Popular belief is that Bangladesh can still do a lot more and reach even greater heights
Very recently Bangladesh successfully crossed its 50th birthday as an independent nation and some remarkable achievements have been realized over the past 50 years such as, rise in GDP from $8 billion to $320 billion; increase in per capita income from $93 to over $2,000; increase in life expectancy from 47 years to 73 years; having a FOREX reserve of $44 billion in 2021 as compared to nothing in 1971; reduction in poverty rate from 82% in 1971 to 20% (pre-COVID); and there are plenty of other noteworthy indicators which prove that Bangladesh is on the right path. However, the popular belief is that Bangladesh can still do a lot more and reach even greater heights and in order to do so there must viable and business friendly fiscal policies in place in order to push the economy into the next phase.
Taxation – A vital component of fiscal policy
A nation’s fiscal policies are crucial in terms of driving growth and development. Fiscal policy is generally comprised of two actions by the government. The first is the taxation framework and the second is government spending and for purposes of this discussion, taxation will be the focus, especially considering the upcoming Bangladesh national budget which is scheduled to be announced in June 2021.
Governments levy taxes in order to receive revenue so that they may finance various operations, goals and initiatives. Taxes come in numerous forms and varieties and each type of tax serves a specific purpose. However, an important attribute of taxes is that they generally accommodate a transfer of wealth from the people to the government. So, if the government takes away too much from the economy then business and investment will suffer. If taxation policies are too aggressive and greedy then it would have the effect of discouraging economic activity whereby the overall revenue base (or tax net) will shrink. As a result, the unintended and opposite effect happens whereby revenue collections fall. Therefore, it is vital that a balance is achieved between revenue collection while at the same time encouraging and boosting economic activity.
Pain points exist in the current taxation framework
Upon a review of the existing tax ordinance, it has been noted that there are certain areas which deserve immediate attention and the primary purpose of this discussion will be to point those out for consideration and possible improvementby the authorities and the national legislature in the upcoming national budget. Furthermore, these pain points which exist in the current taxation framework of Bangladesh have also been voiced by many large business enterprises, both foreign and domestic, which are the primary driving force of the economy. Unless these matters are immediately addressed, they will continue to impact impeding Bangladesh from reaching its full macro-economic potential.
Unrealistic cap on the deduction of promotional expenses
By virtue of Finance Act 2020, any promotional expenses exceeding 0.50% of the disclosed business turnover are inadmissible while computing income from a business or profession. This change in tax law mandates that any promotional expenses exceeding the 0.5% cap must instead be listed as income and therefore, companies will have to pay tax on the remaining disallowed expenditure. Additionally, the ambit of promotional expenses has been made very wide and accordingly, any expense incurred for promotion of business/ profession seems to get covered into its net.
At first glance it is readily apparent that certain business sectors such as Fast-Moving Consumer Goods (FMCG), Pharmaceutical, IT, Telecommunication etc. tend to spend heavily on sales promotion to attract customers and thereby increase their sales and earnings. However, upon a little deeper focus on the nature of business in these specific sectors, it may become clearer that spending heavily on sales promotions is the industry norm and is deemed as the standard operating procedure since these companies exist in a specific business environment where their promotional activities fall into the category of being essential and not simply as a value-added feature. The point here is that spending or not spending or spending less on promotional activities is not a simple or straight forward choice which such companies can easily consider because such expenses and activities are an intrinsic component of their basic business model.This is not unique to just Bangladesh, but it is the same in all other countries in the world where such similar businesses operate.
Capping or limiting the promotional expenses deduction to only 0.5% of turnover would have significant negative consequences to not just the companies operating in those industries where such expenses are a large portion of turnover and those activities are critical but it would also put consumers at a big disadvantage and may also impact employment/unemployment as well as the overall economy.
It is greatly recommended that the relevant authorities please consider immediate withdrawal of section 30(p) of the Income Tax Ordinance with retrospective effect. If the goal is to ultimately restrict and penalize companies showing suspicious activities as promotional activities, then the authorities may please consider a more specific and targeted approach which would only punish those companies which are abusing the income tax ordinance by taking fraudulent and suspicious deductions. However, the way in which the current law is written it is unfairly and most possibly unintentionally, negatively impacting a vast number of corporate taxpayers whose promotional costs are completely legitimate, justified and a critical part of their business model.
Need for tax neutrality in corporate restructuring
Strategic amalgamations and demergers are very popular all over the world since they enable different businesses to synergize by combining or splitting in a tax neutral model. Such strategic transactions have not yet gained popularity in Bangladesh due to the absence of tax neutrality clauses in the ordinance. Hence it is recommended that applicable and definitive tax regulations be introduced so that companies in Bangladesh may also undertake strategic amalgamations and demergers under a tax neutral regime. However, appropriate safeguards must also be in place in order to ensure that genuine strategic transactions are covered under the tax neutrality clauses. In order to attract foreign investments, there is a need for Bangladesh to encourage business reorganizations and align its tax laws with globally accepted norms on such transactions. Accordingly, the following specific provisions may be considered.
Amalgamation - Although the term ‘amalgamation’ is defined in the ITO,1984 (the Ordinance), there is no express provision relating to exemption from capital gains, treatment of cost of assets, carry forward of tax losses and unabsorbed depreciation. The following specific provisions may be brought into the legislation subject to the companies strictly fulfilling the definition of ‘amalgamation’ to enable such transactions to be tax-neutral: a) Capital gain tax exemption for the amalgamating company upon transfer of capital assets pursuant to amalgamation; b) Capital gain tax exemption for shareholders of the amalgamating company on transfer (extinguishment) of shares in the amalgamating company, and as consideration, receipt of new shares of the amalgamated company; c) Permissibility of carry forward of tax losses and unabsorbed depreciation of amalgamating company to the amalgamated company pursuant to amalgamation; and d) Cost of acquisition of capital assets received by the amalgamated company and the shareholders upon amalgamation should be cost/written down value method (in case of depreciable assets) of assets in the hands of the amalgamating company/ its shareholders.
Demerger - Presently, there is no provision in the tax law that allows tax-neutral demerger of business in Bangladesh while the said concept is prevalent in many countries of the world. The following specific provisions may be brought into the legislation in relation to the demerger: a) Definition of tax-neutral demerger; b) Capital gain exemptions in the hands of the demerged company upon transfer of capital assets pursuant to demerger; c) Capital gain exemption in the hands of shareholders of the demerged company on transfer (extinguishment) of shares in the demerged company, and as consideration, receipt of new shares of the resulting company; d) Permissibility of carry forward of tax losses and unabsorbed depreciation of unit of demerged company to the resulting company pursuant to demerger; and e) Cost of acquisition of capital assets received by the resulting company and shareholders upon demerger should be cost/ written down value method (in case of depreciable assets) of assets in the hands of the demerged company/ its shareholders.
Strengthening and utilizing transfer pricing legislation
Bangladesh is increasingly becoming more and more connected to the global markets in terms of manufacturing activities, international transactions, export and import of raw materials and finished goods, exchange of expertise and technical “know-how”, etc. Domestically situated entities are progressively interacting more with their foreign counter parts and related party transactions are becoming very common place. Bangladesh already has transfer pricing related legislation but some further clarity and follow through would benefit both, tax collection as well as the smoothening of international business transactions.
For example, Bangladesh’s current income tax legislation does not expressly provide whether transfer pricing documentation needs to be prepared annually. This may lead to an interpretation that such documentation prepared for one year may be utilized to justify the arm’s length nature of similar transactions undertaken in subsequent years, if the economic analysis is updated with relevant income year data. Due to this underlying ambiguity it may lead to penal consequences if the tax authorities are not in agreement with the above view. Therefore, more specific guidance and clarification needs to be provided about whether the transfer pricing documentation needs to be prepared annually by applicable companies.
Furthermore, there is an ambiguity in the definition of “associated enterprise” whereby the applicable clauses in the tax ordinance mentions three conditions, which are management, control and capital directly/ indirectly through enterprises or intermediaries. However, these clauses do not specify any percentage for control or capital, and it is recommended that further clarifications on this may be provided.
Succession of business and wealth to next generation - Taxation of private trusts
Globally, various families of high net-worth individuals set up private trusts to safeguard the interest of family members and ensure smooth succession of assets to the next generation. While Bangladesh has a trust law, the income-tax provisions are silent on the taxation of non-charitable private family trusts where beneficiaries are immediate family members of settlers and not the society at large. With growing economy and domestic family businesses, there is a need for Bangladeshi promoters to set up appropriate ownership structures through trusts that ensure the growth and longevity of business, and thereby contribute to economy and the generation of employment. Inclusion of specific provisions in the legislation would ensure the proper and intended methods of taxation in the hands of beneficiaries of trust on issues like, receipt of assets by the trust for the benefit of beneficiaries; receipt of income/ assets from the trust; and dissolution of trust.
Foreign entities & expatriate employees are unable to obtain e-TIN
One of the greatest targets of the government is to increase foreign direct investment (FDI) and to attract those global companies which are willing and capable of investing heavily into the economic infrastructure of the country. However, the way in which the e-TIN (tax identification number) system is currently set-up it directly contradicts the government’s overall objective.
Currently the online application form for obtaining e-TIN by foreign entities requires specifying a ‘local registration number’ in Bangladesh. Foreign entities like those rendering services or carrying out activities through any agency constituting a permanent establishment or those earning service income, royalty, etc. may not necessarily have a formal presence or require a ‘local registration number’ in Bangladesh. Similarly, the online application form for obtaining e-TIN by individuals currently requires a ‘work permit number’ in Bangladesh. Expatriates travelling to Bangladesh on A3-Visa and E1-Visa for short duration may not generally obtain a work permit. Such entities and individuals may not be able to obtain e-TIN and consequently may not be able to file return of income and discharge applicable taxes in Bangladesh.
In order to rectify this, a technical update is necessary in the e-TIN application system to allow foreign companies (with no local presence) and foreign expatriate employees to be able to obtain an e-TIN and accordingly undertake the necessary income tax compliances in Bangladesh. Again, this might also have a positive impact on the ease of doing business index.
Double taxation in VAT for nonresident electronic service providers
As per the existing VAT regulations, when a nonresident entity provides “electronic services” to a Bangladeshi unregistered person, it is considered as “supply made in Bangladesh”. Such nonresidents are required to pay VAT via the appointment of a VAT agent. However, under the existing system, when a Bangladeshi unregistered person attempts to pay the nonresident service provider via the Banking channel, 15% VAT is automatically deducted by the Bank. This auto deduction system by the Banks creates a problem of double taxation because the true burden of paying the VAT remains on the nonresident service provider even though 15% has already been deducted from the original payment. Therefore, it is recommended that the banks do not auto withhold such VAT but allow the nonresident service provider to receive their full payment from their customers, from which they may directly pay their VAT to the government.
More specifically, as non-resident entities engaged in the supply of electronic service are in the process of obtaining VAT registration and subsequent payment of VAT, the necessary amendment is requested so that the bank is not required to withhold VAT in respect of such transaction. Therefore the following amendment is suggested in SRO No. 149-AIN/2020/110-Mushak: a) Bank is not required to withhold VAT in respect of non-taxable import of service; and b) Where bank is required to withhold VAT, it should issue VAT deduction at source (VDS) certificate in Form Mushak 6.6 to enable the importer of service to avail the income tax credit.
Taxability of sale of goods or services by electronic means
The scope of income deemed to accrue or arise in Bangladesh covers the income whether directly or indirectly through or from the sale of any goods or services by any electronic means to purchasers in Bangladesh. The lack of specific guidance on taxation mechanism may cause lot of confusion in a scenario where e-commerce transactions in Bangladesh are in an upward rising trend. The inclusion of provisions specifying the mechanism and the extent to which income from transactions through electronic means would be taxed in Bangladesh may be of great ease to e-commerce businesses.
Advance ruling mechanism
Such mechanism is commonly seen in many countries where an entrusted body is empowered to issue rulings and the same ruling is binding on both the income tax authority and the applicant. Prospective foreign investors may generally have queries about such mechanisms to determine the tax consequences arising out of any transaction, to be able to have an efficient tax planning mechanism well in advance and not to be trapped into long drawn litigations. Bringing in income tax law of such advance ruling mechanism can allow non-residents to obtain advance ruling on any question of law or fact in relation to taxability of any proposed transaction. This would encourage foreign investors because they would have comfort and assurance prior to undertaking a particular venture.
While there are various other areas within the current tax ordinance which require further assessment and change, some of the most critical sections which deserve the most immediate attention have been highlighted. It is well agreed upon among the key stake-holders of Bangladesh’s economy that such changes and inclusions would enhance ease of doing business, attract more foreign investment, provide clarity and harmonization between tax laws and business operations, increase the revenue net and bring Bangladesh’s tax framework closer to being in line with internationally accepted ones.
Mamun Rashid is a partner and Syed Yamen Jahangeer is a director with PwC, Bangladesh. Views expressed in this article are their own.