In that article, a revolving cycle had been identified that has emerged in our financial system for whitening untaxed money by abusing concessions and protections provided to private foreign currency accounts under PERA and ease of transfer of funds from abroad as laid down in Section 111(4) of the Income Tax Ordinance, 2001.
In order to understand the abuse of the system, it is essential to understand the rationale of the introduction of the aforesaid two regimes. Private foreign currency accounts for individuals were allowed to be opened under PERA as a part of liberalization of exchange regime in 1992. It is a correct step. These accounts were intended to be financed out of remittances from abroad and Pakistani citizens were allowed cover against exchange fluctuation. As the practiced developed, it was also allowed that such accounts can be fed by acquiring foreign exchange in Pakistan against Pakistan rupee from exchange companies. The objective of this concession was the ease in acquiring foreign currency and its transfer outside Pakistan for genuine reasons. Nevertheless, whilst allowing such concession no restriction or condition was placed to ensure that acquisition of foreign exchange against Pakistan rupee is out of the Pakistan rupee that falls under regulated tax system. As a result of this loop hole, this system was heavily misused. Untaxed money was used to acquire foreign currency in Pakistan and its placement in private foreign currency accounts to avail the concessions and protections available under PERA. Once the money was in private foreign currency account, it could be used for acquiring assets outside Pakistan, financing under invoiced imports and for all other undesirable purposes. This means that a sincere objective was being abused.
Similarly the objective of Section 111(4) of the Income Tax Ordinance, 2001 was to facilitate Pakistanis living abroad to send funds to Pakistan without taxation hassle, because such income is not chargeable to tax in Pakistan. If this provision would not have been there then tax authorities had the power to seek the sources of all assets and expenditure in Pakistan created out of income earned by our expatriates outside Pakistan that has been sent to Pakistan. As in the earlier case, this was also a proper and correct approach. Nevertheless, using the concessions and protections available under PERA for the foreign currency accounts, the concession under Section 111(4) of the Income Tax Ordinance, 2001 has be widely abused for whitening untaxed money that has actually moved from Pakistan.
This description which is a very summarized version of a complex financial abuse was required to be corrected. In the Economic Reform Package, there appears to be a genuine attempt to break this revolving cycle. This aspect has been discussed in the following paragraphs.
The biggest abuse-funding of private foreign currency account against rupees
Under the procedure as was applicable prior to the recent amendment made through the Economic Package on April 8, 2018, it was possible for any person holding private foreign currency account to feed such accounts by acquiring foreign currency against rupees in Pakistan. There was no enquiry or requirement of being a taxpayer in Pakistan for feeding such accounts. This does not happen anywhere in the world especially in a country where there is substantial undocumented money. This lacuna had been identified earlier, however, no serious action was ever taken to plug this loophole in our financial system.
Through an amendment made in PERA read with Foreign Currency Accounts (Protection) Ordinance, 2001 a major change has been made in the law. The law now states as under:
"provided that no cash shall be deposited in an account of a citizen of Pakistan resident in Pakistan unless the account holder is a filer as defined in the Income Tax Ordinance, 2001 (XILX of 2001)."
This is an extremely important change in the 'foreign exchange regime' that was initiated with the introduction of PERA in 1992. This change will have far reaching effect on our economy and taxation system as it had been observed that certain concessions and protections laid down for foreign currency accounts opened under PERA were being abused.
The biggest abuse was the 'deemed' protection of tax evaded money by converting the same into foreign exchange by purchasing foreign currency against Pakistan rupee and placing the same in the foreign currency account.
There were differing views whether such feeding can be enquired by the taxation officer, however, the practice demonstrated that such 'enquiry' was not available. This deemed protection, effectively provided a very safe avenue for the untaxed and corruption money to be placed in foreign currency accounts by purchasing foreign currency against rupee from the open market. Once the money had been converted into foreign currency and placed in the foreign currency account, it was eligible to be transferred outside, inter alia, for all purposes including acquiring assets and funding under invoiced imports or any other purpose. There was no trail and same was effectively within the legal system.
There were two options for stopping this abuse. Under the first option, the proposal should have been complete restriction on feeding the foreign currency account against rupees. The second option is regulated option of purchase and limiting the same to 'tax-filer' under the regulated regime. The argument for the second option is that complete ban will unnecessarily harm the genuine transfer of tax paid money. At this stage, the government has adopted the second approach. It is, however, suggested that matter be closely monitored and if the abuses that have emerged stop then the amended procedure should be continued, otherwise the first option is always available.
As stated earlier, this change is extremely important. It is expected to change the whole structure that had been created against the overall economic interest of Pakistan. This change is the part of overall package that has been announced for the correction of certain fundamental errors that have emerged in our financial culture after 1992. As stated earlier, these changes are part of the overall package enforced to assure that private foreign currency accounts are not used for parking untaxed money. As discussed in author's earlier article, the revolving cycle of movement of foreign exchange is to be broken so that to ensure tangible benefits to the economy of Pakistan. It is opined that the aforesaid step is the first time after 1992 that any attempt has been made to curb the abuse of private foreign currency accounts which were served as a tool to facilitate movement of untainted money. Nevertheless, whilst making correction, it has to be ensured that there is no hurdle or problem for genuine taxpayers and documented tax culture should continue to operate unhindered. In the author's view, a concrete, correct and timely step has been taken that would have medium to long term positive effect on the economy.
Cap on immunity under Section 111(4) of the Income Tax Ordinance, 2001
Section 111(4) of the Income Tax Ordinance, 2001 provides complete immunity without any limit from any tax enquiry as to the source for remittance from abroad. As discussed above, there was a possibility before this amendment to transfer untaxed money out of Pakistan using the private foreign currency account and bring the same back claiming amnesty under Section 111(4) of the Income Tax Ordinance, 2001. With the completion of this cycle, at a very minimal cost, untaxed money could be brought into the tax system. This aberration had been identified by various quarters for a very long time, however, this subject had unnecessarily been considered a taboo. It is heartening to note that reliable studies on the subject had been made that identified that concept of no enquiry would not materially affect the inward remittance.
As a major change, an amendment has been made in Section 111(4) of the Income Tax Ordinance, 2001 whereby there can be enquiry for remittances above Rs 10 million by any person in a year. This means that there will not be any enquiry on small remittances which constitute a substantial part of genuine remittances. Any remittance above, the prescribed amount shall be subject to identification of source.
Prescription of a cap under Section 111(4) of the Income Tax Ordinance, 2001 and ban on feeding cash by non-filers in the foreign currency account is an appropriate step to break the unholy circle. It is a highly appreciable step to plug the loophole that existed in our system.
As per the author, notwithstanding the concept of revolving circle as discussed above, there is no basis of providing immunity without limit for remittances from abroad. Under the modern financial system, where anti-money laundering and counter terrorism is an essential part of any financial system, there cannot be any regime where right for the enquiry of sources is not available.
The new paradigm
A conjunctive analysis of these two important changes reveal that economic managers being State Bank of Pakistan and Federal Board of Revenue have rightly identified that under the present global scenario, there cannot be control on movement of foreign exchange, however, the liberty in that regime cannot be used in the manner that is detrimental to the interest of Pakistan. We are all aware that the menace of under-invoicing is being financed, in addition to 'hawala' transactions, by remittances from the foreign currency account. We all know that negative forces, in the country and outside Pakistan, would be totally unhappy with these corrective measures. It is for the society to decide the correct economic direction for the country.
It is the author's view that a movement for corrective action in the regime has started. The other major reform is substantial reduction in the tax rates for businesses to be undertaken by individuals. These corrective measures along with reduction in rates are signals for our countrymen that it is economically feasible/practical to undertake businesses under a documented system.