The Tax Audit System in Pakistan: Transparency, Challenges, and Reforms

 

Understanding the Tax Audit System in Pakistan: Legal Process, Officers’ Roles, and Taxpayers’ Challenges

Introduction

Tax audits are a crucial part of any taxation system, ensuring compliance with tax laws and identifying discrepancies in financial records. In Pakistan, the tax audit system is governed by various laws, including the Income Tax Ordinance, 2001 (Sections 177, 214C, 120, and 122) and the Sales Tax Act, 1990. While the purpose of audits is to promote tax compliance and discourage evasion, the process can sometimes be complex and challenging for taxpayers. Here you will explore the legal framework of tax audits in Pakistan, the role of tax officers, and the difficulties taxpayers face, while also comparing it to the systems of progressive economies.

Legal Process of Tax Audits in Pakistan

Write here we are talking about The Federal Board of Revenue (FBR), oversees the (Federal) tax audit system in Pakistan. The audit process follows a structured legal framework, including:

1. Selection of Taxpayers for Audit
• Taxpayers can be selected for audit through random selection using an automated system or risk-based selection based on certain indicators, such as inconsistencies in tax returns.
• Sections 177 (on commissioner call) and 214C (balloting) of the Income Tax Ordinance, 2001, empower the FBR to conduct tax audits.
• Sales tax audits are conducted (through manual selection as power delegated by the commissioner) under Section 25 of the Sales Tax Act, 1990.
2. Notices and Documentation
• Once selected, the taxpayer receives a notice under Section 177 of ITO, 2001, requiring them to provide financial records, bank statements, invoices, suppliers ledgers, inventory record, sales and purchases records and other supporting documents.
• Under Section 161, withholding tax agents may also be required to furnish information.
• The taxpayer must comply within the prescribed timeframe to avoid penalties under Section 182.
3. Examination and Findings
• The tax officer reviews financial records to verify income, expenses, and tax payments.
• Discrepancies may lead to further inquiries or reassessments of tax liability under Section 122 notice with 122(5) and 122(9).
• Section 210 allows the Commissioner of Income Tax to delegate audit powers to officers.
4. Finalization and Penalties
• If underreporting or non-compliance is found, additional tax liabilities, penalties and default surcharge may be imposed under Sections 182 and 205.
• The taxpayer has the right to appeal against any unjust assessments through tribunals and courts under Sections 127 to 131.

Role of Tax Officers in Audits

Tax officers play a significant role in the audit process, with responsibilities including:

• Scrutinizing financial records for accuracy.
• Issuing notices and requesting explanations for inconsistencies under Sections 176 and 177.
• Conducting field visits if necessary under Section 175.
• Assessing tax liabilities and imposing penalties where applicable.

While their role is essential for tax compliance, concerns have been raised about lack of transparency, misuse of authority, and undue pressure on taxpayers.

Challenges Faced by Taxpayers

Despite being a necessary function, tax audits often create difficulties for taxpayers, including:

1. Lengthy and Bureaucratic Processes
• Tax audits can take months, causing delays in business operations.
• Appeals against unfair assessments can be time-consuming under Sections 127-131.
2. Excessive Documentation Requirements
• Businesses and individuals often struggle with extensive paperwork and record-keeping requirements. In most of the cases audit tax period is near to time barred and department required to audit the near time barred tax period and be the cause of difficulty in collection of data for that period.
• Section 174 mandates record-keeping for up to six years, which can be burdensome.
3. Harassment and Unfair Practices
• Some taxpayers report undue pressure or unfair demands from tax officers, which leads to concerns about corruption.
• The mindset of the officer is not to accept the arguments of the taxpayer as he is in hurray to make demand and fulfil the target that department have to collect the revenue.
4. Financial Burden
• Unexpected tax demands and penalties under Sections 182 and 205 can create financial stress, especially for small businesses.

Comparison with Tax Audit Systems in Progressive Economies

To understand Pakistan's tax audit system better, we can compare it with tax audit processes in developed countries like the United States, United Kingdom, and Canada:

1. Automated and Transparent Selection
• In countries like the USA (IRS Audits) and UK (HMRC Audits), audit selection is based on clear, transparent, and risk-based criteria using artificial intelligence and predictive analytics.
• Pakistan still relies on partially automated and discretionary selection methods, sometimes leading to allegations of unfair targeting.
2. Digital and Simplified Audit Process
• Canada Revenue Agency (CRA) and HMRC offer digital audit submission portals where businesses can upload records, reducing face-to-face interaction and manual paperwork.
• In Pakistan, most audits require physical visits and manual submission of documents, increasing delays and inefficiencies.
3. Taxpayer Rights and Support
• The USA and UK have robust taxpayer rights, including easy access to independent tax ombudsman services and structured appeal systems.
• Pakistan has an appeal process under Sections 127-131, which is costly and time taking and taxpayers often struggle with prolonged litigation and lack of effective mediation.
4. Strict Anti-Corruption Measures
• Developed countries have strict monitoring of tax officers' conduct, reducing the risk of harassment or unfair tax demands.
• In Pakistan, tax officers' discretionary powers sometimes lead to allegations of corruption, requiring stronger oversight mechanisms.

Recommendations for a Fairer Audit System

To improve the tax audit system in Pakistan, the following measures can be taken:

• Transparency in Audit Selection: A clear and transparent audit selection process can reduce uncertainty.
• Efficient Audit Procedures: Using digital tools and automation can speed up audits.
• Training for Tax Officers: Proper training can help reduce misuse of authority and ensure fair assessments.
• Simplified Compliance Requirements: Reducing unnecessary documentation can make compliance easier for taxpayers.
• Stronger Taxpayer Rights: Establishing independent oversight and quicker appeal mechanisms can protect taxpayers from unfair assessments.

Conclusion

The tax audit system in Pakistan serves an essential purpose in ensuring tax compliance. However, inefficiencies, lack of transparency, and challenges faced by taxpayers highlight the need for reforms. Comparing Pakistan’s system with developed economies like the USA, UK, and Canada shows the potential benefits of digitalization, stronger taxpayer rights, and better regulatory oversight. By adopting fair and transparent practices, both taxpayers and the government can benefit from a more efficient and just audit system.

Public Feedback and Experiences

• Have you ever been audited? What was your experience?
• Were the tax officers, fair in their approach?
• Did you face unnecessary delays or documentation issues?
• What improvements do you think should be made to the tax audit system?
• Any suggestions for making the audit process smoother and more transparent?