Informal economy is the central problem of economic and taxation systems. The chairman of the Securities and Exchange Commission of Pakistan is rightly concerned that the size of undocumented economy is expanding because people are not voluntarily paying taxes.
However, he did not suggest any solution of the problem which, as a regulator, he was expected to. The size of informal economy, estimated by the State Bank of Pakistan, was at around $34 billion in 2011.
The problem of documentation of economy is linked to corporate laws as much as it is related to tax laws. A number of provisions under sections 230-247 and in the Fourth and Fifth Schedules etc., of the Companies Ordinance 1984 (CO) provide for documentation of business transactions, making the company’s board of directors responsible to keep proper books of accounts.
The company is required to record therein transactions concerning all moneys received, expenses in respect of which the receipt and expenditure take place, all purchases of goods and assets, the liabilities etc., of the company which are open for inspection by the SECP. Thus the financial activities of the corporate sector are to be fully documented.
Furthermore, directors and principal officers of a company are made accountable and charged with an offence, if they (or any of them) fail to comply with, intentionally or otherwise, the statutory requirement of maintaining records.
In that case, they shall be penalised for the offence awarding punishment of imprisonment or a fine, or both. The objectives of the aforesaid statutory requirements and the strict measures are to ensure that the accounts should present true and fair view of the state of affairs of the company, safeguard interest of minority shareholders and the exchequer too.
To enhance confidence of minority shareholders, the company ordinance requires that the accounts are audited by external auditors who certify that the company has maintained proper accounts which reflect true and fair view of the state of the affairs of the company.
If a segment of a well-documented corporate sector fails to pay due income tax, SECP needs to fix responsibility for the failure. The SECP’s corporate portfolio comprises 63,226 registered companies as on November 30, 2012. It includes 80 per cent private companies besides listed or unlisted public companies and others.
The companies registered with SECP when compared with the number of income returns filed with tax authorities presents a dismal picture. Tax departments received 21,000 corporate returns in 2010 when 56,000 plus companies were registered with SECP.
In defense for low filers, one may argue that the companies registered with SECP included dormant and defunct companies that did not carry out any business activity. If 12,000 such companies that were on SECP record on June 30, 2010 are excluded, the non-filers from corporate sector constitute over 50 per cent. This indicates a very large size of tax evaders were from the documented sector.
There are also dormant listed companies and account for one-third of around 700 listed firms of Karachi Stock Exchange. Have the regulators probed the reason why the sponsors or directors of such companies are holding same position in other companies?
An analysis of corporate tax returns reveals that a majority of the firms either have declared loss or nil income. The question is that how a company is surviving over the years while continuing to report sustained losses.
The CO empowers the SECP to take action against a company whose liquidity or debt-equity ratio has deteriorated below the specified level, or non-declaration of dividend or sustaining losses etc. Under any such situation, the SECP is required to investigate the affairs of a company. It may appoint administration to take over the management, or even change the directors.
The KESC, a listed company on all the three stock exchanges, is a classical example. It has been reporting losses for years with negative margins and is subject to mismanagement too, yet it is doing its business without interruption and without any questioning by the regulators. Similar is the case with textile companies where sponsors are getting richer despite declaring losses. It is the biggest sector but contributes little tax revenue to the exchequer. Further non-performing loans are piling up. The major borrowers are from corporate sector who are getting the NPLs written off or waiver of their loans by banks. No investigation is done as to where this money was spent by the companies or what were the causes for their failure to repay debts etc.
In fact the mushroom growth of the private companies is a by-product of the listed companies which have siphoned off their fund to their associated private companies. Their associate companies prosper at the cost of minority shareholders of the listed companies who thus evade income tax.
Though the CO has legalised financing to associated companies, it requires revision keeping in view the ground reality of its misuse and adverse impact on the interest of minority shareholders.