Saturday June 15, 2024

IMF wants end to FBR, cabinet powers to award tax incentives

IMF recommends that either pension contributions or benefits be taxed

By Mehtab Haider
May 13, 2024
The International Monetary Funds (IMF) building in Washington, United States. — AFP/File
The International Monetary Fund's (IMF) building in Washington, United States. — AFP/File

ISLAMABAD: The IMF has asked the FBR to repeal discretionary powers of the Board and the cabinet to award tax incentives and bring changes in tax laws of NGOs and charitable organisations as well as taxed pensioners.

On pensions, the IMF recommends that either pension contributions or benefits be taxed. To this end, the IMF wants to eliminate the benefit of deduction of voluntary payments to workers’ participation funds and eliminate exemption of pensions and tax them by applying one of the alternatives described.

Pakistan and the IMF are all set to kick-start critical deliberations this week starting from today (Monday). Pakistan has made a formal request for a fresh bailout package of $6-$8 billion under the Extended Fund Facility (EFF) with the possibility to be augmented through climate finance.

The IMF’s wish list or menu is on the table for tax incentives. The IMF wants the tax incentives should be limited to cases where their economic benefits, in the form of employment and value addition in the economy, exceed the cost to the budget. “In the current dire fiscal situation few, if any, existing incentives would meet that test. Any remaining incentives should be well-designed and cost-based rather than profit-based,” the IMF told the FBR.

It added that cost-based incentives, such as accelerated depreciation and special tax deduction or credits relating to investment expenses, are designed to lower the cost of capital at the outset of the investment period, in order to make projects more profitable at the margin and promote new investment that would not otherwise have been made.

In contrast, profit-based incentives, such as tax holidays and preferential tax rates, are less effective in encouraging investments if profitability is low or only substantial in later stages of the project, and often only increase profits of already profitable projects at the cost of foregone government revenue.

Moreover, the effectiveness of profit-based tax incentives is likely to be attenuated with the implementation of the global minimum tax under pillar two.

“Distortions, complexities, and inequities caused by the special tax regimes for the construction sector are particularly harmful and reduce the tax effort of a highly buoyant sector,” the IMF says and added that the special treatment of the construction sector for both sales tax and income tax purposes should therefore be removed.

The IMF suggests elimination of all tax incentives in the Income Tax Ordinance (ITO), except those which Pakistan is legally obligated to provide or there are clear policy reasons such as to prevent cascading taxation of pass-through income. “This is estimated to yield 0.2 percent of GDP in additional revenue,” the IMF presented its estimates before Pakistani authorities.

In order to better manage tax incentives and related areas of tax policy, the IMF recommends repeal the discretionary power of FBR to award tax incentives for industrial undertakings, and discretionary power of the .cabinet to award tax incentives. The IMF wants to complement the Tax Expenditure Report with a chapter that assesses the cost and benefits of tax incentives.

In case tax incentives are granted in the future, they should be time-bound and subject to regular assessment of costs and benefits. If costs are higher than expected initially and/or benefits lower, incentives should be immediately withdrawn, transform remaining incentives into cost-based incentives, where possible.

The IMF wants to reform the minimum tax allowing the effect of accelerated deductions and implement a half-year rule to limit deductions the year an asset is put in use, repeal the minimum tax over the medium term, as capacity for CIT administration strengthens and CIT revenue increases.

The IMF asked the FBR to discuss with provinces the possibility of harmonizing the tax rate and base (e.g., deductions and rate of depreciation) of the agricultural income tax with that which would apply at the federal level, repeal the existing SME tax framework under the Fourteenth Schedule for the manufacturing sector and tax all manufacturers, phase-out as quickly as practicably possible the special tax regime for the construction sector and subject the sector to the standard income-tax regimes.

The Non-Profit Organisations and Charitable Donations, as explained in the 2019 Report, the current rules relating to charitable donations and non-profit organizations are duplicative and inefficient. All types of donations and non-profit organisations should be subject to the same rules, and the use of tax credits instead of exemptions for particular non-profit organisations would facilitate regulatory oversight over the non-profit nature of these entities such as repeal remaining exemptions for donations and non-profit organisations contained in the Second Schedule of the Ordinance and make them eligible for tax credits, review the charitable donations tax credit, as well as the credit for certain persons, to assess whether changes to eligibility requirement would be desirable.