A Critical Appraisal of Finance Bill, 2006

In the news appearing in the daily press regarding upgrading of Pakistan's ratings, there appears to be an intention to convey a pre-defined picture of this most critical operational document which sets the strategic direction of the country on tactical basis, the Finance Bill. All the economic surveys and analysis from the government normally compares the performance of last year with one and half decade and sometimes, it is specifically compared with any specific year.

The population and basis used for the statistical surveys is disclosed in the most confusing manner but the important thing is the result portrayed is like increase in per capita income. Another obvious example is about foreign and local debt which stands at 28.3% of GDP as on 31st March, 2006 as compared to 52% as on 30th June, 2000. This article is an attempt to highlight the important economic aspects and direct tax aspects of the bill.

ECONOMIC ASPECTS

The GDP is normally defined as the total value of goods and services produced by a nation. A cursory look at the recent past showed that a continuous growth starting from 2000 – 2001 till 2004-2005 can be directly attributed to the international scenario whereby the inward remittances have increased. This has converted our economy into a consumer led economy which lacks diversity and sustainability. This conclusion can easily be drawn from the recent sharp fall in GDP growth trend although the private sector investment in wholesale and retail sector is around 42% during the last year expecting that the consumer led economy will continue to grow.

The major portion of our foreign direct investment was on account of privatization, selling of local industries to foreign parties, stock exchange and property. Such FDI is unable to contribute towards our main issues of transfer of technology and reduction in unemployment rate instead increased the same. However, such FDI is really necessary to finance the deficit of balance of payment which has increased from $4.4 billion to around $9billion, however, the reliance has again been placed to foreign sources, obviously debt, to the tone of Rs118 billion. Similarly, last year the agriculture sector is the key player while this year the contribution from this sector is like next to nothing comparatively.

From the political arena of PESTL analysis one could easily see the fact that current government is dependent upon its allies as the major opposition is, hence, continuity in policy is the most risky factor to decide about. Similarly, the law and order situation in some parts of NWFP and Balochistan provinces also raises the eyebrows which when coupled with the western border situation deteriorate the whole scenario. The legal arena of conducting a business with thousands of laws and increasing transaction cost by slapping indirect taxes is another most important issue.

The technological aspect of Pakistan has never been so strong and now at times when Pakistan is unable to compete with India in the IT sector, the tax collectors has identified another area called IT for the imposition of sales tax. From the social side, the gap and differences between poor and rich is increasing with tremendous speed with the economic measures of government whereby the percentage increase in salaries and pension would make the higher earner the ultimate beneficiary on the other side the excise duty on railway’s AC and first class tickets is suggested to be removed.

INCOME TAX

PERMANENT ESTABLISHMENT

[Section 2 (41) (c)]

There are two amendments suggested in this section. First amendment is the inclusion of the word “fixed”. In general, a PE is a fixed place of business and is clearly in line with OECD and UN Model Treaty. For an enterprise to have a fixed place of business in a contracting state it must operate at a specific geographical location and its activities at that location must endure for more than a temporary period. The place where equipment, such as oil pumping machine, is used can constitute a place of business even if that machine is attended by human agents of the enterprise.

In international taxation, for a place of business to be fixed, it is enough that it has a specific geographical location. For instance, a market place can be the fixed place of business of an enterprise if the enterprise operates a movable stall within that market place on a regular basis. It is immaterial whether an enterprise rents or owns its premises in determining whether the premises constitute a PE.

However, the second amendment is the specification of temporary period which vary country to country. “but only where such site, project and its connected supervisory activities continued for a period or periods aggregating more than 90 days within any twelve months period” [2(41)(c)] requires attention. The explanation appeared regarding this amendment is that in line with OECD model treaty, however, the treaty used the term minimum/temporary period.

To date, Pakistan has signed full fledge 52 treaties and 6 partial treaties. All the full fledge treaties contains various periods and are incompatible with clause (c) of sub-section 41 of section 2. It is the basic principle of international taxation that “a treaty overrides the law of the land”, hence, this 90 days period is only applicable in cases where there is no treaty. CBR must align the impact of these 90 days with the withholding tax provisions or wait for any quasi judicial decision in favour of an efficient tax planner!