Firms enjoying tax exemption to come under greater scrutiny

Companies that enjoy tax exemptions will come under greater scrutiny in the coming days as the tax authority seeks to scan their transactions with associated enterprises in a bid to curb profit shifting and tax evasion. 

As per the proposed Income Tax Bill 2023, if a firm that enjoys tax exemption is engaged in any transactions with associated entities and tax officials find that transactions have not taken place as per open market prices and the income of the firms falls below the actual income, they would be able to impose regular tax rates.

A senior official of the National Board of Revenue (NBR) said there are provisions in the existing Income Tax Ordinance-1984 regarding transactions between associated entities. But there is a lack of clarity in the present law and tax offices could not apply the rules to curb tax evasions that take place through profit shifting by firms.

"We have overhauled the existing provision and defined associated firms in detail in order to remove ambiguity," the official said.

In the Income Tax Bill, which was placed in parliament by Finance Minister AHM Mustafa Kamal on June 8, the tax authority said an entity will be considered an associated enterprise if the firm enjoying the tax holiday participates in the entity's equity capital, controls it, or takes part in its management, directly or indirectly.

If the common person or persons, couples or descendants have investments, control or presence in the management of both companies, the firms will be treated as related enterprises, according to the bill.

An entity will be considered as a related firm of the tax break recipient if any of the two has more than 25 per cent of voting power in another enterprise, directly or indirectly.

Similarly, if a person, couple or descendant holds more than 25 per cent stake in both companies, the firms will be treated as associated enterprises, according to the Income Tax Bill 2023.

Firms will be considered as related enterprises too if they belong to the same group or group of companies.

At present, the government offers tax breaks for 33 types of industrial products such as active pharmaceutical ingredients and radio pharmaceuticals, automobiles and automobile part-making and computer hardware electronics, with the aim of facilitating investments in these areas.

There are allegations that tax-exempt entities show higher profits than their associated enterprises with the intention to evade taxes.

Snehasish Barua, a partner at Snehasish Mahmud & Co, said: "It is known to many of us that exempted entities show much higher profit than a related non-exempted entity within a group of companies. These exempted companies gradually become loss-making when the exemption is lifted or their income reduces while tax rate gradually increases."

The new provision will allow the tax authority to identify tax leakages through internal transfer pricing, he said.

However, Barua said, the discretionary power of an assessing officer might increase as the transaction price will have to be determined on fair value.

"This is because fair valuation is subjective and a complex process which requires a lot of judgement."