Microsoft word - working paper no. 19.doc

Estimating Revenue Losses Evolve from Tax
Evasions in Bangladesh:
A Formal Model under Direct Taxation
AKM Matiur Rahman and Sabera Yasmin
Office of Research and Publications (ORP) American International University-Bangladesh (AIUB) AKM Matiur Rahman and Sabera Yasmin (2008). Estimating Revenue Losses Evolve from Tax Evasions in Bangladesh: A Formal Model under Direct Taxation. AIUB Bus Econ Working Paper Series, No 2008-19, http://orp.aiub.edu/WorkingPaper/WorkingPaper.aspx?year=2008 Copyright 2008 American International University-Bangladesh Estimating Revenue Losses Evolve from Tax Evasions in Bangladesh:
A Formal Model under Direct Taxation
ABSTRACT
This empirical study estimates the revenue losses derived from different categories of taxpayers who used Self-assessment System (SAS) under direct taxation in Bangladesh. Even though a small portion of populations live in urban areas (over 80 percent live in rural areas) that used the SAS in filing tax-returns, they significantly contributed to the problem. Revenue loss due to these taxpayers’ noncompliance with laws of income is a growing problem where the past five year (2000-2004) data statistics suggested that the Private Ltd Companies and Public Ltd Companies contributed significantly to accelerating the problem. With governmental ongoing various measures including the provision of SAS that was designed to encourage taxpayers for compliance, the tax-evasion issue in Bangladesh is critical and it deserves attention without delay. * Contact author: Assistant Professor, School of Business, American International University-
Bangladesh. Dr. Rahman can be contacted at: 84/B, Road No. 21, Banani, Dhaka – 1213, email:
matiur1@aiub.edu, Phone: 8802-9890804, Ext-526, Fax: 8802-8813233.
** Lecturer, Begum Budrunnessa Government Girls’ College, Dhaka – 1000 Bangladesh. Ms. Yasmin is also a doctoral student in the Dept of Political Science, Dhaka University, Bangladesh. 1.0 Introduction
With goals to relieve marginal taxpayers from statutory formalities, other perils (i.e. carrot approaches where taxpayer takes advantages from tax officials for lowering the amount of taxes) and to encourage voluntary compliance, the government of Bangladesh has adopted the Self-assessment System (SAS) by the Finance Act, under Direct Taxation. The SAS was first launched as a prototype in 1981 (Sharker, 2003) and as a result, the number of tax-return filings has increased significantly in the subsequent years. Underpinning the successes, with a goal to convert the Bangladesh-tax-system into a fully functional SAS, the government expanded it in year 1991 and since then a tax system, which is a combination of SAS and Official Assessment System (OAS) is in practice. However, the SAS has not lived up to its expectation (Sharker, 2003). Tax evasion or dodging (provide erroneous information in reporting the amount of income) in tax-returns becomes one of the significant factors, which cause a significant amount of revenue losses (Rahman, 2005) in economy of Bangladesh. Since wealthy people, in general, live in urban area where a least level of dodging can result a huge amount of revenue losses, they mostly use SAS in filing their tax-returns. Therefore, the evasion problem is more severe in urban than that in rural even though over 80 percent of the population live in rural areas. The goal of this study is to estimate the amount of revenue loses arise from as a result of the provision of SAS under direct taxation in Bangladesh. We begin this investigation by identifying various factors in Section 2 that might have linkages with the SAS failures, which resulted revenue losses. The Section 3 layouts the methodology used in data collection and in data manipulations. In Section 4, the revenue losses mathematical models are developed and estimated, which is a mirror of evaluating the performance of the provision of the SAS in Bangladesh tax system. In Section 5, the empirical results are analyzed, compared and discussed. Finally, concluding comments are offered. 2.0 Self-assessment System and Causes of Revenue Losses
Under the Self-assessment-System, the tax appraisal is made by the taxpayer or his/her agent (tax-consultants). In the Tax-Return Form, tax-filer provides information including his/her total income and then calculates the amount of tax thereon. He then files the return along with the tax-payment-receipt on or before the deadline for submission of tax returns. Under tax provision, the SAS is applicable to both individuals and companies. Based on tax zone, the DCT assigned to or the DCT authorized personnel shall receive these tax returns. After receiving the tax-returns, the DCT may proceed to audit any of these tax-files if it is selected for audit Moreover, the NBR executives may also choose files of tax-returns submitted to the DCT for scrutiny; however, only 5 percent of these files can be selected for audit by the NBR. Since the DCT cannot, unless authorized by the NBR, question or conduct a physical investigation on the information provided in the tax-returns, the taxpayer may willingly report other than actual incomes for its own benefits. This false information can be in two folds: undercut or hide the amount of income in the event that taxpayer wanted to pay less amount of taxes or to make the black money (untaxed) to white (legalize) respectively. The common scenarios of undercutting actual income in reporting, which may cause revenue losses are 1. The taxpayer may have different sources of income such as salary, income from agriculture, income from business or profession, income from interest and so on; however, the taxpayer may show one source of income. 2. In case of house property income, the taxpayer may show lesser rent than the actual 3. In case of company, it may show fictitious liabilities, lower revenue in the balance 4. Taxpayer may claim some deductions, which are not entitled under income tax 5. Taxpayer may show donation, gift or loan receipts, which in some cases are fictitious. 6. Taxpayer may show lesser amount of sales or higher expenditures supported by the evidence or documents, which are not verifiable. 7. Taxpayer may bribe tax officials so that the official will not proceed for auditing the 8. Sometimes taxpayer do not know the tax law properly, which item is taxable and which item is tax exempted. So, they don’t charge tax properly which result revenue loss. 9. Taxpayer may submit returns showing loss although it had income in business. 10. Taxpayer may submit false supporting documents with the returns. 11. Taxpayer may submit fake tax-payment receipt. 12. Sometimes calculation of total income and tax thereon is not correct under income tax 13. Professional such as doctors and lawyers, Chartered Accountants do not maintain the records of their incomes as directed under tax laws; they may show lower income in tax-returns. 14. Although the penalty for concealment in SAS is 5 times (500%) of concealed income, taxpayer may willingly show lesser income as because there is no cross verification system in practice. 3.0 Methodology
3.1 Scope, data sources and data collection:
Under the Income Tax Ordinance, 1984 of Bangladesh, taxpayer means a person or entity by whom any amount of taxes are payable to government. Person or entity includes individual(s), firm(s), and association of persons, a Hindu Undivided Family, a local authority, company and each of other artificial juridical persons. Under this Ordinance, Bangladesh is divided into 18 tax-collection zones where 10 zones are located in Dhaka; 3 zones are in Chittagong and; 1 zone in each division of Rajshahi, Sylhet, Khulna & Barisal and 1 zone in the district of Rangpur. There are total 272 tax-offices under these tax zones in which 156 tax-offices are located in Dhaka City, which is the capital of Bangladesh. Since there are no official records on the amount of revenue losses in Bangladesh, it is difficult to provide actual statistics on total revenue losses. With this shortcoming, in aim to make this study feasible, underpinning the definition, the taxpayers are first classified as follows. 3) Financial Institutions including Bank and Insurance Companies 5) Professionals (doctors, engineer & lawyer etc) and The taxpayer category as a foundation, the data of this study was collected from 5 tax-offices in Dhaka City where 30 tax-return-files from the above each category of taxpayers (who have established history of filing returns) were randomly chosen and then examined. Keeping on the same tax filers in the span, the data statistics of revenue losses were collected over 5 year-period. Since taxpayers in urban areas are mostly use the SAS in filing their tax-returns, this prototype is used to describe the entire scenario of total revenue losses evolved from urban areas. Although 80 percent of population, whose income levels are low, live in rural area and most of them do not use the SAS in filing tax-returns, live in rural area, their contributions to revenue losses are insignificant. Therefore, this prototype is used to describe the total revenue losses in Bangladesh instead of urban areas. 3.2 Computer Programs:
All calculations and analyses based on bar/pie charts creations that we report in this article were completed with procedures available using the Excel-2003 (Microsoft Office) for Windows where we created seudo-codes using our mathematical models (Section 4) for calculating total revenue losses for the selected samples. Readers should note that some analyses were optional or automatic output for the basic calculation of revenue losses. 4. Mathematical Models of Estimating Revenue Losses
The amount of revenue losses were calculated from the difference of the amount of tax that was determined by auditing the tax-return submitted and the amount of tax shown by the taxpayer in his or her tax-return under Self-assessment System. The revenue losses, therefore, can be expressed as follows R = Amount of revenue losses uncovered after auditing each tax-return T (A) = Amount of taxes assessed by the authority after auditing each tax-return T (S) = Amount of taxes shown by the tax-payer in each tax-return under SAS TR = Amount of total revenue losses calculated after auditing 30 files of tax-returns from GTR = Amount of grand total revenue losses (revenue losses from six categories of Taxpayers where 30 files in each category) i.e. total number of files = 6 x 30 N = Number of taxpayers categories; here N = 6 and i = 1 n = Number of tax-return files audited; here n = 30 and i = 1 5.0 Results and Discussions
5.1 Public Ltd. Company
The Public Ltd Company means a company, which by its articles i) restricts the right to transfer its shares, if any; ii) prohibits any invitation to the public to subscribe for its shares or debenture, if any; iii) limits the number of its members to fifty not including persons who are its employee. It is one of the primary sources of revenue for government in Bangladesh. In the year 2000, in Figure 1, due to taxpayers' noncompliance, Bangladesh government lost revenue TK 18.4 lakh from 7 files out of 30 tax-files in five-offices in one of the Zones in Dhaka City. In the year 2001, this lose reached to TK 49.8 lakh, which represents over three times higher than that in the previous year and the number of default files reached to 11. In the year 2002, revenue loses declined and reached to TK 22.2 lakh, which represents over fifty percent less revenue lost than the lost in 2001. Moreover, in this year number of inconsistency files declined and reached to six. This was due to government's aggressive measures implemented in 2002. In the year 2003, it increased again and reached to TK 60.3 lakh, which shows over three times higher than that in the previous year and number of inconsistency files increased and reached to ten. This was because some simplifications in Income tax laws regarding submission of return under self-assessment scheme. Taxpayers had freedom to submit returns showing loss income or lesser income than the previous year. In the year 2004, the revenue losses slightly increased and reached to TK 69.5 lakh, however, 8 files out of 30 files found to be defective. Revenue (in TK) lost from thirty files in Five Offices in Dhaka City (2000- Fig. 1: Revenue Losses from Public Ltd Company(s) 5.2 Private Ltd. Company
Private Ltd. Company means a company that is operated under the Company Act where a joint stock privately owned and the company is authorized to sell company shares, by doing so, it limits its liabilities. In general, under the company act, not more than fifty members can hold shares within the company and these must be "desirable individuals". Under the Income Tax Ordinance, 1984, Private Ltd. Companies in Bangladesh are one of the primary sources of governmental revenues. In the year 2000, in Figure 2, Bangladesh government lost revenue TK 44.5 lakh and 8 files found to be defective out of 30 files. In the year 2001, revenue losses declined and reached to TK 13.5 lakh, which represents over three times lower than that in the previous year; however, number of default files increased and reached to 9. In the year 2002, revenue losses increased and reached to TK 85.9 lakh, which represents over six times higher than revenue lost in 2001. Moreover, in this year, number of defective files increased rapidly and reached to 13. This was due to boom economy derived from modern technology, which resulted from a huge number of small company establishments; however, the companies did not provide its actual incomes in their tax returns. In the year 2003, the revenue losses declined and reached to TK 12.4 lakh, which shows almost seven times lower than that in the previous year. In the same year, number of defective files declined and reached to 5. This was due to government's measures after uncovering the facts that the Private Ltd had contributed to the boom economy of the year 2002; however, they did not provide their actual incomes in their tax returns. In the year 2004, the revenue losses increased rapidly and reached to TK 138.9 lakh. Moreover, in the same year, number of defective files increased and reached to 12. Revenue (in TK) lost from thirty files in five Offices in Dhaka City Fig. 2: Revenue Losses from Private Ltd Company(s) 5.3 Financial Institute
Financial Institute is a generic term for banks, trust companies, credits unions and perhaps other investment companies that deal with money, hold money, investment and lend money. Under the Income Tax Ordinance, 1984 of Bangladesh, any commercial or investment bank, trust company, brokerage house, insurance company or other institution that participates in financial transactions involving cash or financial products are required to comply with tax laws. In the year 2000, in Figure 3, Bangladesh government lost revenue TK 9.6 lakh from 6 files out of 30 files in five tax-offices in Dhaka City. In the year 2001, revenue losses declined and reached to TK 7.41 lakh, which represents over eight times lower than that in the previous year. Moreover, in this year, the number of defective files declined with a smaller rate than the rate of revenue lost. In the year 2002, revenue losses declined again and reached to TK 5.32 lakh, which represents 1.3 times less than that in the previous year. Moreover, in year 2002, the number defective files declined and reached to 2. This was due to boom economy derived from modern technology, which established a huge number of small companies in Bangladesh; however, these companies did not provided its actual incomes in their tax returns. In the year 2003, the revenue losses increased and reached to TK 8.07 lakh, which shows little over 1.5 times higher than that in the previous year. This was due to government's measures after uncovering the facts that the Private Ltd had contributed to the boom economy in the year 2002; however, they did not provide their actual incomes in their tax returns. In the year 2004, the revenue losses increased rapidly and reached to TK 12.88 lakh. Revenue (in TK) Lost f rom thirty f iles in f ive tax-of f ices Fig. 3: Revenue losses from Financial Institute 5.4 Taxpayers having Rental Income (Rental Income)
Taxpayers who rent out apartments or commercial buildings and earned rental income are of this category of taxpayers. Under the Income Tax Ordinance, 1984 of Bangladesh, these taxpayers are required to pay taxes based on the money they earn from the tenants. In the year 2000, in Figure 4, Bangladesh government lost revenue TK 4.98 lakh and found inconsistency in 14 files out of 30 files. In the year 2001, revenue losses increased and reached to TK 10.23 lakh, which represents over twice higher than that in the previous year; moreover, number of files that contained inconsistency reached to 15. In the year 2002, revenue losses decreased and reached to TK 1.91 lakh, which represents over five times lower than the revenue lost in 2001. Moreover, in this year, number of inconsistency files declined and reached to 11. This was due to government’s drastic measures on rental income tax returns issues. In the year 2003, the revenue losses increased and reached to TK 2.81 lakh, which shows over 1.4 times higher than that in the previous year. In the same year, number of inconsistency files increased and reached to 12. This was due to government's measures after uncovering the facts that the Rental income taxpayers had contributed to the boom economy of the year 2002; however, they did not provide their actual incomes in their tax returns. In the year 2004, the revenue losses increased rapidly and reached to TK 4.8 lakh. Moreover, in the same year, number of inconsistency files increased and reached to 13. Revenue (inTK) lost f romthirty f iles (2000-2004) Fig. 4: Revenue losses from Rental income taxpayers 5.5 Professionals
In general, professional means one who is engaged in one of the learned professions such as doctor, lawyers etc. and/or who makes it permanent career. For our purpose, under the Income Tax Ordinance, 1984, we use doctors and lawyers in our study as professionals who are required to pay taxes based on professional’s incomes. In the year 2000, in Figure 5, Bangladesh government lost revenue TK 7.23 lakh and found inconsistency in 13 files out of 30 files. In the year 2001, revenue losses decreased and reached to TK 3.77 lakh, which represents over half, lower than that in the previous year; moreover, number of files that contained inconsistency declined and reached to 8. In the year 2002, revenue losses increased and reached to TK 5.85 lakh, which represents over 1.5 times higher than the revenue lost in 2001. Moreover, in this year, number of inconsistency files increased and reached to 11. This was due to government's failure to uncover the fact that the professionals had contributed to the boom economy of the year 2002; however, they were out of government’s drastic measures. In the year 2003, the revenue losses decreased and reached to TK 2.81 lakh, which shows little over double than that in the previous year; however, the number of inconsistency files declined and reached to 7. This was due to government's drastic measures after witnessing the fact of previous year. In the year 2004, the revenue losses increased and reached to TK 4.42 lakh, which shows over 1.5 times higher than that in the previous year. Moreover, in the same year, number of inconsistency files increased and reached to 9. Revenue (inTK)lost f romthirty f iles (2000-2004) Fig.5: Revenue losses from Professionals 5.6 Individuals
Under Income Tax Ordinance, 1984, individual(s) means person(s) who are citizen of Bangladesh and are required to pay taxes under the income tax laws of Bangladesh. In the year 2000, in Figure 6, Bangladesh government lost revenue TK 6.06 lakh and found inconsistency in 10 files out of 30 files. In the year 2001, revenue losses rapidly declined and reached to TK 2.36 lakh, which represents over 2.5 times lower than that in the previous year; moreover, number of files that contained inconsistency declined and reached to 8. In the year 2002, revenue losses rapidly increased and reached to TK 6.05 lakh, which represents over 2.5 times higher than the revenue lost in 2001. Moreover, in this year, number of inconsistency files increased and reached to 16. This was due to government's failure to uncover the fact that the individuals had contributed to the boom economy of the year 2002; however, they were out of government's drastic measures. In the year 2003, the revenue losses slightly declined and reached to TK 5.61 lakh, which shows 0.4 times lower than that in the previous year; moreover, the number of inconsistency files declined and reached to 12. This was due to government's drastic measures after witnessing the fact of the previous year. In the year 2004, the revenue losses increased and reached to TK 6.88 lakh, which shows over 1.2 times higher than that in the previous year. Moreover, in the same year, number of inconsistency files increased and reached to 14. Revenue(inTK) lost f rom thirty f iles (2000-2004) 5.7 Comparisons of Contributions of each Category to Revenue Losses
In 2000, in Figure 7, the government of Bangladesh lost TK 90.79 lakh from 30 tax- return files (sample) in five offices in Dhaka City where the Private Ltd contributed 49 percent of the revenue lost and the Public Ltd contributed 20 percent and placed 2nd. In the same year, the Financial Institutes contributed 11 percent and placed the 3rd, the professionals contributed 8 percent, the Individuals and the Rental contributed 7 and 5 percent respectively to the losses of revenues. Contributions of each category to the losses of revenue in year Fig.7: A Comparison of contributions of revenue losses in 2000 In 2001, in Figure 8, the government lost TK 87.07 lakh from our sample in five offices in Dhaka City where the Public Ltd contributed 57 percents of the revenue lost and the Private Ltd contributed 15 percent and placed the 2nd. In the same year, the Rental contributed 12 percent and placed the 3rd, the financial Institute contributed 9 percent, the Professionals and the Individuals contributed 4 and 3 percent respectively to the losses of revenues. Contributions of each category to the lossess of revenue in year Fig.8: A Comparison of contributions to revenue losses in 2001 In 2002, in Figure 9, the government lost TK 127.39 lakh from our sample in five offices in Dhaka City where the Private Ltd contributed 67 percents of the revenue lost and the Public Ltd contributed 17 percent and placed the 2nd. In the same year, the Individuals and the Professionals each contributed 5 percent, the financial Institute contributed 4 percent and the Rental contributed 2 percent to the losses of revenues. Contributions of each category to losses of revenue in the year Fig. 9: A Comparison of contributions to revenue losses in 2002 In 2003, in Figure 10, the government lost TK 93.46 lakh from our sample in five offices in Dhaka City where the Public Ltd contributed 64 percents of the revenue lost and the Private Ltd contributed 13 percent and placed the 2nd and the Financial Institutes contributed 9 percent and placed the 3rd. In the same year, the Individuals contributed 6 percent, the Professionals and Rental contributed 5 percent and 3 percent respectively to the losses of revenues. Contributions of each category to losses of revenue in the year Fig.10: A Comparison of contributions to revenue losses in 2003 In 2004, in Figure 11, the government lost TK 237.44 lakh from our sample in five offices in Dhaka City where the Private Ltd contributed 59 percents of the revenue lost and the Public Ltd contributed 29 percent and placed the 2nd and the Financial Institutes contributed 5 percent and placed the 3rd. In the same year, the Individuals contributed 3 percent, the Professionals and Rental each contributed 2 percent to the losses of revenues. Contributions of each category to the losses of revenue in year Fig. 11: A Comparison of contributions to revenue losses in 2004 6.0 Conclusions
This study suggests that the taxpayers’ categories mainly, Private Ltd Companies and Public Ltd Companies contribute significantly to tax evasion problem under Self-assessment System, which causes huge amount revenue loses every year in Bangladesh. Even though a small proportion of populations live in urban areas (over 80 percent live in rural areas) that use the SAS in filing tax-returns, their contributions to the problem are the causes of the failure of the SAS, which is rigorous and it deserves attention without delay for a remedy. BIBLIOGRAPHY
The Income Tax Manual, Part-1, The Income Tax Ordinance, 1984, Government of Bangladesh. Rahman, AKM, Matiur (2005), Noncompliance of Income Tax Laws: A Growing Problem in Bangladesh under Direct Taxation, Ph.D. thesis, London Institute of Technology and Research, London, United Kingdom Sarker, Tapan K. (2003), Improving Tax Compliance in Developing Countries via Self- assessment System – What Could Bangladesh Lear from Japan, Asia-Pacific Tax Bulletin, Vol. 9 no. 6, (June).

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