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mtgondal · #38 Wednesday, May 23, 2007

Direct tax policy principles: a review-II By MOHAMMED ASHRAF

ARTICLE (May 23 2007): WHT AGENT RISK:Withholding Tax agents' costs have three folds - taxes borne, taxes collected/deducted and tax administration. The question arises whether Withholding Tax agents are properly focused on managing these significant tax costs. Bear in mind that risks in the tax arena generally come in many guises and Withholding Tax risks are no different.

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Operational Risk - The possibility of processing errors
Which because of volume involved could
lead to significant additional costs
in the shape of additional tax.
Compliance Risk - The possibility of late submission with
consequent penalties
Reputation Risk - Making errors in the employment tax
arena is unlikely to Lead to adverse
external publicity, but it could impact
on staff relations
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Some might argue that these risks have always been present. However, it is apparent that tax authorities see the Withholding Tax compliance arena as a fruitful area for their efforts. It is suggested that companies and governments alike need to consider them and make sure that they factor them properly into planning. The important issue is transparency through WHT Audit and that they are properly reported.

The recent mechanism of filing of Withholding Tax forms does not seem an effective system as accountants are normally busy in management reporting during the first 10 days of the month and this includes monthly closings, apart from the preparation of monthly profit and loss accounts.

It is suggested that the filing date of the 15th of every month needs to be extended to the 25th of every month, quarterly statements needs to be submitted after one month and annual statements after three months, instead of the current two months. However, these statements need to be submitted branch-wise without any need of consolidation, alongwith the Cash/bank ledger of every branch and a summary of adjustments of payments involving the deduction of tax.

Concept of adjustment needs to be specifically incorporated into the Withholding Tax sections of the Income Tax Ordinance, 2001. However; this needs to be reflected in the Foreign Exchange Manual of Pakistan. Any amendment in this regard needs to be made after close consultation with the State Bank of Pakistan. This will also provide ease to the local and multinational businesses. However, transaction involving foreign exchange needs to be reported to Central Board of Revenue and SBP.

RECONCILING PRINCIPLES FINANCIAL ACCOUNTING AND TAX ACCOUNTING The IASB is developing a financial reporting matrix, whereby the various components of a company's result are split broadly into two categories - Operating income which comprise of cash or near-cash items and valuation adjustments, leading to a total performance column described as comprehensive income. This future format of the profit and loss account needs to be incorporated into section 34 of the Income Tax Ordinance, 2001.

I believe that items falling into operating income should form a reasonable basis for tax reporting and assessment. Items included as valuation adjustments need to be considered in more detail. They may include items such as provisions for doubtful debts and obsolete stock etc, they may form a normal part of taxable income according to the provisions of the Income Tax Ordinance, 2001 and various precedence.

However, valuation adjustments are of more subjective and volatile nature and do not therefore posses the features which have traditionally been seen necessary of costs having been incurred or income having been realised, or certainty as to the amount appropriate to be utilised for tax purposes.

There needs to be a detailed review of the items falling into the valuation adjustment category and principles must be developed in the common rules chapter of the Income Tax Ordinance, 2001, for dealing with these items and any other items that may arise in the future.

The main principles should revolve around the distinction between assets readily convertible into cash, where adjustments would be taxed or allowed, and other assets which would be dealt with on a realisation basis for tax purposes. Moreover, the plethora of precedence relating to principles of capital and revenue expenditure/income and realised and unrealised income needs to be immediately considered in the common rules chapter of Income Tax Ordinance, 2001.

COHERENT STRATEGY OF ACCOUNTING AND RECORD KEEPING: Section 32 to 36 of the Income Tax Ordinance, 2001 and Chapter VII - Records and Book-keeping must be aligned with the organisational hierarchy of the tax department and needs to be aligned with the indirect tax laws. A suggestive structure is as follows.

SUGGESTIVE STRUCTURE:

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Category Tax Policy Record Type Legal
Organisational
Structure
------------------------------------------------------------------
Large Tax according IAS/IFRS Incorporated/
to normal Fourth Schedule Unincorporated
accounting Of Companies'
practice Ordinance, 1984 -
SME Medium Tax according Fourth Schedule Incorporated/
to normal Of Companies' Unincorporated
accounting Ordinance, 1984 -
practice -
SME micro Tax according Fourth Schedule Incorporated/
to normal of Companies' Unincorporated
accounting ordinance, 1984 -
practice -
or -
------------------------------------------------------------------
Category Tax Policy Record Type Legal
Organisational
Structure
------------------------------------------------------------------
Final Tax Record Keeping -
Regime Postulates prescribed -
in Income Tax Rules, -
2002 - Chapter VII -
SME small Final Tax Suggestive record Unincorporated
Regime format to be -
prescribed in -
Schedule of Income -
Tax Rules, 2002 -
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Following is a suggestive structure which may be used in conjunction with existing threshold for LTU, MTU and RTO.

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Category Sub-category Quantitative Monetary limit of
Criterion Quantitative
Criterion
------------------------------------------------------------------
Large 1. listed companies Nil Nil
2. Susidiary of a -
listed company -
3. PE or -
Non-Resident -
Company -
4. Monetary Turnover -
Criterion of Staff -
LTU Capital -
SME Medium 1. Non-Listed Nil Nil
2. Private Limited Nil Nil
company -
3. Manufacturing Turnover 2 Billion
Staff 500
Capital 500 million
4. Trading Turnover 900 Million
Staff 200
Capital 200 million
------------------------------------------------------------------
Category Sub-category Quantitative Monetary limit
Criterion of Quantitative
Criterion
------------------------------------------------------------------
5. Service Turnover 500 Million
Staff 200
Capital 200 million
SME Micro 1. Single Member Nil Nil
Private Limted -
Company -
2. Manufacturing Turnover 500 Million
Staff 250
Capital 50 Million
3. Trading Turnover 90 Million
Staff 100
Capital 10 million
4. Service Turnover 50 Million
Staff 50
Capital 10 million
SME Small 1. Manufacturing Turnover 50 Million
Staff 50
Capital 5 Million
3. Trading Turnover 10 Million
Staff 10
Capital 1 million
4. Service Turnover 50 Million
Staff 50
Capital 0.5 million
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ACCOUNTING QUALIFICATION'S: The ACCA syllabus is a benchmark for the whole world according to the United Nations Pakistan's students have the option to choose Pakistan's tax and corporate as part of their studies for appearance in exams. A level playing field with a conducive environment needs to be provided.

This will also help the Central Board of Revenue in interacting with various accounting bodies like the ACCA, ICAP and ICMAP which will enable them to draw the conclusion on the opinions of these public accountants. Moreover, this will also bring healthier competition which will end in quality improvement.

AUDIT: A section is not enough and a chapter needs to be devoted to Audit. Moreover, the existing audit section needs to be rephrased under one chapter which may include audit management, taxpayers' obligation, authorised representative obligation, modus operandi of audit, modus operandi of audit decision, postulates of an audit order and time frame to conduct and complete the audit.

STANDARDIZATION OF ORDERS: There seems to be a dire need to finalise a standard format of orders for assessment, amendment in orders, revision, appeal effect and audit.

Moreover, a standard format of order is also required for CIT Appeals and ITAT, however, when I use the word standard, this means that basic principle based postulates needs to be prescribed, for instance for appellate forms of transaction nature, sections applied, sections not considered, beneficial circulars, accounting and tax principles applicable, department's argument, taxpayer's argument, precedence available, reasons for not considering any of the aforementioned points, argument or precedence and finally the decision itself.

A good speaking order normally reflects this but we must strive to make all orders speaking! Moreover I would request honourable chairman to please specify a time limit for appeal effect orders.

TRANSFER PRICING: Internationally, the horizon is much bigger than the pharmaceuticals and time has come to bring certainty to the businesses. I would suggest that Chapter VI - Transfer Pricing needs to include what the State Administration of Taxation of China has done in line with the OECD guidelines.

THEY HAVE INCLUDED A PRINCIPLE SET OF DOCUMENTATION WHICH INCLUDE:

1. Business and Industry Analysis, that is, description of the industry in which the company operates.

2. Functional Analysis, that is, description of the functions carried out, the assets used and the risks borne by the company in question.

3. Identification and quantification of the related party transactions.

4. Selection of the most appropriate transfer pricing methodology to analyse at arm's length the nature of the related party transactions and;

5. Application of the most appropriate methodology, with conclusions at arm's length of the nature of the pricing of the related party transaction.

This documentation should be prepared before the tax return for the year in question is submitted. There will be no need to submit the report to the Income Tax at the time of return just facing a box. However, no time will be given when the report is required to be submitted through a special notice.

APA is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for those transactions over a fixed period of time.

An APA is formally initiated by a taxpayer and requires negotiations between taxpayer, one or more associated enterprises and one or more tax administrations, hence, can be unilateral, bilateral and multilateral.

TAKAFUL INSURANCE AND REINSURANCE: There is need for the introduction of a new schedule for re-insurance and the provision of special exemptions or deductions to the payers. This will not only help in the development of a new industry, but will also save the outflow of foreign exchange.

SHARIAH COMPLIANT FINANCIAL PRODUCTS: It is high time that a framework needs to be incorporated in the Income Tax Ordinance, 2001, whereby Shariah compliant products are taxed in a way that is neither more nor less advantageous than equivalent banking products. The intended effect must be to allow providers to offer Shariah compliant products, without facing commercial disadvantage, and to enable customers to take up these products without encountering uncertainty or disadvantage over tax treatment.

MURABAHA: The most common problem of Shariah compliant financial products is the involvement of series of a transaction which falls within the ambit of minimum tax, capital gain and fair market value-related provisions which is not the case under conventional financial products.

Section 113 needs to be amended to exclude the sale transaction of a Shariah compliant financial product from the definition of turnover. Moreover, section 153 also needs to be suitably amended to exclude deduction of tax from the instalments by the customer instead of exemption certificate approach.

In furtherance, section 37, 68, 75, 77 and 78 needs to be amended in such a manner that transactions, involving capital gain, entered into by a Shariah compliant financial product provider, should not be taxed under any provision of the Income Tax Ordinance, 2001 in the hands of the Shariah Compliant financial product provider.

IJARA, IJARA WA IQTINA AND DIMINISHING MUSHARAKA: Section 18 needs to be suitably amended to incorporate the concept of Ijara and Ijara wa Iqtina. In the absence of a suitable amendment, the Ijara wa Iqtina relating to a house will fall under section 15 and would put the Shariah compliant product provider at a disadvantage over the conventional bank. The core basis of such an amendment is based on the fact that it involves the payment of rent and principal with rent.

WAKALA - AGENCY: It is suggested that such an income needs to be considered in line with section 151 in the hands of the customer.

(To be concluded)