Pakistan: Incentives for rapid industrialisation.
The performance of the manufacturing sector has been dismally poor during the last three years. The hostile tax structure is one of the factors for this amongst many others. Corporate tax rate at 35 percent is too high. Other countries are reducing corporate rates to 15 percent to 20 percent whereas in Pakistan, the Federal Board of Revenue (FBR) has plans to raise it to 40 percent. It will amount to 50 percent tax rate as 10 percent tax is imposed on dividends that are distributed from profits on which a company has already paid tax. This year tax is also imposed on gain of shares of listed companies if disposed of within 12 months of acquisition. This will further discourage investment in public listed companies.
Pakistan's industrial sector remains structurally narrow-based. This narrow base is predominantly agrarian in nature, and hence susceptible to exogenous factors, such as weather. This is highlighted by the role of cotton and sugarcane in the agriculture and manufacturing sector. Together, these two crops account for nearly 20 percent of value-added agriculture and over 30 percent of LSM. In the face of this reality, it is imperative that the budget makers ensure the policy of diversification as well as developing the indigenous small and medium enterprises and large-scale engineering sectors. But this point is missed in almost every budget presented during the last 15 years.
Tax investment incentives have in recent times become a favourite tool in development strategy both for domestic investors and for attracting foreign direct investment (FDI). The rationale for their use is that they constitute an important, if not a major element, in determining investment behaviour. Unfortunately, the Pakistani budget makers have always been preoccupied with the revenue targets and never gave a serious thought to providing some long-term investment-oriented tax incentives for infrastructure development, without which economic development cannot be achieved. The foreign investors will choose a place which, besides tax incentives, ensures stability, consistency and excellent infrastructure facilities. These elements are missing in Pakistan and the result is 65 percent decline in foreign direct investment.
Incentives increase the net of tax rate of return and thereby reduce the need for large initial capital investment and also reduce risk. The availability of incentives tends to make otherwise unpromising and risky ventures more profitable. There was a dire need to provide some incentives for industrial and business growth in the budget 2010-2011, but one hardly finds any such measures. The following are some of the tax incentives that can go a long way to ensure revival of the economy and rapid industrial growth in the country. The list is not exhaustive, but mentions a few essential ones that have been missed in the Budget 2010-2011.
Industrial investment should be given complete immunity for ten years from probe by the tax authorities, and the foreign exchange regulations should be waived. It will help the State to bring back the capital that fled from the country and also new capital would be attracted, especially from foreign investors and Pakistanis who are keeping billion of dollars abroad. There should be a well thought of scheme to bring untaxed and undeclared money back into the industrial investment. The immunity should be conditional to investment in industry alone.
A ten-year tax holiday for enterprises engaged in developing or operating and maintaining infrastructure facilities should be announced. The infrastructure facilities which will enjoy this benefit should include roads, toll roads, bridges, rail systems, highway projects water supply projects, sanitation, sewage and solid waste management, airports, ports inland ports and inland waterways.
To encourage the best use of technology and to lower the cost of doing business in Pakistan, payments for the following categories of software made to non-residents should be exempted from withholding tax. They are: site licences, software downloaded from the Internet by end-users, and software bundled with hardware.
Intellectual properties and their exploitation has become a significant source of competitive advantage in the knowledge economy these days. To enhance Pakistan's competitiveness in this respect, accelerated amortisation allowance over a three-year period should be allowed for capital expenditure incurred on the following categories of intellectual properties:
- Registered designs;
- Geographical indications;
- Layout designs of integrated circuits; and
- Protection of confidential information.
Employee stock option schemes have a significant impact on corporate performance. The schemes have been powerful tools to motivate their employees to greater innovation and enterprise. This kind of scheme should have income tax exemption for up to Rs. 5 million worth of stock option gains arising from the exercise of the employees' option over a ten-year period. The scheme should be available to all companies that meet certain conditions. One key condition should be that companies will have to offer the stock options to at least half the employees in the company.
Enterprises providing telecommunication services and broadband networks, and Internet service providers which provide these services should be allowed a tax holiday for five years and a deduction of 25 percent of profits for further period of five years. Pakistan must concentrate on the development of IT-based projects, which alone can make us competitive in the world markets in the coming days.
The economic managers while making the budget for financial year 2010-2011 failed to consider the fact that taxation affects the amount of capital available by encouraging or discouraging savings and foreign investment. It can also divert investment and labour from one sector to another. It affects the level and productivity of employment by influencing individual choices between work and leisure, the intensity of effort on the job and employers' decisions on technology. Taxes affect an entity's ability to diversify and expand through their import or input costs and managerial behaviour. They may also have a bearing on less tangible factors such as entrepreneurship and technical progress. Some empirical evidence also suggests causal relationships between the level and types of taxes and key growth determinants in the areas of investments, export, employment, productivity and innovation (Marsden, 1986).
Tax policies must concentrate on the revival of industrial sector by providing some result-oriented incentives for foreign and domestic investment. The single important reason why tax incentives for industrialisation are essential is to get macroeconomic policies right, as the alternative ways of financing government expenditure. Money creation, mandating larger required reserves, domestic borrowing and foreign loans can have very harmful effects on the already ailing economy
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