255 Annexure - 2. TAX EXPENDITURE A Note on Tax Expenditure Tax expenditures are provisions in the tax code, such are exclusions, deductions, credits, and deferrals that are designed to encourage certain kinds of activities or to aid taxpayers in special circumstances. When such provisions are enacted into the tax code, they reduce the amount of tax revenues that may be collected. In this sense, the fiscal effects of tax expenditure are just like those of direct government expenditure. Some tax expenditures involve a permanent loss of revenue, and thus are comparable to a payment by the government; others cause a deferral of revenue to the future, and thus are comparable to an interest-free loan to the taxpayer. Tax expenditures include exemptions from the tax base, allowances deducted from gross income, tax credits deducted from tax liability, tax rate reductions, and tax deferrals (such as accelerated depreciation). Since tax expenditures are designed to accomplish certain public goals that otherwise might be met through direct expenditures, it seems reasonable to apply to tax expenditures the same kind of analysis and review that the budget appropriation receives. It is essential to distinguish between those provisions of the tax code that represent tax expenditures and those that are part of the “basic structure” of a given tax. The basic structure is the set of rules that defines the tax; tax expenditure is an exception to those rules. In general, most taxes have a series of features that define their basic structure. These features are a base on which the tax is levied, such as net income or a particular class of transactions; a taxable unit, such as a person or a corporation; a rate, to be applied to the base; a definition of the geographic limits of the state’s exercise of its tax jurisdiction; and provisions for the administration of the tax. The total expenditures for FY 2005-06 has been estimated to be around 24.9 billion, which is about 12% lower than the previous year mainly due to withdrawal of exemption/ concessions by providing level playing field both to the national and foreign investors/manufacturers. The details for the FY 2005-06 are discussed below: Income Tax Section 53 of the Income Tax Ordinance, 2001 empowers the Federal Government to exempt from tax any income or classes of income, or persons. However, these powers are not being exercised by the Government as it is following a conscious policy of phasing out the existing exemptions gradually and not to allow fresh ones. Categories of exemption listed in Part-I of Second Schedule to the Income Tax Ordinance, 2001 are broadly as under:- i) Exemption related to pensions, provident funds and superannuation fund; ii) Exemption of interest on borrowings from external sources; iii) Exemption to non-profit charitable, religious and welfare activities; iv) Exemption to non-profit educational institutions; v) Exemption relating to electric power generation; and vi) Un-expired period to tax holidays for industrial undertaking. Economic Survey 2005-06 256 The total number of exemptions under the aforesaid categories contained in Part-I of Second Schedule to the Ordinance 2001 is 100. The cost of these exemptions amounts to Rs.4.65 billion. It may be noted that exemption expenditure mainly relates to allowances, capital gains, pensions, provident fund and superannuation fund. Furthermore, exemptions related to charitable activities and non-profit educational institutes are common in both developed and developing countries. The position with regard to the basic threshold of income for charging taxes is similar. The following is the estimated cost of exemptions in fiscal year, 2005-06 as compared to fiscal year 2004-05:- Table 1: Income Tax Expenditure (Rs. in billion) Estimated Revenue Loss No. Major Income Tax Expenditure Items 2005-06 2004-05 1. Pensions 0.70 0.70 2. Allowances 1.15 1.10 3. Income from funds (e.g.NIT units) 0.60 0.60 4. NSS interest income 0.45 0.50 5. Other interest income 0.05 0.05 6. Capital gains 0.95 0.95 7. Sector and enterprise specific exemptions 0.75 0.70 TOTAL: 4.65 4.60 Sales Tax Key exemptions of Sales Tax are agricultural produce, pharmaceutical products, pulses and information technology related items. The cost of Sales Tax exemptions is estimated to be Rs.8.65 billion for the fiscal year 2005-06, against Rs.7.85 billion last year. The Following are the main exemptions in Sales Tax allowable in fiscal year 2005-06 compared to fiscal year 2004-05 [Table 2]. Table 2: Sales Tax Expenditure (Rs. in billion) Estimated Revenue Loss No. Major Sales Tax Expenditure Items 2005-06 2004-05 1. Retailers (including those in turnover scheme) 0 0 2. Pharmaceutical (excluding life saving drugs) 4.80 4.60 3. Tractors and other agriculture machinery. 1.75 1.75 4. Fertilizers 2.0 0.69 5. Others (e.g. agri seeds, cattle feed) 0.10 0.10 TOTAL: 8.65 7.85 Federal Excise The major exemption in federal excise is data communication including the Internet services. There are few other conditional excise exemptions mostly related to supplies of excisable products such as tobacco, POL products supplied to the Armed Forces and UN agencies. The cost of excise exemption is around Rs.400 million. Customs Customs exemptions are mainly given on raw materials and components; plant, machinery and equipment imported by high-tech, priority and value added industries; imports for energy sector projects; and exemptions to exploration and production companies. Some of these exemptions are due to international contractual obligations. The following is the break-up of main exemptions in customs duties allowable in fiscal year 2005-06 compared to fiscal year 2004-05 [Table 3]. Tax Expenditure 257 Table 3: Exemptions in Customs Duties (Rs. in Million) Estimated Revenue Loss S.No SRO No. & Date Description 2005-06 2004-05 1. 438(I)/2001, dated 18.6.2001 Exemption of customs duty on machinery and equipment and construction materials. 0 158 2. 439(I)/2001, dated 18.6.2001 Superseded by 455(I)/2004, Dated 12-06-2004 Concession of customs duty for import of plant, machinery and equipment by the manufacturing industry, tourism related projects, hotels and relocated industrial plants. 5 1,976 3. 357(I)/2002, dated 15.6.2002 Superseded by 456(I)/2004, Dated 12-06-2004 Conditional concession of customs duty on import of raw materials and components etc, for manufacture of certain goods (Survey based) 2830 989 4. 358(I)/2002, dated 15.6.2002 Superseded by 457(I)/2004, Dated 12-06-2004 General and conditional concession of customs duty (non survey) 3778 7,429 5. 558(I)/2004, dated 15.6.2004 Concession of customs duty on goods imported from SAARC and ECO countries. 217 222 6. 678(I)/2004, dated 12.6.2004 Concession of customs duty and sales tax to Exploration and Production (E&P) companies on import of machinery. 1380 1,019 7. 46(I)/2005, dated 11.01.2005 Duty Free Import of Sugar 0 591 Total : 8210 12,384 Following is the consolidated summary of tax expenditures showing percentage increase/decrease for the fiscal year 2005-06 compared to FY 2004-05 [Table-4] Table 4: Summary of Tax Expenditures (Rs. in billion) Cost of Exemptions Type of Tax 2005-06 2004-05 % Change 1. Income Tax 4.65 4.60 1.1 2. Sales Tax 8.65 7.85 10.7 3. Customs Duties 8.21 12.40 -33.8 4. Central Excise 0.40 0.02 100.0 Total 21.91 24.87 11.9 A summary of the projected major tax expenditure items for the fiscal year 2005-06 is as under [Table 5] Table 5: Summary of Major Tax Expenditures for 2005-06 (Rs. in billion) Major Tax expenditure items Estimated Revenue Loss 2005-06 1. General Conditional exemption 6.2 2. Pharmaceutical (excluding life saving drugs) 4.80 3. Import of Machinery, equipment materials etc. 0.5 4. Tractors and other agriculture machinery 1.75 5. Allowances 1.15 6. Capital Gains 0.95 7. Pensions 0.70 8. Sector and Enterprise Specific Exemptions 0.75 9. Fertilizers 2.00 Total 18.80