UNDERSTANDING MINIMUM TAX
The state requires revenue to administer its affairs, to finance expenditures on public good and to pursue development activities. In the modern era, almost all states are generating substantial tax revenue for this purpose.
Tax revenue from direct taxes is preferred to indirect taxes due to distributive and welfare effects on the society. Indirect taxes are regressive in nature and have reducing impact on income and consumption of low-income households, which constitute a dominant proportion of the population, at least in developing countries.
Nonetheless, direct tax revenue is difficult to collect as compared to indirect tax revenue. People bearing incidence of direct taxes don’t want to pay taxes but they eagerly pay, if allowed, to shift incidence to consumers. To meet tax revenue targets, the tax authorities of developing countries like Pakistan are heavily dependent on indirect tax revenue.
As mentioned earlier, people don’t eagerly pay due tax whose incidence is directly on them. In Pakistan, income tax is the only source of direct tax revenue for the federal government. The Federal Board of Revenue (FBR) is responsible for collecting income tax under the provisions of Income Tax Ordinance, 2001 (hereinafter ITO). In view of considerable non-compliance reflecting from less than potential registered taxable persons, underreporting and under-invoicing, non-filing and less-than-potential tax collection, etc., the ITO is replete with withholding tax provisions. In true sense, income tax is to be paid by the taxpayers on taxable income or profits at the time of filing of their annual tax returns. However, withholding tax by the withholding agents on prescribed transactions throughout the year has become a norm. Though withholding taxes provide revenue to the government throughout the year, such taxes, especially presumptive (final) withholding taxes, defeat the very spirit of direct taxation.
Envisaging high level of tax non-compliance, section 113 has been inserted into the ITO, through the Finance Act, 2009, and has been operative from tax year 2010. A taxable person with no taxable income may have a minimum tax liability under the provisions of section 113 of the ITO. As minimum tax has been affecting taxable persons, this article is structured to discuss minimum tax payable under the provisions of the ITO.
Minimum tax under section 113 of ITO is payable when a taxable person has no tax payable on assessed income or profits or has assessed loss or tax computed on income or profits is less than the minimum tax in a tax year. Thus, section 113 of the ITO provides an assurance to the government that taxable persons having turnover in a tax year will pay at least minimum tax.
Minimum tax is payable in addition to tax already paid or payable in respect of deemed income assessed as final discharge of the tax liability under section 169 or under any other provision of the ITO and tax payable or paid under section 4B (super tax).
Minimum tax under section 113 of the ITO is payable by all resident companies from tax year 2010, permanent establishments of the non-resident companies from tax year 2021 and all individuals and associations from tax year 2011.
Section 113 has not prescribed any turnover threshold for charging minimum tax from the resident companies. To provide a level playing field to the resident companies, section 113 has also not prescribed any turnover threshold for charging minimum tax from permanent establishments of non-resident companies. However, section 113 has provided turnover threshold of Rs.10 million and above in tax year 2017 and onwards for charging minimum tax from the individuals and associations. Prior to tax year 2017, the turnover threshold for charging minimum tax from the individuals and associations was Rs.50 million and above.
The turnover for the purpose of charging minimum tax will be: (a) gross sales or gross receipts, exclusive of sales tax and federal excise duty or any trade discounts shown on invoices, or bills, derived from the sale of goods, and also excluding any amount taken as deemed income and is assessed as final discharge of the tax liability for which tax is already paid or payable; (b) the gross fees for the rendering of services for giving benefits including commissions; except covered by final discharge of tax liability for which tax is separately paid or payable; (c) the gross receipts from the execution of contracts; except by final discharge of tax liability for which tax is separately paid or is payable; (d) the company’s share of the amounts stated above of any association of persons of which the company is a member.
For tax year 2020, minimum tax is calculated at 1.5% of the turnover of taxable persons. However, minimum tax is calculated at reduced rate of 0.75% of the total turnover in respect of: (a) oil marketing companies, oil refineries, Sui Southern Gas Company Limited and Sui Northern Gas Pipelines Limited (for the cases where annual turnover exceeds Rs. 1 billion, Pakistani airlines, poultry industry including poultry breeding, broiler production, egg production and poultry feed production, dealers or distributors of fertilizer and person running an online marketplace; (b) at 0.25% in respect of distributors of pharmaceutical products, fast-moving consumer goods and cigarettes, petroleum agents and distributors who are registered under the Sales Tax Act, 1990, rice mills and dealers and flour mills; and (c) at 0.3% of the turnover of motorcycle dealers registered under the Sales Tax Act, 1990.
The intent and purpose of introducing legislation concerning minimum tax under section 113 is clear. It has been empirically proved that switching from a profit tax to a turnover tax reduces evasion levels by up to 60% to 70% of corporate income. So, higher revenue efficiency provides a rationale for the minimum tax, since it provides a much broader tax base as compared to business profits despite the fact that such minimum taxation policy has a necessary trade-off between revenue efficiency and production efficiency, as the turnover taxes are counterproductive. Turnover taxes could cause significant production inefficiencies because of their cascading effect through the production chain, which could imply effective distortions far higher than those from statutory tax rates. But to curtail evasion levels, a country with limited tax enforcement capacity is bound to use minimum tax tools at the expense of production efficiency.
However, to minimize production inefficiency, tax policymakers manage such taxation measures with low tax rate.
The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at email@example.com