International Monetary Fund urges overhaul of Pakistan’s tax system

Islamabad [Pakistan], May 13 (ANI): The International Monetary Fund (IMF) has urged the Federal Board of Revenue (FBR) to revoke the discretionary powers held by the Board and the cabinet in granting tax incentives. Additionally, it calls for amendments in tax laws pertaining to NGOs, charitable organisations, and taxed pensioners, Geo News reported.

Concerning pensions, the IMF suggests either taxing pension contributions or benefits. It proposes eliminating the deduction benefit of voluntary payments to workers’ participation funds and ceasing the exemption of pensions, advocating for taxation via one of the described alternatives.
Critical discussions between Pakistan and the IMF are set to commence this week, starting on Monday. Pakistan formally seeks a fresh bailout package ranging from USD 6 to USD 8 billion under the Extended Fund Facility (EFF), with the potential for augmentation through climate finance, according to the report.
The IMF has outlined a wishlist regarding tax incentives, emphasising that these incentives should only be granted when their economic benefits, such as increased employment and value addition to the economy, outweigh the costs to the budget.
“In the current dire fiscal situation, few, if any, existing incentives would meet that test. Any remaining incentives should be well-designed and cost-based rather than profit-based,” stated the IMF to the FBR.

The IMF differentiates between cost-based incentives, like accelerated depreciation and special tax deductions, designed to reduce initial capital costs and encourage new investments, and profit-based incentives, such as tax holidays and preferential tax rates, which are less effective and may only benefit already profitable projects.
Furthermore, the IMF highlights the adverse effects of special tax regimes in the construction sector, advocating for their removal to enhance tax efficiency.
To streamline tax incentives, the IMF suggests eliminating most tax incentives in the Income Tax Ordinance (ITO), retaining only those legally obligated or deemed necessary for policy reasons. It estimates this action could yield an additional 0.2% of GDP in revenue.

In terms of tax administration, the IMF recommends repealing the FBR’s discretionary power to grant tax incentives for industrial undertakings and the cabinet’s discretionary power to award tax incentives. It proposes augmenting the Tax Expenditure Report with a chapter assessing the costs and benefits of tax incentives.
Future tax incentives, if granted, should be time-bound and subject to regular cost-benefit assessments. If costs outweigh benefits, incentives should be promptly withdrawn or transformed into cost-based incentives.

Additionally, the IMF suggests reforming the minimum tax regime, implementing a half-year rule to limit deductions in the asset’s first year of use, and eventually repealing the minimum tax as capacity for Corporate Income Tax (CIT) administration strengthens.
Regarding agricultural taxation, the IMF advises harmonizing tax rates and bases between federal and provincial levels. It recommends phasing out the SME tax framework for the manufacturing sector and subjecting the construction sector to standard income tax regimes.
Charitable donations and non-profit organizations face proposed reforms, with the IMF calling for streamlined rules and the substitution of tax credits for exemptions to enhance regulatory oversight.
“All types of donations and non-profit organizations should be subject to the same rules,” asserted the IMF, advocating for the repeal of remaining exemptions and the introduction of tax credits. It also suggests reviewing charitable donations tax credits and eligibility requirements for certain persons, Geo News reported.