Finance Act 2024 From promises to policies

Pakistan’s economy is currently facing multifaceted challenges, spanning an economic downturn, high inflation and political turbulence. The political upheavals have adversely affected businesses and consumer sentiments. On the other hand, the massively devastating floods of 2023 disrupted agricultural production, and the sector is struggling to bounce back even today.

Apparently, without a sharp fiscal adjustment and decisive implementation of broad-based reforms, Pakistan’s economy will remain vulnerable to domestic and external shocks. Economic growth is therefore expected to remain below potential over the medium term with some improvements in investment and exports.

The foremost objective of the budget for FY 2024-25 was to give direction and momentum to the manufacturing business and trade sectors of the country. However, contrary to these expectations, no heed has been paid to these most important sectors. Nevertheless, the expectation was for a budget to contain inflation, revive investment and level the playing field with the informal sector, thus generating higher taxable profits and tax revenue.

Moreover, as exports are the only sustainable way to balance the external account, exports and exporters were expected to be encouraged. However, the budgeteers have failed to live up to these expectations. The budget was not only bereft of an economic vision, it also shows lack of capacity to think beyond narrow interests. The budget has exposed the fault lines within the existing power structure.

The continuation of exemptions to civil and military bureaucracy is a manifestation of the latter’s hold on the power matrix. Similarly, the politically powerful agricultural and retail sectors are left out of the tax net. The core objective of budget FY24 is to manage the country within its means, which entails containing the fiscal deficit as desired by the IMF.

To achieve this, the government has opted to mobilise higher revenues rather than reducing size of the budget. Consequently, the size of the budget has increased by 25 percent, rising from Rs14.4tr last year to Rs18.8tr this year. The revenue target has also been set at Rs12.9tr, which is 46pc higher than the last year.

Placing the entire burden of new taxes on trade, industry and salaried class will strangulate the economy. There is no measure in the Finance Bill to make investment more attractive by bringing the corporate tax rate in line with other Asian countries. Pakistan’s corporate tax rate of 39pc is one of the highest in the region, compared to India 29.1pc, Bangladesh 27.5pc and Vietnam 20pc. Bangladesh also offers a 10-year tax holiday to new entrants in the textile sector. With a Super Tax of up to 10pc and double taxation of inter-corporate dividends, the effective tax rate for shareholders in a holding company can amount to over 50pc.

The taxation regimes of the federation and all four provinces show no sign of taxing the agricultural elite. Punjab has budgeted only 0.07pc (Rs3.75bn) and Sindh 0.02pc (Rs6bn) of their budgets as agricultural income tax. The business community, especially the export sector, is highly perturbed over the taxation steps taken under the Finance Bill 2024.

They consider the measures to be unfair and potentially counterproductive, fearing they might squeeze industrial and export sectors which are already under strain. The increased tax rates for salaried persons, non-corporate and exporters from 1pc fixed tax on turnover to normal tax regime raising rates from 29 to 40pc on profits are highly unfair and counterproductive.

The Fixed Tax Regime (FTR) under which exports were liable to 1pc tax on turnover has been withdrawn and replaced by normal taxation at 29pc of taxable profit.

This will disincentivise exports, further hurting export revenues and will increase bureaucratic hurdles. Previously, exporters were paying 1pc turnover tax regardless of profit or loss under FTR regime, introduced in 1991 to remove human interference and facilitate exporters. Through the Finance Act 2024, a 1pc advance tax has also been imposed on export. There is no justification for imposing such a levy. Exporters were already paying 0.25pc EDF in addition to 1pc Income Tax being deducted under Section 154 of the Ordinance.

The average profitability of exporters is around 4pc, thus they are currently paying over 31pc tax. With the imposition of a further 1pc advance tax, their tax ratio will increase to 56pc, which is quite unjust. Exporters cannot transfer the cost increase to foreign buyers. Exporters are part of the global supply chain; therefore, competitiveness is key to surviving in the global marketplace.

On the other hand, the tax rate of non-export sectors is only 1pc which is non-mandatory deduction.

According to current market practices such tax is being avoided and department will only assess such under deduction at the time of audit u/s 161, mostly after 4-5 years of the tax year to which this deduction relates. In case of exporters, minimum tax paid u/s 154 can’t be carried forward as tax credit for next three years to set off against future tax payable and will be deducted on realisation of export proceeds. Whereas, non-exporters are charged to minimum tax u/s 113 and this can be carried forward for next three years as tax credit.

Their tax will be charged at the time of filing of Income Tax Return or on quarterly basis when paying advance tax. An additional advance tax @ 1pc has been applied only for the persons engaged in direct exports at the time of export realisation, whereas no additional withholding tax is applicable for non-export sectors.

To regain stability and establish a base for medium-term recovery, it is imperative to bring reforms to reduce tax burden on industrial sectors and broaden tax base through taxes on agriculture, property and retailers; improve quality of public expenditure by reducing distortive subsidies, improving financial viability of energy sector and increasing private participation in state-owned enterprises; and strengthening management of public debt through better institutions and systems and by developing a domestic debt market.

Despite low tax levels, tax gaps in low tax countries, including Bangladesh, Pakistan and Sri Lanka, are moderate, although such gaps are not necessarily small if measured as a share of current tax revenues rather than as a share of GDP. Better tax policies and administration alone may not help bridge the vast development financing gaps in low tax countries.

The projection of a 30pc growth in tax revenues for the upcoming fiscal year underscores urgent need for tax reforms. This target, challenging to achieve without expanding the tax base, becomes even more pressing as inflation falls and GDP growth remains low. The government must act swiftly to broaden the tax net instead of squeezing the existing taxpayers.

Taxation reforms are essential for unleashing Pakistan’s economic potential. By creating a more equitable, efficient and transparent taxation system, Pakistan can ensure sustainable revenue generation, foster economic growth and reduce inequality.

While the path to reforms is fraught with challenges, the potential benefits for Pakistan’s economy and its people are numerous. The time for action is now to pave the way for a prosperous and equitable future.