Over the time, several efforts were made by the successive governments to document the undocumented Pakistan’s economy but the results were hardly encouraging. Every time, the resistance was quite strong resulting in limited success of such initiatives and reversal of policy decisions taken in this regard.
Against this backdrop, one of the most difficult tasks faced by the government has been about how to broaden the tax net and bring more and more people into the pool of those who pay their taxes. But what has actually happened is that, in a bid to raise its revenues, the government has always put additional tax burden on the already registered tax payers or gone for collection of indirect taxes from the masses.
This policy has been criticised by some economists on the ground that the rate of indirect taxes is the same for all regardless of their financial worth and earning potential. This means a poor labourer and a rich factory owner will pay the same amount of indirect tax on the identical goods they purchase.
One of the most recent steps taken by the government to increase the tax base was the imposition of withholding tax on banking transactions. A rate of 0.3 per cent was applicable on the tax return filers whereas that for non-tax filer was set even higher at 0.6 per cent. This means a non-tax filer is being charged Rs600 withholding tax on withdrawal of Rs100,000 from the bank.
Furthermore, under an amendment made to Section 68 of the Income Tax Ordinance 2001 through the Finance Act 2016, effective from July 1, 2016, the properties in the real estate market would be evaluated (according to the existing market value) under a mechanism set by the State Bank of Pakistan (SBP). After this amendment, it will become difficult or impossible for people to undervalue the property transactions they enter into and save government taxes as well as hide the exact amount that has exchanged hands.
The general perception on ground is that these decisions have not helped the government achieve desired results; rather they have resulted in further expansion of the informal economy and a drastic increase in cash transaction. The opposition camp has criticised the PML-N government for imposing new taxes on masses and allegedly stashing their money abroad through off-shore companies.
The market sources are linking the two decisions and believe that the one to re-evaluate properties was taken as money was being put here instead of the banks to avoid payment of withholding tax.
Asad Chaudhry, a real estate advisor based in Lahore, states that the country already has one of the highest cash to bank deposit ratios in the world and the imposition of withholding tax at such a high rate has further drained banks of their deposits. He says, "People are dealing in cash and that is why the Rs5,000 denomination currency notes are high in demand. It is easy to carry big amounts in cash if you have high denomination notes."
Chaudhry says many traders in the wholesale markets either enter deals verbally or sell goods on credit. On most occasions, he says, cash is not involved and signed parchis (slips) work as negotiable instruments. "The value of these parchis is equal to the amount written on them and they change hands many a time. This helps bearers avoid banking taxes and documentation."
Chaudhry’s assertion about steep fall in the value of bank deposits is corroborated by the figures released by the State Bank of Pakistan (SBP). These figures claim that the Cash in Circulation (CIC) swelled by Rs642 billion between July 1, 2015 and June 3, 2016, up 67 per cent from Rs384 billion during the preceding year. CIC is the amount of freshly released currency notes that are not deposited in banks but remains with people in the form of cash.
The recent boom in the real estate market was also attributed to the availability of excess liquidity with investors who could make more money this way than what they could get in form of interest returns from banks.
Khalid Pervaiz, President Pakistan Anjuman Tajiran, says traders have stopped dealing in banking instruments such as cheques, online transfers, demand drafts, pay orders etc due to the costs involved and resorted to other modes of payment. Furthermore, he says, "people are keeping money with them in the form of cash or gold to avoid tax which is risky keeping in view the security situation of the country."
The ironic part is that while traders and businesses are dealing in cash to save costs, they are investing more on hiring security guards, installing CCTVs, buying metal safes and installing alarm systems. This may cost much to the traders but saves them from being subjected to documentation by tax authorities.
"A Study of Informal Finance Markets in Pakistan" carried out by Adnan Qadir for Pakistan Microfinance Network in 2005 can be cited here for reference. Despite passage of over a decade, the issues are the same and so the modus operandi used by the tax evaders.
On the basis of surveys carried out by the team working on the report it was found that "In many markets, a chit or parchi is the norm for making business transactions and is seldom dishonoured. This system represents a convenient and flexible method that allows business to be conducted at doorsteps without the hassle of documentation or tax liabilities. It was found that most businessmen maintained their accounts through chits, partly due to the lack of skills for maintaining a modern accounting system, but also because of a fear of tax authorities. Most shopkeepers privately admitted that tax evasion is a common phenomenon which is why a large number of businessmen maintain double accounts: there is a margin between cash and credit sale which varies from party to party as well as duration."
The study also points out that: "A popular informal system of transferring money around the world is the hawala system, marked by low commissions, fast transactions, little documentation and round-the-clock operations. The system works through individual ‘brokers’ or ‘operators’ collecting funds at one end of the payment chain and others distributing the funds at the other end.
On the concept of deferred payments, it observes "A common feature of all urban markets is suppliers’ credit, with as much as 90 per cent of transactions in old markets with established players. Its prevalence is attributed to liquidity constraints and the avoidance of handling cash and tax documentation. There is generally a two to four per cent discount built in for cash payments. Richer parties often have the advantage -- a symptom of class segmentation -- because they are able to get better prices on cash as well as better deals even on suppliers’ credit."
Sheikh Mushtaq, a trader in Badami Bagh Steel Market, confirms that this system is still in place there as credit slips are commonly used to carry out transactions. "If someone wants to get cash on an urgent basis they can exchange these slips with certain parties who have cash with them in large quantities. This option is available against certain charges applicable on the deal."
Citing an example, he says, a party that was given a credit slip worth Rs10 million could either use it to make purchases or get it encashed by its supplier after two weeks. As this person needed money urgently he got cash from a party that charged Rs200,000 (2 per cent of the total amount) for providing this service," he concludes.