Confusing signals to investors

The state has a duty to provide an environment conducive to unhindered business

Confusing  signals to investors

Little else is required to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes and a tolerable administration of justice: all the rest being brought about by the natural course of things

— Adam Smith


fair and just taxation system lies at the core of a viable economy, playing a pivotal role in the progress of an autonomous and thriving nation. In Pakistan, every administration faces meagre revenue, escalating costs and subsequent budgetary constraints. The imperative of generating additional revenue remains crucial, given its vital role in financing essential public outlays, such as law enforcement and the upkeep of public infrastructure.

Yearly fixation of revenue targets depends on the economic and fiscal plans of the government. In this exercise, numerous tenets of tax policy come into play, contributing to the establishment of the overarching taxation structure. These tenets encompass impartiality, efficiency, predictability, simplicity, effectiveness, fairness and flexibility.

In pursuit of these objectives, it is crucial for tax laws and regulations to be transparent, simple and uncomplicated. A clear tax framework not only empowers individuals and businesses to align effectively with the taxation structure but also ensures improved calibration. Besides, the state has a duty to establish an environment conducive to unhindered business, investment, advancement, reinvestment, profit distribution and repatriation.

However, there have been insufficient endeavours in Pakistan for expanding the tax base and network. The half-hearted attempts, coupled with meagre resources, result in a failure to fulfill the rising financial demands. Consequently, the governments resort to borrowing.

This inefficiency of the taxation system has significant repercussions for the business landscape in Pakistan, particularly as the state falls short of fulfilling its primary responsibilities. Every business is compelled as a result to individually address its security, power and energy needs. In addition to these challenges, they grapple with excessive taxation.

A highly regressive initiative was undertaken in the Finance Act, 2022 with the retrospective insertion of Section 4C in the Income Tax Ordinance, 2001, effective from July 1, 2022. Under this provision, income surpassing Rs 150 million attracts incremental taxation at rates varying from 1 to 4 percent. However, for specific sectors such as airlines, automobiles, beverages, cement, chemicals, cigarettes and tobacco, fertiliser, iron and steel, LNG terminals, oil marketing, oil refining, petroleum and gas exploration and production, pharmaceuticals, sugar and textiles - if their income exceeds Rs 300 million – a higher rate of 10 percent is provided.

Imposition of the super tax has triggered legal disputes. Writ petitions have been filed under Article 199 of the constitution contesting the retrospective application for tax year 2022 and against discrimination among various sectors. Notwithstanding the challenges, the government, through 2023, expanded the income brackets and prescribed rates varying from 1 to 10 percent for tax year 2023 and beyond.

This regressive action is a final blow to businesses already in a shambles, especially large companies. Swift and intensifying economic instability, characterised by consistently high inflation (surpassing 30 percent) and a policy rate of 22 percent (with prospects of further escalation) have disturbed the already fragile economic equilibrium.

Instead of putting its own house in order and displaying prudence, the government has persisted in overburdening big businesses with onerous taxation. For many months, due to dwindling foreign exchange reserves, multinational corporations were barred by the State Bank of Pakistan from repatriating profits to their head offices. Adding insult to injury, the Federal Board of Revenue blocked bona fide refunds to show higher than actual tax collection.

Swift and intensifying economic instability, characterised by consistently high inflation (surpassing 30 percent) and a policy rate of 22 percent with prospects of further escalation have disturbed the fragile economic equilibrium.

The recent judgment of the Islamabad High Court on Section 4C of the Income Tax Ordinance 2001, in writ petition No. 4027 of 2022 (M/s Fauji Fertiliser Company Limited and another versus Federation of Pakistan and others) and connected matters, aptly characterises this situation: “…unavoidable outcome of successive governments’ extravagance and ineffective handling of public finances.” The judgment also highlights statistics cited in the World Bank’s report, Pakistan’s Federal Public Expenditure Review – Reducing Pakistan’s Persistent Fiscal Deficits – 2023, observing: “The lack of an integrated debt management function undermines sound debt management in Pakistan, leading to suboptimal borrowing choices… The Treasury Single Account can be immediately implemented and can improve cash management and render fiscal savings of up to Rs 404 billion (0.6 percent of FY22 GDP) annually…”

“Federal SOEs impose a significant fiscal drain and pose a substantial fiscal risk on the federal government. Federal commercial SOEs have been incurring losses since FY16, with annual losses averaging at 0.5 percent of GDP over FY16–FY20. Pakistan’s federal SOEs have been found to be the least profitable in the South Asia region. The accumulated SOE losses have become substantial, amounting to 3.1 percent of GDP in FY20…”

The World Bank report clearly reveals that the government has shown little concern about rectifying its internal affairs and tackling opportunities that could contribute to reducing fiscal deficit and overall tax burden. The consequences of economic mismanagement by successive spendthrift administrations should not be borne by the citizens and the business sector. The judgment is well articulated, especially in raising the following issues and questions: “The situation is akin to the kings in medieval times giving free rein to their sheriffs to run amok in the counties to confiscate the produce of their subjects, even after they had paid the tithes, just to fund their extravagant exploits. Is it not a violation of the citizens’ inalienable right under Article 4 to be treated in accordance with the law, where the root cause for imposition of a tax is a persistent violation by the parliament and its progeny, governments, of the commands of the constitution, the FRDLA, and other sovereign commitments for reform?”

Businesses are left with scant resources for strategising growth and expansion. Correspondingly, the net return lacks appeal to attract substantial investments. Under these circumstances, the governments and the establishment have collaborated to attract foreign investment through Special Investment Facilitation Council (SIFC) to ensure that foreign investors do not face any difficulties and that the legal requirements are addressed in a centralised framework.

On the one hand, the government appears unwilling to address the grievances of current foreign investors and MNCs and on the other, there are initiatives like the SIFC. There are no ready solutions available with regard to blocked tax refunds and non-repatriation of already taxed profits. The government’s reluctance to instruct the FBR and the SBP to resolve these persisting issues sends a negative signal. It shatters the investors’ confidence, which in the long run will negatively impact the overall economic outlook.

Those who matter must realise that foreign investment cannot be attracted without fundamental reforms and fiscal discipline. Imposing irrational and burdensome taxes, duties and surcharges on existing taxpayers to achieve revenue targets will yield no benefits. Rather, this might compel them to shut down their businesses or seek more cost-effective alternatives.

Dr Ikramul Haq, an advocate of Supreme Court and writer is adjunct faculty at Lahore University of Management Sciences (LUMS)

Abdul Rauf Shakoori is a corporate lawyer based in the USA

Confusing signals to investors