Pakistan Tax System: Pakistan, a major South Asian country, follows a multifaceted tax structure. The tax system is a crucial part of the economic infrastructure and plays a pivotal role in generating revenue for government operations. Although the primary objective of taxes is revenue generation, a well-structured tax policy must also promote economic growth. This article delves into the various taxes levied in Pakistan, the tax structure, and how they affect the overall economy.
1. The Principle of Taxation in Pakistan
Governments impose taxes as obligatory charges on individuals or corporations. A government entity, whether it’s local, subnational, or national enforces these charges. Furthermore, governments utilize the revenues collected from taxes to finance various activities and infrastructure projects. In Pakistan, the primary objective of taxes is to generate income. However, to maintain a consistent revenue stream, the tax policy must also facilitate growth. Achieving this dual objective requires the tax policy to minimize the deadweight loss resulting from tax imposition and to stimulate transactions. Increased transactions correlate with higher economic growth and increased employment, which, in turn, enhance the taxable capacity of the economy, thereby generating sustainable revenue streams.
2. Legislative Tax Structure in Pakistan
In Pakistan, resource mobilization occurs at both federal and provincial government levels. Main taxes are broadly differentiated into direct and indirect taxes, with surcharges included in the indirect taxes. The Constitution of Pakistan defines the taxes for collection for different tiers of the government. Federal Government is responsible for collecting income tax, corporation tax, wealth tax, property taxes, and gas and petroleum surcharge. On the other hand, Provincial Government collects land revenue, stamp duty, urban immovable property tax, tax on transfer of property, agriculture income tax, capital gains tax, and tax on professions, trades, and callings.
3. Types of Taxes in Pakistan
3.1 Income Tax
Income tax is levied on the income of individuals, corporations, and businesses. It forms a significant source of government revenue in Pakistan. Governments impose income tax on the income earned during a fiscal year, which begins on July 1 and ends on June 30 of the following year.
3.2 Sales Tax
Sales tax, which is imposed on the sale of goods and services, applies different rates depending on the type of goods or services being sold. The standard rate of sales tax stands at 18%, while for luxury items, it may increase up to 25%.
3.3 Federal Excise Duty (FED)
Federal Excise Duty (FED) is a tax levied on specific goods and services produced and consumed in Pakistan. The rates of FED vary according to the type of product.
3.4 Customs Duty
Governments impose Customs Duty as a tax on imported goods, applying it at the time of importation. The rates of customs duty vary depending on the type of goods being imported.
3.5 Capital Gains Tax
Governments levy capital gains tax on the profits individuals earn from selling assets such as immovable property, shares, securities, and other assets. In addition, capital gains are subject to taxation when the sale price of an asset exceeds its initial purchase price. Consequently, any profits made from the appreciation in value are taxed as capital gains. Likewise, capital gains taxes are imposed on both long-term investments held for over a year and short-term investments held for less than a year. Similarly, the tax rates may vary depending on whether the capital gains are classified as long-term or short-term. Therefore, capital gains taxes are an important source of tax revenue for governments.
3.6 Property Tax
Property tax is levied on the value of immovable property, such as land and buildings. The rates of property tax vary depending on the value of the property and its location.
3.7 Withholding Tax
The source of income collects withholding tax, which serves as a levy. Individuals and businesses apply it to various payments, including salaries, dividends, and interest.
4. Tax Structure and its Implications
The tax structure in Pakistan is regressive in nature, contradicting the fairness principle of tax policy. Frequent changes in policy and rates create an environment of uncertainty, particularly for potential investors. Consequently, the uncertainty stemming from frequent changes may discourage investment. Furthermore, the reliance on indirect taxation and withholding regimes significantly increases the compliance cost for taxpayers, especially businesses. Likewise, complex indirect tax systems impose substantial administrative burdens on companies. Similarly, higher compliance costs reduce the returns for businesses and investors. Therefore, keeping tax policies and rates stable along with simpler direct taxation systems can help reduce uncertainty and increase investment. This makes the tax policy inefficient and inconvenient.
5. Excessive Withholding Regime
The Federal Board of Revenue (FBR) has shifted the burden of collection to those conducting transactions. Consequently, about 70% of tax revenue is collected through withholding tax agents such as banks, utilities, telecoms, etc. This places the burden of collection on these businesses and increases their operational costs.
6. High Compliance Cost
The current withholding regime and other documentation drives by FBR are counterproductive due to their high cost of compliance. It takes around 577 hours per year to complete the tax payment process in Pakistan compared to the world average of 108 hours.
7. Fragmented Tax System and Growth
Pakistan’s tax bases are fragmented with services subject to taxes at the provincial level and goods at the federal level. Additionally, there is variation in rates, along with several specific exemptions. Moreover, the standard rates on services also vary between provinces.
8. Complex Taxation Structures
Pakistan ranked 161st among 190 economies for the “paying tax” indicator in the 2020 Doing Business Report. The low performance for this indicator is due to the intricate tax system and high tax compliance costs.
9. Low Fiscal Resource Mobilisation
The low revenue collection stems from a combination of complex laws, primitive tax collection mechanisms, and the high discretion granted to tax collecting authorities. Furthermore, the tax base for nearly all types of taxes remains narrow due to the prevalence of wide-ranging exemptions, concessions, and the existence of a black economy.
10. Inefficient Tax Planning
In Pakistan, the Income Tax code categorizes incomes into separate blocks. Tax liability should be assessed at the end of the year, enabling returns to reconcile all advance payments. Moreover, all incomes should receive equal treatment and not be differentiated.
11. Tax Expenditures in Pakistan
There is a significant revenue loss from SROs based and under 5th, 6th, and 8th Schedules of tax codes. There has been hardly any economic appraisal of these waivers.
12. Conclusion
The Pakistan tax system is complex, with numerous types of taxes. For individuals, corporations, and businesses to comply with the tax laws and regulations, it is vital to understand the different types of taxes and their rates. The government of Pakistan continues to refine its tax policies and laws to create a more efficient and effective tax system in Pakistan.
