Sources told Business Recorder on Wednesday that a report of Directorate General of Internal Audit prepared by Shahid Bashir Director Central Region has explained methods used for unearthing international tax evasion using avoidance of double taxation conventions and treaties.
Some common measures introduced by government in the domestic laws, international and national tax treaties to counter international tax avoidance and evasion are improving access to bank and other information; general anti-avoidance/anti-abuse rules; controlled foreign company and foreign investment fund legislation; arm's length principle.; rules addressing treaty shopping; thin capitalisation rules; rules to deal with certain financial market innovations and effective international exchange of information.
The report said that Pakistan has also introduced legislation and measures to counter international tax avoidance and evasion through Income Tax Ordinance 2001 promulgated in July 2002. The section 105 of Ordinance 2001 deals with taxation of permanent establishment in Pakistan of non-resident persons whereas section 106 deals with important issue of thin capitalisation. The section 107 deals with agreements for avoidance of double taxation and prevention of fiscal evasion. Similarly, section 108 deals with transaction between associates and section 109 deals with re-characterisation of income and deduction.
Similarly important concept of arm's-length and no arm's-length transactions has been explained in section 78 of the Ordinance 2001. It is hoped that in future issues arising out of foreign source income and taxation would be dealt with by tax authorities keeping in view the concepts introduced through Income Tax Ordinance 2001 to ensure non-leakage of tax revenues.
In case of unreported income from per se legal activities, the taxpayer indulges in concealment of domestic cash income, eg a taxpayer self-employed in cash economy (restaurant, taxi, small shop etc) "skimming" ie taxpayer reports only part of his income or the taxpayer indulges in cash transactions.
The other cases of unreported income from per se legal activities include cash carried cross border, deposit in foreign bank accounts, concealment of income from international trade eg taxpayer producing goods sold legally and also exported with a request to some international customers to pay full or part to foreign bank account.
Similarly, the taxpayer can also make arrangements such as having off shore companies controlled by taxpayer for domestic business and customer then contract with off shore companies and pay directly to those off shore companies. However, the taxpayer conceals his relationship to off shore companies and the example of these kinds include any kind of distance service (e-service), buying and selling real estate, etc.
In case of unreported income from per se criminal activity examples include residents receiving bribe in cash abroad, on foreign bank account or through secretly controlled foreign company or trust. Other examples of unreported income from this source include profits from criminal activities of any kind in cash abroad, on foreign bank accounts and through secretly controlled foreign companies and trust.
The example of false deductions include taxpayer's receiving loans from foreign entities and deducting interest payment as business cost where in fact the foreign entity is secretly controlled by the taxpayer or the loaned funds are in fact taxpayer's own funds which he has hidden using with that foreign entity (this is not only the case of tax evasion but also of money laundering).
The example of concealed residence is an individual taxpayer may claim not to be a resident but is fact a resident. Similarly, corporation not incorporated/registered where their place of management is not their actual place of management.
In order to control tax evasion, the most important factor is to have a fair and generally accepted tax system that encourages public expenditures. Tax administrations that enable, encourage and enforce the law are generally able to counter tax evasion. In order to counter tax evasion some methods included detection of evasion through tax audits and clearly specifying in the tax return whether taxpayers have any foreign accounts, control any foreign entity or hold any foreign property thereby forcing the taxpayers to reply to a specific question.
Sources said that the use of information collected by anti-money laundering authorities and increased communication between tax authorities and anti-money laundering authorities would also check evasion. The international exchange of information on issues such as interest/salary paid abroad, other remuneration abroad, taxpayer addresses abroad, company ownership and company directorship etc.
Countries have evolved different responses to counter tax avoidance. Some of the approaches evolved include stricter disclosure regimes; specific anti-avoidance/anti abuse rules; general anti-avoidance/anti abuse rules and doctrines, taxpayer penalties and third party penalties.
The report said that most countries have developed specific anti-avoidance rules to cater for tax avoidance practices like transfer pricing. The rules dealing with transfer pricing are generally based on the principle of "arm's-length transactions". The arm's-length principle is an international taxation principle that serves the objective of securing the proper tax base in each jurisdiction ie country or state and also helps to avoid double taxation.
Another tool generally used to avoid and evade tax is a use of tax havens. Tax havens by definition is a jurisdiction making itself available as a tax haven for avoidance of tax which would have otherwise be paid in relatively high tax countries, the report added.