Tax systems of South Asian countries are at varying levels of development, which can create distinct tax issues for companies doing business within their borders. Nevertheless, rising globalization of businesses and the need to increase compliance and collections are common factors underlying tax policy and compliance issues for these countries. Some of the most important tax developments for foreign companies investing in Pakistan, Bangladesh and Sri Lanka are summarized below. We also offer a glimpse of Afghanistan’s efforts to set the stage to compete for more foreign investment as its political stability recovers.
Pakistan – tax collection challenges
Unlike many MESA countries, Pakistan’s tax system is based on self-assessment. The regime was introduced in 2001, and it has been significantly improved over time. In the recent past, however, a spreading culture of tax evasion has made it increasingly difficult for the government to collect taxes due.
The situation has caused the government to increase borrowing, reduce development spending, and cut services to citizens. To improve tax compliance, Pakistan is investigating ways to broaden its tax base and boost collections. These measures include reducing certain taxes, amending the country’s sales tax, and committing to gradually eliminate all taxes except its income and sales taxes. According to Pakistan’s Finance Minister, these and other measures are expected to increase tax collections by 25 percent in 2012-13 over the previous year.3 Like most other tax authorities worldwide, Pakistan’s tax authority is also focusing on cross-border taxation, and particularly transfer prices, to protect its tax base and increase its share of tax revenues.
The tax authority is challenging companies’ transfer pricing practices through aggressive interpretations of the permanent establishment clauses of Pakistan’s extensive network of over 60 tax treaties.
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Bangladesh and Sri Lanka – expanding tax bases
Bangladesh and Sri Lanka have similar tax systems, and they are grappling with similar tax issues. Like Pakistan, both countries struggle with low tax compliance and they are taking steps to increase collections and enhance the effectiveness of their tax systems. For example:
- Bangladesh has improved its tax administration by enhancing taxpayer services, introducing an electronic tax filing system, and adopting new compliance incentives such as tax cards and certificates.
- Sri Lanka has reduced personal and corporate tax rates, eliminated a number of miscellaneous taxes and levies, and eased restrictions on the deductibility of business expenditures. Bangladesh and Sri Lanka are also looking to rely more on value added taxes (VAT) to broaden their tax bases and increase revenues. Proposals approved by the Bangladesh government in July 2012 would introduce an alternative dispute mechanisms for resolving VAT appeals, together with harsh penalties, including jail terms, for VAT evasion and document forgery.
Over the past 2 years, Sri Lanka has sought to improve its VAT with a variety of reforms. These include increasing input tax credits, reducing its VAT on financial services and luxury goods (from 20 percent to 12 percent), and introducing new exemptions that target a range of imported manufacturing inputs. As in Pakistan, the tax authorities of Bangladesh and Sri Lanka have each set their sights on transfer pricing by closely scrutinizing the methodology, reasonableness and implementation arm’s length cross-border charges of related parties. Permanent establishment issues are also attracting close scrutiny.
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Afghanistan – putting a priority on tax reform
As conflict in Afghanistan continues, the government is working to modernize its tax system and establish a tax treaty network. Much of this work aims to help the country attract more foreign investment as its political stability improves. In the past several years, the Afghani government has introduced new withholding tax rules, special tax provisions for resource industries, a revised version of its turnover tax, and business-friendly corporate tax changes, including loss carryover and accelerated tax depreciation rules.
On the tax administration front, the country has restructured its tax collection department to better service large, medium-size and small businesses, invested in hiring and training staff, and introduced new tax dispute resolution procedures.
Looking ahead, the country is moving to a self-assessment system and seeking to improve its use of information technology in its tax audit processes. A new VAT system will be introduced in 2014. With help from the International Monetary Fund, Afghanistan has developed its own model tax treaty, and the country is currently engaged in its first tax treaty talks with Turkey and Iran.
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