International Tax Dialogue (ITD) Global Conference on Effective Micro and Small Business Compliance Management – Tax Policy and Tax Administration Solutions Manila, Philippines, 2-5 March 2010 Indirect Taxation of the Underground Economy The Potential and Limits of Withholding Taxes in Bangladesh By Nasiruddin Ahmed, PhD Chairman, National Board of Revenue and Aminur Rahman Member ( Income Tax Policy) National Board of Revenue Dhaka, Bangladesh Objective and outline of presentation Objective To explore the potential of withholding income tax for collecting taxes from the underground economy of Bangladesh. Outline • Introduction • The underground economy • Structure of taxation • Withholding taxes • Concluding remarks 1. Introduction • Bangladesh is a low-income economy of South Asia • With a territory of 147570 square km, it is inhabitated by about 150 million people. • In FY 2008-09, Bangladesh had a GDP of US$ 89.55 billion. • The real GDP growth rate is 5.9 percent and per capita GNI is US$ 690. • In recent years, Bangladesh has achieved significant gain in human development. • Bangladesh aspires to become a middle income economy by 2021 • The underground economy constitutes a sizeable portion of the economy . 2. The underground economy 2.1 Dimensions of an underground economy Table 1: Dimensions of an underground economy Illegal economic activities Legal but not reported in national accounts bribery, gambling, Tax evasion , smuggling, extortion, Tax avoidance, etc. drug dealing, black marketing, work done by illegal immigrants, etc 2. The underground economy (cont.) 2.2.Studies on the underground economy of Bangladesh Table 2: Studies relating to Underground Economy of Bangladesh Name of Author Year Estimates of the underground economy Reza 1989 Exceeded one third the country’s formal GDP in FY 1985-86 Bartlett 1990 Informal sector was 65% of labour force in Dhaka in late 1980s. Hassan, 1997 Average size of the underground economy of Bangladesh was about 23% of the formal GDP during 1972-1995. Asaduzzaman 1998 Average size of the underground economy was 21.4% of GDP in FY 1989-90. Hossain 2003 Average size of the underground economy was 16.03% of GDP during 1974-75 to 1999-2000 and 25% of GDP in 1999-2000 (by survey method). Austrian University 2003 Bangladesh’s informal sector reached 34.9% of official GDP in 2000-01 Park 2005 Average size of the underground economy was around 37% of official GDP during the beginning of 2000s. 2. The underground economy ( cont…) 2.3 Factors contributing to the underground economy • Large number of taxpayers maintains no accounts or non- formal accounts. • Large number of non-banking transactions (cash transaction or barter) • Under reporting value of asset. • Illegal income remained unreported for obvious reason. • Weak enforcement of laws • Agriculture sector basically remains outside the tax net. 2. The underground economy ( cont..) 2.4 Bangladesh dealing with the underground economy National Board of Revenue (NBR) has taken measures to- • Bring more persons under tax net (broadening the tax net); • Collect tax from the underground economy; • Investigate tax evasion cases. 3. Structure of taxation Tax-GDP ratio is the lowest in Bangladesh compared to its South Asian neighbours. Tax-GDP ratio in Bangladesh is given in Table-3. Table 3: Tax-GDP ratio Financial Year Tax: GDP ratio 2004-05 8.60 2005-06 8.70 2006-07 8.30 2007-08 8.89 2008-09 9.00 Source : Bangladesh Economic Review 2009, Ministry of Finance The number of taxpayers is 1.65 million. The indicators of tax-GDP ratio and number of taxpayers in comparison to population shows existence of substantial underground economy in Bangladesh. 3. Structure of taxation (cont..) The tax structure in Bangladesh shows the preponderance of indirect taxes over direct taxes (Table-4). Table 4: Tax structure in Bangladesh (In billion taka) Financial Year Direct Taxes Indirect Taxes Total 2004-05 58.27 (19%) 240.77 (81%) 299.64 2005-06 74.23 (22%) 265.80 (78 %) 340.02 2006-07 90.50 (24%) 281.69 (76%) 372.19 2007-08 121.80 ( 26%) 352.47 (74%) 474.36 2008-09 142.73 (27%) 382.53 (73%) 525.26 Source: Annual Report, National Board of Revenue 4. Withholding taxes 4.1 Potentials of collecting tax from the underground economy 4.1. Potential: • any income earned is likely to be invested or saved in some form; • in many cases invested amount generate interest or return from assets; • most assets need registration for ownership; • tax can be effectively levied on return of assets or at the time of registration 4. Withholding taxes 4.1 Potentials of collecting tax from the underground economy (cont..) From tax administration perspective- • It is an in-built machinery to collect tax where non-compliance is very high; • Taxes are being collected from organized small number of tax-points through WIT, rather than from many informal taxpayers from diverse locations; • Information regarding the parameters of income is also collected in the process for using in future assessment or audit; • Government exchequer gets year-round revenue rather than seasonal revenue. 4. Withholding taxes 4.1 Potentials of collecting tax from the underground economy (cont..) From taxpayers perspective- • Easy to pay as the taxpayers earn and avoid time-consuming tax deposit to selected banks or treasury; • Less pressure on cash flow at the end of the year for reduced tax liability at the time of filing return; and • Avoiding arbitrary estimate of income by tax administration. 4. Withholding taxes 4.2 Limits of withholding taxes Income of illegal economy remains outside the mainstream. Presence of informal accounting records Presence of cash basis of transaction Inadequate capacity building in tax department Lack of incentive of tax deducting authorities 4. Withholding taxes (cont..) 4.3 Authorities responsible for tax withholding program : 1. Government 2. Director General, Bureau of Manpower, Employment and Training 3. Permitting authority (issuing any permission or renewal of permission for manufacture of bricks) 4. Registration authority (registering any document for transfer of any land or building or apartment) 5. City Corporation or Paurashava 6. Commissioner of Customs 7. Authorized authority (authority duly authorised for a particular purpose, say, for shipping business of a resident under section 53AA) 8. Chief Executive Officer of stock exchange 4. Withholding taxes (cont..) 4.3 Authorities responsible for tax withholding program (cont…): 9. Company or its principal officer 10. Bank or insurance company or cooperative bank 11. Issuers of securities (Government or companies) 12. Sellers of banderols to any manufacturer of cigarettes 13. Employer 14. NGO (non-government organization) 15. Film producer 16. Chief Executive of any trust 17. University or medical college or dental college or engineering college 18. Auction seller 4. Withholding taxes (cont..) 4.4 Heads of withholding income tax Table 5 : Heads of withholding income tax Sl. Heads of withholding income tax Section/ Rate SRO 1 Salaries 50 10% to 25% 2 Discount on the real value of Bangladesh Bank ( Central 50A Individual-25% Bank ) bills Company- 37.5/42.5% 3 Interest on securities 51 10% 4 Payment to contractors & sub-contractors 52 1% to 4% 5 Payment on indenting commission or shipping agency 52 Indenting- 3.5% commission Shipping- 5% 6 Fees for Doctors 52A(1) 10% 7 Royalty or technical know-how fee 52A(2) 10% 8 Fees for professional and technical services 52A(3) 10% 9 Payment for certain services like stevedoring agency, 52AA 7.5% private security service 10 Clearing and forwarding agents 52AAA 7.5% 11 Cigarette manufacturing 52B 6% on bandrols 4. Withholding taxes ( cont..) 4.4 Heads of withholding income tax ( cont..) Sl. Heads of withholding income tax Section/ Rate SRO 12 Compensation against acquisition of property 52C 2% 13 Interest on saving instruments 52D 10% 14 Brick Manufacturer 52F Tk 10,000 to Tk 18,000 15 Commission of letter of credit 52I 5% 16 Renewal of trade license by City Corporation or 52K Tk 500 Paurashava /License 17 Trustee fees 52L 10% 18 Freight forward agency commission 52M 7.5% 19 Rental power company 52N 4% 20 Foreign technician serving in diamond cutting industries 52 O 5% 21 Importer 53 3% 22 House property 53A 3% and 5% 23 Shipping business of a resident 53AA 3% and 5% 4. Withholding taxes ( cont…) 4.4 Heads of withholding income tax ( cont..) Sl. Heads of withholding income tax Section Rate /SRO 24 Export of manpower 53B 10% 25 Export of knit-wear and woven garments, 53BB 0.025% etc 26 Member of Stock Exchanges 53BBB 0.025% 27 Export of any goods except certain items 53BBBB 0.25% 28 Goods or property sold by public auction 53C 5% 29 Courier business of a non-resident 53CC 7.5% 30 Payment to actors and actresses 53D 5% 31 Commission, discount or fees 53E 7.5% 32 Commission or remuneration paid to agent 53EE 4% of foreign buyer 4. Withholding taxes (cont..) 4.4 Heads of withholding income tax ( cont..) Sl. Heads of withholding income tax Section Rate /SRO 33 Interest on saving deposits and fixed deposits 53F 10% 34 Real estate or land development business 53FF Land-5% , 2% and 1% Apartment- 250/SM 35 Insurance Commission 53G 3% 36 Fees of surveyors of general insurance company 53GG 7.5% 37 Transfer of property 53H 5%, 2% and 1% 38 Interest on deposit of post office and saving bank 53 I 10% account 39 Rental value of vacant land or plant or machinery 53J 3% to 5% 40 Tax from advertising bill of newspaper or magazine or 53K 3% private television channel 41 Dividends 54 Company -20% Res. Indivi-10% Non-res Ind-25% 42 Income from lottery and other windfall income 55 20% 43 Income of non-residents 56 25% 4. Withholding taxes (cont..) 4.4 Heads of withholding income tax (cont…) Sl. Heads of withholding income tax Section /SRO Rate 44 Registration/fitness renewal SRO no-187- Tk 3,000 to Tk 8,000 for motor vehicles plying for Ain/2009, date- hire 01.07.2009 45 Registration/fitness renewal SRO no-171- Tk. 2,500 to Tk. for personal motor vehicles Ain/2009, date- 10,000 not plying for hire 30.06.2009 46 Registration/fitness renewal SRO no-173- Tk 50 /per passenger for inland river vessels Ain/2009, date- Tk 70 /per ton capacity 30.06.2009 4. Withholding taxes (cont..) 4.5 Ensuring tax withholding : To ensure functioning of tax withholding, the following provisions have been incorporated in income tax code :- • The related expenditure is not admissible while determining its income if the deduction is not made or deducted amount is not deposited [ section 30]; • The amount deductible plus interest @ 2% per month can be recovered from the paying/registering authority [ section 57 ] • Tax authority is empowered to audit tax deduction [ section 117A] 4. Withholding taxes (cont..) 4.6 Contribution of withholding income tax in income tax revenue: Table 6: Contribution of income tax (Figures in billion taka) Financial Withholding Total tax % Year income tax collected 2004-05 33.5 55.8 60.04 2005-06 40.1 71.6 56.01 2006-07 51.6 87.2 59.17 2007-08 61.8 117.4 52.64 2008-09 86.7 138.6 62.55 Source : Annual Report, National Board of Revenue 5. Concluding remarks Along with withholding taxes, the following policy recommendations are made to tax the activities of the underground economy : • Implementing the reform agenda initiated at the NBR • Simplification and fully automating tax collection system under a central database • Launching continuous taxpayers’ awareness programs for broadening tax net 5.Concluding remarks (cont…) • Enhancing the capability of the NBR officials for combating tax evasion •Rewarding the taxpayers who pay considerable amount of taxes so that other people feel encouraged to pay taxes •Establishing tax information management and research centre to collect income related information of taxpayers from both primary and secondary sources.