ISLAMABAD: The World Bank says tax regulations in Pakistan are frequently altered, and unpredictable tax rules worsen the business climate and may deter potential investment.

The report “Towards a more friendly tax regime: Key challenges in South Asia,” points out that South Asia’s tax regulations are complex and difficult to administer and comply with. Complexity stems from availability of special schemes, reduced rates and exemptions for different sectors, locations, types of firms or products.

Furthermore, tax laws are often written in vague language, which makes it difficult for a typical small and medium enterprise (SME) to understand its tax liabilities and provide room for multiple interpretations by both firms and tax administrators, creating opportunities for leakages and corruption, according to the report.

The report cites Pakistan and Bangladesh among the South Asian governments who make changes in tax regulations much more frequently. The changes were even more frequent in Pakistan.

“Such frequent changes mean that taxpayers should continuously follow tax notifications published in the official gazette to stay informed about their tax obligations,” report says.

The report says the administrative burden of tax compliance is hardest in Pakistan where firms have to make 47 payments and spend 594 hours or 74 man days per year dealing with tax regulations versus 12 payments and 175 hours in high income OECD countries. Eighty seven per cent of time spent on dealing with taxes or 514 hours per year in Pakistan is spent on VAT compliance.

The report revealed that 29pc of firms in Pakistan are expected to give gifts when dealing with tax officials. Such rampant corruption hurts business, particularly SMEs, undermines confidence in government institutions and reduces willingness to pay taxes.

The report says corporate income tax rates in South Asia are higher than in other developing regions. The average corporate income tax rate for Bangladesh, India, Pakistan and Sri Lanka is 32pc compared to the global average of 24pc. Corporate income tax rates have gone down in all regions over the past decade.

While South Asian countries have followed the trend, they started with higher initial rates and reduced them by a smaller percentage than elsewhere in the world. Pakistan has made some progress in reducing the number of VAT exemptions and broadening its sales tax base; the sales tax in Pakistan is charged in VAT mode.

In Pakistan, there is double taxation of select services, like banking, insurance and franchise services that are taxed both by FBR through the federal excise duty and by provincial authorities through the sales tax. Both the sales tax and federal excise duty are charged in VAT mode. This has resulted in numerous appeals by taxpayers who were subjected to double taxation.

The report says all the four South Asian countries provide tax incentives to specific economic activities, without a clear rational. Agricultural income receives special tax treatment throughout the region. In India and Pakistan, agricultural income is largely untaxed. In both countries, only the states or provinces have a constitutional right to collect agricultural income taxes.

In Pakistan, all four provinces tax agricultural income but in implementation “the income tax” actually functions as a land tax, which is paid by large landholders based on the acreage of land owned.

Tax policies in South Asia distort investment and consumption decisions as firms are given incentives to specialise in activities and products based on tax schemes rather than economic rational. There is little evidence that tax incentives in South Asia address market failures. They are granted to less productive business, high tech industries and random businesses which do not have an obvious association with large positive externalities.

The report suggests the governments that reform of tax legislation should aim at elimination of most special schemes and creation of an incentive neutral tax policy to broaden the tax base and ensure a level-playing field.

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