Govt in a fix amid IMF diktat on tax policy

THE upcoming budget presents challenges for the fragile federal coalition government. The 10-day IMF mission visit concludes with a focus on increasing revenue collection and reform demands. Undoubtedly, reforms are important, but the lender’s primary focus is increasing revenue through existing and new tax initiatives in the upcoming budget. However, the IMF delegation left without a final decision, particularly on the tax front.

During their visit, IMF staff obtained additional information on key sectors. The Federal Board of Revenue also shared various tax measures and details on exemptions. The lender will shortly share a list of demands that must be approved by the federal government as a precondition for reaching a Staff-Level Agreement for a new loan.

The budget is set to be announced on June 7, but tax authorities have not decided on any tax measures, and they are awaiting the IMF’s policy directions. However, the department anticipates harsh demands that will be difficult to fulfil due to divergent political viewpoints within the coalition government. Several tax officials have observed that the attitude of the Fund staff towards tax issues during these meetings was less enthusiastic than in previous meetings.

Background interviews and discussions with high-ranking FBR officials have revealed that the forthcoming budget will be a litmus test for the Shehbaz-led coalition government, determining whether to make difficult decisions that may impact existing taxpayers.

The revenue collection for the next fiscal year will be divided into two parts -- autonomous growth and revenue measures. According to the FBR estimates, the autonomous revenue collection (to come from GDP growth and inflation) will be over Rs1,150tr in FY25. Over and beyond this, the federal government will decide on revenue measures in consultation with the IMF. Now, reaching an agreement on tax measures will be difficult and may result in politically tricky and unpopular decisions.

The tax exemption cost is estimated to be more than Rs2.4tr in FY24. The majority of these tax breaks are for essentials, such as food, as well as for political and economic reasons. The FBR shared the revenue impact of each exemption with the IMF.

FBR believes most tax exemptions are related to the economic policy, including exemptions for special economic zones, export processing zones, the Gwadar economic zone, CPEC-related projects, IPPs, and international agreements. It will be difficult for the government to change exemptions in these areas.

The second highest exemption cost is for food, pharmaceuticals, and other basic services. This will make it extremely difficult for the government, particularly the current coalition government, to withdraw the exemptions. However, in terms of revenue, other exemptions might generate significantly less revenue. A few exemptions, such as those for pesticides, can be withdrawn. However, the issue will not be resolved if the government refuses to touch economic policy and essential exemptions.

The IMF expected policy measures to raise revenue between Rs500bn and Rs600bn in FY25. To maximise revenue, the government has one option: hike tax rates on all federal taxes (income tax, sales tax, federal excise duty, and customs duty) or levy new taxes. The IMF wants to boost taxes on two new areas: tax pension income and agricultural income. On the former, the FBR has already presented a working document to the Fund. No decision has been made because the Fund wishes to replicate salary slabs on the pensioners’ income. Agriculture income taxation is already in place, but the provincial government prioritising might result in raising the most revenue possible from the incomes of large farmers.

At the same time, the finance ministry opposes a sales tax on petroleum goods, claiming that the revenue will have to be divided among the provinces. Instead, the ministry supports the concept of increasing the petroleum development levy. FBR claimed that the IMF is not advocating for a sales tax on petroleum items, and that the ultimate decision would be made by the federal government.

The FBR is left with just one option: raise all withholding tax rates, other taxes, levy a sales tax on solar panels, increase the incidence of taxes on mobile phones, cigarettes and traders, etc. The IMF has not asked for import tariffs, but the government may impose regulatory duties or increase existing rates.

The board announced over Rs400bn in revenue measures such as super tax, deemed rental income under 7E and windfall profits. However, the collections from these measures have been halted in courts. FBR is gravely concerned about the increase in stay orders for major revenue measures. Before entering into a new agreement, the IMF will also demand that the government guarantee the protection of tax measures.

Published in Dawn, May 26th, 2024