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Direct taxes favoured: think tank floats Rs 200 billion taxation proposals
May, 08th 2014

Institute for Policy Reforms (IPR), a policy think tank on Wednesday floated Rs 200 billion taxation proposals for upcoming budget (2014-15) with almost 55 percent of the additional revenues accrued through direct taxes.

Sharing the budget proposals of the IPR at an event on Wednesday, top economist and managing director IPR Dr Hafiz Pasha said that the proposed revenue target for the FBR in 2014-15 is Rs 2,700 billion representing a growth rate of 20 percent. With normal growth, FBR revenue is likely to reach Rs 2500 billion. Therefore, taxation proposals are required which could yield Rs 200 billion in 2014-15.

Almost 55 percent of the additional revenues accrue from proposals in direct taxes. This will make the tax system more progressive and convey the right signals to the people. Pasha said that the estimated tax expenditure of income tax has been worked out at Rs 260 billion including Rs 110.1 billion income tax exemptions; tax deductions and allowances Rs 98.3 billion and concessionary tax rates Rs 37.7 billion.

Proposing Rs 200 billion taxation proposals for 2014-15, the renowned economist said that 55 percent of the additional revenue would come from direct taxes. He focused on rationalisation of tax expenditure in income tax. In the next Finance Bill of 2014-15, it has been proposed to tackle the issue of under taxation of Capital Gains on Securities. This will involve enhancement in the withholding tax on shares/securities traded in the stock exchanges, in lieu of capital gains. The proposal is to introduce Securities Transaction Tax, of the type that exists already in India. The suggested rate is 0.5 percent of the traded value of a share. Suitable arrangements will have to be made by FBR to ensure that this tax is fully collected. Exemption of income of certain trusts, NGOs, etc: This will only become applicable if the business income exceeds 50 percent of the total income (including charitable contributions). The taxable business income may be taxed at the reduced rate of 20 percent.

Tax deduction on provisioning of banks: This provision is contained in the Seventh Schedule of the ITO. The proposal is to restrict this benefit only to bad loans to SMEs, agriculture and exports. Tax deduction on pensions: Pension contributions already enjoy tax deductibility. The present system of also exempting pension income, in effect, provides a double benefit. As such, the second benefit is proposed to be withdrawn, especially in the case of retired corporate executives, for annual pension income in excess of Rs 750, 000.

Concessionary rate of sales tax: There is a tax rebate of 2.5 percent if sales are made only to registered persons. This is proposed to be withdrawn, as some buyers may be genuine small tax payers. Concessionary rate on dividends: All dividends may be subject to the standard rate of 10 percent. Concessionary rate on teachers: The partial concession currently available may be withdrawn.

He said that currently, different forms of unearned capital income are taxed as separate blocks of income. The proposal is to make a transition from scheduler to comprehensive income taxation. As such we recommend the withdrawal of the presumptive and final tax of 10 percent on dividends, interest from bank deposits, profit on government securities and prize bonds.

This may be replaced by a minimum withholding tax of 10 percent, which will make the tax system more progressive and also raise additional revenues. He was of the view that capital gains on property is more in the nature of income and should be within the fiscal powers of the Federal government. However, the focus should be on taxation of real, net nominal gains. Overall, the above three sets of proposals will signal the more towards progressive taxation, especially through broadening of tax to more effectively cover capital gains and unearned incomes.

Dr Pasha said that the 'big move' expected this year is the large-scale withdrawal of SROs, providing for special exemptions or concessions, in import duties and the GST. This is in the form of a Structural Benchmark in the IMF Program, to be implemented by June 2014.

The major Chapters of the Harmonised System which enjoy the largest tax breaks due to SROs are mostly either intermediate or capital goods, with the exception of automobiles which fall largely in the consumer good category. The impact of SROs, consequently, is an enhancement in effective rates of protection (ERPs) to domestic industry. For example, the ERP of the automotive sector is as high as 116%, according to Pasha (2012), due largely to SROs.

While many of the SROs represent the lobbying efforts of influential industrial groups, an indiscriminate and large-scale withdrawal could constitute a big 'negative shock' and lead to some displacement of domestic industry. Therefore, two basic principles need to be observed in the rationalisation of import duty SROs as follows:

Principle 1: No withdrawal of SROs on basic food items falling in Chapters 1 to 23.

Principle 2: Cascading down the statutory rate of import duties as follows: Rate of import duty on raw materials 5 percent, machinery 5 percent, intermediate goods 15 percent finished goods be subjected to 25 percent.

Simultaneous withdrawal of SROs and scaling down of import tariffs will enable industry to absorb the big move, while leading to a simpler and more transparent import tariff regime.

On the withdrawal of sales tax SROs, he said that the principal imports benefiting from SROs are capital goods (41 percent) and intermediate goods (38 percent). Bulk of the sales tax paid on these goods will be tax invoiced away as inputs into domestic production. Therefore, while the removal of these SROs may remove distortions, it will not contribute as much to additional revenues as is generally anticipated. SROs in the domestic component of the GST are limited. Excluding items in the Sixth Schedule, there is a case for withdrawal of SROs.

As proposed in the Finance Bill of 2013-14, reduction in the corporate income tax rate by 1 percent each year to 30 percent finally. As such, the rate for 2014-15 will be 33 percent. Scheduled banks have been excluded from this benefit. It is proposed that they may also be included, subject to the condition that 25 percent or more of incremental advances during a year are to micro finance, SMEs and agriculture combined. It has been proposed to increase in the tax credit for balancing and modernisation from 10 percent to 20 percent. It further proposed ten year tax holiday for power sector. The initial depreciation allowance has been reduced from 50 percent to 25 percent in the Finance Bill of 2013-14. It is proposed that from the second year onwards the rate of depreciation admissible may be increased from 10 percent to 15 percent.

The IPR proposed to bring down the rate of withholding tax in telecommunications from 15 percent to 10 percent. On the sales tax side, it proposed to raise the threshold level in GST from turnover of Rs 5 million to Rs 7.5 million, in line with past inflation. Allow input tax invoicing of machinery in line with the accelerated depreciation allowance in income tax.

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