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An analysis of the Finance Act 1990.

An Analysis of the Finance Act 1990

Lord Summer said in one of his celebrated judgments that the way of tax payers is hard and that the Legislature does not go out of its way to make it any easier. The Finance Bill, 1990 had generated so much heat and become so controversial that the Federation of Chamber of Commerce and Industry had threatened to give a call for country-wide strike unless major changes were made in the Finance Bill to meet their viewpoint. But the tax proposals which have now become, with minor amendments, law, would affect all categories of tax-payers who will have to pay more in order to meet the huge deficit in the Budget.

A number of substantive changes in the Income Tax Ordinance, 1979 have been made to raise additional revenues by imposing new taxes, increasing the existing rates of taxes, withdrawing exemptions and curbing widespread tax evasion. In this article an effort is made to assess the effectiveness and impact of these changes.

Deemed Income

Normally, income-tax is charged on income which accrues or arises or is received in Pakistan, but very often certain income does not accrue or arise or is not received in the technical sense, but the taxpayer derives full benefit of such income in an indirect way. In such cases, the law requires that the amounts be deemed to be income which has accrued or arisen to an assessee and be charged to tax like other taxable income.

Section 12 of the Ordinance deals with such deemed income. In 1987, sub-section (18) was added to this Section in order to tax cash loans received by an assessee in excess of Rs. 50,000 in any income year from any person other than a bank or a financial institution. The sub-section deemed such loans to be income accruing or arising to an assessee and charged them to tax. The idea was to encourage tax-payers to use Bank Accounts for major financial transactions so that documentation of the economy could be introduced and use of fictitious names for hiding income discouraged. However, the sub-section (18) soom became ineffective when the CBR, under pressure from the trade and industry, issued SRO 838(1)87 on 26.10.1987. It is submitted that issuing of this SRO was ultra-vires of the powers of CBR as it was not competent to over-rule the National Assembly which had already approved the provision.

The Finance Act 1990 now revives sub-section (18) in a modified form, substituting Rs. 100,000 for Rs. 50,000 and at the same time withdrawing SRO 838(1)87 in Part IV of the Second Schedule.

Although, attempts will be made to defeat this provision by, for example, splitting up of the cash loans in smaller amounts, yet the main objective of documentation would be achieved to a certain extent.

Sub-section (18) of Section 12 provides that the loan in excess of Rs. 100,000 should have been received by a crossed cheque drawn on a bank. The expression "crossed cheque" should be amplified to include other instruments through which transfers of money take place. Similarly, the word "bank" should be defined in accordance with the provisions of Banking Law.

Directors' Remuneration

A new clause (cc) in Section 24 is proposed to be introduced to restrict the salaries of directors' of a domestic company (as from a public company) to 20 per cent of the total income of such company before the deduction of directors' salaries from the total income. In the case of an individual director, the aggregate amount of salary is not to exceed Rs. 360,000 for a period exceeding eleven months or Rs. 30,000 per month where the income relates to a period of less than eleven months.

The intention behind this new provision appears to be to prevent reduction of tax liability of the private companies through the device of paying huge sums of money as remuneration and commission to their directors whenever there are bumper profits. The average tax rate in the case of individuals is much lower than the private companies.

Although the objective of this provision is laudable, the method proposed to be adopted for achieving the objective is questionable and may prove counter-productive. it will not be difficult for the private companies and individual directors to keep such profits outside the books of account and deprive the Exchequer more than what he expects to collect through this provision. Besides, the provision is discriminatory as the directors of public companies have been exempted from this restriction. The salary of Rs. 30,000 for a director in these days of high costs is not much particularly when an employee of the same company may be drawing a much higher salary according to market conditions. In any case, it is wrong on principle to impose one's own judgment regarding the reasonableness of a salary in a private company. Salaries like all other prices are determined by market conditions. As to whether a salary paid is reasonable or not can easily be determined by looking at comparable cases. If the salary appears to be unreasonable, the excess may be disallowed for good and valid reasons. For this purpose, necessary amendment can be made in clause (viii) of Section 23 which lays down the criteria for determining the reasonableness of bonus or commission for services rendered. This amendment would not only eliminate the arbitrariness of proposed clause (cc), but permit determination of salaries of directors in a private company according to market conditions.

Donations

In connection with any expenditure in excess of Rs. 25,000, a new clause (FF) is inserted in Section 24 disallowing any expenditure in excess of Rs. 25,000 incurred after 30th June, 1990, payment of which is made otherwise than a crossed cheque drawn on a bank or by a crossed bank draft. Attempts will be made to defeat this provision by splitting up of a transaction into smaller amounts. It is, therefore, suggested that after the word "incurred", the words "on a transaction" be added so that if any attempt to split up the transaction is made, it can be foiled by pointing out that the smaller amounts are part of the same transaction.

The existing sub-section (3) of Section 47 provides that in respect of any Board, University, Institution or Fund referred to in clauses (a), (b) and (c) of sub-section (1), the sums eligible for allowance under Section 47, shall not exceed Rs. 500,000 in the case of companies, and Rs. 10,00,000 in other cases. In the case of any Institution or Fund which is established in Pakistan for a religious or charitable purpose and is approved by the CBR for that purpose, the limit of eligible allowance is Rs. 500,000. However, sub-section (3A) of Section 47 further restricts the above limits to 5 per cent of the total income of a private company, and 25 per cent of the total income of any other assessee.

Different limits for different institutions create unnecessary complications. Therefore, these limits are now proposed to be substituted by a single uniform limit of Rs. 500,000 or 5 per cent of the total income of an assesses whichever is the less. However, the allowances are to be included in the total income of an assessee whichever is the less. However, the allowances are to be included in the total income and taken into account for the purpose of determining the average rate of tax.

Dividend Income

At present dividend income from various sources other than private companies, enjoy total exemption to the extent of Rs. 15,000. The excess is liable to deduction of tax at source at 7.5 per cent as an independent block of income. The Finance Bill proposes to reduce this limit to Rs. 10,000, but keeps the rate of tax intact for the dividend in excess of Rs. 10,000.

The provision will depress the Stock Market, discourage investment in new subscriptions and hit hard those middle and lower middle class people whose only source of income is dividends or whose total income inclusive of dividends is below taxable limit. Apart from this, it appears that the provision is discriminatory in the case of those persons whose total income inclusive of dividends is less than Rs. 40,000 per year. It is a moot point for consideration as to whether the provision is discriminatory or not and whether the Government have legal power to propose such discriminatory legislation.

At present, a company having a total income of Rs. 50,000 per annum and other tax-payers having a total income of Rs. 100,000 per annum, are required to pay for the current year advance tax in four instalments based on the latest completed assessment. The Finance Act has increased the limit in the case of latter category to Rs. 150,000, but does not propose any increase in the limit in the case of companies. There is obvious inconsistency in this approach. Besides, it is not understood why an unsolicited concession has been made to those tax-payers who fall in the highest income bracket particularly when the whole thrust of the Finance Act is towards tapping as many new sources of revenue as possible. This concession is in sharp contract to the proposed amendment in Section 50(6A) whereby even the non-taxable persons may be caught into the tax net.

Self-Assessment Scheme

Sections 59(1) and 59(B) are amended in order to revive the Self-Assessment Scheme which was discontinued. The scope of the Scheme is proposed to be confined to individuals, firms (both registered and unregistered), association of persons and Hindu undivided families whose total or last assessed income is below Rs. 200,000 per year. The Scheme will not apply to companies or to those who fail to comply with the rules of the Scheme. Five per cent of the returns filed under the Scheme will be selected through computer ballot for total audit.

Panel system of assessment has been done away with for the time being, but the relevant provisions in the Ordinance have not been deleted or amended. Evidently, the Government does not want to give up this option for all times to come and may revive it at any future time as it has revived the Self-Assessment Scheme. Government has found the Panel System worst than old system and has chosen the lesser evil for want of a better substitute.

Through a proviso added to the existing Section 116, a period of two years has been fixed for completion of the penalty proceedings. This is a very good improvement as there is at present no time limit for imposing a penalty after the issuance of notice to that effect. The amendment will minimise the inconvenience to the tax-payers and will help the Income Tax Department to accelerate the pace of disposal of penalty cases.

A new Section 165A is inserted in the Ordinance empowering the CBR to delegate, by notification in the official Gazette any of its powers. The object obviously is to seek the assistance of outside agencies in carrying out a reasonably accurate country-wise survey of new tax-payers as the existing number of tax-payers on the record of the Income Tax Department is much too small having regard to the population and rise in the level of incomes. The provision can also be used to hire the services of professionals for carrying out external audit of income-tax assessments. The provision is, however, ironical as it shows lack of faith in the efficacy of tax collecting machinery. This situation was bound to arise owing to deep erosion of efficiency and ethical standards. However, it is very doubtful that outside agencies will be able to render any worthwhile assistance. Chances of success are very bleak. No half-baked measures will work in a hopeless situation.

Delegation of Powers

It is suggested that along with documentation of economy and use of computers for assessment purposes, the tax collecting machinery be overhauled to raise the standard of efficiency and ethical standards. This can be done by inducting well-qualified, trained and highly motivated officers as Tax Collectors. Both Customs and Income Tax Departments play a very crucial role in the mobilization of resources. Surprisingly, however, the expenditure of these Departments is only a very small percentage of the revenue which they collect. Therefore, the Government should consider devising a special pay structure and attractive scheme of incentives for the officers of these departments based on the revenue which they are expected to collect. Besides, modern technology should be used to change the time-consuming and archaic procedures, improve coordination, communication and use of information. Greate care should be exercised in the selection of officers and employees of these departments. It is only through such measures that Government will be able to check widespread tax evasion. Efficiency, proper compliance of tax laws, accountability are key factors for achieving any meaningful results.

Tax Credit

Section 107 is amended to allow the concession of tax credit for replacement, balancing and modernisation of plant and machinery to the period of installation between 1st of July 1990 to 30th of June 1993. This is a good amendment which will encourage industrial growth.

First Schedule: Paragraph A of this Schedule is amended to tax income from a prize or a prize bond or winnings of a raffle, lottery or cross-word puzzle. Similarly, casual income which now enjoys total exemption, is proposed to be taxed if it exceeds Rs. 25,000. Accordingly, subsection 7(c) is proposed to be inserted in Section 50 for deduction of tax at source on such payments.

It may be pointed out that the basic scheme of the Income Tax Law is to tax income which is not precisely defined in the statute but which the Privy Council has defined to mean a `periodical return coming in with some sort of regularity or expected regularity from a definite source'. The source need not necessarily be the one which is expected to be continuously productive but it must be one whose object is the production of a definite return excluding anything in the nature of mere windfall. However, the need for larger and larger resources to meet ever-increasing development and non-development expenditure and the proliferation of casual sources of income, has forced the successive Finance Ministers to discard sophisticated concepts of taxation and subject to tax anything which can augment the resources of the Government.

Amendment proposed in Part II of this Schedule will increase the rate of super-tax of private companies by 5 per cent. Experience has shown that increase in the rates of tax is always counter-productive as the existing rates are already high. However, the main object of this amendment appears to be to encourage the conversion of private companies into public companies. The number of listed companies is only about 200 as compared to over 2500 private and unlisted companies.

Amendment in Part III of this Schedule changed the existing method of levying surcharge on higher incomes. At present, surcharge at 10 per cent of the tax payable is leviable on a total income which exceeds Rs. 200,000. Now the surcharge at the same rate will be levied on the tax payable in respect of total income which exceeds Rs. 100,000. In other words, the cumulative rate of tax has been increased in the case of tax-payers whose incomes exceed Rs. 100,000 per year. In the case of a person whose total income does not exceed Rs. 100,000 (including at least 50 per cent of salary income) and whose return qualifies for acceptance under the Self-Assessment Scheme, the amount of surcharge has been fixed at Rs. 600.

Amendment in Part IV of this Schedule seeks to nullify the effect of court ruling that the benefit of Export Rebate can be extended even to a partner of a firm or a member of an Association of Persons.

Second Schedule: The existing clause (16) is substituted by a new clause which consolidates all pension exemptions in a single clause, making, however, a significant change in the case of those pensioners whose total income (inclusive of pension) exceeds Rs. 100,000 per year. The average rate of tax in the case of such pensioners will naturally increase.

The existing clauses (62) and (62A) provide total exemption to any income of a trust which is administered under a scheme approved by the Federal Government and is established in Pakistan for the welfare of retired and serving personnel of Army, Federal and Provincial Governments. Through a proviso to be added to these clauses, it is proposed to withdraw exemption from that portion of income which is attributed to a business set up by the Trust on or after 1st day of July, 1990.

This is a good change as tax exemptions of a business whose products are sold in the market, create distortions in prices and confer undue advantage on the beneficiaries over their competitors.

Charitable Trusts

The scope of exemption granted by clause(93) of the Second Schedule is extended to "any sum invested in the purchase of Certificates, Government Securities (including Development Loans), Shares, Debentures, Debenture Stock, other stocks and shares referred to in Section 41 of the Income Tax Ordinance. Clause (93) applies to religious and charitable trusts. Therefore, the exempted income must actually be applied or finally set apart for religious and charitable purposes otherwise the exemption would not be available.

The amendment in clause (95A) of the Second Schedule withdrew exemption of income now available to a Provincial Seed Corporation. The amendment should improve the operational efficiency of this Corporation and make its products competitive in the open market. An amendment is also made in clause (95B) of the Second Schedule, which now exempts from tax profits and gains of a Pakistani company engaged exclusively in the rendering of agro services. The exemption will not be available in respect of any assessment year commencing on or after 1st day of July, 1990.

Clause (96) of the Second Schedule is amended to tax income from renting of agricultural machinery which is now exempt upto June 1993. In other words the exemption has been curtailed by three years.

Agro-Services

The amendment in clause (103) of the Second Schedule withdrew exemption from a Cooperative Society carrying on the business of banking. In the case of other Cooperative Societies, exemption is proposed to be withdrawn to that portion of their income which is derived from the lending of money and leasing of buildings or of land to their members. Exemption is also proposed to be withdrawn from the Societies in respect of interest and dividends derived from their investments with any other Cooperative Societies.
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Title Annotation:Pakistan
Author:Hasan, M.G.
Publication:Economic Review
Date:Jul 1, 1990
Words:3131
Previous Article:Budget 1990-91 an assessment.
Next Article:Summary of tax proposals 1990-91.
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