminal negligence or collusion.

One recent example is Investment Tax Scheme, 2008 in which unexplained or under-assessed assets were allowed to be incorporated in the books by paying 2% tax only. Apparently it looked as if it would add at least something to the revenue and bring assets from black to regular economy. Unfortunately drafting was such that the department lost revenue more than it collected.

It was due to availability of tax depreciation allowance on such assets in the tax year 2009 and onwards. Besides, date upto which assets created were covered under the scheme was faulty and assets created in the current tax year were also included in it. Later amendment of the date was too late to arrest the damage.

Thus it acted as a tool for tax planning in which paying two rupees as tax under the scheme saved more than ten rupees in the same tax year besides enjoying immunity from tax of the previous years. Further, remaining value of the assets (WDV) shall be allowed as deduction over the years in the form of tax depreciation, thus giving more benefits to such tax evaders over the years. What was achieved? Nothing.

The Task Force on Tax had warned against such schemes as they serve as an incentive for tax evasion and a disincentive for honest taxpayers. Nobody was taken to task for such a fiasco. Rather the persons who were movers and approvers of this scheme were given promotions and better postings, as reward for their ‘good’ work.

A number of amendments are introduced in haste and in a haphazard manner which result in loss of revenue. This aspect needs more attention as has stressed by the Hon’ble Chief Justice of Pakistan. Amendments in the law should be made after comprehensive study and its impact on different other provisions of tax laws, other laws and businesses.

It is suggested that the parliament should have a ‘Ways and Means Committee’ as it exists in the USA. Members of the committee should represent all provinces, all political parties in the Parliament. The Committee may also have non-voting co-members from the tax profession (including accountants, lawyers, economists, etc). The jurisdiction may include both expenditure and revenue measures.

Judicious analysis at this level will help prevent unscrupulous expenditure as well as imprudent tax measures which currently get approved without much discussion in the Parliament.

FBR will have to plead its case for each new tax provision/amendment with its full scientific analysis based on different parameters, keeping in view all the affected stakeholders.Such a committee or its sub-committee should be given the task of supervising subordinate legislation also.

IMPROVING TAX LAW Currently the Income Tax Ordinance, 2001 is in practice. The earlier ones (Income Tax Act, 1922 and Income Tax Ordinance, 1979) have been repealed. In just 7 years, more than 1,000 amendments have been made and many more are being contemplated.

In India, 3300 amendments were made in their Ordinance over a period of 30 years, we are at a greater pace in that direction and expect to beat that record in just 10-12 years. On account of these amendments, N.A. Palkhivala called their Ordinance a national disgrace. What word should we use for our nascent but badly mutilated tax ordinance?

Taxation through an Ordinance ipso facto is a national disgrace in a democratic country. The Ordinance suffers from more deformities. Its diction is ambiguous; its impact is unfairness; its compliance is cumbersome; its discretion is awesome. Dilating upon its diction and structure, the Hon’ble Karachi High Court observed as under:

“The Income Tax Ordinance, 2001 is a very badly drafted document and has in fact distorted the entire law and scheme of Income Tax in this country, which prior to the coming into force of Income Tax Ordinance, 2001 was very clear. The drafting of law contained in the Income Tax Ordinance, 1979 was much better and clear than the drafting of law contained in the Income Tax Ordinance, 2001.

The scheme of law contained in the Income Tax Act, 1922 and Repealed Income Tax Ordinance, 1979 was clear and unambiguous while the provisions contained in the Income Tax Ordinance, 2001 are confusing on account of inaptness, lack of dexterity and lack of clarity on the part of draftsman.” [2006 PTD 734]

ABSENCE OF FAIRNESS Income Tax is a tax on persons on the basis of their income. However, since 1991-92, there was started a new type of taxation called presumptive taxation on a large scale. In this case anything can be deemed as income and taxed. For example, all your supplies made to different companies shall be treated as ‘income’ without allowing any expenditure.

Such taxation was challenged, but in the Elahi Cotton case, the Hon’ble Supreme Court of Pakistan, after discussing the then prevailing conditions of the country and general tax evasion, held such taxation to be constitutional on the principle of ‘the power of taxation rests on necessity’. The department took it as a free license. Now FBR is always on the hunt.

It searches new avenues where it could impose a withholding tax responsibility on a person, then making it a final tax under the presumptive scheme. This taxation is unjust on many grounds. First of all it ignores the bottom line of profit or loss in the business.

Secondly, such type of taxation is beneficial to the higher income groups and detrimental to the lower income groups creating socio economic distortions in the system, for redressal of which the income tax is supposed to play a part. This can be seen from the following examples:

Further, this type of taxation has divested income tax of its ‘directness’ and the burden can usually be shifted, as indirect taxes, causing inflation in the economic system. Apart from other withholding tax provisions, Chapter XII, in original form, contained 3 types of advance tax. The aim was to do away with these taxes in first few years of the Ordinance.

However, the department has managed to enhance the scope of these provisions from 3 items to 8 items. Further in many cases, tax deducted/collected has been converted from advance tax to final tax. Nothing can be more unfair than to deem tax collected on electricity bills as final tax where electricity bill is upto Rs 20,000 per month.

Similarly, tax is collected from each mobile phone card even if it is used by a college student having no source of income is liable to tax. Such categories of taxpayers are loved by the FBR because tax is collected from them even when they do not have any taxable income and they do not dare to apply for refund, thanks to the fear the FBR has in the general public.

Is it not moral duty of the department to pay a refund in all such cases suo moto? At present, it is wishful thinking, as tax refund is not paid in the majority of the cases, even on application for refund. You dare to apply and they come equipped with all possible provisions of law to deny it and unsettle your settled matters.

It is therefore suggested that even if withholding tax provisions are essential, the concept of treating withheld tax as final tax be changed. Final tax liability of each person should be determined on the basis of income computed in accordance with the generally applicable principles of accounting with certain necessary adjustments as per tax law.

UNDUE EXEMPTIONS IN TAX LAW In economies like ours, there is always a need to promote certain underdeveloped areas and sectors by giving tax incentives. However, tax exemptions and concessions contained in the Second Schedule to the Ordinance at the time are not for this purpose.

They give exemptions to the already privileged classes. Elimination of exemptions contained in clauses (51), (52), (53), (55), (56) of Part I of the Second Schedule applicable to President, Generals, Governors, Ministers, Judges, etc is expected to build up the image of our tax law as a fair law.

SIMPLIFICATION OF TAX LAWS Tax laws are complex and many. You have to consult a number of laws and regulations, etc before you reach a conclusion. These include the Income Tax Ordinance, 2001, Income Tax Rules, 2002, Circulars and SROs issued regularly, Advance Rulings, different treaties with other countries and judicial pronouncements, etc.

The FBR tries to achieve what is not in the law through different SROs. Here is the authority to make or break a taxpayer depending upon how influential or weak a taxpayer is. FBR has made the life of taxpayers miserable by trapping them.

For example, FBR has not come up with comprehensive withholding tax statements. Instead it prefers to send notices to the taxpayers a number of years later to reconcile the figures with those given in the tax return with the final accounts, as well as the withholding tax statements under Rule 44 of the Rules. This delayed approach of the department pays.

It collects tax both from the payee and the payer of amounts liable to withholding tax illegally, when it is authorised to collect only from one such person under section 161 or 162. Unscrupulous elements in the department make use of this discretion to their own advantage also.

Similarly, income tax return formats are not prepared with dexterity which makes their filling difficult for ordinary taxpayer increasing his cost of tax compliance. Tax Returns should be prepared comprehensively and once prepared should not be changed each year. If any change is necessary, it may be incorporated in a manner the previous return retains its format except this change, instead of changing the entire format.

The returns for the tax year 2008 have been found so difficult to understand that the department itself has to suggest a provision authorising it to ask the taxpayers to provide a reconciliation statement showing how taxable income was arrived at from the accounting income.

The department should be competent enough to extract all such reconciliations from the tax return. Lack of capability to design such a return, should not result in punishment of the taxpayers in the form of increased burden on compliance in such cases.

Change management in the department is almost non-existent which has already caused loss of billions of rupees (from such acts like the destruction and misplacement of record during the process of structural transformation from the circle based system to the function-based system).

Besides what is discussed above, the following few acts can be helpful in improving the performance of the department and better tax administration on the income tax side in FBR.

i. There is need to seriously deliberate how tax cases can be disposed of within a reasonable period, otherwise our system would never acquire credibility. The ordinance has a number of provisions where no time frame is given. The departmental officers make use of this lacuna and issue notices at their pleasure and to their advantage. For example, they can issue notice of audit at any time in respect of a tax year.

Notices of tax year 2006 are being served now in 2009. In the repealed Ordinance the limit was one year. There is no time limit to complete audit under section 177. The limit to issue order after completion of audit is not provided in the law. No time frame has been given to pass orders in respect of withholding tax default under section 161.

ii. The tax authorities must announce a well considered long term tax policy for the next 5-10 years so that people can properly plan their businesses and FDI is also attracted.

iii. Tax laws need to be rationalised and the provisions of the act be made simple and concise. There is need to revisit deeming provisions which are used to tax otherwise untaxable amounts of income.

iv. Tax evaders should be punished strictly. That does not mean to cause undue inconvenience and harassment to honest taxpayers. Rather strictness should be focused on people who, despite having taxable income, are not taxpayers.

v. Bona fide and genuine mistakes or lapses should not lead to penalties and prosecutions in case of existing taxpayers.

vi. The tax authorities should not resort to court litigation indiscriminately.

Restoring confidence of the tax machinery itself Tax machinery should have faith in the fact that it can deliver. It will deliver when there is cohesion in the work force and the work force is satisfied. Improvement in remuneration package was a step in the right direction.

However, salary package alone is not enough. The FBR needs transparency in its internal management especially human resource management. At present, the situation is not enviable. Many lobbies and groups are working in the department. Creation of Inland Revenue Service without an Act of the Parliament has disturbed the people of the Customs, Sales Tax and Excise Group.

On petition of the aggrieved parties, the Hon’ble Islamabad Hight Court was pleased to cancel the formation of this new service and issue status quo orders till finalisation of the case. At a critical juncture when the country demands concerted efforts to collect every single penny due from all tax payers, tax managers are fighting for their own perceived rights.

The division does not stop there. There are groups in the income tax department itself. The perception that a particular group is being given important posts and promotions is wide spread in the department. There are rumours that a few officers were promoted even without meeting mandatory training requirements at NIPA/Staff College.

While normally there are no transfers in the last quarter of the fiscal year, this year the circus is on without realising its adverse impact on revenue collection. The government had to accept an IMF loan with harsh conditionalities due to insufficient revenue generated by the tax and non-tax avenues, the target is not being focused on by the FBR. There is need to implement the policy of rewarding honest, capable and competent officers of the tax department.

At present, it is exactly the opposite. Sycophancy is being treated as a virtue for posting and transfer. Those who caused the loss of millions of rupees by letting hundreds of cases going time barred in MTU Lahore are treated as heroes.

FBR is still far from presenting a holistic picture of a taxpayer regarding his income, sales etc which could have been achieved by integrating the computer systems of all four taxes and duties. However, after spending millions of rupees on the project, it is still not ready to start.

Now Mahasil is being tested at LTU, Lahore and the unofficial feedback of the users is discouraging due to defects in the system. It means that the taxpayers will have to suffer for internal intrigues and inefficiencies of the department.

Those who failed complete such an important task in time need to be replaced with competent and focused persons. In the presence of a reputable company PRAL, the department should not have been struggling with Mahasil at this belated stage.

The FBR needs to attend these matters, or clarify whether it is just grapevine propaganda so that tax officials work in tandem to perform their national duty of implementing the tax laws judiciously.

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My Not-for-Profit Organization doesn’t pay taxes, is this standard applicable to me?

Yes. The standard is applicable to all material income tax positions. The standard defines a tax position as a position taken in a previously filed tax return or a position expected to be taken in a future return. Not-for-Profit Organizations assert a critical tax position when they file their Form 990 indicating that they are “tax exempt”. Additionally, since Not-for-Profit Organizations pay taxes on their unrelated business income they make judgments in determining unrelated revenue streams as well as taxes due.

Where do I start?
First step is to identify all tax positions taken by the organization. Remember this is an ongoing process it is not one- time identification. An organization should identify tax positions in jurisdictions in which it files a return or would be subject to income taxes. For example, if an organization has nexus in a jurisdiction in which it has income, then the organization has to consider whether a tax return should have been filed in that jurisdiction.  This applies to the determination of unrelated business income subject to income tax.

The standard also addresses a few specific questions that should be pointed out. The first relates to whether income is attributable to an organization or its owners, as in the cases with partnerships and S-corporations. The standard reiterates: if income taxes are attributed to the entity then those taxes are classified as income taxes; if income taxes are attributed to owners, those taxes are not considered income taxes of the entity and not subject to this new standard. The second relates to consolidated or combined groups. Entities within a consolidated or combined group should consider tax positions of all entities within the group regardless of the tax status of the reporting entity.

Unit of account
The organization should establish a unit of account for tax positions.  Essentially, this encompasses how tax positions are grouped. The unit of account for any given tax position is a judgment made by the organization and should consider the manner in which the organization prepares and supports its income tax return, and the approach the organization anticipates the tax authorities will take during an examination. Once a unit of account is established, it should be consistently applied to similar positions unless there is a change in facts and circumstances which indicate that a different unit of account is more appropriate than the one previously used. It is worth noting that there is a possibility that multiple organizations evaluating the same tax positions could conclude on different units of account.

The Two-Step Process: Recognition and Measurement
After tax positions have been identified (and grouped by unit of account) they are subject to what is being called the two-step process.

Recognition
The first step is determining whether a tax position has met the recognition threshold. The FASB’s threshold is “more likely than not”, which represents a likelihood greater than 50% that a tax position would be up held by a taxing authority. All organizations must at least perform step 1 for all tax positions. The FASB inserts a presumption that all tax positions will be examined by a taxing authority (this means the “it’s never happened before” argument exist no longer). If management determines that it is more likely than not that 100% of a tax position would be sustained by a taxing authority then the organization has a highly certain tax position. Highly certain tax positions must be based on clear and unambiguous tax law; stand on its own merits and be documented by the organization. If management determines that it is more likely than not that a tax position will not be sustained by a taxing authority then the organization moves on to the measurement step. It is worth noting that if timing is the only uncertainty (i.e. depreciation and/or amortization) an organization can skip the recognition step and go directly to measurement.

Measurement
The measurement of a tax position represents management’s best judgment of the amount the organization would accept in a settlement with a taxing authority.

Changes in Judgment
Since the identification and evaluation of tax positions is an on- going process there could be instances in which there is a change in facts and circumstances and even laws that would cause an organization to have a change in judgments made related to tax positions. However, changes in judgment must arise from the change in facts and circumstances and not the re-evaluation of information that was available at the time the original judgment was made. An organization would recognize a previously unrecognized tax position in the first period the more likely than not threshold is met, the statue of limitations has expired (i.e. a taxing authority can no longer challenge a position) or when a tax position is settled through examination, negotiation or litigation. An organization would derecognize a previously recognized tax position in the first period that the more likely than not threshold is not met. Any changes in measurement as a result of changes in judgment should be reflected in the period in which the change occurs.

Adoption
The cumulative effect of the adoption of this standard is reported as an adjustment to the opening unrestricted net asset balance.

Disclosures
Required for Nonpublic Companies
The latest release of this accounting standard amended the disclosure requirements for nonpublic organizations. As a result nonpublic organizations are required to disclose the following: interest and penalty classification policy, this relates to whether the organization’s policy is to classify interest and penalties as operating expense or income tax expense, both are acceptable: the amount of interest and penalties for the periods presented, description of the tax years subject to examination by major jurisdictions, these would include any years that have not passed the statue of limitations; additionally, nonpublic companies have to do a 12 month look forward (12 months forward from the reporting date) and make a determination as to the possibility of changes and disclose the nature of uncertainty, nature of the event that would cause a change, and an estimate of the range of the reasonably possible change or a statement that an estimate cannot be made.

Not Required for Nonpublic Companies
The guidance for applying the standard to nonpublic companies eliminated the requirement for disclosing a tabular presentation and the amount of unrecognized tax benefit that, if recognized would impact the effective tax rate.

Definition of a Public Company
It is important to note that the accounting standard definition of a public company includes a nonpublic company that is consolidated with a public company for reporting purposes. Therefore a Not-for-Profit organization that has a public company parent company and is consolidated with the parent company would be considered a public company in applying this standard.

Sources: ASC 740-10 Accounting for Uncertainty in Income Taxes ASU 2009-06

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