The Trust in Tax Evaders

The Task Force on Tax Reforms points out that ‘various tax amnesty schemes have contributed to the erosion of faith in the fairness of the system’. Had the Federal Bureau of Revenue (FBR) studied this observation, Invest-ment Tax Scheme ITS: 2008 would have not been issued for the benefit of “tax evaders”. Like every other tax amnesty scheme, this scheme is an admission of the inability of the tax machinery to collect tax from the potential taxpayers and a slap on the face of honest taxpayers. Have millions of dollars spent on “re-forming” FBR gone down the drain? It appears as if we are going to have more such schemes in future as Sec 120-A has been inserted in the Finance Act, 2008 , authorising FBR to issue such schemes. According to the ITS 2008, tax evaders have been given the option to pay investment tax at two per cent of the fair market value of all undisclosed moveable/immovable, undisclosed/unexplained investments/ assets at any time from July 1, 2008 to December, 31, 2008. No question will be asked regarding the source of such assets, investments, etc. The declarant can bring these assets on the balance sheet once tax is paid.

The scheme covers all such assets up to June 30, 2007. The fair market value on the basis of which tax shall be paid has not been defined. The reason for not prescribing basis of valuation of assets/investments has been given as follows: “The Scheme of “Investment Tax – 2008” is a voluntary scheme through which government has reposed trust in the taxpayers and an opportunity has been provided to legitimise the unexplained and undisclosed assets at a nominal rate of two per cent of the fair market value of the assets as declared.” However, the trust reposed is not in taxpayers but in the tax evaders.The fair market value shall be declared as on June 30, 2008. Once it is declared and brought on balance-sheet, the taxpayer can also claim depreciation with effect from July 01, 2008 as per Sec 23 of the ordinance. Suppose there are two private limited companies. One is honest taxpayer who has paid tax over the last five years and the other a tax evader now lured by investment tax scheme to declare his undisclosed assets. Suppose that each company has income of Rs100 in each of these following years. The tax liability in each of these cases will be as under:

Tax Year      Taxable income*      Rate of tax         Tax paid
                                                                                         Honest            Tax evader company
                                                                                         taxpayer         opting Investment
                                                                                         company          tax scheme
                                  Rs.                         %                    Rs.                  Rs.
  2003                        100                         43                    43                     0
  2004                        100                         41                    41                     0
  2005                        100                         39                    39                     0
  2006                        100                         37                    37                     0
  2007                        100                         35                    35                     0
                                  500                                                 195                   0
Tax paid under                                                                 0                      10
investment tax on
income scheme
Total tax paid                                                                  195**               10
Percentage tax                                                                39%                  2%

* Effect of re-investment of income has not been taken which otherwise would have increased tax liability of the honest taxpayer.
* Tax compliance cost, opportunity cost, additional taxes on late payment, etc would have been paid by the honest taxpayer and the tax evader will have no such cost.

The scheme seems to have been drafted in undue haste. It is sketchy and the same is now being clarified by issuing of circulars. First, the last date up to which assets were covered in the scheme was mentioned as June 30, 2008, later explained in Circular No. 7 that it was meant to be June 30, 2007. Realising its mistake in the scheme as well as in the circular No. 7, another circular No. 8 of 2008 was issued amending the original scheme. Now it is settled that the scheme applied to all undeclared assets or income on which tax was not paid up to June 30, 2007. But what would happen in those cases where a person has filed investment tax on assets up to June 30, 2008 before issuance of clarification or amendment? A source of litigation has already been generated. The scheme envisages that new tax payers availing ITS 2008 shall be obliged to file return of income for the tax year 2008 and subsequent three consecutive tax years. The department shall not question the source of acquisition of assets declared under the scheme for the past years and obligation of filing income tax return, if any, for the last five years. Who can be more generous than FBR? The scheme does not spell out consequences of not filing any subsequent income tax return up to tax year 2011. No default clause exists in the scheme. However, the FBR in a subsequent circular clarified that in such cases immunity of the scheme shall not be available. When the scheme itself is silent in this regard, any presumption through clarification would be against the express words of the authorising section 120-A of the ordinance. Although in a subsequent circular it was suggested that valuation of the assets might be made on legal and accounting practices, the CIT cannot question its valuation. This means the declarant can further avoid tax by declaring an asset at an under- stated value.

While the scheme says that that its scope extends to the existing and new taxpayers, in the circular No 7 it has been explained as under: “The scheme is applicable to all undisclosed assets/income which somehow or the other could not be disclosed and remained un-explained. Issues pending in appeals or raised/detected by the department would be dealt with under normal law and not under specific provisions of the scheme.” The above clarification impliedly means that concession is only where the department could not put hands on black money due to any reason (omission, commission, inefficiency, collision, to count a few) and not where there was genuine difference of opinion about the valuation of an asset or quantum of income. Similarly, where an asset has been declared at a lower value than the real one, strictly speaking it is not undeclared or undisclosed; so according to above clarification, it is not covered in the scheme. However, the same circular 7 states that it will cover the period up to tax year 2007 where tax payer is prevented under the law to make good any under declaration or non-declaration of income/assets. The FBR should issue a comprehensive circular addressing all such relevant issues to remove ambiguities.

The FBR should now realise that reforms do mean sitting in glass houses, getting returns through web-mails and increasing salaries. The real reforms would be when the present unjust system of taxation is replaced with a just, fair and equitable system of taxation keeping in view socio-economic conditions of our people. The reforms would be successful only if the honest tax payers are encouraged and not the tax evaders through such schemes. The legislature instead of patronising and rewarding inefficiencies, should promote tax culture by taking the FBR to task for failing to collect due amount of tax from tax evaders. Like Fiscal Responsibility Act, it should contain a clause prohibiting amnesty schemes. Can new FBR chairman declare that ITS 2008 would be the last scheme of tax amnesty or at least that no such scheme shall again be announced in the next 20-25 years? Such commitment would indicate how effective are those reforms and how much capable FBR has become after all these changes. The tax law should be made a bit relaxed where a taxpayer is regular taxpayer and strict where a person liable to tax is not paying any tax at all. Only this shift shall encourage tax culture, otherwise tax evaders would still consider ITS as only a “tax trap”. When tax evaders are enjoying tax amnesty for the last 61 years without paying any tax, why would they pay tax at two per cent to fall in tax net. What is solution then? Do not crush existing taxpayers, search new ones. When the cost of compliance would be lower than the potential cost of non-compliance, the tax culture would flourish.