System of Taxation in Pakistan - CAF-02 Tax Practices

**DEFINITION AND OBJECTIVES OF TAXATION** - Collection of share of individual and organization's income by Govt under a law. **Revenue & non-revenue objectives of taxation:** - To collect revenue to run the Government - Fair distribution of wealth - Use it as a tool to implement its...

**DEFINITION AND OBJECTIVES OF TAXATION** - Collection of share of individual and organization's income by Govt under a law. **Revenue & non-revenue objectives of taxation:** - To collect revenue to run the Government - Fair distribution of wealth - Use it as a tool to implement its policies **Examples:** - Encourage production of certain goods by granting exemptions *(locally assembled cars)* - Encourage local purchase by charging high tax rates on imports *(high sales tax on imported mobile phones, chocolates)* - Trade negotiations with other countries *(Double taxation treaties)* - Counter the effect of inflation and depression *(during inflation, increase tax rates to control demand and during depression, reduce tax rates to stimulate economic activity)* - Reduce inequalities in financial status - Encourage R&D, increase skill level of work force *(25% tax credit on salary income of a full time teacher/researcher employed in a non-profit education/research institution duly recognized by HEC, University etc)* - Implement laws to eliminate discrimination among various businesses *(sales tax applicable \@18% across almost all sectors, with some exceptions)* - Discourage certain undesirable sectors and activities *(High FED on cigarettes)* - Discourage investment abroad *(company established in special economic zones -- FIEDMC)* - Document the economy *(amount transferred otherwise than banking channel shall be taxed)* **ILLUSTRATION: OBJECTIVES OF FOLLOWING TAX LAWS!** **Tax Law** **Objective** ------------------------------------------------------------------------------------ ------------------------------------------------------------ Tax on salary income Revenue collection Money not transferred through banking channel is treated as income Documentation of economy Tax on moveable assets *(tax on private vehicles)* Fair distribution of wealth Higher taxes on imports of luxury goods Encourage local industry, stop outflow of FC Tax rebate on R&D Promotion of innovation Zero rating on exports Encourage inflow of foreign currency, boost local industry Tax credit on donations to approved institutions *(Shaukat Khanum Memorial Trust)* Encourage donations to such institutions Minimal tax on exports by IT sector *(0.25% income tax on turnover)* Support IT sector **TAXES : FOR DEVELOPMENT *(ECONOMIC GROWTH)*** - Provide tax incentives to areas designated as Free zones, industrial zone and economic zone *(M3 industrial city and Allama Iqbal Industrial City in Faisalabad -- 10 year income tax exemption)* : (employment, economic prosperity) - Tax rich at higher rates, tax lower income groups at lower rates *(slab rates, super tax on income \> Rs. 150m)* : (fair distribution of wealth) - High customs duty on luxury items : (promote local industry) - Tax credits on donations : (promote welfare activities) - Tax exemptions to charitable org/educational & research institutions : (promote charity work) - Tax exemption to agriculture sector : (promote agriculture) **BASICS OF TAXATION LAWS** Canons of Taxation by Adam Smith *(Principles on which a tax system should be based)* **❑ Equality :** Tax should be proportional to income *(rich should pay more)* **❑ Certainty :** Tax liabilities should be clear and certain *(no ambiquity)* **❑ Convenience of payment :** Taxes should be collected at a time and in a manner convenient for taxpayer *(monthly, deduction at source by employer)* **❑ Economy of collection :** Taxes should not be expensive to collect and should not discourage business. *(POS systems, IRIS automatically calculates tax liability, Digital risk assessment procedures)* **PRINCIPLES FOR LEVY OF TAX** **❑ The Benefit Principle :** The individuals should be taxed in proportion to the benefits they receive from the governments and that taxes should be paid by those people who receive the direct benefit of government programs and projects out of the taxes paid *(Road toll)* **❑ Abitility-to-pay Principle :** Taxes should relate with the person's income i.e., those with greater income should be taxed. Similarly, even rate of tax could increase with higher income. *(Progressive tax rates)* **❑ The Equal-Distribution Principle :** Income may be taxed at a fixed percentage i.e., people who earn more should pay more taxes, but not at a higher rate of tax. **\ ** **KINDS OF TAXES** **❑ Proportional tax/Flat Tax :** A tax system that requires the same percentage of income from all taxpayers regardless of their earnings. *(29% tax rate for companies)* **❑ Regressive tax :** A tax that takes a larger percentage from a person's low-income than from another person's high-income. *(GST @ 18% on necessities is regressive for low income groups)* **❑ Progressive tax :** A tax that takes a larger percentage from high-income earners than it does from low-income earners. **CHARACTERISTICS OF TAX LAWS** - Tax is an enforced contribution - Tax is generally payable in cash (bank) - Payment of taxes should be based on the ability to pay principle - Tax is levied on income, transactions or property - Tax is levied by the state which has jurisdiction over the person or property - Tax is levied by the law making body of the state - Tax is levied for public purposes **PRINCIPLES OF A SOUND TAX SYSTEM** **❑ Fiscal adequacy :** Sources of state income should be sufficient to provide for all its expenses. **❑ Equality :** Tax should be proportional to income *(rich should pay more)* **❑ Administrative feasibility :** Tax should be clear to taxpayers as to time and manner of payment and not discourage business activity *(Many businesses relocated their manufacturing facilities to countries like UAE)* Tax should be enforceable by trained, skilled and adequate public officials. **❑ Consistency with economic goals :** Basic services for the public *(SEZ to encourage investment to boost manufacturing and exports)* **TYPES OF TAXES IN PAKISTAN** 1. DIRECT TAXES 2. INDIRECT TAXES **DIRECT TAXES:** Direct taxes primarily comprise of Income Tax. In the Income Tax Ordinance, 2001, tax is levied generally on the net income of a taxpayer earned during a tax year computed by applying the specified tax rates as applicable to respective taxpayer. **Income Tax:** All income is classified under the following heads: - Salary - Income from property - Income from business - Capital gains; and - Income from other sources **Capital Value Tax :** Capital value tax on different transaction such as transfer of immoveable property. **INDIRECT TAXES :** **Custom Duty :** Goods imported and exported from Pakistan are liable to rates of customs duties. The general scheme envisages higher rates on luxury items as well as on less essential goods *(Lower custom duties on industrial plants and machinery and raw material as compared with those on consumer goods)* **Federal Excise Duty :** Levied on a limited number of goods produced or manufactured, and services provided or rendered in Pakistan. *(e.g., FED on banking transactions is applicable in Pakistan)* **Sales Tax :** Levied at various stages of economic activity @ 17 % on: - All goods imported into Pakistan, payable by the importers - All supplies made in Pakistan by a registered person in the course of any business carried on by him