Need for an equitable and people friendly-tax regime

Far-reaching fundamental changes have been done to the tax structure of the country in the recent past. It is true that laws have to evolve and change to suit the changing socio economic environment.

The new tax law among other things aim at widening the tax net in the country.

While acknowledging the numerous good features in the new system one has to recognise the need for fine tuning and making the system more equitable.

Withholding Tax

Withholding tax (WHT) is a method to collect taxes with ease and speed. It is an effective and less expensive way of revenue collection for tax administration. WHT is the mechanism used by most countries to retain the tax on cross boarder payments subject to any Double Tax Avoidance Agreements. 

Currently, in the domestic front, WHT tax is applicable on employment income, interest, rents, fees, partnership income etc. WHT on rent is liable on any amount even, say Rs. 2,000 per month. Even if the income of land lord is less than the statutory tax free allowance of Rs. 500,000 still WHT has to be deducted. There are no provisions to get directions from the Department to stop such deductions. 

One segment of the society is charged with income tax though their income is less than statutory tax free limit making an inequitable element in the current system. Therefore, there is a need to stipulate a minimum limit such as Rs. 50,000 per month for rent for WHT purpose. 

WHT on fees also needs to be revisited. Currently a fee of Rs. 50,000 or more paid to an individual or proprietorship business will be subject to a WHT of 5%. This person may not be an income tax liable person getting an income exceeding Rs. 500,000 per year. The Rs. 50,000- payment may even be a one-off payment. 

If a single person provide his services through a proprietorship he is subject to WHT while two or more people provide services through a partnership or a company such fees are not subject to WHT. This can be amended to say if fees in aggregate of Rs. 500,000 or more per annum paid to a person it should be liable for WHT in the following period and broadened to cover all businesses or proprietorships be exempted along with other businesses. 

Similarly partnership income is also liable to WHT irrespective of the amount. Earlier there was a limit of Rs. 1,000,000 for a partnership to be liable for income tax. Presently no such tax free limits exist and even an income of say Rs. 5,000 will be liable to WHT at 8%. 

If a partnership business earns an income of Rs. 1,100,000 in 2017/18, the partnership tax liability is Rs. 8,000. If this partnership has the same income for 2018/19, it will be liable to a tax of Rs. 88,000 in the form of WHT in other words income tax. If the partners do not have any other income and the profit is shared equally there will be an over payment of Rs. 80,000. Start-up entrepreneurs will be in difficulties if no minimum limit is not set for WHT on partnership income. 

Thus some of the provisions of the law may hinder informal sector of the economy and stifle the economic growth in the medium to long term.

Economic Service Charge

Economic Service Charge (ESC) was introduced in 2004 to recover some tax in lieu of income tax from those entities who were exempt from income tax and those who were declaring loses in the accounts. In fact this was done to recover loss of revenue due to tax exemptions, tax evasions and avoidance during that period. 

Though ESC is related to turnover, the intention was to collect a tax where income tax is not paid. Later ESC was made liable for even profit making entities. However, ESC was allowed to be deductible from income tax liability. ESC could be carried forward and set off for 4 years against income tax. Also there was a maximum limit of Rs. 250,000,000 for ESC liability. The intention of the law was to facilitate deductions of ESC to a large extent from income tax. 

According to current ESC regime there is no maximum limit on ESC liability. ESC carried forward is allowed only for three years. Further, the rate has been raised to 0.5% on the turnover of almost all business entities with the turnover of more than Rs. 12,500,000 per quarter. 

The component of ESC which cannot be deductible from Income Tax becomes a cost for business and in turn this may be passed on to customers ESC which started with the features of income tax (Direct tax) is increasingly becoming an indirect tax such as VAT and NBT. Tax like this on exports may affect the competitiveness of our exports in the highly competitive international market. There is an urgent need to revisit the current ESC regime. 

Income Tax

Under earlier system exports income were subject to concessionary tax rates. Under the present system a person who exports more than 80% of the turnover only is entitled for a concessionary rate. Any business entity starts exporting initially on a small way. Such exports become liable to Income Tax at the rate of 24%.

Taxpayer rights

Taxpayers are the ones who contribute to the coffers of the Government enabling the smooth running of the State. In the process Taxpayers do not get any direct benefit in return. In this context it is very important to give due consideration for the rights of the taxpayers. If taxpayers do not send a valid appeal against an assessment due to some reasons, earlier law provided for an objection against taxes in default. This facility has been taken away under the current law. Interest on tax in disputes can be as high as 20% per annum. The penalty imposed on non-compliance are prohibitively high in many instances. 

People who are within the tax system and pay taxes must not be treated very harshly. The Commissioner General must be given powers to determine interest and penalties fairly under just and equitable circumstances. 

Tax practitioners

Tax practitioners, mostly chartered accountants and lawyers, are providing a yeoman service in this country. Most of the tax payers are ignorant about our complex tax system. Tax practitioners are the ones bridging the gap between tax payers and Inland Revenue, enabling smooth revenue collection in the country. 

Chartered accountants and lawyers are bound by their professional code of ethics in discharging their professional duties. In this context the new requirement for practitioners to sign the tax return of tax payers has put them in a dilemma. They provide their services based on information provided by the taxpayer. If we take an individual tax return, an individual is required to provide even the information about his or her jewellery. How can a practitioner verify such information? In this context it will not be fair to expect the practitioners to certify the return.

All in all the new Inland Revenue Act No.24 of 2017 is a step in the right direction. However, as this is a complete repeal of the old income tax law in the country, teething issues must be expected and addressed to in suitable manner by way of introducing appropriate amendments as we evolve under new Inland Revenue Act.

(The writer, FCA, ACMACPA, is a Chartered Accountant.)