Document o f The World Bank

Report No: 30374 - PK

FOR OFFICIAL USE ONLY

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 53.5 MILLION (US$78.5 MILLION EQUIVALENT)

ANb

PROPOSED LOAN

IN THE AMOUNT OF US$24.4 MILLION

TO THE

ISLAMIC REPUBLIC OF PAKISTAN

FOR THE

TAX ADMINISTRATION REFORM PROJECT

November 5,2004

Finance and Private Sector Development Unit South Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective October 28,2004)

PRs 61.05 = US$US$I US$0.016 = PRs 1

Currency Unit = Pakistani Rupee (PRs)

FISCAL YEAR July 1 -- June 30

ABBREVIATIONS AND ACRONYMS

AGP- Auditor General of Pakistan AGPR- Accountant General Pakistan Revenue AOP- Annual Operational Plans APL- Adaptable Program Loan CAS- Country Assistance Strategy CBR- Central Board of Revenue CCFR- Cabinet Committee for Finance and Revenue CFAA- Country Financial Accountability Assessment CTFD- Customs and Tax Fraud Division DFID- Department for Intemational Development DPL- Development Policy Loan EAP- East Asia and Pacific Region ECA- Europe and Central Asia FARAH- Financial Accounting, Reporting, and Auditing Handbook FATA- Federaily Administered Tribal Zones FMR- Financial Monitoring Reports GDP- Gross Domestic Product GFR- Government Financial Rules GoP- Government of Pakistan GPN- General Procurement Notice GST- General Sales Tax HRM- Human Resource Management ICB- Intemational Competitive Bidding ICT- Information Communication Technology IDA- International Development Assessment IMF- International Monetary Fund IMS- Information Management Systems LAC- Latin America and Caribbean Region LIL- Learning and Innovation Loan LTU- Large Taxpayer Offices MTR- Mid-term Review MTU- Medium Taxpayer Unit NCB- National Competitive Bidding NIC- Natural Identification Card NID- National Intelligence Division NIS- New Items Statement PATA- Provincially Administered Tribal Zones PIFRA- Financial Reporting and Auditing PIP- Project Implementation Plan PMR- Project Management Reports PMU- Project Management Unit PPF- Project Preparation Facility PRSC- Poverty Reduction Structural Credit PRSP- Poverty Reduction Strategy Paper PSDSF- Public Sector Debt Sustainability Framework RMU- Risk Management Unit RTO- Regional Tax Ofice SBD- Standard Bidding Document SOE- Statement of Expenditures STARR- Sales Tax Automated Refunds RepositoIy TFC- Taxpayer Facilitation Centers TMS- Tax Management System UNDB- United Nations Development Business VAT- Value Added Tax WAPDA- Water and Power Development Authority

Vice President: Praful C. Patel Country ManageriDirector: John W. Wall

Sector ManageriDirector: Task Team LeaderrTask Manager:

Joseph Del Mar Pemia Mudassir Khan

FOR 0 PAKISTAN

PAKISTAN TAX ADMINISTRATION REFORMS PROJECT

Th is document has a restr icted d is t r ibu t ion and may b e used by recipients only in the per formance of the i r o f f ic ia l duties. I t s contents may not b e otherwise disclosed

I without World Bank authorization.

CONTENTS

A. Project Development Objective

1. Project development objective 2. Key performance indicators

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2. Main sector issues and Government strategy 3, Sector issues to be addressed by the project and strategic choices

C. Project Description Summary

1. Project components 2. Key policy and institutional reforms supported by the project 3. Benefits and' target population 4. Institutional and implementation arrangements

D. Project Rationale

1, Project alternatives considered and reasons for rejection 2. Major related projects financed by the Bank andor other development agencies 3. Lessons learned and reflected in the project design 4. Indications o f borrower commitment and ownership 5. Value added o f Bank support in this project

E. Summary Project Analysis

1. Economic 2. Financial 3. Technical 4. Institutional 5, Environmental 6. Social 7. Safeguard Policies

Page

3 4

4 5

10

11 23 23 24

25 26 28 28 29

29 30 31 31 32 32 34

F. Sustainability and Risks

1. Sustainability 34

2. Critical risks 3. Possible controversial aspects

G. Main Conditions

1. Effectiveness Condition 2. Other

H. Readiness for Implementation

I. Compliance with Bank Policies

Annexes

Annex 1: Project Design Summary Annex 2: Detailed Project Description Annex 3 : Estimated Project Costs Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary Annex 6: (A) Procurement Arrangements

(B) Financial Management and Disbursement Arrangements Annex 7 : Project Processing Schedule Annex 8: Documents in the Project File Annex 9: Statement o f Loans and Credits Annex 10: Country at a Glance

34 37

37 37

38

38

39 47 72 73 83 84 90 95 96 97 99

MAW) Map o f ISLAMIC REPUBLIC OF PAKISTAN - Page 101

PAKISTAN Pakistan Tax Administration Reforms Project

Project Appraisal Document South Asia Regional Office

SASFP

late: November 5,2004 3ector Managermirector: Simon C. Bell Zountry ManagerDirector: John W. Wall 'roject ID: PO77306 Lending Instrument: Specific Investment Loan (SIL)

Team Leader: Mudassir Khan Sector@): General public administration sector (100%) Theme@): Tax policy and administration (P), Trade facilitation and market access (P)

[ ]Loan [ ]Credit [ ]Grant [ ]Guarantee [ ]Other: For LoanslCreditslOthers: Loan Currency: United States Dollar Amount (US$m): 102.9

Initial choice of Interest-rate basis: Maintain as Variable

Type of repayment schedule: [xi Fixed at Commitment, with the following repayment method (choose one): level [ ] Linked to Disbursement

Conversion options: [XICurrency [XIInterest Rate [ ]Caps/Collars:

rinancing Plan fUS$m): Source Local Foreign Total 30RROWElURECIPIENT .BRD iDA JK: BRITISH DEPARTMENT FOR INTERNATIONAL 3EVELOPMENT (DFID)

23.10 0.00 0.00 0.00

0.00 24.40 78.50 23.00

23.10 24.40 78.50 23 .OO

Borrower: GOVERNMENT OF PAKISTAN Responsible agency: CENTRAL BOARD OF REVENUE Address: Constitution Avenue, Islamabad Contact Person: M.S. Lal, Member (Policy & Tax Reform) Tel: 0092-5 1-9201482 Fax: 0092-5 1-9208864 Email: taxreforms@cbr.gov.pk

Project implementation period: 5 years Expected effectiveness date: 0113 112005 Expected closing date: 1213 112009

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A. Project Development Objective

1. Project development objective: (see Annex 1)

The development objective o f the Project i s to fundamentally reform the Central Board o f Revenue (CBR) for a more efficient and effective revenue administration system. The project aims to facilitate and promote voluntary compliance, increase the overall collection result and guarantee fairer and more equitable application o f tax laws. Additionally, the new human resource policy framework and management system combined with modernized procedures and institutional structure will lead to an increase in transparency and integrity o f the tax administration operations. The project aims to strengthen tax administration to contribute to the achievement o f fiscal targets and facilitate the collection o f optimum tax revenues.

The Tax Administration Reform Project (TAW) seeks to support the reforms initiated by the government for improving tax administration. The overriding objective i s to raise tax revenue through improved compliance with tax laws and broadening o f the tax base; improving effectiveness, responsiveness and efficiency o f tax administration through institutional and procedural reforms; improving collection through transparent and high quality tax services; and strengthening audit and enforcement procedures.

This Project follows the successll completion o f an IDF Grant which was extended tu the Government in 2000 to facilitate development o f implementation pl&s for institutional reform o f CBR. TAW supports the continuation and effective implementation o f the reforms initiated to enhance the capability o f the tax system. Specifically, project objectives include:

a. Improving organizational efficiency and effectiveness of revenue administration: Create an autonomous, transparent, and efficient CBR that i s organized around functional lines, encourages self assessment and dispenses a fair and equitable process o f tax administration. This will include modernizing tax operations for faster and reliable processing o f tax returns, increased capacity for record keeping and management o f data through effective integration o f business processes and information systems. In addition, this will include improvements in staff productivity and morale through adoption of best practice policies for recruitment, training, performance evaluation and compensation.

b. Promoting compliance through strengthened audit and enforcement capacity and transparent and high quality tax services: Compliance will be enforced through a risk based audit system as well as fair and effective enforcement mechanisms that directly respond to changes in the environment using information technology and a new intelligence and r isk management system. Voluntary compliance with tax and custom laws will be promoted through an intensive taxpayer education and facilitation program, re-engineering o f C B R s business processes and reorienting i t s operational culture towards a transparent and service-oriented organization. This will include building effective-working relationships with taxpayers and minimizing contact between taxpayers and tax officials to reduce discretion on part o f tax officials and subsequent opportunities for corruption.

c. Improving trade facititation through modern and internationally acceptable customs procedures: Introducing simplified, modern and risk-based import and export clearance and related procedures, and bringing the system in line with internationally acceptable standards to improve trade facilitation.

d. Improving integrity and fairness of tax administration: Implementation o f a comprehensive

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anti-comption strategy, including the creation o f an internal audit and internal affairs unit, regular taxpayer and staff feedback surveys, and the dissemination o f a new code o f conduct. To design and implement a new administrative dispute resolution mechanism.

2. Key performance indicators: (see Annex 1)

Key performance indicators for th i s project will include both outcome and output indicators. Primary outcome o f the project i s to raise tax revenue measured by increase in tax-to-GDP ratio. A benchmark study specifically for customs will be carried out for performance measurement and monitoring will be done against these indicators during the project life.

Each project component will have i ts own measurable performance indicators as indicated below:

Macro Indicators Total tax revenues collected by CBWGDP ’

Tax revenues collected by sector/GDP Average time taken by new businesses to register with tax authorities

Organizational efficiency and effectiveness Amount o f taxes collected/Number o f tax administration staff

Compliance management 3

- . .

Number o f registered active taxpayers Tax revenues paid on timehotal tax revenues assessed Ratio ‘additional taxes collected aRer tax audithumber o f tax audits conducted” Stakeholder opinion on quality o f services provided (collected through a structured survey conducted by an independent firm and through report cards, if introduced)

Trade facilitation Reduction o f the average customs clearance time to under 1 day by end o f 2006, and to under 4 hours by end of the project, at designated sites.

Integrity and fairness . *

.

Public perception o f revenue administration integrity as measured by periodic surveys Staff perception o f integrity measured by periodic surveys Average number o f days to complete administrative appeals process

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 28262-PAK Date of latest CAS discussion: March 26,2004

The CAS focuses on improving prospects for stable economic growth by reducing fiscal imbalances and enhancing private sector response to reform initiatives, through institutional strengthening and increasing efficiency, accountability and transparency o f core fiscal functions o f the public sector, while encouraging greater documentation o f the economy. This project will achieve the CAS objectives by establishing a new institutional framework for tax administration, which will widen the tax base and improve the efficiency and effectiveness of tax collection. Eventually, the project will lead to increased tax revenue, reduced government’s dependence on non-tax revenue sources and the budget deficit, whilst greater efficiency will decrease the amount of time spent by businesses on these non-productive activities and encourage more

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businesses to move into the formal sector.

Regional Countries

Singapore Sri Lanka Thailand

China

2. M a i n sector issues and Government strategy:

Background

Tax to GDP Ratio

15.4 14.5 13.8 16.8

0-w

Since the early nineties, successive governments have tried to reform Pakistan’s tax system. These attempts, however, have yielded limited results and the tax to GDP ratio has remained in a narrow band, between 1 1 to 13 percent since the 1990.

Bangladesh

I Tax Revenue as YO of GDP

12.6

9.5% 9.0%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Central Board of Revenue *The graph only represents Tax Revenue collected by CBR

India Nepal

According to the Organization for Economic Cooperation and Development, tax revenue as a percentage o f GDP in developed countries ranges from around 30 to 50 percent, with an average o f 38 percent, while the average in developing countries i s about 18 percent. Although Pakistan’s tax/GDP ratio at 12.9 percent i s well below the average for developing countries, it does not fare too badly when compared with other countries in the region.

14.6 9.6

Table 1 : Tax to GDP ratio, selected countries

rpp Philitmines I 12.3 I I Indonesia I 13.1 I I Pakistan I 12.9* I

I ran

Sector Issues

8.5

The low tax to GDP ratio in Pakistan i s primarily due to inherent weaknesses in the tax system including: (i) inefficient tax administration; (ii) a narrow tax base; (iii) skewed tax structure; (iv) a complex and non-transparent tax system; and, (v) corruption and tax evasion. Each of these issues i s discussed in detail below.

(i) Inefficient tax administration: Despite previous reform efforts, many o f the long-standing deficiencies in tax administration have not been rectified. The tax department has suffered from profound institutional weaknesses related to poor management, weak human resources, low pay, lack o f adequate systems o f financial and physical control, low quality and quantity o f tax auditors, unduly bureaucratic processes with excessive scope for discretion and rent seeking by individual staff, deteriorating physical infrastructure, lack o f transparency in the collection o f import duties, and resistance to change. Other critical shortcomings include: (i) poor identification o f non-filers and stop-filers; (ii) poor audit program design, implementation, and sequential follow-up; (iii) poor use o f database for cross checking; and (iv) absence o f tax transit and audit'inspection controls in customs.

(ii) Narrow tax base: Approximately 39.41 mill ion men and women are employed in Pakistan. Of these, only about 1.53 mill ion (3.9 percent) pay tax. This ratio i s quite low especially when compared with that o f the U S - 46 percent, UK - 48 percent and Australia - 53 percent.

The tax base in Pakistan i s narrow due to three main reasons. Firstly, a large proportion o f the employed labor force i s employed in small-scale agriculture or informal enterprises, which usually do not pay regularhixed wages and, if they do, these earnings are below the taxable threshold.

Secondly, the salary allowance and privileges o f certain groups are given concessions under the Income Tax Ordinance 2001 and the Income Tax Rules 2002. These include widows, pensioners, research organizations, non-govemmental organizations and those working in international development agencies. Such concessions exclude a large number o f individuals from paying income tax and effectively reduce income tax revenue.

Thirdly, many transactions in Pakistan are made on a cash basis and are not documented. This makes it difficult to identify and register individuals and businesses and once registered, it i s still difficult to assess income earned, corporate profits and tumover.

(iii) Skewed tax structure: In most developing countries, where income distribution i s uneven, it i s easier to generate revenue by taxing usage o f commodities rather than the wealth/income o f the rich.

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This mechanism, however, raises the cost o f living for lower income groups. For countries trying to improve standards o f living, th is can prove counterproductive unless introduced with zero-rating on basic goods and services used by the poor.

Historically, the Government o f Pakistan has relied heavily on indirect taxes to meet i ts fiscal needs. While efforts have been successful in reducing this dependence, indirect taxation st i l l constitutes nearly 68 percent o f government’s total tax revenue. This i s composed o f sales tax - 66 percent, customs - 19 percent and the remaining 15 percent through central excise duty.

Direct & Indirect Tax Revenue 80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

(iv) Complex tax system: Pakistan’s tax laws are complicated and the process o f filing returns and collecting re fhds cumbersome. Moreover, the system i s characterized by fkequently changing and ad hoc legal and administrative arrangements, which provides opportunities for increased discretion and enhanced opportunities for corruption. Taxpayers in Pakistan often have insufficient or uncertain knowledge o f their tax obligations and there i s little support to help them understand the laws and/or motivate them to improve compliance. This leads to a serious undermining o f taxpayer confidence in the tax system, which in turn, filters through to lower tax revenue.

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(v) Corruption and tax evasion: In Pakistan, salaries and incentives for tax officials have been highly inadequate and fall short o f what officials could earn in the private sector. In various surveys conducted to identify the root causes o f corruption, including perception survey carried out by the Task Force on Tax Administration, poor compensation was cited as one o f the primary reasons for corruption. Other reasons included the discretionary powers o f tax officials, lack o f accountability, complex structure o f tax system, greed and societal pressures. In addition, the taxation system provided CBR employees opportunities to accept andor demand bribes and fostered extortion. There are broadly two levels o f corruption: firstly, a smaller proportion o f corrupt officers that extort the level o f payments that no reward system can address; secondly, a larger proportion o f officers involved in corrupt practices are doing so in order to feed, clothe and house their families. Improving the compensation and reward system that i s linked with performance, reducing discretionary powers, introducing tax assessment and collection procedures that do not involve contact o f taxpayers with tax officials, training and education o f tax officials and taxpayers and developing adequate accountability mechanisms would help towards eradicating th i s ill from the system.

On the other side, the informal structure o f the economy and non transparency o f the tax code and tax collection practices also make it easy to manipulate data and evade taxes. In addition, the causes o f corruption in the private sector include; lack o f tax culture, high tax rates, greed, lack o f accountability and fear o f extortion or wastage o f money paid in taxes. However, the main reason for tax evasion cited in the surveys was the belief o f people that they do not get anything in return o f the taxes paid. Simplifying the tax system, educating the taxpayers, improving mechanisms for compiling data and keeping records along with appropriate collection and enforcement procedures can go a long way in addressing this problem.

Government Strategy

Realizing that increasing tax revenue i s critical for fiscal development, the Government has adopted a two-pronged strategy: tax policy change - to make the tax system more responsive to growth and easier to administer; and, tax administration improvements - to increase efficiency o f collection. Specifically, the Government plans to make the tax policy more equitable, bring more taxpayers into the net, reduce the number o f taxes, streamline the tax laws to make them taxpayer friendly, improve tax enforcement, and put in place a tax administration system which i s efficient and responsive.

Government efforts to reform have been more concerted during the last few years. In June 2000, a Task Force supported by the Bank was set-up to review the problems o f CBR. The Task Force presented a detailed report in May 2001 and recommended a complete shift in the tax system from assessment to a r isk based system with simpler laws and procedures that relies on audit and reduces the contact o f tax Officials with taxpayers. Based on this approach, in November 200 1, CBR developed a broad strategy for reforms focusing on: (i) restructuring o f CBR along functional lines and integration o f income, sales and excise taxes; (ii) reengineering and automating business processes and workflows; (iii) establishing databases for reporting and audit purposes; (iv) introducing self assessment system for filing o f tax returns; (v) improving services for the taxpayers; and, (vi) strengthening the human resource base. To improve its fiscal position, the Government intends to enhance the tax to GDP ratio that has remained stagnant at around 11 to 13 percent as a result o f a narrow tax base, weak tax administration, a complex tax regime, and widespread culture o f tax evasion and corruption. For this, the Government i s focusing on improving tax policy and strengthening tax administration. Tax policy reforms include: (i) abolition o f wealth tax; (ii) introduction o f two-tier Agriculture Income Tax in all provinces; (iii) reduction in multiplicity o f taxes both at federal and provincial levels; (iv) rationalization o f various taxes; (v) reduction in Corporate Tax for banking and non-banking companies from 58 to 47 percent and from 45 to 43 percent respectively; (vi)

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extending General Sales Tax to fourteen categories o f services; (vii) broadening the base o f General Sales Tax; (viii) rationalization o f import duties, bringing down maximum tariff to 25 percent and reducing tariff slabs from five to four; (ix) lowering o f income tax rate to 35 percent; (x) gradual withdrawal o f Central Excise Duties; and, (xi) eliminating all tax whitener schemes.

Simultaneously, the Government made extensive policy reforms including change in organizational structure of CBR, which has provided management with some level o f autonomy through the Cabinet Committee on Federal Revenues, to implement reforms and has allowed private sector induction at the top level. Within th is framework, CBR has increased the salary levels o f about 150 staff working at pilot reform initiatives as part o f reform team. The staff was selected through a competitive process o f internal job postings. In addition, job descriptions and a database o f staff with their education and ski l ls has also been developed. This i s a major step in determining training and capacity building requirements as well as identifying non trainable staff who will be linked to the performance management system. All these initiatives have given the ‘change’ signal and has helped create ownership for the reform agenda.

The Government has cut the number o f tax exemptions significantly as a move towards an SRO free culture. In the last three budgets, over 75 exemptions were withdrawn under Income Tax and GST while the GST coverage was also expanded to include 14 addtional categories. Income Tax exemptions through SROs were discontinued and are now required to be part o f the Finance Bill. Most o f the remaining exemptions correspond to core policy objectives or international agreements and are estimated to cost nearly 0.5 percent o f GDP.

The CBR, while it continued with i ts short term ‘quick win’ reforms, also started preparation o f a m e d i d l o n g term reform program with Bank assistance. A Project Preparation Facility o f US$2.9 mill ion was processed in 2002 to support implementation of the reform initiatives as well as hiring o f an international consulting firm (Maxwell Stamp) to prepare a comprehensive strategy with implementation timelines and costs for the m e d i d l o n g term reform program.

Short term reform measures focus on design and testing o f pilot schemes including the Large Taxpayer Unit (LTU), the Medium Taxpayer Unit (MTU), customs selectivity and post clearance audit, sales tax refund program, universal self assessment scheme, human resource information management system and training and staff development. These reforms have partly been supported through the Public Sector Capacity Building Project approved by the Bank in early 2004. The m e d i d l o n g term program will focus on development o f the reforms across the country and throughout CBR operations.

Essentially, the reform program i s based on the following seven integrated building blocks:

(i) While remaining a government department, CBR w i l l be provided with greater autonomy in determining i t s own policies and strategies in relation to recruitment, salaries, investment and operation methods.

(ii) Restructuring the CBR into a modem functionally based and integrated Revenue Organization.

(iii) Promotion o f voluntary tax compliance and the re-orientation o f i t s operating culture towards a transparent service-oriented organization through the implementation o f a comprehensive taxpayer, and internal staff, education, training and facilitation program.

(iv) Adoption o f modem effective tax administration methods and policies through re-engineering o f i ts

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operating procedures, particularly focusing on:

0

0 0 0

0

Introducing a consolidated self-assessment scheme; Minimizing the taxpayers - tax officials interface; Adopting ‘Selectivity and Risk Management’ principles; Replacing the present transaction based audit practice with the application o f selective post return and clearance audit method across all taxes; Systematic and comprehensive registration o f taxpayers in a single register applicable across all taxes; Widening o f the tax base; Amending the Tax and Customs laws to enforce reforms as necessary; Introducing fair and equitable appeals and appeasement procedures; Introducing stronger enforcement penalties; and Redesigning tax processes to reflect increased functionality and gradual integration o f tax administration.

(v) Increased use o f information technology and systems, both proprietary and custom built, across all taxes to reduce processing times, increase administrative efficiency & transparency, and ensure that the benefits o f shared information are reflected in increased levels o f compliance.

(vi) Improvements in productivity o f CBR staff and management through a comprehensive Human Resource Development program to substantially raise staff skills, quality level and integrity in l ine with international standards through training, monitoring, restructuring and redeployment.

(vii) Rationalization and refurbishment o f accomniodation, fittings and equipment to accommodate the new processes and programs.

3. Sector issues to be addressed by the project and strategic choices:

The Project would address most o f the sector issues identified above through an integrated reform program which targets strengthening the institution through organizational and management reforms, improving the sk i l l mix and developing the level o f existing capacity, re-engineering o f operational processes and systems, and introducing modem and automated risk based tax systems that would reduce the contact o f tax payer and tax official to minimize corruption.

The strategy i s to restructure CBR along functional lines and have an integrated tax administration over the long term. Integration o f different types o f taxes will provide taxpayers with a single point o f access and they would benefit from simplified procedures that have been proven intemationally to increase compliance. In addition, comprehensive multi-tax audits will reduce the frequency o f visits to taxpayers. Moreover, streamlined training and capacity building will allow the CBR to deploy staf f in a more flexible manner. Merging o f direct and sales tax will be phased over a realistic period considering legal, political, geographical, taxpayer type, and revenue implications.

A number o f key strategic choices were faced while planning the project and include the following:

0 Initially, it was considered that CBR would be made independent and a new Pakistan Revenue Authority would be established. However, the choice o f keeping CBR within the Government set-up while providing it with necessary autonomy to operate and take decisions with respect to hiring, remuneration, placement, promotion and other day to day tax implementation issues, was

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made. This was decided considering the international experience with s imi lar structures and their implications for reforms.

CBR as a strategy decided to have a phased approach to reforms where ‘pilots’ are being implemented in key strategic areas, as against implementation o f a program at the national level. Establishment o f LTU and MTUs was widely appreciated by the stakeholders including and most importantly private sector businesses. This approach was chosen as it was regarded as an internationally accepted and successful method o f implementing large scale public sector reforms. This also has a demonstration effect where successes gamer greater support for reforms.

CBR also decided to have a functional based organizational structure instead o f the tax type. The approach would be implemented over a number o f years. A pilot ‘Large Taxpayer Unit’ has already been implemented which brings income and sales tax amongst other functions such as audit under one window. This model would gradually be replicated in all major cities o f the country. In addition, CBR has created positions o f functional members at the senior management level and has recruited private sector professionals in these positions.

One o f the key choices was to build the reform momentum and gain internal buy-in prior to initiating the reforms. This was carried out through a number o f ‘Change Management’ workshop and face to face discussions with staff as well as broader discussion with stakeholders.

C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown):

The proposed Project will support the Government revamp the tax administration system. I t would support initiative to redress major shortcomings in tax administration through investment in human resource and information technology, modernizing collection and audit procedures, fostering voluntary compliance, and strengthening the institutional framework for tax enforcement. This proposed Project has funding support in the form o f a grant by DFID.

The Government i s committed to reform institutions through incentives and accountability to breakout from a vicious cycle o f high rates, predatory administration, tax evasion and low revenues to a virtuous cycle o f lower rates, equitable tax structures, fair administration, voluntary compliance and higher revenue. CBR reform i s an important pillar o f Government’s broader strategy for reforming public sector institutions. Similar reforms have also been initiated at the State Bank o f Pakistan, Securities and Exchange Commission o f Pakistan, WAPDA, and the Office o f the Auditor General. Additionally, the Government has also launched a wider Public Sector Capacity Building initiative with the Bank’s assistance.

As i t s commitment, the Cabinet approved the reform strategy for CBR which allowed it to prepare a comprehensive reform program. Moreover, the Government established a Cabinet Committee for Federal Revenues headed by the Finance Minister, which not only gives CBR autonomy to implement the reform program but also to institute mechanisms which would sustain the reforms once they have been implemented.

The proposed Project i s designed around a comprehensive reform strategy and includes the following seven components: (i) Management and Institutional Development; (ii) Improving Revenue Operations; (iii) Strengthening Revenue Services; (iv) Creating a Tax Compliant Culture; (v) Adopting Responsive IT Systems; (vi) Infrastructure Up-gradation and Development; and, (vii) Project Management and

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Implementation. Within these components training, consultant services for business process re-engineering and information technology will also have DFID financial support during implementation.

(i) Management and Institutional Development

The CBR’s human and institutional development strategy w i l l support and enhance the broader tax reform strategy by driving:

0

0

0

Strategic changes within CBR’s organizational structure; Transformation o f the organization’s culture & ethos; and, Development o f sound people-management policies and procedures.

(ia) Organization and Policy CBR headquarters i s currently organized on a hybrid basis with excessive line functions reporting to the Chairman. At the field level, direct and indirect tax administration are totally separate. The direct tax administration i s based wholly on the geographic distribution o f taxpayers with multiple tiers o f decision-making and supervision. A service function and program i s lacking. Appropriate structures to deal with large taxpayers have only recently been introduced on a pilot basis. Government rules and regulations do not provide sufficient administrative and financial flexibility for an eficient management o f i t s operations. CBR does not have the necessary discretion to re-allocate budgeted funds within main appropriations to react to changing expenditure needs.

This subcomponent will support activities aimed at moving from a tax-type to a functional structure at CBR headquarters and in the field offices. Activities would include streamlining the management structure at CBR headquarters and consolidating the fragmented office network for income tax and sales tax administration into twelve regional tax offices (RTOs). A formal annual planning process will be introduced and the performance measurement system will be revised and broadened. The subcomponent will also assist in reviewing the requirements for more financial, functional, and administrative flexibility and developing related accountability mechanisms. I t also aims to improve the legal framework for tax administration and support strengthening o f tax policy capacity. In addition, support to the design and implementation o f a comprehensive integrity strategy for the CBR will be provided.

(ib) Human Resource Development This subcomponent addresses the following core areas o f human resource development:

(1) Human Resource Management: The organization i s significantly overstaffed, particularly at lower organizational levels. Furthermore, the expectation o f job security i s stronger for a career untied to performance criteria. This will need to change, especially when more widespread use o f information technology and reengineering o f business processes take place during the modernization process. This i s expected to bring about competition for jobs requiring new competencies and change the operational and administrative environment o f CBR.

This subcomponent will support: workforce rationalization; creation o f new and redefining existing professional positions to meet new functional and operational requirements; development o f a human resource management policy framework; and, adoption o f new pay and benefits regime, including merit-based pay and incentive systems.

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(2) Training: Delivery: The current training system i s not geared to address the existing training needs o f CBR. For most staff, there i s no explicit linkage o f training to career advancement or promotion, and neither training needs analysis i s carried out by the local offices o f CBR. Finally, lack o f performance evaluation leads to a haphazard application o f an essentially supply driven training. The CBR in-house study on "Traning needs analysis" recently published needs to be implemented.

This would support: (i) development o f a new CBR training strategy to meet the requirements o f the new functional organization, including the core area o f management. I t would also help CBR establish an integrated training directorate for tax and customs administration; (ii) coordinate preparation and supervision o f training needs analysis and prepare requisite training plans for all staff as a part o f the annual performance evaluation process; (iii) prepare annual training plan focusing on specific training in functional areas for upper-level staff and management sk i l ls for officers; (iv) offer refresher courses for technical staff and officers; (v) organize an internal induction training, not through the Civil Service Administration, focused exclusively on content germane to tax administration; (vi) provide advanced training on an assessed needs basis, and establish facilities so that courses can be carried out on a decentralized basis; and, (vii) allocate budget resource to the training function.

(3) Imurove Professional Ethics: A Code o f Conduct and Ethics need to be implemented in addition to the general code o f conduct that applies to all government officials promulgated in 1964. Because the working environment o f CBR differs from that o f most public servants, experience from other countries suggests that development o f a separate code for routine revenue administrative work i s needed. Timely enforcement i s a critical element in implementing such codes. In CBR, there are protracted delays in processing cases o f corruption caused by understaffing, which will need to be remedied.

This supports development o f a special code o f conduct and ethics through: (i) training o f managers to brief staff on i t s contents, their rights and responsibilities, and enforcement procedures; (ii) training o f staff assigned to investigate inquiries into staf f alleged breaches o f the code; and, (iii) development o f clear guidelines for managers and supervisors on how to deal with complaints alleging staff corruption.

(ic) Internal Audit CBR lacks a dedicated intemal audit function to ensure that the business processes established are properly followed. This subcomponent will establish a specialized internal audit functions in CBR. I t will set up a central internal audit office for planning, program direction, procedures, training and evaluation of the internal audit program throughout the CBR. Field-based intemal audit un i ts will be established to implement intemal audit plans in the operational components o f customs and taxation.

(id) Internal Affairs and Vigilance Units In the current organizational structure there i s no dedicated department in CBR responsible for the detection o f cases o f collusion between revenue administration officials and taxpayers. In practice, th i s has led to a situation where CBR i s confronted with multiple interference and inquiries from outside agencies, such as the National and Regional Accountability Bureaus, the

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Federal Investigation Agency, and the Investigation Bureau. Th is has led to questionable inquiries into CBR’s daily operations, as quite often issues raised during such investigations are highly technical in nature and the probing agencies do not have the necessary competency and knowledge. Regarding disciplinary measures against corrupt officials, the main responsibility lies with the Director General o f Inspections and the Director General o f Inquiries. In practice, there are substantial delays in enforcing disciplinary measures and a lack o f focus in the organization on expediting processing corruption case.

This subcomponent will assist in creating a specialized intemal affairs function and vigilance function at CBR headquarters. These functions will be responsible for investigating allegations against CBR officials and detecting corrupt practices and corrupt officials.

(ie) Change Management This subcomponent will support activities aimed at developing and implementing appropriate strategies for managing organizational change at all levels o f the tax administration, including communication strategies to explain the rationale and potential impact o f the planned changes to al l managers, officers, staff, taxpayers and other stakeholders.

(ii) Improving Revenue Operations

CBR will reorganize i tse l f to meet the management and functional requirements and challenges o f a modem tax administration system. The long term vision o f CBR provides for a functionally integrated tax administration system; moving to such a structure will avoid the present duplication o f functions such as audit, collection and enforcement across departments. Managing direct and sales taxes separately makes it more expensive to comply and more difficult for taxpayers who have multiple tax dealings to comply. The integration will provide taxpayers with a single point o f access, enabling them to easily obtain all the information required to assess their tax liabilities. However, recognizing the challenges o f the change process during the transition period, CBR will maintain the separation o f function by tax type in the initial reform period with the aim o f gradually reducing this over time, while carefully considering the legal, political, geographical and revenue implications.

In order for CBR to make this major reform program a success, it will ensure that i t s organizational structure supports the procedural and operational changes arising from the reforms. The following are some o f the main subcomponents that will be addressed by the proposed project.

(Ea) Direct Tax O f the three revenue administrations, Direct Tax i s the one which has the greatest need o f reform. I t s operations are performed through costly, inefficient and ineffective processes and procedures at 96 locations by more than 750 circles. The collective revenue yield o f such operations has been chronically poor and grossly short o f potential. Mutual dissatisfaction o f taxpayers and o f the CBR’s staff i s persistently high, under current operations.

The project will support government’s planned reform o f direct tax by: flattening the organization structure, improving the identification and registration process, specializing the handling o f large and medium taxpayers affairs, establishing a tax-payer self-assessmentlself-declaration approach, maintaining a taxpayer database containing all assessment and payment data, establishing capability to quickly detect taxpayer non-filing and non-payment.

Twelve Regional Tax Offices (RTOs) will be the focal points for all Direct Tax operations in the

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mid to long term (except for large taxpayers, which will be handled by LTUs). The functional program areas to be carried out at each o f the 12 future RTOs are Taxpayer Facilitation (includes Registration); Taxpayer Audit; Collection & Enforcement; Investigation o f Tax FraudEvasion; Information Processing; Human Resources; Information Technology; and Legal.

Direct taxes will require use o f information technology to support several functions. The direct tax organizational un i ts (e.g., LTUs and RTOs) w i l l require appropriate hardware, system software and network support. In addition to the hardware, th is subcomponent envisages the development o f following software systems:

0 Taxpayer registration system: This system will register taxpayers for direct taxes. Currently, CBR i s using a National Taxpayer Number for all taxpayers. However, for ease o f data capture from data sources outside CBR, it i s recommended that the CBR uses National Identification Card (NIC) number for individual taxpayers and continue to use NTN for business taxpayers. Income tax information processing and accounting system: This system will process a filed tax return and update a taxpayer’s account. The Tax Management System (TMS) developed at the MTU can be expanded to provide th is functionality. Case tracking System for collection/enforcement: This system will track a case and provide i ts status (received, closed and inventoried, etc.) as it proceeds through the system. Computerized audit selection system: This system will select cases for audit based on audit selection criteria established by member audit.

0

0

0

Among the most important project strategies and initiatives for Direct Tax are:

(a) Establish more specialization uni ts for handling o f direct operations for the country’s largest taxpayers;

(b) The operations o f the LTU will serve as “a model office” for replication to CBR’s operations elsewhere;

(c) Two more LTUs will be established in the mid term. The three LTUs will be the focal point in the future for a l l operations applicable to the country’s largest taxpayers;

(d) Decentralize operations for other taxpayers based on functional structures; (e) The operations o f the MTU wi l l serve as an inter im “model office” for the re-engineered

operations o f Direct Tax and w i l l be replicated to other sites across the country in the short term;

( f ) Based on the results o f the Lahore “model office test”, five more MTUs are already scheduled to be established

(g) In the medium to long term, the MTUs will become part o f the 12 Regional Tax Offices (RTOs), where Income and Sales Tax operations will f i rst be co-located, and in the long term, integrated.

(h) Several data processing operations for Income Tax under a universal self-assessment system will be established to process income tax returns, tax payments, and other documents. Among the numerous operations’ requirements for data processing centers are rapid processing o f all documents; electronic documentation o f accurate information for the integrated tax information system’s databases; and “capture” o f key data for taxpayer control and enforcement - risk-nianagement information; identification o f non-filers and stop filers; verification and matching o f 3rd-party information for audit, collection & enforcement; etc.

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In order to achieve the objectives stated above, this subcomponent will support a series o f reform initiatives including: (1) legal authority; (2) organization and management; (3) business processes and procedures; (4) human resources (including training and recruitment); (5) facilities and infrastructure; and, (6) information technology.

(iib) The Federal Sales Tax Act, 1990, enables the federal government to impose ST based upon the value added at each stage o f selling o f the goods. Internationally, th i s form o f taxation i s known as Value Added Tax (VAT). At present, there i s a universal rate o f 15 percent applied to most goods. Exemption i s provided for a number o f goods including most basic foodstuff, drugs, computer hardware and software, selected agricultural equipment, commercial ships and aircraft. Exports, sales to diplomats, and supplies in the Export Processing Zone are all zero-rated. The ST does not apply to transactions within the Federally Administered Tribal Zones (FATA) and Provincially Administered Tribal Zones (PATA). An Act o f Parliament cannot be enforced in these districts without agreement o f the Provincial Assembly and Governor. Agreement to enforce the Federal Sales Tax Act has not been obtained. The constitution empowers the Federal Government to levy excise duties other than on liquor, opium or narcotics. The most pressing issue with ST and excise duties that this component will address i s the limited number of ST registrants and their poor compliance - about 88,000 registered units.

Sales Tax and Central Excise

This component will also review the number of goods and services that currently receive an exemption. To bring ST in Pakistan in line with general international practice, the share o f ST should be distributed equitably and requires increase in the scope o f goods and services liable. ST will also be developed to allow for tax input credits for office equipment, office supplies, building materials, electricity consumed and other items used to support taxable activities. The input tax claims and ST refunds system will be reviewed and streamlined. Sales taxes will need use o f the taxpayer registration, case tracking and computerized audit selection systems discussed above. In addition, sales tax information and communication system would be developed to process and reconcile a filed sales tax return.

(iic) Customs The long-term objectives o f the customs reform component are to modernize import and export clearance procedures, and related procedures that impact upon trade facilitation, in accordance with internationally accepted principles and methods and will also improve revenue collection. The building blocks o f the CBR's reform strategy in customs are based upon the following principles, guidelines and procedures. The application o f the principle o f customs controls will allow the CBR to:

0

0

0 expedite trade and travel.

focus on high-risk areas and therefore ensure more effective use o f available resources; increase ability to detect offences and non-compliant traders and travelers; offer compliant traders and travelers greater facilitation; and,

Risk management has been universally adopted as a key principle in customs procedural reform. According to the General Annex o f the Revised Kyoto Convention, "Customs controls should be carried out on a selective basis using risk management". The Chapter defines risk management as -- the systematic application o f management procedures and practices which provide Customs with the necessary information to address movements and consignments which present a risk techniques to the greatest extent possible.

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Customs will move progressively away from “blanket” controls and detailed procedures that impact on all or most importers and exporters, to interventions that are highly targeted towards identified r isk shipments, traders and goods.

Reforms will also introduce self-assessment and provide the speedy clearances to those that have proved and maintained their dependability. Face-to-face contact will be limited and CBR plans to strictly limit access by customs agents to secure accommodation. Plans call for development o f a system enabling electronic preparatiodsubmission o f declarations, internet/EDI transmission, selection o f declaration for audit based on risk analysis, and electronic assessmenthelease.

(iii) Strengthening Revenue Services

(iiia) Audit At present, there are different audit schemes for different taxes, and the development o f audit .

programs varies both in quantity and quality. In certain cases, individual employees have developed advanced control programs and audit case selection systems. Rewards are based upon fulfillment o f the goal set for collection rather than the number and quality o f audits.

Some o f the problems plaguing the audit function include: lack o f cost effectiveness; non differentiation o f the various forms o f control; audit experiences not extracted and distributed throughout C B R the auditing process characterized by a bargaining process between the auditor/collector and the taxpayer; and, the selection o f cases for audit not carried out according to a structured risk assessment - carried out randomly.

Selection o f cases for audit, under risk-assessment systems i s very difficult anywhere in the world. A great deal o f work st i l l needs to be done to establish a viable system in the CBR, and the time i s now to do so, before the next round o f tax returns i s filed under USAS. Despite the need for transparency in tax administration, this data should not be shared with taxpayers and tax practitioners as i s the practise world wide.

The project will support the establishment o f a Tax Audit Function as a separate functional stream. It will also develop an automated approach to audit-case selection based upon consideration o f the risks o f under reporting and underpayment o f taxes and case distribution among auditors with specialized functions. The audit function will be strengthened through independent quality reviews and audit parameters will be imbedded in the Information Management system, allowing the system to identify returns/filings for further scrutiny.

(iiib) Voluntary and Enforced Collection The establishment o f an effective collection and enforcement function i s a critical element o f any tax administration reform. Accordingly, CBR will establish a Collections and Enforcement Function at the head office which will be responsible for providing direction, developing policies and procedures and providing support to regional operations. The Function will be responsible for identifying non-filers and taking appropriate action. I t will also assist in updating registration records. To summarize, the Function will be responsible for the following activities:

0 Enforcement / Collection; 0

0 Demand outstanding returns; Monitoring of filing and payments including withholding taxes;

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0 Recovery o f outstanding taxes; 0 Imposing interest and penalties; 0 Conducting intemayextemal surveys; and, 0 Collecting data on taxpayer assets, to aid eventual enforced collection.

An integral part o f the Collections and Enforcement Function will be the development o f a computer system and tax database that w i l l facilitate the collection o f taxes. This will issue notices, calculate interest and penalties, and identify non-filers. It will interface with external sources o f information like banks and utility companies to identify non-filers or stop-filers and to facilitate collection. Unlawful practices at the taxpayer level, are addressed under ‘collection and enforcement’ in the section ‘creating a tax complaint culture’.

(iiic) Appeals and Dispute Resolution Improved Revenue services will also focus on appeals and dispute-resolution processes. The Appeals and Dispute Resolution sub component will address development o f systems, procedures and processes which must be perceived as fair, expeditious and transparent by all interested parties. Highlighted w i l l be a single, two-phase avenue o f appeal for all kinds o f taxes. The f irst phase will be at an administrative, but quasi-judicial level, followed by a judicial level, if necessary. The national appeals and adjudication system will be uniformly administered across the different tax disciplines.

This sub component would also support pilot efforts to meet the objectives described above. For example, the soon to be established pilot “Dispute Resolution Complex” at the present Sales Tax (East) Collectorate in Karachi will test functional specialization o f re-engineered dispute resolution processes. This pilot proposes to improve:

0 Alignment o f tax laws; 0 Infrastructure and facilities; 0

0

0 0

Training and tenure posting o f adjudicating officers; Protection from extraneous influences and investigating agencies; Countrywide computerization o f Adjudication Collectorates; On-line access o f the adjudicating officers to data on valuation, imports-exports, local production o f goods, informatiodprofiles o f taxpayers, case laws, latest rulingljudgments o f superior courts; and

0 Computer-generated adjudication orders.

(iiid) At present, there i s inadequate focus on intelligence and risk management and there i s limited operational capacity. This function however, becomes highly critical with the introduction o f Universal Self Assessment and involves much more than simple data collection.

National Intelligence and Risk Management

This sub component provides for creation o f an intelligence-gathering function at the national level which will cover and support all operational areas o f the three Revenue streams at the field level - Direct Tax, Sales and Excise Taxes, Customs, Exports. A national risk-management function will be co-located with the intelligence function to provide similar support field operations. The risk-management function will design automated systems and databases based on ratiodtaxpayer profileshdustry and goods “profiles”/etc. to gather, analyze and identify cases for audit and enforcement which have the greatest risk for revenue loss to the Government. The intelligence function will focus heavily on creation and use o f automated databases for the identification and

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preparation o f cases for field investigation which meet criteria for potential Wcustoms fraud or evasion.

(iiie) Customs and Tax Frauds Customs and tax frauds pose a serious economic, industrial and social threat to Pakistan. CBR under the project will introduce measures that would protect against these threats.

This subcomponent would support creation o f an integrated Tax & Customs Fraud function with specialists to investigate alleged offenses by taxpayers/traders under the relevant legislation and recommend for prosecution those confirmed cases, after careful, thorough, documented and professional investigation. Together with a highly-qualified, highly-trained staff o f investigators, the function will be provided with well developed, integrated IT and communications systems.

This highly-specialized function does not yet exist in the CBR and will need to be established. Assistance will be sought from Revenue and Customs Investigation organizations o f other countries, since the CBR’s investigation staff will also be required to establish liaison with international and national organizations to facilitate mutual support and assistance in their respective investigations.

(iv) Creating a Tax Compliant Culture

(iva) Taxpayer Education and Facilitation Tax facilitation and education i s currently minimal and will need to be strengthened considerably if universal self-assessment requiring taxpayers to maintain transaction documentation to be successful. The tax education and facilitation function will include a strong and well coordinated communications program promoting the development o f greater compliance and a user friendly, supportive interface between the CBR and corporate and individual taxpayers. I t will also introduce a program outlining the principles o f a good tax administration system (transparent, fair, automated, simple and cost-effectiveness); develop a quality assurance monitoring program; and introduce easy-to-comply-with forms and document requirements that are compatible wi th a computerized operation.

The tax administration system will provide taxpayers with a single point o f access, enabling them to easily obtain all the information required to assess their tax liabilities. This will be instigated through the establishment o f 60 to 75 Taxpayer Facilitation Centers (TFCs). A key objective o f the TFCs will be to promote tax facilitation through the promotion o f self-assessment for tax liability.

The TE & F will research, plan, design, develop, implement and manage programs to elicit ideas, opinions and feedback from the taxpayers, TE & F staff, and other stakeholders. I t will establish an ongoing monitoring and quality assurance program involving the launch and facilitation o f forums between appropriate internal and external stakeholders.

(a) Communications Program: The quality o f service that taxpayers can currently access varies across Pakistan. The reform strategy will address th is inequality and raise service standards across all areas. A key component o f this effort will be the application o f modern basic communication principles, ensuring that taxpayers have access information. Explanatory literature will also be developed and updated regularly. The literature (publications, brochures and booklets) will cover dissemination o f laws, rules, procedures and changes from time to time particularly with reference to the universal self-assessment

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and record keeping requirements.

(b) Intemet Facilities: The information super highway, or the Intemet, i s an important driving force behind the new work methodology, enabling improved communications both between CBR and the taxpayers as well as within CBR. By making IT an integral part of the organization, CBR will revolutionize the way it functions and manages i t s relationships with taxpayers by reducing the interaction with taxpayers.

(c) Call Centers: Considering evolving demands, a call center will be established to facilitate taxpayer contact through e-mail, letters, faxes and telephone calls. The potential to successfully introduce this component o f the TE 8z F function i s high. At present, ‘hits’ on CBR’s web-page show that a number o f taxpayers are willing to use modem @chnology to an extent that would not otherwise be possible were contact restricted to face-to-face consultations. Moreover, the call center will answer both internal and external questions and queries. As such, it will also be used as a communication tool to unify tax administration procedures and practices within the CBR itself.

(ivb) Taxpayer Identification and Registration The ability to identify taxpayer’s revenue activities i s an essential element o f a modem tax system and begins with registration. CBR’s intent i s to have a highly accurate taxpayer registration system for all tax purposes and for all taxpayers. This will: (a) facilitate exchange o f data; (b) avoid duplicate and erroneous registrations; and, (c) establish a database o f taxpayer information. Data scrubbing exercises have already been conducted by the MTU in Lahore to clean up and organize National taxpayer Numbers of taxpayers in i t s jurisdiction; th i s exercise will be extended to national scale with project rollout. Third party information will be matched against information declared by each taxpayer to ensure full and correct reporting and payment o f taxes. Interfaces will be built with such external reporting sources to capture appropriate data.

(v) Adopting Responsive IT Systems

The information technology strategy will help the CBR transform the way it functions and supports it’s reform objectives. The strategy will be driven by selected CBR officers from the tax administration and IT departments, supported by tax specialists and other specialists covering areas such as audit, HR, information communication technology (ICT) and taxpayer education.

Therefore the ICT strategy will be based on the following principles:

Determining a technology path that will support CBR’s ICT needs o f today and i t s future objectives considering i t s users’ skill level, and the need for a practical approach to bring technology to users; and, Providing technology to enable CBR to achieve i ts revenue and reform targets by making procedures and their application transparent and providing easy access to timely and accurate information for decision making.

The goal o f the ICT strategy i s to move from a highly manual to an automated environment in which computers are used to facilitate decision making by various functional and technical teams/ authorities. To support this, information will be made available at all strategic points within the organization to:

0 Improve management control to levels approximating those experienced in industrialized

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countries; Increase transparency o f tax administration; Reduce interaction with taxpayers in day-to-day operations; Manage information for broadening the tax-net, increasing revenues, and facilitating trade; Identify and adopt international best-practices; and, A l low for multi-directional communication under the electronic signatures ordinance, 2002.

0 0 0

0 0

Despite substantial past investments in information technology by CBR, desired results have not been achieved because standard IT development methodology has not been followed. IT project management has been inadequate with almost no preparation for a user interface, little management ownership and isolated systems development. Moreover, the development o f IT systems in the past has proceeded in an ad hoc and unplanned manner so that most departments operate stand-alone modules that are not integrated into the main system.

Learning from these previous mistakes, CBR’s IT strategy includes a long-term harmonized information management structure that provides complete, accurate, and up-to-date information, which i s delivered in a useful manner and at a reasonable cost. The I C T strategy moves away from manual systems to independent PC L A N s and enterprise-wide, network-based clients. It will move processing work to end users’ desktop while maintaining shared resources, thus reducing the load on centralized resources. Finally, the server technology will supply cost-effective computing and will provide the foundation for swift, effective and efficient execution o f all tax administration tasks. This will require that the entire process and work culture i s re-engineered. Experience indicates that organizational capacity in terms o f human resource plays a critical role in successfully deploying a new business strategy using information technology.

Information input, output, and storage requirements are a basic ingredient in any systems planning across the CBR, no less than transaction processing. Data management will thus be a key consideration in the Information Systems Planning process. A decision on the extent o f storage o f previous years’ data will be made by all relevant stakeholders as part o f a data management plan, prior to the commencement o f any large data conversion exercise. The storage, retrieval and cataloging o f these records, in electronic form preferably, will involve a coordinated plan starting from changes in tax law/regulation to design of the physical systems for movement o f paper, all the way down to design o f paper forms for annual returns going forward; a study and commensurate optimization along the entire chain o f information flow in physical and electronic form i s called for.

The CBR will maintain a two-tier M I S system which will provide al l statistical information and tools necessary to support multi-dimensional revenue analysis and predictiodprojection capabilities for CBR’s national budget exercise. The central M I S system will also provide modules to capture and process al l HR, financial and budget-related information including asset management.

A Central Information Depository System will also be developed providing easy, on-line access to all relevant acts, all SROs, case history, transaction profiles, sector profiles, revenue profiles, industry profiles, manuals, rules, procedures, publications and announcements. Currently, CBR employees do not have easy access to this information impacting their productivity. The provision o f th is repository would enhance employee productivity and improve working conditions.

(vi) Infrastructure Up-gradation and Development

CBR’s workforce tolerates working conditions which hinders their efficiency considerably. To address this,

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CBR will improve the physical worlung environment for i ts employees. As re-engineering and computerization o f working processes (and the reduced number o f tax offices) leads to reductions in the number o f s ta f f required, the per-capita cost o f providing better working conditions becomes more manageable. Better conditions are likely to translate into further improvements in productivity.

Office modemization so far i s mainly focused on a small number o f pilot sites. There i s a basic need to develop a comprehensive accommodation modemization plan. This plan should be developed simultaneously with the reorganization o f the tax administration as any delay in the latter could mean significant additional costs in independently implemented capital investments and rehbishments. In addition, offices will need to be consolidated and in the case o f sales tax and direct tax co-located. Currently, substandard short term leased accomodation i s not conducive to carrying out the business o f revenue administration. Finally, the ability o f the CBR to lease or rent accommodations o f appropriate quality i s compromised but the inability o f CBR to gain the necessary autonomy over managing i t s infrastructure required to remedy these issues.

This subcomponent supports: the preparation o f a comprehensive accommodation modemization plan in line with the roll-out o f the functional organization; the ownership o f more buildings by CBR as part o f the accommodation reform process; opening up the possibility o f entering into long-term leases for office space where major renovations have been carried out; gaining assurances for the Public Works Department that infrastructure will be routinely performed in a timely manner; granting sufficient authority to CBR so that needed infrastructure for the roll-out o f the LTU, MTU and RTOs i s available.

(vii) Program Management and Implementation

This component would finance a structure for implementing the project, including: a Project Management Unit (PMU) which would provide overall coordination as well as take responsibly for managing the incremental changes necessary to effect implementation o f each component and related activities o f the Project. The P M U would also be responsible for reporting on Project implementation and manage all disbursement, procurement and financial management activities under the project and according to Bank Guidelines.

An integral part of the P M U responsibilities will be establishing the monitoring and evaluation component o f the proposed project. The P M U has established performance indicators detailed in the Project Implementation Plan (PIP) to monitor impact o f the project and measure i t s success. The key areas that will be monitored include; the ratio o f revenue collected to GDP, taxpayer satisfaction surveys, audit enforcement, labor efficient processes, the use o f IT and the improved organizational structure. In each o f these areas the PMT w i l l prepare a baseline scenario with objective and subjective performance targets.

Project Cost Detail

Component

Management and Institutional Development Improving Revenue Operations Strengthening Revenue Services Creating a Tax Compliant Culture Adopting Responsive IT Systems Infrastructure Up-gradation and Development

9.29 92.72 6.63 6.26 3.65

24.00

6.2 62.2 4.4 4.2 2.4

16.1

7.90 80.20 5.64 5.33 3.30

18.03

6.3 63.7 4.5 4.2 2.6

14.3

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Program Management and Implementation Preparation Advance

Total Project Costs

Front-end fee

3.05 2.0 2.60 2.1 1 3.40 1 2.3, 1 2.90 1 2.3 1 149.00 100.0 125.90 100.0

0.00 0.0 0.00 0.0 Total Financing Required I 149.00 I 100.0 I 125.90 I 100.0 I

2. Key policy and institutional reforms supported by the project:

The proposed project supports the overall policy reforms o f the Government to improve delivery o f taxpayer services, raise tax revenues, and thereby improve enabling environment for private sector development. I t will also have broader implications for civil service reforms as discussed in the following paragraphs.

3. Benefits and target population:

If the outputs of the project (e.g. an autonomous CBR, improved tax collection processes, enhanced voluntary compliance and improved audit) are successfully implemented, then the major benefits from the project would be: (i) qualitative improvements in tax administration in terms o f effectiveness and transparency; (ii) more equitable treatment o f taxpayer, and reduction in taxpayer’s cost o f compliance with tax laws; (iii) measurable improvement in monitoring and control (financial and physical) o f imports; (iv) increased tax revenues; and, (v) improvement in the enabling environment for private sector development.

The immediate target beneficiaries would be taxpayers at the household and corporate levels, and tax administration departments and collectorates. Measures included in the project would also encourage the private sector to move from the informal to the formal sectors. Businesses would be encouraged to grow and pay their fair share o f taxes without undue hassle and time spent complying with regulations. The recently completed Investment Climate Assessment (ICA) for Pakistan revealed that this was one of the major constraints to business growth and development.

The proposed project will also have the following secondary benefits: (i) for the f irst time an attempt would be made to address corruption, inefficiency o f public administration, and governance issues in one o f the most critical government agencies; (ii) test methods to address problems that plague the whole o f Pakistan’s public administration; and, (iii) generate knowledge that can be a guide for Government’s broader civil service reform.

The Bank’s recent report, ‘A Framework for Civ i l Service Reform in Pakistan’, supports the proposed tax administration reform process on account o f i t s demonstration effects for undertaking broader c iv i l service reforms. Introducing increased efficiency in raising tax revenue implies that the government would reduce the amount spent on tax administration and reduce the need for skilled managerial resources in this area.

If successfU, the Project targets to raise government revenues from a current base o f Rs.5 18 bil l ion to Rs.960 bil l ion over a period o f five years (based on revenue projections done for purposes o f cost-benefit analysis as mentioned in Annex 4). This would go a long way to reduce the budget deficit, reduce the government’s reliance on non-tax sources o f income and allow greater fiscal space for pro-poor budgetary allocations.

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4. Institutional and implementation arrangements:

(a) Institutional arrangements:

(i) The new Chairman o f CBR i s fully committed to undertake the reforms. Private sector professionals were inducted as members to head h c t i o n a l areas, middle management i s being trained in change management, new qualified people are being inducted from outside, and a restructuring team o f CBR staff members was selected to spearhead the reform internally. To ensure sustainability o f reforms, a Cabinet Committee for Finance and Revenues (CCFR) headed by the Finance Minister was created and the Board was given a permanent fixed-term tenure, granting CBR greater autonomy from the government. CBR, through CCFR was also given financial and managerial autonomy on staff recruitmentkompensation and investments in training and facilities for the purpose o f institution building. The Chairman o f CBR, and the Board would be responsible for overall implementation o f the project, with each member responsible for implementation o f components within hisher functional area.

Executing Agency: The Central Board o f Revenue (CBR) will be the implementing agency.

(ii) Member Policy and Restructuring. The member reports to the Chairman. The unit, apart from several key administration staff will also h i re full-time outside consultants to assist in implementation o f the respective project components. An integral part o f the P M U responsibilities will be to establish monitoring and evaluation component o f the proposed project. The P M U has established performance indicators detailed in the Project Implementation Plan (PIP) to monitor impact o f the project and measure i t s success. The key areas that will be monitored include the ratio o f revenue collected to GDP, taxpayer satisfaction surveys, audit enforcement, labor efficient processes, the use o f IT and the improved organizational structure. In each o f these areas, the P M U will prepare a baseline scenario with objective and subjective performance targets.

Proiect Management Unit (PMU): The unit has been constituted and i s operating under

(iii) Accountinp financial reporting and auditing arrangements: Project records and accounts would be maintained by the P M U to reflect, in accordance with sound accounting practices, the operations, resources, and expenditures for each project activity. The accounts will be consolidated annually into financial statements for the project as a whole. Supporting documentation will be made available to Bank missions and independent auditors as required. For expenditures incurred on the basis o f Statements o f Expenditures (SOEs), al l records providing evidence o f such expenditures will be retained by the P M U until at least one year after the Bank has received the audit report for the fiscal year in which the last withdrawal from the Credit Account or payment out o f the Special Account i s made, whichever i s later. Project records and accounts, including the Special Account and SOEs, wi l l be audited annually in accordance with appropriate auditing principles consistently applied by auditors acceptable to the Bank, with terms o f reference for auditors and reports approved by the Bank. The Bank’s Financial Accounting, Reporting, and Auditing Handbook (FARAH) published in January 1995 would be used by the auditors in accordance with the Bank’s auditing guidelines. Audit reports will be furnished to the Bank, within four months after the closure o f the Government’s fiscal year.

(b) Project Implementation:

The Project will be implemented over a five year period. Sub-project rollouts will be staggered to minimize resource pressure. The basic underlying premise o f the project i s the P M U will be responsible for overall implementation along with al l Members who would be responsible for delivering results in their own

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functional areas. Implementation performance will be monitored by the P M U and reviewed quarterly by Bank Staff (including consultants as necessary) to enable the Bank and the Government to evaluate achievement o f project objectives. Such reviews would also enable, at an appropriate time, determination o f the size, scope and timing o f a possible follow-on project and wi l l also feed into the wider civil service reform initiatives.

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

Pakistan’s fiscal crisis i s deep and cannot easily be resolved. The low level o f tax collection has jeopardized national goals o f poverty alleviation and improvement in public services like health care and education. Taxes collected are currently insufficient for debt-service and defense. Therefore, the reform o f tax administration i s one o f the most pressing tasks for the government. There i s little choice but to tackle this area head-on. Government has therefore made a firm commitment to address these issues. Having made this decision, there are a number o f ways to achieve th is end.

Firstly, some governments around the world have decided to adopt an independent revenue authority model while others have decided to reform tax administrations that remain more firmly under the control o f the Ministry o f Finance. Secondly, government could decide to adopt a piece-meal approach to the reform process deciding to reform tax administration in a modular fashion, evolution rather than revolution. Thirdly, government could continue to conduct i t s operations on the same basis rather than moving towards a compliance culture and voluntary self-assessment. Confronted with each o f these decisions, the government has gone for the later option.

In terms o f Bank instruments that could support such a reform program, the government could have chosen a Learning and Innovation Loan (LIL), an Adaptable Program Loan (APL) or a Structure Adjustment Credit (SAC).

(0 A LIL was considered early in the preparation process. A LIL could have been used to pilot reforms in one key area and then look to scale up the results and develop a larger more longer term project at a later stage. This approach was rejected for a number o f reasons. Firstly, piece-meal reforms have been tried in the past and have run against bureaucratic inertia in other areas o f the CBR. I t i s impossible to expect one small part o f the tax administration to function efficiently unless the whole culture i s reoriented. Secondly, government felt that in preparing a LIL and then waiting for the outcomes o f the innovation and building them into a more comprehensive project would risk losing the reform momentum and allowing the vested interests against reform to regroup and oppose future reform measures.

Introducing a LIL (Comprehensive Reform Vs Incremental Reform)

Therefore, the main strategic choice made by the Government was to eschew incremental measures to strengthen tax administration in favor o f a more fundamental and faster-paced change strategy. This reflected widespread demand for basic reform, the critical need to increase revenues on a sustained basis, serious doubts that current personnel and compensation policies and practices would permit meaningful improvements in tax collection, and the less-than-satisfactory results o f previous remedial efforts. For these reasons, government has decided to reject the LIL approach and go for an investment loan.

- 25 -

(ii) An adaptable program loan could be used to support a phased implementation o f reforms. This would have the advantage that the Bank could review progress during the course o f the reform program and approve future credit tranches on the basis o f performance achieved during program implementation. However, govemment preferred to seek a stronger signal o f support to the entire reform program from the Bank in order to strengthen i ts reform agenda. Choosing the investment loan over the APL has greater r isks for the Bank in case there i s a change in government, unforeseen resistance to reform or slow implementation. However, government has shown a strong commitment and ownership o f this essentially home-grown program and it was felt that an investment loan would be the most appropriate instrument to support this program. In order to address the down-side risk, the program includes a risk mitigation, exit strategy (see below under risks).

An Adaptable Program Loan (APL)

Project I Sector Issue

(iii) The other alternative that could be used to support such a reform program i s the Development Policy Loadcredi t (DPL). Although such an instrument could be used to support a broad reform program, government felt that it would be inappropriate in th is case as; the reform objectives are very detailed and would not be well-supported by a high level policy matrix, the timeline required for such ambitious reforms stretches to several years whereas the D P L would traditionally be disbursed in a shorter time period. Moreover, the D P L approach would not be as efficient to direct resources to a large number o f complex inter-related tasks.

A development policy loadcredit (DPL)

(PSR) Ratings

2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned).

The State Bank o f Pakistan i s undergoing a s imi lar reform program involving improvements in i t s policies, processes and systems. The Bank has supported these reforms through (i) the Financial Sector Deepening and Intermediation Project, which closed in FYO 1, and during implementation was restructured as a TA project; and, (ii) the Banking Sector Technical Assistance Project which i s ongoing and includes broader financial sector reforms.

The ongoing Financial Reporting and Auditing (PIFRA) Project which has to an extent been able to restructure the Office o f the Auditor General and Controller General o f Accounts through separation o f the accounting and auditing functions o f the department. A second phase o f this project i s under preparation which aims to deepen and broaden the reforms

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3ank-financed 4ccounts and Auditing

Asian Development Bank

International Monetary Fund

3anking

Modemization o f Customs Administration Project - PAK Loan33140-01

Tax Administration TA Missioi February 2003

Banking

Tax Administration

Tax Administration

Tax Administration

Tax Administration

Trade & Transport Facilitation

Public Sector Capacity

PIFRA-I (CreditCR292 1 -PAK)

Financial Sector Deepening and Intermediation (LoanLN3 808-PAK)

Banking Sector Technical Assistance (CreditCR3 688-PAK)

Revenue Administration Refom Project - Bulgaria; Ln3384S

Second Tax Administration Modemization Project - Russian Federation; Ln46880

Tax Administration Reform Project - Jamaica; CPL-3758OiSCL-3758A I

Tax Administration Modemization Project - H w w Y ; CPL-36350;SCL-3535A; SCPM-3 63 5 S

Trade and Transport Facilitation Project (CreditCR3 500)

Public Sector Capacity Buildinj

(Bank-finance Implementation Progress (IP)

l___L

S

S

S

S

S

S

S

S

S

I (Highly Unsat

lrojects only) Development

Objective (DO)

S

S

S

S

S

S

S

S

S

ICtOry)

- 27 -

3. Lessons learned and reflected in the project design:

Lessons learned from Bank supported tax administration reforms in LAC, EAP, ECA Regions, and previous efforts to improve tax administration in Pakistan, highlight the following as success factors: (i) high level political support and ownership o f program; (ii) presence o f ‘champions o f change’ within the tax department; (iii) market based salary structures and merit based career development prospects; (iv) special attention to taxpayer facilitation; (v) reduction in the discretionary powers o f tax officials; (vi) simplification o f procedures for filing and processing o f tax returns; (vii) establishment o f a consultative process with representative trade bodies in tax administration matters to improve compliance; (viii) training and greater continuity o f s taf f in functional postings to develop expertise; and, (ix) adequate counterpart funding for the project and adequate funding for tax administration; (x) the project involved extensive consultations with all major donors including IMF, ADB, DFID, USAID that was spread over several missions and in some cases involved joint missions with IMF, DFID provided donor support in the form o f a grant.

The project contains the following features to incorporate the lessons learnt:

0 0

Ownership: Support o f the governments’ own initiative to reform tax administration. Commitment to reform: Supported at the highest levels o f government, with clear public commitment o f the Finance Minister to overhaul tax administration. Commitment o f Chairman CBR and management s ta f f to reforms. Vision and Strategy: CBR has ‘vision’ o f a renewed tax administration system that i s shared. I t has already developed a strategy to achieve this vision that has been approved by the Cabinet. Compliance culture: make efforts to promote tax compliance, through the provision o f improved services, a self assessment system, as well as implementation o f a strengthened audit effort to raise the perceived risk o f detection o f non-compliance; Customer-oriented: a large effort will be made to educate tax payers and ensure their satisfaction with the tax collection service; and Incentives: introduce better and performance based staff incentives, Institutional Arrangements: an established mechanism to ensure smooth implementation and adherence to Bank guidelines on procurement and financial management.

0

0

0

0

0

4. Indications of borrower commitment and ownership:

L o w levels o f tax collection have seriously curtailed Government spending on poverty reduction as well as on improvement o f public services. Tax reforms are, hence, being singled out as the foremost priority o f the government and improvements in tax administration categorically promised by the Finance Minister and are integral to Government’s Poverty Reduction Strategy.

The strength o f the Government’s commitment to tax administration reform i s shown by the following: (i) approval o f the tax reform program by the Cabinet; (ii) creation o f CCFR constituted o f key Cabinet ministers and federal secretaries and headed by the Finance Minister; (iii) the authorities have visited abroad and invited officials from other relevant countries to learn from their experiences; (iv) CBR has set up a Restructuring Team, spffed by the best and the brightest personnel, to be full time counterparts to implement reforms headed by Member Policy and Restructuring; and (v) set up o f the Large and Medium taxpayer units; (vi) pilot projects in customs and sales tax areas; (vii) introduction o f renewed human resource policies, improved salary structure for staff qualified to work in pilots along with a new performance management system.

In addition, the Finance Minister, in his FY05 budget speech to the Parliament, highlighted Government’s

- 28 -

tax policy and administration reform initiatives and emphasized the importance to further the process o f administration reforms.

5. Value added of Bank support in this project:

Bank support would provide high-quality technical advice based on worldwide and regional experience in tax administration; convey credibility and transparency to the reform effort; strengthen the hands o f the pro-reform elements in the Government and CBR; and promote efficient and effective use o f the resources supporting the Government’s program. The Bank during the reform process in collaboration with other donors provided both technical asssistance from IMF and grant financing from DFID.

In addition, the pilot initiatives in tax administration that were supported by the Bank, have started to show positive results and it would be highly valuable for the Bank to support implementation and replication o f these reforms on a national basis for the country to realize i ts full benefits.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4): 0 Cost benefit 0 Cost effectiveness 0 Other (specify)

NPV=US$34928 million; ERR = 3 15.7 % (see Annex 4)

The main economic benefits of the tax administration reforms can be summarized as:

0 An increase in government revenues as a result o f widening o f the tax base in terms o f more taxpayers and more transactions coming into the tax net out o f the grey or underground economy; (financial benefits) Improvement in customs procedures aim to reduce the average time to clear customs fi-om the existing 8 days to 1 day by the end o f the project period. This will reduce the cost o f doing business since it will reduce the number of days importers need to borrow from banks to finance imports. Improvement in voluntary tax compliance rates implying early revenue generation for the government, saving interest payments and administrative costs related to enforcing compliance; Reduction in taxpayers’ costs associated with tax compliance; Economy-wide gains to the private sector as an increasing number o f economic agents operate under the same set o f rules and taxes, enhancing competition (more level playing field); Greater predictability o f tax liability and lower costs o f doing business for the private sector.

0

0

0

0

0

All the economic benefits o f tax administration are not measurable. In this exercise, only the f irst four benefits summarized above have been measured and included in the financial costibenefit analysis. Apart from the revenue benefits discussed below, the non-revenue benefits measured here are:

0 Reduction in number o f days it takes to clear customs means lower interest costs for private sector calculated using the value o f total imports, average bank lending rate and savings in days to clear customs. Improvements in voluntary tax compliance rates means revenue will accrue to the government at am earlier date than before the reform, which could involve a lengthy period o f audit and possible litigation. The gains to the government are equivalent to the potential interest earning on increased voluntary compliance revenue, where the average interest rate on public debt reflects the potential earnings of revenue. Data on voluntary tax compliance i s available for direct taxes during the last

0

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two years, the period o f reforms. I t i s assumed that the improvement w i l l continue at the current pace for the next 12 years. Reduction in taxpayers’ costs associated with tax compliance can only be estimated for corporate taxpayers. It i s assumed that this i s in terms o f reduction in time spent by corporate accountants and staf f to comply with direct tax, sales tax and customs regulations. Various assumptions were made regarding the number o f accountants, their average salaries and the average time savings.

0

2. Financial (see Annex 4 and Annex 5): NPV=US$ 34552 million; FRR = 302.3 % (see Annex 4)

The N P V o f government costs are insignificant compared to the financial and economic benefits o f the project. Naturally the FRR of the project i s very high. The financial benefits o f tax administration reform have been measured in terms o f an increase in the tax/GDP ratio. The CBR tax/GDP ratio rose to a peak o f 12.6 in 1995196, declining in subsequent years and averaging about 11.5 over the last 8 years. An improvement in the TadGDP ratio above 1 1.5 has been attributed in the projection period to Tax Administration Reform in terms o f widening o f the tax base. The financial benefit i s the increase in revenue due to improvement in the ratio.

The analysis was carried out in a number o f variants. The f i rs t i s a standard analysis, in which the future stream o f revenue i s calculated on the basis o f a GDP elasticity o f revenue o f 1.2. In the second variant, an alternative process i s used to estimate that stream o f revenue, which will make the present value o f financial benefits equal the present value o f costs o f the government. In the third variant, the cost benefit analysis does not take into account revenue benefits o f the government and focuses only on the benefits included in the economic benefits (excluding the financial benefits). In the final and fourth variant, total revenue projections are the same as in the f irst variant (based on an elasticity o f 1.2) but the increase in revenue attributable to the tax administration reform i s limited to the increase in revenues expected from LTUs & MTUs. For all these variants, the cost o f the project has been treated in two ways. In the first, the analysis has treated the government’s initial investment as equity and the IDA loan as a standard loan, treating repayment o f the loan over 15 years (instead o f the actual 40 years which would increase the N P V significantly) as continuing costs o f the government (standard treatment) to calculate the ‘government’s NPV o f costs and benefits’. As an alternative, the analysis treated the entire cost o f the project as equity investment and calculated the FRR on the total investment.

Main assumptions:

0

0

0

GDP and inflation projections: GDP rising gradually to 6% in year 7 and remaining constant subsequently; inflation fixed at 4% Exchange rate fixed at Rsl$= 57.5 Discount rate for N P V calculations = 5%

CBR tax/GDP derived from GDP elasticity o f revenue o f 1.2; the ratio rises from 1 1.74 in 2003104 to 13.5 in 2008109.

Fiscal Impact:

The changing structure o f taxation has made projecting revenue a difficult exercise. However, in recent years the share of indirect taxes in total revenue has stabilized suggesting that the tax reform has more or less worked i tse l f through and i ts impact on revenue shares i s unlikely to be unpredictable. In addition, tax administration reforms are starting to produce positive results. Hence, revenue projections are less likely to

- 30 -

fail due to failure in projecting W G D P values than due to overestimation o f GDP growth rates. In th is context, it i s useful to note that 2002103 was the f irst t ime that the start-of-the-year revenue target (Rs.460 billion) was achieved and the target (Rs.5 10 billion) for 2003/04 was also realized.

The relationship between federal tax revenue and its base (GDP at market prices) has been examined using regression analysis. The results indicate that the taxation structure has become buoyant overtime. The elasticity o f tax revenue with respect to GDP has increased from 0.978 in the early 90’s to 1.158 in recent years. An elasticity of 1.2 has been used here to make projections since it gives accurate ex post projection results. Revenue projections have been made using IMF projections o f GDP and inflation that are consistent with the Public Sector Debt Sustainability Framework (PSDSF) for 1998/99 - 2008/09.

3. Technical:

CBR has developed a comprehensive organization-wide information systems plan - focusing on commonality o f platforms, data structures, data storage, business process, and application design. Use o f information technology and automation would not only bring efficiencies within the organization but would help improve transparency in the process of tax collection, reduce discretion and, as a result lower the cost o f doing business for the private sector.

4. Institutional:

4.1 Executing agencies:

The Central Board o f Revenue (CBR) will be the implementing agency under a Project Agreement to be entered into between the Bank and the CBR. The new Chairman o f CBR i s fully committed to undertake reforms. Private sector professionals were inducted as members to head functional areas, middle management i s being trained in change management, new qualified people are being inducted from outside, and a restructuring team o f CBR s ta f f members was selected to spearhead the reform internally. To ensure sustainability o f reforms, a Cabinet Committee for Finance and Revenues (CCFR) headed by the Finance Minister was created and the Board was given a fixed-term tenure, granting CBR greater autonomy from the government. CBR, through CCFR was also given financial and managerial autonomy on staff recruitmentkompensation and investments in training and facilities for the purpose o f institution building. The Chairman of CBR, and the Board would be responsible for overall implementation o f the project, with each member responsible for implementation o f components within hidher functional area.

4.2 Project management:

The unit has been constituted and i s operating under Member Policy and Restructuring. The Member reports to the Chairman. The unit, apart from several key administration staff will also hire full-time outside consultants to assist in implementation o f the respective project components. An IT program manager will be responsible for deputizing for the lead consultant and focusing on technology and development issues. An integral part o f the PMU responsibilities will be establishing the monitoring and evaluation component o f the proposed project. The P M U has established performance indicators detailed in the Project Implementation Plan (PIP) to monitor impact of the project and measure i t s success. The key areas that will be monitored include; the ratio o f revenue collected to GDP, taxpayer satisfaction surveys, audit enforcement, labor efficient processes, the use o f IT and the improved organizational structure. In each o f these areas the P M U will prepare a baseline scenario with objective and subjective performance targets.

4.3 Procurement issues:

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Procurement o f goods and civil works wi l l be carried out in accordance with the Bank's Procurement Guidelines, and procurement o f consultants' services in accordance with the Consultants' Guidelines. The procurement capacity assessment and applicable procurement procedures are provided in Annex 6A.

4.4 Financial management issues:

Project records and accounts would be maintained by the P M U to reflect, in accordance with sound accounting practices, the operations, resources, and expenditures for each project activity. The accounts will be consolidated annually into financial statements for the project as a whole. Supporting documentation will be made available to Bank missions and independent auditors as required. For expenditures incurred on the basis o f Statements o f Expenditures (SOEs), all records providing evidence o f such expenditures will be retained by the P M U until at least one year after the Bank has received the audit report for the fiscal year in which the last withdrawal from the Credit Account or payment out o f the Special Account i s made, whichever i s later. Project records and accounts, including the Special Account and SOEs, will be audited annually in accordance with appropriate auditing principles consistently applied by auditors acceptable to the Bank, with terms o f reference for auditors and reports approved by the Bank. The Bank's Financial Accounting, Reporting, and Auditing Handbook (FAMH) published in January 1995 would be used by the auditors in accordance with the Bank's auditing guidelines. Audited Financial Statements will be fwnished to the Bank, within six months after the closure o f the Government's fiscal year.

5. Environmental: 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis.

No t Applicable

5.2 What are the main features o f the EMP and are they adequate?

Not Applicable

5.3 For Category A and B projects, timeline and status o f EA:

Environmental Category: C (Not Required)

Date o f receipt of final draft: Not Applicable

5.4 How have stakeholders been consulted at the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms o f consultation that were used and which groups were consulted?

Not Applicable

5.5 What mechanisms have been established to monitor and evaluate the impact o f the project on the environment? Do the indicators reflect the objectives and results o f the EMP?

Not Applicable

6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes.

The social issues that emerge from the project are the impact o f the reform on people. One o f the social benefits i s more equitable treatment o f taxpayer and a fall in the taxpayers cost o f compliance.

The project aims to improve the service delivery through taxpayers' facilitation and aims to educate the taxpayers to ensure their satisfaction with tax collection service. In this context i t will introduce a program

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that i s transparent, fair, simple, automated and cost-effective. Thus, also meeting the social development objectives.

In order to solve the problem o f overstaffing, the government may also undertake rightsizing. In this context, the project will be sensitive to the social cost o f the activity for which staff competencies will need to be assessed. There would be opportunities for retraining staf f meeting the requisite competencies or suitable to be trained. Other staff will be at Government's disposal and would likely be provided compensation for early retiremenfloluntary Retirement Scheme. In case o f the VRS option, a VRS assessment will also be conducted.

Custom and tax fraud affect the entire economy (social, economic and industrial). To protect against th i s threat the Custom and Tax Fraud Division will be set up that will need to win professional respect and trust o f i t s counterparts. The building o f trust and breaking down o f barriers i s a slow process and also a social development outcome. A specialist training program is envisaged towards th is objective.

Another social issue'that may arise would be the project's ability to be inclusive in i t s service delivery. Closely related to this i s the project's aim to minimize contact between taxpayers and tax officials and reduce discretionary powers of tax officials. This would directly benefit all groups particularly those groups that do not have access to higher echelons o f powers.

Finally, the project aims to provide a "voice" to stakeholders through the establishment o f the consultative process with representatives o f trade bodies in tax administration to improve compliance.

6.2 Participatory Approach: How are key stakeholders participating in the project?

Key stakeholders have been involved with the project all through i t s development cycle via a series o f stakeholders consultation that have been held from the initial stages. Additionally, stakeholder consultation are in-built into the project and will occur at regular intervals to obtain feedback and improve the design and implementation.

6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations?

Consultations have been held and will be held with relevant civil society organizations as well as trade and business bodies who are major stakeholders o f the project. One o f the mechanism i s the establishment o f a consultative process with representatives o f trade bodies (that represent the trade and business communities). Regular consultations are in-built into the project.

6.4 What institutional arrangements have been provided to ensure the project achieves i t s social development outcomes?

The social development outcomes are a component o f the the project's outcomes (and not independent o f the project) hence the institutional arrangement being put in place for the project will also achieve the social development outcomes.

6.5 How will the project monitor performance in terms o f social development outcomes?

The monitoring indicators o f the project will also reflect the social development outcomes. Some of them are :

0

0

Taxpayers satisfaction through stakeholder opinion on quality o f service provided (collected through structured survey conducted) Impact o f removal o f discretionary powers o f tax officials (reflected through surveys)

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0

0

Responsiveness to consultative process (measured by changes brought about as a result o f feedback) Public perception o f revenue administration integrity as measured by periodic surveys

7. Safeguard Policies: - 7.1 Are any o f the following safeguard policies triggered by the pro’ect . ’F Triggered 1 --

-- Policy

Safety of Dams (OP 4.37, BP 4.37) Projects in International Waters (OP 7.50, BP 7.50, GP 7.50)

0 Yes 0 No 0 Yes 0 No

Proiects in DisDuted Areas (OP 7.60. BP 7.60. GP 7.60)* YAP (. Nn L

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

This i s a tax reform project and safeguard policies are not applicable.

F. Sustainability and Risks 1. Sustainability:

Prospects for sustainability increase when the Government i tse l f drives a reform program and incorporates intemational experience and stakeholder feedback in the design. The Government has discussed the reform program at various levels to ensure stakeholder buy-in. In addition, a clear strategy has been prepared providing for implementation o f reform measures over the short, medium and long term. The short term measures have already shown visible and positive outcomes which give strength to the reform program and improve i t s chances o f being sustainable.

2. Critical Risks (reflecting the failure o f critical assumptions found in the fourth column o f Annex 1):

The project i s classified as ‘substantial risk’. Reforming CBR involves challenging various vested interests which have existed for decades and have a strong hold in the political and bureaucratic circles. However, if CBR i s able to capitalize on the government’s commitment to reform as well as the momentum generated through it own short term measures, it can quickly move forward with the broader reforms before any vested interests creep-in to slow down the process. There are massive gains to be made for the entire economy if the reforms are implemented successfully and are sustained in the long run.

The following critical r isks can affect project implementation:

e several initiatives and i s embarking on a broad based reform program for restructuring o f tax administration machinery. The reform momentum already generated could slow down if CBR i s unable to capitalize on the current support for reform from within, related government departments and other stakeholders. It i s essential that CBR moves forward with timely reforms which demonstrate concrete outcomes that would be difficult to reverse and to ensure continued support from the

Lack of continuous support from the Government due to vested interest: CBR has introduced

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government.

S

a Insuflcient support to provide the required level of independence and autonomy: Although CBR has been given autonomy within the government setup through creation o f CCFR, implementation of CCFR’s decisions can get held up at the ministerial level which may derail the reform process. It would be important for the govemment to gives its support for ensuring effective implementation o f the Cabinet Committee’s decisions.

Tax reforms have been singled out as the foremost priority o f the govemment. Approval o f tax reform program by the Cabinet and creation o f CCFR among some initiatives indicating commitment and ownership o f the reform process by the highest levels o f the Government.

e Staff resistance to change including opposition from interest groups: Reform implementation would not proceed smoothly if there i s resistance to reform from within CBR. To avoid this, CBR has held quite a number o f change management workshops and has obtained a certain level o f support which was critical to initiate the reform process. It would be important that similar measures are integrated into the reform strategy to ensure continued staf f buy-in into the program. In addition, efforts need to be made to provide assurances to staf f at all levels o f fair and equitable treatment during implementation through the change management leadership.

a Implementation risk: Reform can only succeed with strong ownership and commitment. Delays in implementation o f the reforms can weaken government commitment jeopardizing the entire reform process. I t i s important that there i s strong leadership which can guide and oversee implementation. Professional program managers will need to be inducted into the Policy and Tax Reform team overseeing the implementation. In addition, there need to be mechanisms built into the reform program which would gather feedback during implementation to incorporate lessons and ensure continued support from the stakeholders.

a reform projects. To avoid this, CBR has developed a strategy where ‘pilots’ in critical reform areas would be implemented prior to undertaking institutional restructuring and changes in systems at the country level. These pilots will enable CBR to form accurate expectations about the results o f reforms at the country level as well as incorporate feedback into the process. In addition, CBR i s continuously reviewing international experience o f similar reforms and incorporating the relevant lessons learnt.

Program not yielding desired resultdoutcomes: This i s always an issue when implementing large

a

have been addressed. Other safeguard risks -financial management, procurement, social and environment: These

Risk I Risk Rating 1 Risk Mitigation Measure From Outputs to Objective Lack o f continuous support Government in policies.

by the

IContinued political interference. H The project provides for the restruring o f CBR within the Government setup. However, CBR will have necessary autonomy to operate and take decisions with respect to hiring,

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Impact o f reforms may not be f i l l y visible in the initial years and there may even be i plunge in revenues which could lead to resistance by vested interests.

S Key stakeholders, including trade bodies, have been involved with the project throughout i t s development cycle via a series o f consultations and the feedback has been incorporated into the project. Moreover, input from various stakeholders will be sought throughout at regular intervals in order to improvise on the design and implementation o f the project.

Delays in implementation due to bureaucratic processes.

From Components to Outputs Resistance to change by staf f causing problems in implementation o f tax administration reforms.

Inadequate support to rationalize workforce and implement performance based reward mechanism.

interest groups; e.g., trade bodies.

Limited capacity o f CBR to implement technology and risk-based systems including customs.

M

M

S

The project introduces better and performance based s ta f f incentives to rationalize workforce. Additionally positions at the senior managemen level have been created and private sector professionals recruited in order to introduce be! practices and preparing CBR to implement the proposed reforms.

Strengthening Revenue Services component o f the project ensures that CBR i s fully geared to implement broad based reforms addressing critical risk management issues.

remuneration, placement, promotion and other day-to-day tax implementation issues.

CBR's existing structure i s deep and highly bureaucratic and the process o f change will be long and painful. However, a more efficient and effective revenue administration model will facilitate and promote voluntary compliance and increase overall collection results in the long run. The "pilots" in critical reform areas, implemented prior to undertaking institutional restructuring and changes in systems at the country level, would enable CBR to form accurate expectations about the results and incorporate feedback into the process to achieve desired results.

M Adequate monitoring and established mechanisr to ensure smooth implementation have been outlined under the project.

I

S In order to gain intemal buy-in prior to initiatin the reforms, a number o f "Change Management workshops and face-to-face discussions with staf f have been carried out.

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Success in managing public perception and inculcating tax compliant culture especially confidence o f tax payers in the impartiality of the self assessment policy.

Variance in the actual versus perceived independence o f arbitration and adjudication process.

I

Limited capacity o f CBR in terms o f project management and coordination within different departments to implement proposed administration reforms.

S

S

M

Overall Risk Rating S Risk Ratina - H (High Risk), S (Substantial Risk), M (Modest Risk), P - . - . . . . H

rhe tax education and facilitation function will include a strong and well coordinated Zommunications program to generate a Zompliance-oriented and a user-fiiendly interface between the CBR and taxpayers. The proposed tax administration system will be kansparent, fair, automated, simple and 2ost-effective. This i s expected to be achieved through the establishment o f TFCs.

The quality assurance and monitoring program will ensure that the reform process responds to &payer expectations as well as measure performance o f the project.

Under the Management and Institutional Development component, the project proposes a new CBR training strategy to meet the requirements of the new functional organization, including the core area o f management, an integrated training directorate for the tax and customs administration, preparation and supervision o f training needs analysis as a part o f the annual performance evaluation process and allocated budget resource to the training function. Professional program managers will need to be inducted into the Policy and Tax Reform team overseeing the implementation.

Negligible or Low Risk)

3. Possible Controversial Aspects:

None

G. Main Loan Conditions 1. Effectiveness Condition

Standard Conditions for IDA Credit and DFID Grant will apply.

2. Other [classify according to covenant types used in the Legal Agreements.]

0

0

CBR would prepare and furnish to the Association financial monitoring reports on a quarterly basis. CBR will maintain a financial management system, including records and accounts, and prepare financial statements in accordance with consistently applied accounting standards acceptable to the Association. CBR will have the Project records and accounts, including the Special Account and SOEs, audited 0

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annually in accordance with appropriate auditing principles consistently applied by auditors acceptable to the Bank, with terms o f reference for auditors and reports approved by the Bank.

H. Readiness for Implementation 0 1. a) The engineering design documents for the first year's activities are complete and ready for the start

[xi 1. b) Not applicable. o f project implementation.

2. The procurement documents for the first year's activities are complete and ready for the start o f

[xi 3. The Project Implementation Plan has been appraised and found to be realistic and o f satisfactory

0 4. The following items are lacking and are discussed under loan conditions (Section G):

project implementation.

quality.

1. Compliance with Bank Policies 1. This project complies with all applicable Bank policies.

0 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies.

\L WQJ! i. --J

Mudassir Khan Simon C. Bell John W. Wall Team Leader Sector ManagerlDirector Country ManagedDirector

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Annex 1: Project Design Summary PAKISTAN: Pakistan Tax Administration Reforms Project

I Hierarchy of ObJectives Sector-related CAS Goal: Improving prospects for stable economic growth by reducing fiscal imbalances; and enhancing private sector development, institutional strengthening and increasing efficiency, accountability and transparency o f core fiscal functions o f the public sector, while encouraging greater documentation o f the economy.

Project Development Objective: Improving organizational efficiency and effectiveness o f revenue administration.

I

I

Improving compliance management through strengthened audit and enforcement capacity and transparent and high-quality tax service

Key Performance Indicators

Sector Indicators: 0 Total tax revenues

collected by CBWGDP 0 Tax revenues collected by

sector/GDP 0 Perception o f enterprises

regarding the nature and severity o f impediments to private sector development, if any, imposed by the tax administration

0 Average time taken by new businesses to register for tax purposes

3utcome I Impact ndicators: 0 Average number o f days

taken to identify and notify taxpayers who fail to f i le tax declarations or pay taxes

0 Numberof taxpayers/number o f tax administration employees

0 Reduction in the overall ratio ‘Employees at officer levellemployees at staff level’

complaints to the tax administration

0 Average number o f days taken to process a sales tax refund

0 Percentage o f tax returns filed electronically

0 Reduced number o f

0 Number of registered active taxpayers

e Ratio “Amount o f taxes paid on timenotal amount o f tax assessed”

e Ratio ‘additional taxes collected after tax audit/number o f tax audits conducted”

Data Collection Strategy

Sector1 country reports: 0 CAS monitoring

activities 0 Government economic

and sector reports 0 CBR and Ministry o f

Finance reports 0 World Bank project

supervision reports 0 Periodic surveys o f

taxpayers and other stakeholders

’roject repotts:

0 CBRreports 0 World bank project

supervision reports 0 IMFreports 0 Periodic surveys o f

taxpayers and other stakeholders

0 CBRreports 0 World Bank project

supervision reports 0 IMFreport 0 Periodic surveys o f

taxpayers and other stakeholders

Critical Assumptions from Goal to Bank Mission) 0 Political stability 0 Continued public

pressure for improved public sector performance

from Objective to Goal)

0 Continued government commitment to reforming public sector institutions and facilitating private sector development

0 Maintenance o f sound macro-economic and fiscal policies

0 Ability to adjust to external shocks

0 Continued political support for the modernization o f the revenue collection system

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I

Improving trade facilitation through modern and internationally accepted customs procedures

I

Improve integrity and fairness o f tax administration

Output from each Component:

0 Amount o f tax arrears recovered in a fiscal yearhotal amount o f arrears at the beginning o f the fiscal Year

0 Perception o f taxpayers regarding the quality o f service provided by the CBR measured by periodic surveys

0 Performance against agreed standards for responding to telephone, personal, and written inquiries

0 Using the risk based approach, reduce the number o f import declarations selected for physical inspection at designated sites to 20 percent

customs clearance time at the border to under lday by the end o f 2006, and by to under 4 hours by end o f the project, at designated sites

0 Perception o f traders and other stakeholders regarding the quality o f services responsiveness to complaints and integrity o f customs administration as indicated by periodic surveys

0 Reduce the average

0 Public perception o f revenue administration integrity as measured by periodic surveys

0 Staff perception of integrity as measured by periodic surveys

0 Average number o f days to complete administrative appeals process

htput Indicators:

0 Monthly performance measurement according to W B methodology

0 CBRreports 0 World Bank project

supervision reports 0 Periodic surveys o f

traders and other stakeholders

'roject reports: [from Outputs to Objective)

- 4 0 -

1. Tax administration restructured along functional

I

I

2. Management and control systems improved.

0 Tax-type functions at CBR abolished and number o f members reduced.

0 Direct and income tax administration at field office level co-located in 12 RTOs with support function merged.

0 Three special offices for the administration o f large taxpayers created.

Taxpayer Facilitation Centers established .

0 Between 60 and 75

0 Regular corporate planning process and annual business planning established.

0 New performance monitoring system designed and implemented.

affairs functions established and operational.

0 Internal audit and interna

0 Workforce rationalizatioi

0 Annual Operational Plans (AOPs)

0 Project Management Reports (PMRs)

0 World Bank Supervision reports

0 Mid-term review (MTR) 0 Consultant reports 0 Taxpayer and staff

surveys

0 Sustained commitment to improvement in the performance of the CBR at the political, managerial, professional and technical levels.

management to build ownership for the reforms and minimize resistance from managers, staff, taxpayers and other stakeholders.

0 CBR i s granted sufficient autonomy to implement reforms.

Government to support CBR in rationalizing i t s workforce.

0 Legal changes required for implementation o f project activities accepted by the Parliament and enacted in a timely manner.

measure CBR performance not exclusively based on revenue production, but takes into account broade fiscal policy objectives, such as achievements in trade facilitation, reduction in compliance costs, and private sector development.

0 Effective change

0 Willingness o f

0 Governments accepts to

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ianagement system stablished and training apacity improved.

I. Revenue operations mproved.

plan implemented, sufficient number o f professional positions created to meet functiona organizational requirements.

0 New human resources management, staffing an( pay policy adopted, including merit based pa> and incentive systems.

strategy implemented to meet the requirement o f the new functional organization, including ii core areas o f management.

0 Code o f Ethics implemented.

0 Change management structure developed and implemented in tandem with yearly project implementation plans.

Information System implemented and adoptec for routine HR management.

0 New training CBR

0 HumanResource

0 Administration o f incoml tax changed from a circlc structure to a streamline( territorial functional structure.

0 Business processes re-engineered

0 Self-assessment for income tax implemented

0 Risk-based audit selectio system introduced

0 Risk-management group at customs pilot site established

0 Specialized customs post clearance audit group established

0 Self-assessment system for importers introduced

0 Importer, exporter, customs agent, supplier, and commodity profile

- 4 2 -

i. Revenue services ,trengthened

I. Tax compliance culture mproved

, Responsive IT systems dopted

established 0 Refimd management

system implemented

0 Integrated taxpayer database and single taxpayer account established and functioning

0 Automated approach to audit case selection based on risk-assessment introduced

0 Automated approach to audit case assignment among auditors implemented

0 Specialized collection and enforcement functions at CBR headquarters established

adjudication systems and processes implemented

division with collocated risk-management system implemented

0 Specialized customs and tax fraud division established

0 New appeals and

0 National intelligence

0 Unified CBR website designed and used for taxpayer facilitation

0 Call center to facilitate taxpayer contact established Taxpayer facilitation center, points and mobile facilitation spots

0 Tax forms reviewed and simplified

0 Taxpayer charter developed and promulgated using various intemal and extemal media

0 IT platforms across entire organization standardized and integrated

0 Central lnformation

- 4 3 -

I. Infrastructure upgraded

). Project managed efficiently mplementation progress nonitored and evaluated on ime

Depository System (CTFDS) established

0 Users enabled and empowered to acts as agents o f change in I T development Data storage organized for efficiency and cost-effectiveness; use o f electronic data storage maximized and paper records reduced to minimal levels

0 Open- space office configurations for CBR adopted and implemented

accommodation standard? revised

0 Inventory o f transport fleet completed and replacement plans developed

0 Building and

0 Quality assurance and change management methodologies implemented

operational plans preparec on schedule

0 Semi-annual project management reports (PMRs) prepared in advance o f supervision missions

0 Procurement carried out in accordance with World Bank Guidelines

0 Project financial management carried out in accordance with World Bank Guidelines

0 Annual project audit completed in a timely manner by independent auditors

0 An implementation completion report reflecting CBR's evaluation o f the project prepared before project

0 High quality annual

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'roject Components I iub-components: . Mgt. & Inst. Ievelopment .I Organization & Policy .2 Training & Development .3 Internal Audit .4 Internal Affairs .5 Change management

!. Revenue Operations L.1 Direct Tax L.2 Sales Tax L.3 Customs

closing

Inputs: (budget for each component) $9.3m $4.4m $3.2m $0.6m $0.4m $0.7m

!. Revenue Services 4.1 Audit 4.2 Collection & Znforcement 4.3 Appeals & Dispute 4.4 National Int.& Risk Mgt

4.5 Customs & Tax Fraud

1. Creating a tax :ompliance culture 4. 1 Taxpayer Ident.& Reg. 4.2 Taxpayer Ed.&Facilitation 3.3 Impact Eval.& Qlty 4ssur.

5. Adopting Responsive Systems

6. Infrastructure Up-grade

7. Project Management

$92.7m $29.8m $23.8m $39.lm

$6,6m $1.7m $l.Om $1.6m $1.5m $0.8m

$6.3m

$2.9m $2.4m

$1.0m

$3.6m

$24.0m

$3.lm

roject reports:

[R assessment. Training eeds analysis. Approved ,aining plan. Job escriptions, Performance fanagement Criteria and ystem.

mnual reviews, quarterly eports, supervision reports, urveys..

from Components to htputs)

Govt has the political wi l l o under-take down-sizing.

VRS i s completed on the )asis o f an appropriate ight-sizing plan.

iki l ls needed and job jescriptions match actual ieeds in new organization. . Reform program i s able to :hange management culture md work environment. . Training needs assessment s undertaken and training dan approved and implemented. - Performance management is successfully introduced.

HR audit i s completed. Job

Decisions are taken regarding; IT platforms, systems architecture, software packages i.e. off the shelf or in-house development.

A suitable communications strategy i s undertaken that i s able to reach all major stakeholders. User-friendly website created and able to attract sufficient number o f users.

- 4 5 -

- 4 6 -

Annex 2: Detailed Project Description PAKISTAN: Pakistan Tax Administration Reforms Project

By Component:

Project Component 1 - US$9.29 million

The proposed Project i s designed around a comprehensive reform strategy and includes the following seven components: (i) Management and Institutional Development; (ii) Improving Revenue Operations; (iii) Strengthening Revenue Services; (iv) Creating a Tax Compliant Culture; (v) Adopting Responsive IT Systems; (vi) Infrastructure Up-gradation and Development; and, (vii) Project Management and Implementation. Within these components training, consultant services for business process re-engineering and information technology will also have DFID financial support during implementation. (See annex 6 for catogory wise allocation).

(i) Management and Institutional Development

The CBR’s human and institutional development strategy will support and enhance the broader tax reform strategy by driving:

0 0

0

Strategic changes within CBR’s organizational structure; Transformation o f the organization’s culture & ethos; Development o f sound people-management policies and procedures.

(ia) Organization and Policy This sub-component addresses key institutional, organizational, and legal constraints o f tax and customs administration. I t aims at reorganizing the CBR to facilitate an efficient planning, execution and supervision o f core administrative functions. Greater managerial flexibility and exemption from certain legal and regulatory acts which negatively affect the attempts o f CBR to improve performance will require better and clearer planning and accountability mechanisms. The sub-component w i l l strengthen corporate planning processes and support the development o f clear tax reform steering as well as accountability mechanisms. I t will implement the f irst steps in the process o f moving to a functional structure o f tax administration.

In particular, the sub-component will:

0 Streamline the top management structure in the CBR. CBR currently has 17 members reporting directly to the Chairman CBR. This creates an unmanageable supervision and coordination task for the Chairman. The top management structure will be changed and restructured to reflect the four key areas o f top management responsibility: revenue operations, revenue services, management services, and policy and reform. Create the necessary organizational structure in the CBR to move to an essentially functional structure o f tax administration. While some features o f the current tax-type organization will continue to exist for some time, the functional responsibilities o f audit, collection and enforcement, investigation, and taxpayer education and facilitation will be strengthened and their managerial role increased. Introduce a formal annual planning and performance monitoring process. CBR did not have

0

0

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corporate plans in the past. The reform strategy and the PIP prepared by Maxwell Stamp in cooperation with CBR management i s the f i rst real corporate planning document. The long-term reform planning wi l l be supplemented by a formal annual planning process. Each wing and function o f the CBR w i l l develop regular formal annual reports, which will include performance measures and analysis for the past year and planned developments in the next 12 month plus a three-year outlook. Performance measurement o f CBR will be broadened and will move away from a focus exclusively on revenue collection. A broader set o f performance indicators will be developed, including regular feedback surveys from employees, taxpayers and other stakeholders. A specific set o f performance indicators will also be introduced for Customs activities. Decentralize logistical support. To facilitate the concentration o f CBR on the true headquarter functions o f program development and supervisory tasks, regional support hubs will be created to provide technical support to line administration. Implement the f i rst stage in the process to move to a functional structure o f tax administration at the regional/local level. The sub-component will support the co-location o f income tax and sales tax administration to prepare for the full merger o f tax administration functions. In particular it will support the creation o f twelve regional tax offices (RTOs). In these offices all operational and support functions except for tax audits, specialized enforcement tasks (basic enforcement and collection will be merged), legal affairs and appeals will be merged and moved to a full functional basis. Non-integrated functions will be co-located to facilitate cooperation, in particular the organization o f comprehensive tax audits. For large taxpayers the roll-out o f the LTU concept will continue with the creation o f two additional LTUs. Strengthen tax policy capacity in the CBR. A parallel activity to strengthen the tax policy capacity at the Ministry o f Finance will be launched under the public sector capacity building project. Develop a comprehensive integrity strategy for the CBR. CBR has in place a number o f important elements o f an anti-comption strategy for tax administration, such as a disciplinary and criminal penalty regime for cases o f corruption and an inquiry function to investigate cases o f staff malpractice. A new Code o f Conduct has just been drafled and i s now distributed to all employees. However, some important elements o f a credible integrity initiative, including, e.g. a clear public commitment to increase integrity and a monitoring process to assess progress made in increasing integrity in tax and customs administration are st i l l missing. The sub-component will support as part o f the overall CBR planning process the development o f a comprehensive integrity strategy for tax and customs administration and the implementation o f the key components o f this strategy. (This activity i s closely linked to other project activities, in particular the sub-components on internal audit and internal affairs, human resource development, and information technology).

(ib) Human Resources Development

(1) Human Resource Management. This will include developing an overall Human Resource Management strategy based on modem principles o f organizational and human capital development ad employment rationalization scheme to reflect the rollout o f the restructured CBR, including MTUs, LTUs and RTOs. Specifically, the subcomponent will:

Develop a workforce rationalization strategy and implementation plan to reflect the rollout o f the new functional organization, including staffing o f LTUs, MTUs and RTOs. This will include an employee contingency fund and redeployment

- 4 8 -

strategy covering all current staff and those not selected into the functional CBR.

0

0

0

0

0

0

0

0

(2)

Review and develop transparent and standard procedures for s ta f f recruitment, selection, rotation, and promotion. Rationalize the pay structure to permit merit-based pay increases, rewards, bonuses and promotions; Develop a strategy for moving staff selected into the functional CBR onto the new pay structure and ensure that the old scheme i s phased out in l ine with the employment rationalization scheme in an expeditious manner. Develop career paths and update position descriptions accordingly based on the new functional organization occupational categories taking into account the new ski l ls and competencies required against the currently existing s ta f f profile. Develop as a priority a workforce planning strategy including succession planning to identify highly competent staff to provide the necessary leadership during the reform. Develop a performance evaluation system based on transparent criteria and implement as associated incentive structure. Prepare and implement a Code o f Ethics and Conduct specifically for the CBR that incorporates features designed to safeguard the reputation o f the agency for integrity and to identify and eliminate sources o f corruption through appropriate review and enforcement mechanisms. Establish and professionally staff the corporate communications office in order to gain internal as well as public support for reforms.

Training. This subcomponent will focus on the capacity building o f the CBR staff with specific aim to:

0

0

0

0

0

(3)

Train managers in formulation o f training strategy, budget, personnel management, monitoring, and evaluation. Strengthen capacity to provide continuing professional training in line with the requirements o f the new functional organizational model, including train the trainer. Develop curricula and training manuals for subjects relating to the reform for different levels o f trainees, focused on both training and retraining, including use o f classroom-based and electronic educational delivery systems. Include special attention to grades 1 1 - 16 as well as higher professional grades, but consideration o f retraining needs o f s ta f f at lower levels who may be selected into the new functional organization. Strengthen regional training centers to meet local capacity-building and competency needs in the new functional organization. After initial training has occurred needed to roll-out new business processes and functional offices, evaluate the impact o f training on individual, unit and CBR performance. Use evaluation to provide benchmark for performance evaluation, as well as to systematically improve and institutionalize courses o f study ad approaches to teaching and learning.

Improve Professional Ethics. A Code o f Conduct and Ethics would be developed under th i s component Timely enforcement i s a critical element in implementing such codes and in CBR, there are protracted delays in processing cases o f corruption caused by

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understaffing, which will need to be remedied. Therefore, following steps are included under this subcomponent:

0

0

0

Training o f managers to brief s ta f f on the contents o f the Code o f Conduct and Ethics, their rights and responsibilities, and enforcement procedures. Training o f s ta f f assigned to investigate inquiries into staff alleged breaches o f the code. Development o f clear guidelines for managers and supervisors on how to deal with complaints alleging staff corruption. Prepare professional ethics and conduct training modules suitable for ongoing workshops and seminars in CBR on an ongoing basis, and as an integral part o f continuing professional and career development.

(ic) Internal Audit This subcomponent will:

0 Establish a specialized internal audit functions in CBR. I t will set up a central internal audit office for planning, program direction, procedures, training and evaluation o f the internal audit program throughout the CBR for which staff would rely on intelligence built into the system to identify possible errors and irregularities. Field-based internal audit units will be established to implement internal audit plans in the operational components o f customs, direct, and indirect tax.

0

(id) Internal Affairs and Vigilance In practice, there i s substantial uncoordinated involvement o f external agencies in examining allegations o f corruption in the CBR. This partly reflects the fact there i s no existing top-level organizational unit, which i s sufficiently independent from operational work, that i s specifically charged with investigating corruption cases. This subcomponent w i l l address this issue by assisting in creating a specialized internal affairs function at CBR headquarters. The internal affairs function will report directly to the Chairman CBR and will be responsible for reviewing the compliance o f CBR officers and staff with the CBR rules and regulations. In addition, a vigilance unit will be established to investigate allegations against CBR officials and detecting corrupt practices and corrupt officials. The vigilance unit will be headed by a senior manager who i s not a regular CBR official and will report directly to the Secretary Revenue. It will take over cases from the internal affairs unit when indications o f a criminal offence become apparent. I t will also start investigations based on information received from outside stakeholders, in particular other government agencies charged with counteracting corruption in government agencies and taxpayers.

(ie) Change Management This sub-component will support activities aimed at developing and implementing appropriate strategies for managing organizational change at all levels o f the tax administration, including communication strategies to explain the rationale and potential impact o f the planned changes to all managers, officers, staff, taxpayers and other stakeholders. This will include measures to encourage participation o f managers and staff in the change process, the piloting o f important changes to learn from experience, the creation o f feedback mechanisms, and the training o f staff responsible for change management activities.

Project Component 2 - US$93.17 million

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(ii) Improving Revenue Operations

This component would support extensive and very significant strategies and initiatives to transform the administrations o f the CBR’s three revenue streams: Direct Tax, Sales Tax and Central Excise; and Customs - (1) from pure enforcement, to a risk-based self-assessment systems based on voluntary compliance o f taxpayers; and, (2) from a mix o f organization structures o f the three streams to consistent ones that are functionally-based, automated, decentralized and modem.

To accomplish the transformation, strategies and initiatives will focus on extensive re-engineering o f the core business processes and operating procedures o f each o f the CBR’s three administrations over the next five years and beyond. The three revenue administrations represent this component’s three main sub-components; Le., (1) Direct Tax; (2) Sales Tax and Central Excise; and, (3) Customs. The degree o f re-engineering required varies among the administrations o f the three revenue streams (Sales Tax, the lowest), and comments in the respective sections below, by sub-component, describe some highlights unique to each.

However, the main reform objective o f the project in the long term i s extensive integration o f the revenue streams. Therefore, highlights o f what the collective re-engineering efforts are designed to accomplish the long term in the integrated operations o f the CBR are as follows:

Redesign organization structures and business processes in ways which will lead to co-location as soon as possible - and eventually, to integration - o f the Direct and Sales Tax administrations to improve the CBR’s efficiency and effectiveness and also to lessen the burden on taxpayers; In the long term, merge as many support services as possible for all Revenue administrations, including Customs, even though Customs operations will always be maintained as a separate wing because i t s operations are very different from those o f direct and sales taxes; In the long term, in Customs operations, modernize export and import clearance and related procedures which impact upon trade facilitation, in accordance with intemationally accepted principles and methods; Assign one unique identification number across all taxes for each taxpayer and convert andor cross-reference all databases to the one-number system; Create an integrated tax information system, including a taxpayer account for each taxpayer and a taxpayer accounting system, governed by the unique taxpayer-identification-number system, to enable matching of 3rd-party information against each taxpayer’s self-assessment declarations and support the various enforcement functions o f Audit, Criminal Investigation; Collection & Enforcement; etc. Provide a single site where taxpayers can easily and quickly register for all taxes, with simple registration instructions, forms, procedures and CBR staff assistance; Organize and base al l revenue operations processes and procedures, including those o f Customs, on a self-assessment scheme; Replace the current, transaction-based activities o f respective operations’ staffs with modem programs for compliance/enforcement based on post-return and post-clearance, risk-management systems; Design and implement modem risk-management systems - with mathematical ratios, taxpayer profiles; industry standards, etc. - to support compliance-enforcement programs - for audit; for collection and enforcement; for criminal investigations - which are further supported by information technology equipment, MIS, and an integrated tax information system, with the ability to match 3rd-party data, among other features;

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Differentiate treatment among taxpayers-tradersklearing agents by revenue potential and r isk; i.e., by their potential risk to the Government’s tax revenue and by the degree o f their historical compliance or non-compliance with the voluntary compliance system; Establish and expand Large Taxpayer Programs for special handling o f the small percentage o f taxpayershaders (4-5%) who every year pay a major part (up to 90y0) o f the Government’s annual tax and customs revenues; Design procedures and processes which will help minimize interfaces between taxpayers and tax and customs officials and create mechanisms to combat corruption and insure transparency and accountability; Decentralize Direct Tax operations from the Central Office to 12 proposed Regional Offices in Pakistan’s main population centers; Test decentralized, fimctional operations at controlled pilot schemes, e.g. Medium Taxpayer Units, and phase-in the implementation o f testedproven operations and organization structures throughout the country; Design vigorous enforcement programs to target taxpayers who choose not to comply voluntarily; and, Design and introduce amendmentdadditions to the Tax and Customs laws which will support and enable the envisioned reforms and transformation.

Below are strategies and initiatives more specific to each o f the administrations which will be supported by the respective sub components.

(iia) Direct Tax Direct tax administration i s generally regarded to be the area o f CBR performance with the greatest need o f reform. The structure i s a deep and highly bureaucratic one that expands to hundreds o f base level offices, each o f which has a high degree o f independence. The operating techniques are outdated and ineffective and use o f technology i s quite limited.

The administration o f direct tax remains problematic for a large number o f reasons. The direct tax organization structure consists o f five distinct levels and i s both costly and ineffective. Tax officials have too much to do and, therefore, cannot accomplish their assigned tasks with completeness and quality. Taxpayers are constantly inconvenienced with the necessity to meet with tax officials and “negotiate” various documents, assessments and payments. Taxpayers have a direct linkage by the system to one tax official who can abuse the relationship with little risk o f reprisal. Compensation i s so low as to fail to provide a reasonable standard of living for tax officials and their families. Office space, equipment and services are inadequate and there i s l i t t le use o f technology. Training o f tax officials i s inadequate. Taxpayers file a large number o f complaints and appeals, the outcome o f which i s very frequently a partial or total reversal o f the prior decision made.

The cumulative result o f the above conditions i s that the final direct tax determinations are frequently weak, negotiated, and in many cases arbitrary determinations, which do not in any substantive way reflect the true tax liability o f a taxpayer under the law. This substantially reduces the amount o f tax that i s ultimately assessed and collected. In addition, the total base o f taxpayers registered and paying taxes falls far short o f the number that are obligated to f i l e and pay income taxes under the tax law.

Many o f the reform measures planned and described above apply specifically to the organization structures and the re-engineering o f the core business processes o f Direct Tax, particularly in the

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short and mid terms. In fact, the required transformation o f the operations o f Direct Tax has already begun and will continue through the initiatives proposed for th is sub component.

The future organization structure for administration o f direct tax wil l also be based upon a functional approach. Several functional members will provide functional program planning, policies, direction, training and evaluation from the central office o f the CBR. Tax administration activities will eventually be collocated into twelve regional tax offices (RTOs), with extended operations for taxpayer facilitation purposes into 60-75 taxpayer facilitation centers (TFCs). There will also be three large taxpayer offices (LTUs). There i s already a good start with the creation o f Karachi LTU that i s serving around 600 gazetted taxpayers. Around 50 officials from both the Income Tax and Sales Tax Departments have been brought together, organized and collocated on a functional basis. In addition, a Medium Taxpayer Unit (MTU) has been setup in Lahore. Based on i t s experience, CBR plans to established another 5 in the next year. These MTUs wi l l become part o f the 12 regional tax offices that will co-locate Sales tax and Income tax, providing for greater sharing o f information, resources and removing duplication o f certain common functions. However, CBR should pause, review and correct the problems described above before entering bad data in the databases o f the new MTUs. The time and effort in these endeavors i s time well spent because correcting unreliable data later will cost considerably more, as learned not only from the Lahore experiences, but from international best practices. Also, before implementation o f Rawalpindi and the other new MTUs, CBR should carefully review, decide and document what features o f the Lahore “pilot” should be applied to the other MTUs - software, staffing, procedures, etc. (and other parts o f the overall organization) and what features should not be applied - and the reasons why.

Modem tax administrations design and implement a “Records Controls and Disposition Policy” which authorizes phased retirement and eventual destruction o f records, aRer the statutes o f limitations for audit, collection and criminal investigation have expired. There i s no need to store and maintain records forever. In a few appeals and legal cases, original documents are required. For other types o f cases, photocopies or electronic versions o f documents are al l that are usually needed. The following recommendations are expected to yield significant savings in terms o f space, facilities and time o f technical personnel currently being dedicated to clerical work which can be applied instead to revenue operations and revenue services:

1. Remove all but the most necessary tax-retum files from the Lahore MTU and store removed files at the regional DPC or at a “warehouse” with the s taf f and safeguards as described above.

2. D o not store tax retums and documents at the Rawalpindi MTU nor at the other MTUs to be established this year and later. Instead, apply Recommendation 1.

3. Review statute-of-limitation parameters under the law, and request authorization from the CCFR to proceed to phase-in destruction o f a l l existing records beyond administrative action because o f the expiration o f statutes o f limitation - at least, a l l records before 1990 - particularly documents pertaining to accounts receivable which are 10 years old and older.

4. Design, write and implement a “Records Controls and Disposition Policy” which will permit modem administration o f tax returns and documents under USAS.

5. Apply the above recommendations to other revenue operations facilities, e.g. LTUs.

Among the most important project strategies and initiatives for Direct Tax are:

0 Establish more specialization un i t s for handlipg o f direct operations for the country’s largest taxpayers.

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0

0

0 0

0

0

0

0

0

0

One Large Taxpayers Unit (LTU) was already established and got underway in Karachi in October 2002. There has already been some degree o f integration o f income and sales/excise tax operations for Audit, Enforcement, Taxpayer Facilitation and Legal at the Karachi LTU. I t s facilities are excellent. I t s staff i s well organized on a functional basis. Jurisdiction has been expanded from the initial 300 large taxpayers to more than 500 based on revised criteria and i s expected to reach 600. The HR and Information Processing functions lend good support to the operations functions. The operations o f the LTU will serve as “a model office“ for replication to CBR’s operations elsewhere; Two more L T U s will be established in the mid term; LTUs will be the focal point in the future for all operations applicable to the country’s largest taxpayers. Decentralize operations for other taxpayers based on functional structures A Medium Taxpayers Unit (MTU) in Lahore recently began operations. I t s facilities are excellent and i t s small s ta f f (not yet fully staffed) i s highly motivated. The MTU currently has 10,000 taxpayers under i t s jurisdiction - medium and small businesses and wage earners - but it i s expected to gradually expand to 50,000. Policies and procedures under a functional structure - Audit, Collection & Enforcement, and Taxpayer Facilitation - are being tested. The operations o f the MTU will serve as an interim “model office” for the re-engineered operations o f Direct Tax and will be replicated to other sites across the country in the short term; Based on the results o f the Lahore “model office test”, five more MTUs are already scheduled to be established; In the medium to long term, the MTUs will become part o f the 12 Regional Tax Offices (RTOs), where Income and Sales Tax operations will f irst be co-located, and in the long term, integrated. Several data processing operations for Income Tax under a universal self-assessment system will be established to process income tax returns, tax payments, and other documents. Among the numerous operations’ requirements for data processing centers are rapid processing o f all documents; electronic documentation o f accurate information for the integrated tax information system’s databases; and “capture” o f key data for taxpayer control and enforcement - risk-management information; identification o f non-filers and stop filers; verification and matching o f 3rd-party information for audit, collection & enforcement; etc.

(iib) The CBR’s Sales Tax operations have been organized on a functional basis for some time and are largely based on self-assessment principles. Operations are supported by many modern tools and techniques to facilitate compliance/enforcement activities at some locations. For example, the Model Sales Tax House’s organization and operations recently established in Karachi have excellent facilities and modem IT systems designed to meet users’ needs. Operations there under a functional basis - already integrated with Central Excise - are wel l organized and coordinated.

Sales Tax & Central Excise Tax

Nevertheless, there i s s t i l l much room for improvement in the operations o f the Sales Tax wing. Therefore, th is sub-component proposes strategies and initiatives to continue to test and refine the on-going core business processes for widespread application throughout the country and for testing co-location and eventual integration with Direct Tax. In the short and medium term, the project would focus particular emphasis on:

0 Design o f systems and compliance programs to increase the number o f taxpayers in the tax net;

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e.g., establish special un i ts at Collectorates to examine internal and public records to detect taxpayers not in compliance. Currently, there are only 150,000 registered taxpayers from a liability-base estimated between 800,000 to 1.5 million; Refining automated systems to track and expedite refunds for exporters; The Sales Tax Automated Refunds Repository (STARR) pilot introduced in October 2002 has made good progress in reducing the workload backlog and will continue to be refined; Preliminary risk analyses o f large-refund claimants under “Green, Yellow and Red” classifications have had good success and will need to continue to be refined and applied to all taxpayers; Refining and improving the current automated risk-management systems to classify and treat all taxpayers in accordance with their objective r isk assessments (not just large traders); Streamlining compliance requirements and lessening the burden for low-risk taxpayers, particularly for large taxpayers; Bolstering taxpayer facilitation services considerably, e.g. initiatives to provide current tax-return forms through newspapers and through the CBR’s website; At LTUs, monitoring and refining the integrated operations o f Sales, Excise and Direct Taxes for eventual replication and implementation across the country; Designing automated systems and procedures to monitor the timely receipt o f documents and payments from banks and to expeditiously follow-up on reconciliation discrepancies; Testing and improving dispute resolution processes for taxpayers (e.g. the Dispute Resolution Complex soon to be established in Karachi - see below; Introducing necessary legislation to support operations, e.g. requiring record-keeping by taxpayers o f purchaseshales; permitting tax authorities to make presumptive assessments, under pre-defined criteria, etc.

Central Excise Collectorates are merged with Sales Tax Collectorates and their operations will continue to be brought under the centralized system o f sales tax. The Central Excise regime will continue to be withdrawn or minimized, and i t s share o f federal tax revenues will continue to decline dramatically (21% in 1997-98 to 8% in 2003-04).

(iic) Customs Generally, the Customs Administration currently falls far short o f meeting best international standards and practices recommended by the WTO and the WCO. For example, current operations are burdened by outdated, complex legislation, processes and procedures; by general staff inefficiency; and by serious revenue losses because o f weak andor fraudulent execution o f key functions, such as undervaluation o f goods and audits.

Most aspects o f the Customs Administration need fundamental changes, including i t s organization structure; i t s minimal service orientation; the whole spectrum o f i t s Human Resources and management programs; i ts very limited IT systems; and the urgent need to upgrade i t s facilities for s taf f and taxpayers. Some work has already been accomplished to modernize export and import clearance and related procedures which impact upon trade facilitation, in accordance with internationally accepted principles and methods, but a great deal o f reform work remains to be done.

This sub component would support strategies and initiatives to continue to convert operations from an assessment to a self-assessment system supported by automated, selective verification systems and programs. To meet overall international standards and practices, initiatives target re-engineering o f a l l major business processes, including import and export procedures; valuation o f imports and .

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exports; transshipment controls; controls o f warehousing and licensees; procedural reforms to expeditiously process refunds; and focusing on targets for enforcement based on modem selection methods, e.g.

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Selective verification programs at time o f entry processing will be supported by post-release verifications and audits. Intelligence and investigation programs will be designed to support the verification programs as well. Verification actions will also be applied differently among different categories o f tradersklearing agents and goods. Goods and credit claims o f large traders who have proven themselves historically and consistently to be dependable, low-risk (gold card members), for example, will be handled the most expeditiously; Re-engineering o f Customs’ business processes, particularly, will focus on minimizing interactions between tradersklearing agents and Customs officials.

0

As with Direct and Sales Tax, the “pilot approach” will be applied to re-engineering o f Customs’ business processes. For example, this sub-component would support the collective strategies and initiatives o f a pilot project launched in March 2004 in Karachi for C u s t o F which has been approved to test a new approach to the operating procedures for process flow in the clearance o f imports and exports. As described by a FAD mission o f the IMF in March 2003 - “The pilot will be designed to test the most important concepts o f the entire Customs reform program - electronic transmission o f entries; selectivity, including automatic selection o f entries that are ‘‘free to leave” (green channel); those requiring documentary checks (yellow channel); and shipments requiring physical inspection (red channel); computer assignment o f appraising and examining officers; and post-release verification and audit.”

The replication across the country during the next few years o f the results o f the “model pilot” would be supported by this sub component.

Project Component 3 - US$ 6.62 million

(iii) Strengthening Revenue Services

As explained in the introduction, the Central-Office level will design national programs, policies, procedures and annual work plans for all Revenue Operations, in accordance with international best practices and standards for functional organizations. The annual work plans developed by the Central Office will all be executed at proposed 12 Regional Offices for Direct Tax; at Sales Tax Collectorates; and at Customs field formations, in accordance with the policies, procedures and standards established by the Central Office.

Functional Revenue Services will be provided to field Revenue Operations by corresponding functional uni ts at the Central Office and at Regional Hubs for Direct Tax in order for field offices to execute work plans efficiently and effectively. Therefore, this component has five functional sub-components:

(iiia) Audit The main thrust o f th i s sub component will be on strategies and initiatives to establish a Tax Audit h c t i o n as a separate functional stream, under which w i l l be developed and implemented at a national level, among many modemization initiatives:

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Policies, procedures and operating manuals Automated audit-case selection systems based on risk management concepts for all three revenue streams; Automated audit-case assignment systems for auditors; Quality standards and formal and independent structure for conducting on-going review o f quality; Organization structures to improve efficiency and effectiveness e.g. establish specialized un i t s for large taxpayer audits, for simple office audits, etc. Annual Audit Plans for Direct and Sales Taxes which cover available resources and projected case audits at the various jurisdictions; Programs and procedures for detection o f potential fraudevasion for referral to the Customs & Tax Fraud function; Organization performance objectives measurement criteria; Specifically for audits by Customs staf f at i t s Customs Houses Post Clearance Audit methods and procedures Post Clearance Audit Selection system Post Clearance Annual Audit Program Risk ratings for warehouse Audits Spot-check program for low-risk warehouse audits MIS requirements for all Revenue Operations; Selection and training o f Auditors for each Revenue Operation.

(iiib) Voluntary and Enforced Collection The Collection and Enforcement function at the Central Offices will provide functional services to support regional Collection and Enforcement operations, where functional un i ts will be assigned responsibilities to:

Monitor compliance with filing and payment requirements o f taxpayers; Demand and secure outstanding tax returns; Recover taxes in arrears; Impose interest and penalties for noncompliance; Conduct intemavextemal surveys to detect unregistered taxpayers; Collect and analyze internal and 3rd-party data about taxpayer assets to support enforced collection efforts; Enforce collection; Detect criminal violations and report them to the Customs & Tax Fraud uni ts.

The Collection & Enforcement unit at the national level will also be developing policies, procedures and manuals; annual operational plans; organization performance criteria and measurements; M I S requirements; and criteria for help in the selection and training o f staff.

Legislation will be introduced to enable assumption o f some o f the responsibilities described above by operations un i t s o f Collection & Enforcement.

(iiic) Appeals and Dispute Resolution This function i s generally characterized by a mutual distrust between taxpayers and the CBR. Delaying tactics on the part o f some taxpayers, as well as poor quality or incomplete audit reports have resulted in delays in the judicial system (cases can take up to 2 years or more) and a large

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number o f pending cases. Without improved audit details, the expeditious disposal o f adjudicationlappeal cases i s severely hindered.

Furthermore, there i s a lack o f knowledge among CBR staff regarding newly decided cases and precedence cases. This results in a number o f tax decisions not upheld by the appeal bodies. As such, the large number o f annulled or modified tax decisions lessens the efficiency and the credibility o f the CBR.

The proposed project wi l l support the reform efforts to improve this function. In order to build a relationship o f mutual trust, the CBR i s continuing to develop appeals and adjudication systems and processes that are fair, expeditious and transparent. There will be a single avenue o f appeal for a l l kinds o f taxes. This will be comprised o f an initial administrative (quasi-judicial) level, which, in turn will be followed by a judicial phase.

CBR Member Legal wi l l be responsible for developing this national appeals program and its associated procedures, and staff at the local level will be responsible for implementing them. The national appeals and adjudication program will be uniformly administered across the different tax disciplines, and will preserve and enhance the taxpayers' rights to appeal, ensuring the appeal system i s transparent and more "user-friendly".

(iiid) I t i s important to identify that CBR under the project will create a corporate National Intelligence Division (NID) with a co-located Risk Management Unit (RMU). I t s capability will span all operational areas o f Direct and Indirect taxes and those areas o f Customs activities that affect revenue collection [Customs risk management objectives are much wider than other revenue administrations, as they address: (i) supply chain security issues; (ii) non-revenue related criminality; (iii) control over movements o f goods; (iv) cross-border cooperation; and, (v) relations with other agencies including the police and other security forces, standards and quality control, health and phyto-sanitary administrations, and transport authorities. A large part o f th is information i s irrelevant for revenue purposes, and involves classified intelligence. For these reasons, it i s essential that the Customs risk management policy be multi-tiered], and will form a new functional area under Member Revenue Services.

National Intelligence and Risk Management

RMU will analyze and report on the overall taxpayer environment (strategic analysis), and individual taxpayer performance and level o f r i sk (planning analysis). I t s ' primary responsibility will be to ensure that statistically and analytically sound information i s available to audit and enforcement. The NID will be responsible primarily for identifying and preparing cases for investigation where serious evasion o f tax or prohibition i s suspected. Both units will require specialized training as well as systems capability for s ta f f to perform these functions effectively.

(iiie) Customs and Tax Fraud Investigation i s an inherent component o f all the tax systems administered by the CBR but i s fragmented between Customs and the Tax divisions. In some cases investigation staff are also the intelligence officers and are required to investigate both internal and external situations with consequent conflicts o f interest and conflicting priorities. The first step i s setting up the Customs and Tax Fraud Division (CTFD). It follows that any staf f recruited must have similar personal qualities and receive even more extensive technical training. The staff will work in teams with team members specializing in the different taxation disciplines. CTFD will be required to build liaisons with other national and intemational organizations as part o f i ts operating strategy. The

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building o f trust and the breaking down o f barriers i s a slow and painful process but one that must be completed for CTFD to reach i t s full potential and effectiveness.

Major tax evasion and smuggling are intemational crimes that require intemational solutions. CTFD will be responsible to bring perpetrators o f such offences into custody and for prosecution under the relevant legislation. In this regard, CTFD must also win professional respect, t rust and confidence o f i ts counterparts. Therefore, the people selected for intemational liaison must be competent and should be empowered to decide and act (albeit within a well defined area o f responsibility) to further building an image o f a professional and dedicated investigation force beyond corruption. A whole program o f specialist training (e.g., covert surveillance, interviewing, search o f premises, high speed driving, defensive driving, arrest and constraint, and radio discipline, etc.) will be carried out. However, the Customs component o f this program should distinguish between enforcement for revenue violation purposes and the detection and prosecution o f criminal activities that are not linked to other tax systems.

Project Component 4 - US$6.27 million

(iv) Creating a Tax Compliant Culture

(iva) Taxpayer Education and Facilitation The primary purpose o f th i s sub-component i s to transform the way CBR functions by streamlining and improving efficiencies in tax administration. This sub-component will support the following activities.

Desiminddevelouing Taxpayer Facilitation Center (TFC) software. Currently, two major avenues by which taxpayer facilitation will take place are planned

CBR Web page: The CBR web page will be used as a key facilitation point and would need to be designed in a way to satisfy the needs o f the taxpayers. Currently there are several web pages will be merged or closely coordinated. The web page will potentially be used for training taxpayers, electronic filing, distribution o f forms, forum for discussions and filing complaints, registration/ de-registration o f taxpayers, distributing explanatory booklets, and processing incoming taxpayer queries and responses.

0 Cull Center: Considering evolving demands, a call center will be established to facilitate taxpayer contact through e-mail, letters, faxes and telephone calls. The establishment o f a call center will offer numerous advantages to CBR such as flexibility in locating employees away from the employment centers and expensive locations, not needing employees who are tax experts, and better utilization o f staff. To better conduct the functions o f the call center, records o f taxpayer questions and answers would be maintained in a database which can be referenced by the call center s taf f in responding to taxpayer queries. Use o f questions and answers database would result in uniformity o f answers and enhanced quality o f response. Some o f more frequently asked questions and related answers can be put on the CBR web site for public use. The numerous advantages o f th is include:

- CBR TE & F employees may be located in the Call Centre, which in tum, does not need to be located in or near existing offices or in expensive locations (indeed, centres are often located in areas with an employment need);

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- Telecommunication w i l l go through wires or will be transmitted; - The call center will be supported by a database with all the asked and answered questions. This safeguards the high quality o f - Database questions and answers w i l l be monitored by expert tax staf f ensuring quality control o f answers; - Call Center staff w i l l directly answer 80-90 % of the questions and remits - the remainder will be relayed to back-up-experts; - Employees need not be tax experts; rather, they will have other qualities, such as computer literacy (ability to handle database oriented approach and other people-centered skills; - The call center will be flexible, connecting more s ta f f during peak demand periods using modem telephone techniques. The .telephone system will be a huge net connecting people and computers; - The cost for establishing the center will be reasonable, resulting in a cost per question that i s very low; - Expert knowledge can be readily accessed; and - The staff will be allocated according to fluctuating demands o f direct contacts - as phone calls - and indirect contacts.

answers;

search-engines), a service

In addition to above software, for helping taxpayer facilitation, software for allowing for registratiodde-registration o f taxpayers would need to be developed. This software will be driven by a centralized database o f taxpayer identification numbers so as to ensure that the same taxpayer number i s not assigned to more than one taxpayer by the regional offices. Eventually, taxpayers would be able to registedde-register through the CBR web site.

Communications Propram: The quality o f service that taxpayers can currently access varies across Pakistan. The reform strategy will address this inequality and raise service standards across all areas. A key component o f th i s effort will be the application o f modem basic communication principles, ensuring that taxpayers have access to a flow o f information that is:

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Relevant - what the taxpayer needs; Timely - when the taxpayer needs it; Of high quality - correct and undisputable; and, Simple - enabling the taxpayer quick and efficient access.

Explanatory literature will also be developed and updated regularly. The literature (publications, brochures and booklets) will cover dissemination o f laws, rules, procedures and changes from time to time particularly with reference to the universal self-assessment and record keeping requirements.

The publication o f a monthly or quarterly newsletter as part o f the communication strategy, in collaboration with other components, will be evaluated and implemented in the medium-term reform period.

Internet Facilities: The information super highway, or the Internet, i s an important driving force behind the new work methodology, enabling improved communications both between CBR and the taxpayers as well as within CBR. By making IT an integral part o f the organization, CBR will revolutionize the way it functions and manages i t s relationships with taxpayers by reducing the interaction with taxpayers. Internet will be used for:

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Intemal and extemal information; Training taxpayers and staff; Intemal and extemal communication; Electronic filing; Distribution o f forms; Providing a forum for discussion and complaints; Registration and de-registration; Publishing explanatory booklets for reading and printouts; and, Processing o f incoming tax forms as well as i t s outgoing correspondence. CBR will initiate consultative interaction with stakeholders and oversee development o f computer software for electronic submissions o f returns and statements.

Taxpayer Identification and Registration - - - As the CBR moves to one-step registration for all taxes, one number will be used as the unique taxpayer identification number. The importance to modem tax administrations o f highly accurate, reliable, computerized information databases, which start with the taxuayer identification and registration functions, cannot be overemphasized. Therefore, this subcomponent would support all steps in the CBR’s transition to the revised taxpayer identification and registration, including:

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(ivc)

Necessary legislation for assignment o f unique NTN; Design or re-design o f the NTN: Insure that the NTN has enough digits for future use Include a check digit appended to the number (for error detection) etc. Conversion o f existing databases (file reference numbers; other NTNs; etc.) to new NTN; and Design o f administrative procedures: Design o f new registration form; Instructions for taxpayer registration; Where registration i s to be done (including website); Requirements for printed registration certificate; Redesign o f tax forms and other documents to provide for the mandatory inclusion o f the NTN; Content and format o f notification letters to notify taxpayers o f their new NTN and the requirements for i t s use.

Quality Assurance and Monitoring A quality-asswance monitoring program i s necessary both for the taxpayer and the CBR to ensure that CBR’s taxpayer education and facilitation function responds to taxpayer expectations and motivates the use o f increased resources. Following information technology initiatives under the proposed project will provide much o f the CBR’s QA functions o f performance measurement and monitoring; the system will generate standard reports as well as support ad hoc queries in support o f these functions.

This subcomponent will include: (i) a Sales Tax Information System; (ii) a Direct Tax Information System; and a Customs Information System. Details o f these systems are dicussed under component 5. In addition, a computerized management information system for managers to monitor the operations o f the CBR would also be developed. By combining data from the master tax f i l e with detailed information on audit and collection processes, it would be possible to develop an

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information system that will provide required details on tax administration operations. Depending on the level o f details o f the data collected, such information will be available at the aggregate level o f the tax administration or at the more disaggregate levels o f the tax offices and tax officials. The information will also be available for any period o f time covered by the underlying data, allowing one to compare operations over time. The management information system will be used as the basis for budgeting and resource allocation, for rewarding outstanding performance, for identifying problem areas, and for highlighting evasion.

Responsibility Office o f Member I M S

I t i s important to note that tax administration information can also be extremely useful in informing tax and budget policymakers about the existing tax system and in assessing the likely consequences o f changes to that system. For example, summary statistics based on information from tax returns can be useful in identifjwg trends in the taxpaying population. Economic models can be developed to forecast tax (and non-tax) receipts, or to estimate the revenue and distributional effects o f proposed tax law changes.

cost Included in Component 1

Project Component 5 - US$3.65 million

(V) Adopting Responsive IT Systems

This component will help CBR transform the way it functions by re-engineering the business processes, thereby furthering the reform objectives. The I M S department under Member I M S would primarily drive th is component. The costs indicated above are for IT costs related to developing a centralized integrated database and developing uniform systems development standards and architectural plans. In addition to these costs, substantial amount o f costs shown in components 1,2,3 and 4 are related to hardware and software development related to re-engineering and automating those components. This component will support the following sub-components:

(Va) ICTCBR

The primary purpose o f th is sub-component i s to transform the way CBR functions by employing IT to move from a highly manual to an automated environment in which computers are used to facilitate decision-making. The objectives o f this subcomponent are:

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Improving management control to levels approximating those experienced in industrialized countries; Increasing the transparency o f tax administration; Reducing interaction with taxpayers in day-to-day operations; Managing information for broadening the tax-net, increasing revenue and facilitating trade; Identifying and adopting international best practices; Allowing for multi-directional electronic communication under the electronic signature ordinance, 2002; and, Streamlining and improving efficiencies in tax administration.

Despite substantial past investments in information technology by the CBR, desired results have not been achieved because standard IT development methodology has not been followed, and IT project management has been inadequate with almost no preparation for a user interface, l i t t le

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management ownership and isolated systems development. Moreover, the development o f IT systems in the past has proceeded in an ad hoc and unplanned manner so that most departments operate stand-alone modules that are not integrated into the main system. There i s also a general recognition that CBR’s IT projects have been high cost, have produced less than expected except in isolated cases, and failed to boost performance significantly. Acknowledging previous mistakes, CBR wants to reform i t s Information Systems to deliver complete, accurate, and up-to-date information in a useful manner and at a reasonable cost. This may require that entire processes and work culture be re-engineered.

This sub-component will support the following activities:

e Overall IT strategy development including determining appropriate hardwarehoftware infrastructure for the CBR: The very f irst activity supporting this would be development o f an information systems plan (ISP). For reforms to be successfbl, IT needs to be an essential component o f the reform program and development o f an ISP i s the first step towards having a unified vision o f IT at CBR. The ISP should describe the current architecture (in terms o f location, hardware, software and network resources) and a target architecture (also, in terms o f location, hardware, software and network resources). Once a clear definition o f current and target architecture has been achieved, ISP should lay out a transition strategy for going from current to target architecture. The transition strategy should detail the phased deployment o f hardware from current locations to new, the upgrade or replacement o f software towards a unified platform, and the rollout o f training for CBR employees. The ISP should also establish standards for the System Development L i fe Cycle. Additionally, the ISP should address data management and conversion.

Consistent with the new strategy, the I M S department will maintain standards for hardware, software and network platforms that will remain binding across all jurisdictions unless exceptions are specifically sought and granted. I t i s entirely possible that all un i t s will not be on the same timeline for upgrades and hence there will be some variation, but such variations should not span entirely different.generations o f technology if there i s planning and oversight at the center.

e Set up appropriate contractual relationship with PRAL: I t will involve decisions on whether PRAL will be one o f the bidders for development tasks envisaged in th is project or just provide operational and management support. Furthermore, this activity will address restructuring o f the PRAL organization to reflect the needs and organization structure o f i t s principal client - the CBR. The I M S group will be strengthened with the inclusion o f revenue officers and other domain experts.

e Set up systems operations and management control at the CBR: This activity will clearly delineate whether CBR’s IMS department or PRAL will be responsible for systems operations. The sub-component also envisages the setting up o f an IT help desk facility at regional centers and headquarters. The help desk will provide f i rst and second l ine desktop and networks support. Furthermore, support staff will carry out routine housekeeping operations for al l systems and network components. Maintenance and support contracts would be put in place to ensure technical support for the data communication infrastructure.

e Set up user liaison mechanism through Information Management Systems unit: The objective o f this activity i s to facilitate interaction between IT technical s ta f f and

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non-technical users, and the IT User Liaison role exists to bridge the gap between users and developers. The User Liaison role comprises activities undertaken on an on-going basis as well as for project-related activities.

Activities will include maintaining periodic but regular contact with a nominated constituency o f user groups, monitoring satisfaction levels o f users in relation to the software and hardware they use, identifying and monitoring areas o f dissatisfaction which may be indicative o f a need to modify or upgrade software or hardware, and assisting user groups to identify and make explicit the source(s) o f their dissatisfaction and to prepare submissions for change.

Project-based activities will include participating in preliminary meetings between users and developers, ensuring that the technical project manager creates & maintains the project timeline and milestones, that periodic progress meetings take place, users are properly trained, that there i s an end-of-project review meeting, and that lessons learned are documented.

Designing/developing case monitoring and management software: An automated system will be developed and implemented in connection with the establishment o f the central taxpayer database. The system will generate a structured case file for every case selected for a tax audit. The case management system will automatically initiate requests for required documentation, and will initiate reminders and supplementary information to assist the case auditors. I t will also track the status o f a case from initiation to conclusion.

Designing/developing the National Intelligence Division WID) and Risk Management Unit (RMU) software: This sub-component will ensure that the necessary databases needed by NID and RMU are established, cross-tax accessibility i s provided, and the necessary taxpayer performance information i s routinely input at source. The cross tax database and the software will enable search and capture o f cross-related data, tailored to the individual needs o f each tax department. To th i s end, current data collected by each tax department would need to be reviewed and supplementary data requirements and software needs would need to be defined.

Designing/developing the Customs and Tax Fraud Division (CTFD) software: The f irst requirement from the CTFD i s to build an IT infrastructure that wil l enable access to the databases o f the Revenue Divisions and Customs. Later direct access to Police and other criminal databases, vehicle registration databases, travel companies etcetera will also be added.

Designing/developing the Asset Management & Inventory software: This sub-component will support the asset management and inventory control function for hardware and software assets o f CBR. Subsequently, other infrastructure assets would also be inventoried and added to the inventory management system.

Selecting or developing a Human Resource Management (flu) application and adapting it to CBR environment. This system will eventually have record for each CBR employee into the database and relevant personal and payroll information will be maintained.

Designing/developing Taxpayer Facilitation Center (TFC) software. Currently, two major avenues by which taxpayer facilitation will take place are planned:

CBR Web page: The CBR web page will be used as a key facilitation point and would need to be

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designed in a way to satisfy the needs o f the taxpayers. Currently, several web pages will be merged or closely coordinated. The web page will potentially be used for training taxpayers, electronic filing, distribution o f forms, forum for discussions and filing complaints, registratiodde-registration o f taxpayers, distributing explanatory booklets, and processing incoming taxpayer queries and responses.

Responsibility

Call Centers: Considering evolving demands, a call center will be established to facilitate taxpayer contact through e-mail, letters, faxes and telephone calls. The establishment o f a call center will offer numerous advantages to CBR such as flexibility in locating employees away from the employment centers and expensive locations, not needing employees who are tax experts, and better utilization o f staff. To better conduct the functions o f the call center, records o f taxpayer questions and answers would be maintained in a database which can be referenced by the call center staff in responding to taxpayer queries. Use o f questions and answers database would result in uniformity o f answers and enhanced quality o f response. Some o f more frequently asked questions and related answers can be put on the CBR web site for public use.

cost

In addition to above software, for helping taxpayer facilitation, software for allowing for registratiodde-registration o f taxpayers would need to be developed. This software will be driven by a centralized database o f taxpayer identification numbers so as to ensure that the same taxpayer number i s not assigned to more than one taxpayer by the regional offices. Eventually, taxpayers would be able to registedde-register through the CBR web site.

Office o f Member I M S

Desigddevelop CBR ’s Central Information Depository System: The objective i s to provide wide, open and transparent access to detailed information conceming the activities, decisions and the actions o f the administration within CBR. This information will be easily accessible to employees having authorized access from any region o f the country. The CBR’s Central Information Depository System (CTFDS) w i l l be the technology solution to all i t s information needs. CTFDS will replace the current practice o f holding and moving physical information with a safe and dependable computerized and catalogued information entrykapture & retrieval system. The CTFDS will maintain the following information in a user and access-friendly catalogue.

Included in Comnonent 2.2

e Design/develop a centralized integrated database incorporating the functions of software developed in the sub-components 5.2, 5.3 and 5.4 and the software components described above: This activity will ensure that taxpayer data for direct, sales and customs tax are all stored in an integrated database so a unified view o f a taxpayer’s account can be provided to CBR staff, if needed. The development o f an integrated database will accrue several benefits to CBR on a going forward basis. Use o f an integrated database will ensure platform homogeneity, would ensure that various uni ts within CBR would use consistent coding mechanism and unique taxpayer identification numbers. Currently, CBR i s stymied by fragmented systems development and use o f an integrated database would alleviate this problem and foster integrated development.

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Member Sales Tax in conjunction with Member I M S will develophpgrade i t s current system, bringing uniformity and a total systems solution to the entire l ife cycle starting from (a) registration to (b) return, (c) reconciliation o f unit accounts (sales vs. purchases), (d) risk based and system analyzed targeted audit, (e) refund, ( f ) enforcement, (g) appeaVlega1 proceedings and (h) adjudication. In order to provide the total process solution, all relevant sections within a Collectorate will need to be networked with all end users including the managers. The Sales Tax Information system will also require off-line access to the central system located at CBR to post and/or retrieve unit profile information to and from other restricted users, such as other Collectorates, Direct Tax & Customs.

The Sales Tax Information System would help CBR in moving from routine administration to a risk management and targeted, post audit based, functional operation. With inputs from return and audit information, the system w i l l develop a unit profile and transaction account register to compare, analyze and reconcile purchase information against returns submitted by registered f i rms to determine anomalies for possible audit(s), and to register unregistered units. Effective targeting o f taxpayers for post audit based on risk analysis will require information on all taxpayers. In this subcomponent, CBR would develop a system to register taxpayers from transaction information fed into the system at the end o f each audit, together with information from other sources and systems such as Sales Tax returns, Customs and Direct Tax.

The system will also provide modules to enter, retrieve and track audit findings, appeal and adjudication information. Moreover, the system will be used to produce most pre-formatted standard communications to taxpayers, such as notices, and will track taxpayer compliance, prompting tax authorities for the next action. The system will also be used for audit 8i enforcement resource allocation and will replace manual audit, enforcement and adjudication for low revenue compliance/impact units.

To support the overall tax administration program, the integrated Sales Tax system will provide online Act, SROs, Help, and standard and customized management and operational report facilities.

(Vc) Direct T a x Information System

I ResDonsibilitv I cost I I Office o f Member I M S I Included in ComDonent 2.1 I

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Direct Tax Administration activities will be automated by the development, upgrade and modification o f existing processing and information systems. Such systems will significantly increase the effectiveness and efficiency in the administration o f direct tax and remove potential for evasion by reducing human error. I t is, however, important to ensure that the systems are fully integrated with all the tax administration procedures before a significant investment i s made in computer technology.

Computer processing and information systems will initially be built on a regional basis, with a view to develop over the mid-to-long term, a centralized master tax file comprising data on each taxpayer. The file will include, but will not necessarily be limited to, information on each taxpayer’s account and information from his tax return. The analysis o f information on the master tax fi le will be an extremely effective tool for tax administration, particularly when linked to information from third-party sources.

The Direct Tax Information system will contain the following functionality:

(i) registration information o f all taxpayers, as well as a record o f tax liabilities, payments, penalties, interest, and transaction dates.

Registration and Accounting. The system w i l l need to maintain up-to-date

(ii) non-filers by comparing records on the master tax f i l e with information from third-party sources, such as banks, utilities, and automobile and property tax records. It would identify stop-filers by comparing tax returns that have been filed in the past with returns currently due.

Identification of Non-Filers and Stop-Filers. The system would identify

(iii) calculations on tax returns, as the data are input. I f an inconsistency reveals an error on the part o f the taxpayer, the system will flag the inconsistency and generate a supporting notice. The system would also match information on returns with third-party sources to verify that all income was reported, such as interest paid by banks and dividends paid by corporations.

Verification and Matching of Information. The systems will verify mathematical

(iv) correspondence with taxpayers. This correspondence w i l l include billing for arrears, notifying taxpayers o f mathematical errors or inconsistencies on their returns, and notifying non-filers or stop-filers that they must f i l e a return. The correspondence system will not eliminate the need for face-to-face contact between tax officials and taxpayers, but will significantly reduce the need for such contact. It will also encourage voluntary compliance by improving the uniformity (i.e., fairness) o f the tax administration system, and by letting taxpayers know that the CBR i s using computers to analyze information on their returns. Perhaps most importantly, it will free-up human resources for other tasks.

Taxpayer Correspondence. The system w i l l be used to handle routine

(v) Audit Selection. Selected tax returns will be identified by the system for audit. Here, one approach i s to develop statistical norms for different classes o f taxpayers, to measure the extent to which any given taxpayer deviates from the norm for his group, and to set a priority for audit as a function o f that deviation. Another approach i s to use statistical techniques to correlate audit results with information on tax returns so that it

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will be possible to identify potentially productive audits solely from information on the tax return.

Responsibility Office o f Member IMS

(Vd) Customs Information System

cost Included in Component 2.3

The CBR i s faced with a choice in either developing a Customs management solution in-house, or acquiring and customizing a system such as A S Y C U D A H , SOFIX, TIMS or Microclear. Either option can provide a total systems solution to the entire l ife cycle o f Customs clearance and other functions dependent on clearance information such as warehouse, duty exemption and drawback, duty remission, refund etc. Since Customs will move away from 100% examination to clearing consignments using risk management and post clearance audit, the system will be designed to support those schemes. Also, the system will enable importers to launch their declarations electronically either from a BOE processing center and/or from their own office as a remote user. The Pilot at Karachi Intemational Container Terminal has adopted Microclear; the results o f the pilot will determine the platform to be used for organization-wide rollout.

Based on the above broad outline, the Pakistan Customs system will have the following modules functioning consecutively, i.e., each module dependent on information processed and passed from the previous module:

(i) Manifest. After capturing IGMIEGM information, the system will screen ,

importers, description o f goods, country o f origin, country o f export, weights, etc against pre-set green and red l i s t profiles. Green l is t consignments will wait for lodgment o f the GD, matching details between the IGM and GD and final clearance from the GD system. A percentage o f green consignments will be randomly re-directed by the system to red channels. All red channel consignments will be examined and a pre-formatted examination report will be entered into the system to validate against the declared (BOE) information. If validation checks out, the system will allow clearance o f the consignment.

(ii) General Declaration (GD). The GD module will be developed to provide importers, exporters and their agents, the in-house capability to enter GD information electronically and/or print the GD for submission to Customs manually, and retain the data for their future internal use and possible audit by Customs. It will allow the following:

Hardcopy GD data to be entered by Customs operators; Importers to enter GD data from their offices; and, Customs agents to launch GD using an authorized GD processing center.

All GDs, regardless o f entry point will go through data validation against coded information, such as country code, currency code, and tariff (HS code before being registered and issued a registration number). To assist users to submit accurate and complete declarations, the GD module will provide online help for codes, relevant SROs, Customs Ac t and listings o f required supporting documents as per classification, country o f origidshipment, and exemption, etc.

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(iii) to stakeholders o f modem Customs organizations to give the same amount o f attention to the law-abiding as to suspect taxpayers. Stakeholders who voluntarily obey the law expect to receive the benefits, including less Customs intervention, and therefore delays, and the costs that delays incur. Increasingly, the CBR expects Customs to differentiate between complying and non-complying stakeholders. To this end, the CBR will employ Risk management techques supported by software. Under these, the CBR will identify risks (potential threats), analyze them to determine their likelihood and consequences, and devise management and mitigation strategies.

Risk Management/Selectivity. I t i s a wasteful use o f resources and unacceptable

The selectivity module will be the Customs r isk management tool for both imports and export clearances. I t will target consignments based on risk criteria supported and analyzed by other modules l i ke Manifest, GD, Profile, and Audit etc. The module will select consignments at item level for physical examinations and documentation checks (red), or documentation checks only, subject to selective post audit (yellow), or immediate clearance and selective post clearance audits (green). A certain percentage o f green & yellow consignments w i l l be randomly redirected by the system to a higher channel. Additionally, the selectivity module will direct consignments to different groups based on classification o f the major item o f the declared GD, and randomly select appraisers and examining officers within each group.

(iv) Valuation. The system w i l l build the capacity for Customs to refer to a multi sourced value reference database in order to implement transaction value methods and protect revenue by controlling and managing both local and international valuation risk/fi-aud. The selectivity module will be designed to select consignments at the item level, flagging the value o f an item outside the acceptable range which has the same or similar commercial description and i s from the same country of origin. The module will also provide Customs transaction history from different sources such as the Customs clearance system, information subscribed from international value reference banks, and data manually entered from other authorized sources such as the Intemet. The system will allow users to enter an H S code and find values previously processed and / or stored by the Valuation authority. It will also allow users to sort the presented data by country o f origin, by commercial description, or by transaction period. The system will provide a range o f values (high and low) against each type o f query.

(v) Appraisement & Assessment. RED and yellow GDs will be evaluated further. Based on the findings/decision(s) o f the valuation expert, appraiser, andor physical inspector entered electronically using a fixed structure-reporting tool, the appraiser will amend the GD for minor errors and initiate an electronic assessment process. The system will calculate duty and taxes based on approved classification and value, and will keep an audit trail o f all changes made to the GD.

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(vi) assessment (red, yellow or green). Depending on the importer’s/agent’s status with the Customs, the system will print the assessment notice for manual distribution or send i t electronically to the selected importerdagents. The customs system will have a payment module designed to operate from i t s corresponding bank(s) and accept payments in cash, against credit, or as a debit against preset accounts (for large taxpayers). After confirmation o f payment, the system will generate a gate pass for manual distribution or send it electronically to the selected importers/agents for clearing goods. The same information will also be posted to the port part o f the Customs system and at the gates.

Payment. The system will generate an assessment notice at the end o f each

(vii) Auction. The Customs system will clear items from the manifest and initiate auction proceedings for all goods not cleared within a specified time. The system will generate relevant notices to all concerned parties including the inspector for physical examination o f the goods to be auctioned. It w i l l also capture inspection related information such as the good’s classification, quantity and weight. The system’s valuation module will provide the auction’s initial reference value based on the classification reported by the inspector. And the system will capture post auction information and update manifest records.

(viii) Post Clearance Audit. A systems-based approach will be adopted for post audit based on risk factors and audit principles. The audit management module will use pre-defmed criteria to provide management with a l i s t o f importers and GDs for possible post clearance audit. The l is t i s based on high to low risk importers/GDs. Management will use the l i s t to select the required number o f GDs or importers to audit within a period based on available resources.

(ix) Profile. Profiles o f all importers, exporters, bond operators and agents will be maintained by the system, capturing information from each stage o f the GD processing life. Each profile will have a multi-dimensional outlook - such as the importer’s profile connected to, the export profile (if any), the profile o f similar importers, the commodity vs. value profile o f the same importer against others, the agent’s profile, and how it relates to other importers’ profiles etc. Each profile will also have audit, penalty and adjudication information, where necessary.

(x) exemption, duty remission, and licensed manufacturing warehouses etc., calling for the reconciliation o f export and import data at the raw material level. This will be managed electronically by applying a single coefficient rate determined by the IOCO for each product and against each unit o f export. The system will apply all duty and taxes applicable to each imported raw material against the value determined by the IOCO using the customs valuation module. The system will then provide a single rate o f refund/exemption against each unit o f manufactured product after adding the duty and tax incidents of all the imported raw materials. Both duties and value changes will be updated periodically on a schedule to be determined by the IOCO. The rate will be published and available at the CBR’s Website.

Coefficient. Coefficients are maintained for various schemes such as duty

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(xi) process duty drawback as soon as export takes place. It will calculate the drawback and make this information electronically available. The system will post the drawback amount against the exporter’s import account in the payment module as credit against future imports, and / or immediate payment from the corresponding bank(s).

Duty Drawback. Applying the coefficient scheme, the customs system will

(xii) will determine the system-calculated quantity o f imports o f a l l raw materials against any particular export order and apply th i s to all imports under duty remission and manufacturing bonded warehouses. I t w i l l also capture relevant export data such as the export date, flag possible audits for non-compliance, and initiate procedures to cash bank guarantees or bonds.

Duty Remission & Manufacturing Bonded Warehouse. The customs system

(xiii) movement o f the goods until release.

Transshipment. The customs system will identify transshipments and monitor the

(xiv) Management Report. The management reporting module o f the Customs system will provide both management and statistical reports currently used by the CBR, and also allow ad hoc queries. I t will be used at both central and field locations, and will generate information regarding revenue collection by chapter, H S Code, and commodity etc. It will also provide comparison statements between budget and actual collection at any given date.

(xv) access to the Customs Act, SROs, internal rules & guidelines, profiles o f major stakeholders, revenue, and activities by H S Code.

Help Customs Module. The Customs Help module will provide officials with

Project Component 6 - USS24.00 million

6. Infrastructure Up-gradation and Development

The component will focus on:

0

0

0

0

0 0 0

0

0

0

upgrading the quality and quantity o f work spaces, equipment and supplies; consolidation o f 96 tax offices into 60 in 15 regions, and refurbishment o f premises; construction o f new buildings as required for the modernization effort; increasing rent ceilings and lease periods to facilitate the acquisition o f appropriate accommodations; establishment o f residential accommodation for staff; building taxpayer services facilitation centers within main buildings or at targeted locations; establish dedicated reception and service areas for taxpayers for consultations with CBR representatives; renovate existing buildings andor construct new buildings for the co-location o f direct tax and sales tax in preparation o f the eventual integration o f these functions; rationalize budget requirements and forecasting capacity and ensure supplies and services o f RTU, LTUs, and TFCs at required levels; prepare an infrastructure plan to accommodate the IT needs of the CBR as they evolve with the business processes engineering roll-out as well as the IT needs for the Headquarters management

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function; and, rationalize the transportation requirement o f the CBR in line with the new functional and operational requirements.

0

Project Component 7 - US$3.06 million

7. Program Management and Implementation

This component would finance implementation o f the project including setting up o f a Project Managment Unit (PMU) to:

be responsible for overall project co-ordination, monitoring and reporting. There will be an on-going dialogue and feedback with CBR management and the project stakeholders to ensure ownership and to promptly resolve problems. provide overall coordination as well as take responsibility for managing the incremental changes necessary to effect implementation o f each component and related activities o f the Project; report on Project implementation and manage all disbursement and financial management activities under the project; establish monitoring and evaluation component o f the project for performance measurement; monitor ratio o f revenue collected to GDP, taxpayer satisfaction surveys, audit enforcement, labor efficient processes, the use o f IT and the improved organizational structure; and, develop a baseline scenario with objective and subjective performance targets.

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Annex 3: Estimated Project Costs PAKISTAN: Pakistan Tax Administration Reforms Project

!--

I Project Cost By Component Management and Institutional Development Improving Revenue Operations Strengthening Revenue Services Tax Compliance Culture Adopting Responsive I T Systems Infrastructure Up-gradation Programme Management Preparation Advance Total Baseline Cost

Physical Contingencies Price Contingencies

1.43 15.75 0.94 0.88 0.47

24.00 1.90 0.05

45.42 0.00 0.00

7.86 77.42

5.68 5.39 3.18 0.00 1.20 2.85

103.58 0.00 0.00

9.29 93.17

6.62 6.27 3.65

24.00 3.10 2.90

149.00 0.00 0.00

45.42 103.58 149.00 Front-end fee 0.00 0.00

Total Financing Required 45.42 103.58 149.00

1 Total Project Costs

Project Cost By Category Goods Works Technical Assistance Training Programme Management ICT (Customized Software) ICT (Server, PC, SW General, Office Eq, UPS, Data Comm) Other

3.00 24.00

1.93 1 .oo 1.90 6.50 7.04 0.05

0.00 0.00

14.12 9.00 1.20

47.80 28.61 2.85

3.00 24.00 16.05 10.00 3.10

54.30 35.65 2.90

Total Project Cost: 45.42 103.58 149.00

Total Financing Required 45.42 103.58 149.00 Front-end fee 0.00 0.00

The taxes are included as part o f Government contribution. The total project's cost also includes US$ 23 million with equivilant DFID financing

1 Identifiable taxes and duties are 10.08 (US$m) and the total project cost, net o f taxes, i s 138.92 (US$m). Therefore, the project cost sharing ratio i s 74.07%

o f total project cost net o f taxes.

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Annex 4: Cost Benefit Analysis Summary PAKISTAN: Pakistan Tax Administration Reforms Project

costs: US$ million Net Benefits: US$ million IRR: ?4n

[For projects with benefits that are measured in monetary terms]

(92) (134)

34,836 34,418

315.7 302.3

I I I I I I

1 If the difference between the present value of financial and economic flows i s large and cannot be explained by

taxes and subsidies, a brief explanation o f the difference i s warranted, e.g. "The value o f financial benefits i s less than that o f economic benefits because o f controls on electricity tariffs."

Summary of Benefits and Costs:

Background

Making tax revenue projections in Pakistan has been complicated by a wide ranging tax reform that has been going on for over fifteen years now. The structure and rates o f taxes have changed much during th i s period making previously estimated relationships between tax revenue and i t s base obsolete. Now, federal tax revenue i s generated mainly by four major taxes which are direct taxes, sales tax, customs duties, and central excise duties. Following the accelerated implementation o f the Ta r iERe fom after 1993, and the introduction o f GST on the basis o f value added in 1990, the shares o f various taxes in total revenue has changed sharply. The share o f direct taxes in total federal tax revenue has increased from 18% in 1990191 to over 32% in 2002103. Almost 95% o f direct tax revenue i s generated by income and corporate taxes and the rest i s generated through workers' welfare fund, capital value tax and other minor receipts. The major share o f revenues from income and corporate taxes, (about 55%) i s now generated through withholding taxes, and the rest i s contributed through voluntary compliance (i.e., payments received with returns) and demand creation by assessment o f returns after their receipt. However, the contribution o f the latter i s expected to fall in future due to the introduction o f universal self-assessment in income tax.

With the introduction o f VAT mode o f General Sales Tax (GST) and i t s subsequent expansion to include services and utilities in i ts base, i ts contribution to federal revenue receipts has increased from 15.4% in 199019 1 to 44.7% in 2002-03. There are two important components o f GST: sales tax on consumption o f domestically produced goods and services and sales tax on imports. A standard rate o f 15% i s currently applicable on both, domestically produced and imported goods with a few exceptions where higher rates are applicable, essentially on commodities that are traded by un-registered businesses and individuals.

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The dependence on intemational trade taxes in the shape o f customs duties has declined over this period. The share o f customs duties in federal revenue receipts has reduced from 45.7% in 1990-91 to 12.3% in 2002-03 mainly due to the reduction o f maximum tariff rate from 125% to 25% during the last decade and through the decrease o f the number o f tariff slabs to only four. Due to these tax policy changes, the effective rate o f customs duties on total imports has come down to 10.2% in 2003-04.

Revenues from central excise duty have also declined as the duty i s gradually replaced by GST. Its coverage has been reduced to a few commodities which now include cement, cigarettes, beverages, POL products and natural gas. Reflecting the shrinking base, i t s share in total federal revenue collection has declined from 20.9% in 1990/91 to 10.9% in 2002-03.

Share of Direct and Indirect Taxes in Federal Receipts

1990-9 1 199 1-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-0 1 200 1-02 2002-03

Direct Taxes 18.0 20.4 24.0 25.1 27.4 29.1 30.1 35.0 35.8 32.5 31.8 35.3 32.9

Indirect Taxes Total 82.0 79.6 76.0 74.9 72.6 70.9 69.9 65.0 64.2 67.5 68.2 64.7 68.1

Customs 45 44 40 37 34 33 31 25 21 18 17 12 15

Sales Tax 14 15 15 18 19 19 20 18 23 34 39 41 43

Excise Dut 23 21 21 20 19 19 20 21 20 16 12 11 10

Source: Central Board o f Revenue

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The changing structure o f taxation has made projecting revenue a difficult exercise. Throughout the 1990’s, projections o f government revenues turned out to be overly optimistic. The discrepancies between projections and outturns were so large as to make it difficult to assess whether poor program implementation was the cause or the consequence o f these discrepancies. GDP growth rate was overestimated on average by 2 percentage points from 1993 onwards. Coupled with unrealistically ambitious tax revenue/GDP targets, revenue projections never materialized. This was partly because building a budget on the basis of overly optimistic revenue projections avoided making tough expenditure restraining decisions. But more importantly, two mutually reinforcing problems occurred during this period. First, the strategic orientation o f shifting taxation from intemational trade to domestic activities proceeded at an uneven pace causing sequencing problems. W h i l e the reduction in tariffs on trade was fast, it took much longer for the GST to yield comparable revenue. Second, attempts to meet fiscal deficit targets led to frequent ad hoc tax and expenditure cut measures. While hikes in tax rates appeared in the short term to be effective in raising revenue, in the medium term it may have contributed to reducing the tax base further by encouraging tax evasion. All this was further reinforced by severe tax administration weaknesses and widespread tax exemptions.

In making revenue projections for 2004/05 to 2008/09, it i s noteworthy that the share o f indirect taxes in total revenue has stabilized in the range 67%-68% during the last four years which implies that the tax reform has more or less worked itself through and i t s impact on revenue shares i s unlikely to be unpredictable. In addition, the pilot initiatives in tax administration have produced positive results. Hence, revenue projections are less likely to fail due to failure in projecting tax/GDP values than due to overestimation o f GDP growth rates. In th i s context it i s useful to note that 2002/03 was the f r s t time that the start-of-the-year revenue target (Rs.460 billion) was achieved and the target (Rs.5 10 billion) for 2003/04 was also realized.

In order to project revenue collections for the next five years o f project life, it i s important to take account o f some important aspects o f individual taxes and the changes that have taken place in recent years.

The growth o f direct tax revenue reflects the income tax base o f 2.21 mill ion individual and 24,438 corporate taxpayers, increasing annually by 8% and 7% respectively. The buoyancy o f the tax has been enhanced by the withdrawal o f exemptions and extending the withholding tax regime. There are now 25 types o f transactions subject to WHT, increasing from 6 in 1979. Looking ahead, with a growing number o f taxpayers, the reliance on WHT i s being reduced under the tax reforms.

The number o f sales tax registrants has also increased from 33,000 in 1996197 to 160,000 in 2002/03. And GST has been extended to most commodities and utilities and services.

Tax-GDP Relationship:

The relationship between federal tax revenue and i t s base (GDP at market prices) has been examined on the basis o f regression analysis. Elasticity estimates were obtained for three sample sizes. The largest sample included data from 1980/8 1 to 2002/03 including pre-reform, reform and post reform periods. The second sample examined the relationship for the period after the start o f the reforms over the period 1990/9 1 to 2002/03. Finally, the third sample examined the relationship over the period following the completion o f the first round o f tax policy reforms, from 1997/98 to 2002/03.

The results indicate that the taxation structure has turned buoyant overtime. The elasticity o f tax revenue with respect to GDP has increased from 0.978 for the f i rst sample to 0.991 for the second sample. I t has further increased to 1.158 on the basis of the most recent sample. I t may be added that despite the obvious

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reduction in degrees o f freedom, the regression estimates for the recent period sample yielded fairly close projections o f tax receipts, however, the adjusted elasticity of 1.2 has been used.

2006-07

Projections of Federal Tax Receipts:

703

Revenue projections have been made using IMF projections o f GDP and inflation which &e consistent with the Public Sector Debt Sustainability Framework (PSDSF) for 1998/99 - 2008/09. An adjusted elasticity estimate o f 1.2 has been used for projections.

2007-08

Projections o f Tax Revenue (Rs. Billion)

Revenue

784

Projections 2003-04 2004-05 2005-06 632

2003-04

Revenue PRSP Projections Outlook

517 510

12008-09 I 875 I *actual collection

A Comparison of Projections with PRSP Outlook:

The Poverty Reduction Strategy Paper (PRSP) projections o f federal tax receipts are higher and the difference rises to Rs.20 bil l ion over five years. The projections start from a higher base due to better collections in 2003-4.

2004-05 2005-06 2006-07 2007-08 784

Pakistan's Federal Bureau of Statistics completed in May 2004 a comprehensive revision of the national accounts statistics. Ths base was moved from I980/81 to 1999/00 and several new sectors of economic activity were included. The results of this revision are a nominal GDP for 1999/00 and subsequent years that are about 20% higher than previously estimated levels. The Project Appraisal Document (and the IMF's Eighth Review document ofJune 2004 and the Bank's PRSCprogram document of August 2004) uses the "old" GDP series.

Assumed Growth o f Real GDP under Alternative Sources (y ercentages)

I

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Note: PSDSF : Public Sector Debt Sustainability Framework;

TadGDP

The second reason for the high growth in tax receipts under PRSP i s the assumed values o f tax/GDP ratios in the coming years. The PRSP assumes that this ratio will increase from 1 1.5% in 2003/04 to 12.5% in 2007/08. On the other hand, under projections used here, th i s ratio increases steadily from 11.74 to 13.5 during the same period.

Our Study PRSP

Derived and Assumed TadGDP Ratios

2003-04 1 1 S O 11.5 I 2004-05 I 11.73 I 11.7 I

2006-07 2007-08

I 2005-06 I 11.87 I 11.9 I 12.01 12.2 12.16 12.5

Conclusion

For purposes o f estimating the economic benefits o f the project and to conduct financial cost benefit analysis, this study has adopted revenue projections based on tax/GDP ratios derived from a GDP elasticity o f revenue o f 1.2.

The reliability o f revenue projections will depend to a great extent on predicting GDP growth rates correctly. This study i s inclined to adopt the more conservative projections o f GDP growth rates because o f the continuing low investment ratios. Although the tax - GDP elasticity includes the impact o f some o f the policy and administration reforms introduced during the last few years, it was adjusted downwards to account for one t ime impact o f few o f the measures. It i s important to understand that the policy reforms introduced during the last several years including reduction of customs tariffs, lowering o f income tax rates, increasing income exemption l i m i t s and abolition o f wealth tax has had a negative effect on revenues but over time are expected to result in widening the base.

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Tax Revenue and GDP Elasticity Estimates I

Sample Period

198018 1 - 2002103

199019 1 - 2002103

1997198 - 2002103

Adjusted elasticity

Elasticity Estimate

0.978

0.99 1

1.158

1.2 (used in this study)

200 3 -04 2004-05 2005-06 2006-07 2007-08

Economic Benefits of Restructuring Tax Administration

4404 4420 517 4836 4875 567 5321 5397 632 5855 599 1 703 6449 6668 784

The Tax Administration Reform has seven components: (i) Management and Institutional Development; (ii) Improving Revenue Operations; (iii) Strengthening Revenue Services; (iv) Creating a Tax Compliant culture; (v) Adopting Responsive IT Systems; (vi) Infrastructure Up-gradation and Development; and, (vii) Project Management and Implementation. There are many aspects o f reforms within these components some o f which are highlighted here to identify the economic benefits that are likely to accrue from the project.

As part o f improving revenue operations, the CBR aims to adopt a functionally integrated tax administrative system which will avoid the current practice o f costly duplication o f functions such as audit, collection and enforcement across departments. The present system makes it more difficult and costly for taxpayers with multiple tax dealings as well to comply with tax laws. In particular, the current direct tax system i s both costly and ineffective, and inconveniences taxpayers and opens them to potential abuse by officials. The reforms will overcome these shortcomings and establish the capacity to quickly detect taxpayer non-filing and non-payment. The reforms in sales tax administration will address the limited number o f ST registrants and their poor compliance, as well as improve timeliness and accuracy of refunds. Reforms in customs will modemize import and export clearance procedures and enhance trade facilitation, thus reducing the cost o f doing business in Pakistan while reducing evasion o f customs duty. As part o f strengthening revenue services, the reforms will reduce tax and customs fraud which poses a serious economic and industrial threat to the private sector. All these measures are l ikely to reduce tax administrative costs, enhance tax revenue, reduce private sector tax compliance costs and reduce economy-wide cost o f doing business in Pakistan.

As part o f strengthening revenue services, the tax audit functions will be separated and streamlined, developing an automated approach to selection, based on risk assessment o f under-reporting and

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under-payment o f taxes. This w i l l reduce the number o f audits across the economy saving private sector compliance costs, but at the same time improve tax compliance and increase revenue.

The information technology strategy w i l l enable CBR to achieve i t s revenue and reform targets in a transparent, timely and accurate manner. I T will help improve management, increase transparency in tax administration, reduce interaction with taxpayers, broaden the tax net, increase revenue and facilitate trade. The gains from al l these will accrue to the government in terms o f more revenue, lesser costs, and to the private sector in terms o f greater predictability, more level playing field, lower costs o f compliance and doing business.

The main economic benefits o f the tax administration reforms can thus be summarized as:

an increase in government revenues as a result o f widening o f the tax base in terms o f more taxpayers and more transactions coming into the tax net out o f the grey or underground economy; (ftnancial benefits); improvement in customs procedures aim to reduce the average time to clear customs from the existing 8 days to 1 day by the end o f the project period. This will reduce the cost o f doing business since it will reduce the number o f days importers need to borrow from banks to finance imports; improvement in voluntary tax compliance rates implying early revenue generation for the government, saving interest payments and administrative costs related to enforcing compliance; reduction in taxpayers’ costs associated with tax compliance; economy-wide gains to the private sector as an increasing number o f economic agents operate under the same set o f rules and taxes, enhancing competition (more level playing field); and, greater predictability o f tax liability and lower costs o f doing business for the private sector.

All the economic benefits o f tax administration are not measurable. In this exercise, only the f irst four benefits summarized above have been measured and included in the financial costhenefit analysis:

1.

11.

... 111.

iv.

The financial benefit o f tax administration reform in terms o f higher tax/GDP ratio. The CBR tax/GDP ratio rose to a peak o f 12.6 in 1995/96, declining in subsequent years and averaging about 1 1.5 over the last 8 years. This exercise has taken th i s average as the norm, and attributed all improvement in the tax/GDP ratio in future years to tax administration reform in terms o f widening o f the tax base. The financial benefit i s the increase in revenue due to improvement in the ratio. Reduction in number o f days it takes to clear customs means lower interest costs for private sector calculated using the value o f total imports, average bank lending rate and savings in days to clear customs. Improvements in voluntary tax compliance rates means revenue will accrue to the government at an earlier date than before the reform, which could involve a lengthy period o f audit and possible litigation. The gains to the government are equivalent to the potential interest earning on increased voluntary compliance revenue, where the average interest rate on public debt reflects the potential earnings o f revenue. Data on voluntary tax compliance i s available for direct taxes during the last two years, the period o f reforms. I t i s assumed that the improvement will continue at the current pace for the next 12 years. Reduction in taxpayers’ costs asspciated with tax compliance can only be estimated for corporate taxpayers. I t i s assumed that this i s in terms o f reduction in time spent by corporate accountants and staf f to comply with direct tax, sales tax and customs regulations. Various assumptions were made regarding the number o f accountants, their average salaries and the average time savings.

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Main Assumptions:

Following are the main assumptions used to determine the Present Value o f the flows:

0

0 0 0

GDP and inflation projections: GDP rising gradually to 6% in year 7 and remaining constant subsequently; inflation fixed at 4% Exchange rate fixed at Rsl$= 57.5 Discount rate for N P V calculations = 5% CBR W G D P derived from GDP elasticity o f revenue o f 1.2; the ratio rises from 1 1.74 in 2003104 to 13.5 in 2008109

Sensitivity analysis / Switching values of critical items:

The IDA loan i s for a period o f 35 years and strictly speaking the cost benefit analysis should span that period. But in order to analyse the viability of the project over a period o f 10 years following the dispersal of the loan, the analysis i s restricted to a 15 year period, assuming an early retirement o f the loan. This will bias the P V estimates o f costs to be higher.

Cost o f the project: IDA loan $ l o o m i l (Terms: 0.5%’ 35 years, 10 yr grace) GOP contribution !$ 2 2 m i l Grant (DFID) $ 2 3 m i l (no impact on costs)

The contribution o f the GOP and IDA are disbursed during the f i r s t six years o f the project. The repayment o f the loan starts in the sixth year, 35 equal installments for the f i r s t 6-14 years, with the remaining balance repaid in the 15th year to allow the analysis to be restricted to a 15 year period. The analysis was carried out in a number o f variants. The f irst i s a standard analysis, in which the future stream of revenue i s calculated on the basis o f a GDP elasticity o f revenue o f 1.2. In the second variant, an iterative process i s used to estimate the stream o f revenue, which will make the present value o f financial benefits equal the present value o f costs o f the government. In the third variant, the cost benefit does not take into account revenue benefits o f the government and focuses only on the benefits included in the economic benefits (excluding the financial benefits). In the final and fourth variant, total revenue projections are the same as in the first variant (based on an elasticity o f 1.2) but the increase in revenue attributable to the tax administration reform i s limited to the increase in revenues expected from LTUs and MTUs. For al l these variants, the cost o f the project has been treated in two ways. In the first, the analysis has treated the government’s initial investment as equity and the IDA loan as a standard loan, treating repayment o f the loan over 15 years as continuing costs o f the government (standard treatment) to calculate the ‘government’s NPV o f costs and benefits’. As an alternative, the analysis treated the entire cost of the project as equity investment and calculated the ‘project’s N P V o f costs and benefits’.

Assumptions:

a GDP and inflation projections: GDP rising gradually to 6% in year 7 and remaining constant

Exchange rate fixed at Rs/$= 57.5

CBR W G D P derived from GDP elasticity o f revenue o f 1.2; the ratio rises from 1 1.74 in

subsequently; inflation fixed at 4% 0

0

a

Discount rate for N P V calculations = 5%

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2003104 to 13.5 in 2008109

CBR RevlGDP

Results:

11.45 I 11.51 I 11.51 I 11.51 I 11.51 I 11.51

Variant 1 : NPV o f Financial Benefits NPV o f Economic Benefits NPV o f Government Costs The NPV o f government costs are insignificant compared to the financial and economic benefits o f the project. Naturally the IRR o f the project i s very high. FRR o f Project for the Government

= $34,552 mill ion = $34,928 mill ion = $ -92 mill ion

= 521.9 %

ERR o f Govt. Project ERR o f Project

Even if the entire cost o f the project i s treated uniformly, and the loan i s also treated as investment cost early in the period, so that NPV o f costs i s increased, benefits are s t i l l much larger than the NPV o f costs. NPV o f Project Costs (Treating loan as initial cost) = $ -134 mill ion FRR o f Total Investment = 302.3%

54.9% 26.5%

Variant 2: The stream o f revenue which will equate the N P V o f financial benefits to NPV of Government expenses i s given below together with the implied CBR RevenuelGDP ratios.

Project year 1 1 2 1 3 1 4 1 5 1 6

I Revenue Proiection Rs. bill. I 460 I 517 I 584 I 668 I 755 I 852 I

Non-Financial Benefits $ mn

I NPV o f Fin. benefits $ mn I 80 I

2.88 I 5.88 I 12.51 I 20.43 I 29.81 I 32.87

I NPV o f Econ. benefits $ mn I 444 I I N P V o f Govt. Expenses $ mn I -801 I N P V o f Proi. Exuenses $ mn I -I 151

The minimum revenues required to equate the N P V o f financial benefits to NPV o f costs will result in economic benefits that far exceed the costs o f the project and the ERR o f the project will s t i l l be significantly higher than the rate o f discount. The minimum required revenues are also much less than the projected revenues in section 1 o f this paper.

variant 3: The stream o f non-financial benefits (excluding govemment revenues) during the f i rs t 6 years i s given below:

The benefits o f the project excluding increases in govemment revenue are substantial. The N P V o f these benefits i s much greater than the costs o f the government and the project costs. The ERR remains

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significantly positive.

Add. Rev. f rom LTUs, MTUs & others (Rs bn)

I N P V Non-Fin. benefits $ mn I 370 I

0 7.9 9.3 18.1 11 9.8 9.6

Variant 4: Attributing only the additional revenue from LTUs to the Tax Administration Reform instead o f the entire revenue increase resulting from improvement in the tax/GDP ratio, means the financial benefits from the project are reduced. Yet the N P V o f financial benefits outweight he NPV o f costs by a big margin.

N P V o f Econ. benefits $ mn N P V o f Govt. Expenses $ mn

2,06 1 -80

I N P V o f F i n . benefits $mn I 1,684 I

I NPVofProj.Expenses$mn I -115 I Conclusions:

The results o f the cost benefit analysis show that the project’s viability i s independent o f the assumptions used. If the economic benefits that could not be measured were included in the analysis, the benefits to the government and the economy would be even higher.

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Annex 5: Financial Summary PAKISTAN: Pakistan Tax Administration Reforms Project

Years Ending

I Year1 I Year2 1 Year3 I Year4 I Year5 1 Year6 I Year7 Total Financing Required Project Costs Investment Costs 30.4 42.3 33.3 23.5 16.5 0.0 0.0

Recurrent Costs 1 .o 0.8 0.6 0.4 0.2 0.0 0.0 Total Project Costs 31.4 43.1 33.9 23.9 16.7 0.0 0.0

Front-end fee 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Financing 31.4 43.1 33.9 23.9 16.7 0.0 0.0 -

Financing I BRDll D A 18.4 32.0 24.2 15.9 12.4 0.0 0.0 Government 8.0 6.1 4.7 3.0 1.3 0.0 0.0

Central 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Provincial 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Go-financiers 5.0 5.0 5.0 5 .O 3 .O 0.0 0.0 User FeeslBeneficiaries 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Project Financing 31.4 43.1 33.9 23.9 16.7 0.0 0.0

Main assumptions: The Project will be implemented over a period o f five years. As few o f the major contracts are expected to be awarded in the first year, bulk o f the costs will incur in the initial years o f project implementation.

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Annex 6(A): Procurement Arrangements PAKISTAN: Pakistan Tax Administration Reforms Project

Procurement

Procurement Capacity

Central Board o f Revenue (CBR), will primarily be responsible and accountable for implementation o f the project including carrying out procurement. Procurement activities will be carried out by Project Directorate. The agency i s staffed by a Project Director and the Procurement unit will be staffed by specialist procurement officers.

An assessment o f the capacity o f the Implementing Agency to implement procurement actions for the project has been carried out by Procurement Accredited Staff during appraisal. The assessment reviewed the procedures, organizational structure for implementing the project and project’s staff responsible for procurement. No significant areas o f weaknesses were identified, since the P M U has experience o f the Bank’s procurement procedures. However, there may not be any dedicated procurement staff in the field offices and there i s a general lack o f expertise in th Bank’s procurement procedures. In i t s responses the P M U appeared to be more reliant on the Bank‘s Guidelines as a primary procurement process. I t was explained that the Bank would like to see the enhancement o f the CBR’s procurement capacity so as to gradually move towards accreditation.

In order to strengthen procurement capacity, the staffing plan includes the appointment o f a Procurement Specialist, who i s expected to be on board soon. This will contribute to the Project’s procurements being completed efficiently in accordance with the Bank’s guidelines. Once the person i s appointed, training on WB Procurement Procedures would be required. The training would also be extended to a wider audience if procurement for the project i s carried out in the field offices.

Procurement Methods

Procurement for the proposed project would be carried out in accordance with the World Bank’s “Guidelines: Procurement Under IBRD Loans and IDA Credits” dated M a y 2004; and “Guidelines: Selection and Employment o f Consultants by World Bank Borrowers” dated May 2004, and the provisions stipulated in the Legal Agreement. The general description o f various items under different expenditure category are described below and summarized in Table A. For each contract to be financed by the Credit, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The Procurement Plan will be updated at least every eight months or as required to reflect the actual project implementation needs and improvements in institutional capacity.

All expected procurement o f goods, works and consultants’ services will be listed in the project’s General Procurement Notice (GPN). The GPN will be published in the United Nations Development Business (UNDB). All ICB contracts will be published on UNDB on-line, independent o f the value o f the contract.

Civil Works:

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Works procured under th is project, would include renovation and refurbishment for CBR, MTUs, LTUs, Direct and Sales Tax, and Customs. Civ i l works generally comprise contracts for new as well as upgrading o f existing buildings, and are not expected to attract the interest o f foreign contractors. Accordingly, all c iv i l works under the project will be procured through National Competitive Bidding (NCB) procedures acceptable to-Bank's Standard Bidding Documents (SBD) for all National SBD agreed with (or satisfactory to) the Bank.

However, if foreign f i r m s wish to participate in these contracts, they will be permitted.

Goods

Goods under the Project would generally include computers, proprietary software, office equipment, motor vehicles and furniture. International Competitive Bidding (ICB) procedures will be followed for each Goods contract estimated to cost more than US$200,000 equivalent. Domestic preference will be allowed to local manufacturers on I C B contracts. Goods estimated to cost between US$50,000 equivalent andUS$200,000 per contract will be procured through National Competitive Bidding (NCB) procedures acceptable to IDA. Small value off-the-shelf goods estimated to cost US$50,000 equivalent or less per contract are expected to be procured following Nationalhntemational Shopping procedures in accordance with the Procurement Guidelines.

Improvement of Bidding Procedures under National Competitive Bidding

The following improvements in bidding procedures will apply to all procurement o f Goods and Works under National Competitive Bidding, in order to ensure economy, efficiency, transparency and broad consistency with the provisions o f Section 1 o f the Guidelines:

0

0

0

0

0

0 0

0

0

0 0

0

Invitation to bid shall be advertised in at least one national newspaper with a wide circulation, at least 30 days prior to the deadline for the submission o f bids; bid documents shall be made available, by mail or in person, to all who are willing to pay the required fee; foreign bidders shall not be precluded f iom bidding and no preference o f any kind shall be given to national bidders in the bidding process; bidding shall not be restricted to pre-registered firms; qualification criteria shall be stated in the bidding documents; bids shall be opened in public, immediately after the deadline for submission o f bids; bids shall not be rejected merely on the basis o f a comparison with an official estimate without the prior concurrence o f the Association; before rejecting all bids and soliciting new bids, the Association's prior concurrence shall be obtained; bids shall be solicited and contracts shall be awarded on the basis o f unit prices and not on the basis o f a composite schedule o f rates; contracts shall not be awarded on the basis o f nationally negotiated rates; contracts shall be awarded to the lowest evaluated and qualified bidder; and, post-bidding negotiations shall not be allowed with the lowest evaluated or any other bidders.

Consultants' Services:

The credit will finance several consultancy assignments and short and long term nationaVIntemationa1 individuals for the implementation agencies for management advice in policy reforms, studies, etc.

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Contracts with consulting f m s estimated to cost more than $200,000 per contract will be procured in accordance with Quality and Cost Based Selection procedures. Contracts estimated to cost less than $100,000 per contract may be procured through the method o f Selection Based on Consultants' Qualifications. For contracts with consulting f m s estimated to cost less than $500,000 equivalent per contract, the shortlist o f consultants may comprise entirely national consultants in accordance with the provisions o f paragraphs 2.7 o f the Consultant Guidelines. Contracts with individual consultants will be procured in accordance with the provisions o f paragraphs 5.1 to 5.4 in Section V o f the Consultants Guidelines. In view o f some specialized training that may be needed by a few agencies, the services o f universities/ institutions to impart this training may be procured through 'single source selection' in accordance with the provisions o f paragraphs 3.9 to 3.13 o f the Consultants Guidelines.

Training and Workshops :

The credit will finance long term and short term staff development programs both local and foreign for the staff. In addition, there will be a series o f national workshops conducted by the participating agencies to enhance staff capacity.

Procurement Planning

Procurement under the project will be carried out in accordance with the agreed procurement plans. Procurement plans will be closely monitored and updated every eight months.

Review of Procurement by the Bank (Table B)

Prior Review: 0

0

0

The first N C B contract for Goods o f the each Participating agency, irrespective o f value, and thereafter each contract for Goods estimated to cost US$200,000 equivalent or more. The first N C B contract for works o f the each Participating agency, irrespective o f value, and thereafter each contract for Works estimated to cost US$200,000 equivalent or more. The f irst Consultants' Services contract with consulting f i r m s o f each Participating agency, irrespective o f value, and the first consulting services contract with individual consultants o f the each Participating agency, irrespective o f value, and thereafter al l contracts with f i rms estimated to cost US$lOO,OOO equivalent or more, and with individuals estimated to cost US$ 50,000 equivalent or more.

All other contracts will be subject to Post-Review by the Bank. The Implementing Agency will send to the Bank on a quarterly basis, a l is t o f all contracts subject to post-review.

Procurement Information and documentation

Procurement information will be recorded and reported as follows by the Implementing Agency:

1. Complete procurement documentation for each contract, including bidding documents, advertisements, bids received, bid evaluations, letters o f acceptance, contract agreements, securities, related correspondence etc., will be maintained by each implementing agency in an orderly manner so as to readily available for audit.

2. Contract award information will be promptly recorded and contract rosters, in the Bank's sample format, maintained by the Implementing Agency.

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3. Comprehensive quarterly reports by the Implementing Agency indicating:

0

0 revised cost estimates, where applicable, for each contract; status o f on-going procurement, including a comparison o f originally planned and actual dates o f the procurement actions, including preparation o f bidding documents, advertising, bidding, evaluation, contract award and completion t ime for each contract; and updated procurement plans, including revised dates, where applicable, for the procurement actions. 0

Procurement methods (Table A)

Table A: Project Costs by Procurement Arrangements (US$ million equivalent)

I Procurement Method’ 1 Expenditure Category ICE NCB Ot he:

4. Training and Workshops

I’ Figures in parentheses are the amounts to be financed by the Bank Loan. All costs include contingencies.

2’ Includes civil works and goods to be procured through national shopping, consulting services, services of contracted staff of the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units.

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Table A I : Consultant Selection Arrangements (optional) (US$ million equivalent)

Total (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) 108.37 1.50 0.00 0.00 0.00 0.00 0.00 109.87

Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed Figures in parentheses are the amounts to be financed by the Bank Loan.

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Prior review thresholds (Table B)

Contract Value Threshold

Expenditure Category (US$ thousands)

Table B: Thresholds for Procurement Methods and Prior Review'

Contracts Subject to Procurement Prior Review

Method (US$ millions) 1. Works

Total value of contracts subject to prior review: US$114.65

Frequency of procurement supervision missions proposed: One every 6 months (includes special procurement supervision for post-review/audits)

Overall Procurement Risk Assessment: High

.. . ..

"Thresholds generally differ by country and project. Consult "Assessment o f Agency's Capacity to Implement Procurement" and contact the Regional Procurement Adviser for guidance.

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Annex 6(B): Financial Management and Disbursement Arrangements PAKISTAN: Pakistan Tax Administration Reforms Project

Risk Staffing

Financial ManaPement

1. Summary of the Financial Management Assessment

Risk Rating Risk Mitigating Measures Medium Induction o f Accounts Officer

(BPS 18/17)

Country issues: The draft CFAA report points to weak budget execution but th i s does not apply in th i s case. Experience with the existing portfolio indicates weak enforcement o f financial regulations and inaccurate financial reporting. However, th is has been taken care o f in this case with the key financial management personnel appointed on deputation from AGP’s office who will remain associated with the project during i t s life.

Internal control Medium Induction o f Intemal Auditor (BPS 18)

The risk rating i s M e d i d L o w but may be brought down to L o w if the above actions are completed.

Strengths and weaknesses:

Strengths: 1. Professional finance manager and deputy 2. Prior experience o f deputy in handling Bank financed projects

Weaknesses : 1. Absence o f financial management support staff 2. Absence o f internal audit arrangements

Staffmg: ATRS i s handling financial management of three ongoing projects with fourteen more expected to come up in the next few months. ATRS i s headed by Secretary (Expenditure) who i s on deputation from the Auditor General o f Pakistan’s (AGP) office. The Secretary holds an MBA degree in Finance. Similarly, the Second Secretary (ATRS) who heads the section i s on deputation [of three years] from AGP’s office. H e i s an MBA with majors in Finance, IT & M I S and a Fellow Member o f the Pakistan Institute o f Public Finance Accountants (PIPFA). The Second Secretary has prior experience of handling financial management of Bank financed projects.

There i s no support staff to assist the Second Secretary and some additional s taf f would be required to handle the additional work load and for proper intemal controls (segregation o f duties). AGP’s office has approved the appointment o f an internal auditor and accounts officer in addition to the two officers already on deputation. These staf f would remain with P M U during the l ife o f the project.

Budget preparation and execution: ATRS would submit the budget proposal (based on the Project Implementation Plan) to the Finance Division/Planning Division. After clearance by the Priorities Committee o f Planning Division, the New Items Statement (NIS) would be prepared by the CBR. N I S would be submitted to the Finance Division under intimation to the Planning Division after which the budget would be approved by the Ministry o f Finance.

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Appropriation registers would be maintained that would show the annual budget figures under each head o f account. Expenditure (both GoP and Bank) would be entered and unutilized balance struck after each transaction. A consolidated budget monitoring statement would be prepared by ATRS for Program Director’s review. A copy o f the statement would be submitted to the Finance Division.

Fund Flow Arrangements: After approval o f the budget, the Finance Division would be requested to release funds. The Finance Division would release funds under intimation to the Accountant General Pakistan Revenues (AGPR). AGPR would issue a sanction to the Federal Treasury Office (FTO) which would in turn authorize National Bank o f Pakistan to transfer funds to the Assignment Account.

Bank’s share o f expenditure would be incurred out o f a Special Account that would be opened for the project. The Special Account would be operated jointly by the Program Director and another officer to be nominated by the Chairman. Transaction based system o f reimbursement would be used for the project.

Accounting policies and procedures: Government’s Financial Rules (GFRs), delegation o f powers and chart o f accounts would be used for the project. Counterpart funds are expected to flow thru the Assignment Account that i s already being used for the three ongoing projects. The respective chiefs o f various components would incur expenditure under their respective command and submit vouchers to ATRS. Separate books o f account (for both Bank and counterpart funds) would be maintained for the project. As per present practice, release and utilization o f counterpart funds i s reconciled with the Federal Treasury Office and the AGPR respectively on a monthly basis. Th is practice would be continued for the project. Subsidiary record would be maintained for producing Financial Monitoring Reports (FMRs).

Payment process: Bills received would be checked by the Assistant Accounts Officer and Accounts Officer before review by the Second Secretary and Secretary ATRS. All payments related to the project would be approved by the Chairman after these have been seen by a committee comprising Member Policy & Tax Reform, Member Administration, the concerned Member and the Financial Advisor. A bills payable register would be maintained to record all invoices and payments in respect thereof. An advances register would be maintained for recording mobilization advance to contractors.

Fixed assets accounting: Fixed assets would be centrally procured by ATRS and delivered to the relevant sites. All sites would maintain subsidiary record in respect o f fixed assets that would be tallied with the control account maintained at ATRS. Fixed assets would be physically verified at least once every year.

Financial reporting: Bank’s financial management and reporting requirements (including quarterly Financial Monitoring Reports - FMRs) have been explained to the ATRS officials and it has been agreed that the expenditure ledger would be so designed as to show the project expenditure by disbursement category and by component.

Payroll processing: Payroll i s computerized at the Accountant General Pakistan Revenues (AGPR) CBR advises the AGPR for any changes in staff remuneration e.g. absenteeism, transfers, etc.

Internal audit: Although there are three Internal Audit Departments in CBR for Income Tax, Customs and Sales Tax, ATRS i s not subject to internal audit. Also, since the counterpart funds would be released thru the Assignment Account, there would be no pre-audit by AGPR. Therefore, one o f the additional s ta f f to be obtained from AGP’s office would look after th is aspect.

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External Audit: There were no material audit observations in respect o f audit o f the PPF or for the three projects for FY’02 and FY’03.

s1. No. 1. 2.

Impact of procurement arrangements: Bank’s procurement guidelines would be followed for the project. Procurement assessment i s under process after which the impact o f procurement arrangements on the financial management system would be assessed.

Agreed Action Responsibility

Accounts Officer to be in place (BPS 18/17) Internal Auditor to be in place (BPS 18)

CBR CBR

Financial covenants: Standard financial covenants would be included in the legal documents.

Audited Financial Statement Project/SOE

Special Account

Supervision plan: Normal supervision by Bank’s financial management staf f i s recommended since the project would have adequate financial management arrangements before negotiations.

Due Date 31 December 31 December

Agreed Actions: The AGP’s office has approved appointment o f the two officers on deputation with CBR.

Expenditure Category (1) Works

(2) Vehicles

IDA Credit (US$ million) IBRD Loan (US$ million) 18.00 - --

2.40 -- -_

DFID Grant(US$ m

The Intemal Control Questionnaire i s in the fi le.

2. Audit Arrangements

3. Disbursement Arrangements

The proposed Credit amount o f USD 102.9 mill ion and Grant of US$23 mil equvalent f rom DFID are expected to be disbursed over a period of five years and would cover about 85% o f the project cost. The withdrawals from the IDA Credit and DFID Grant would be under traditional transaction based disbursement systems.

The allocation o f the Credit/ Grant proceeds by disbursement category and percentage to be financed are show in the table below. 100% withdrawals, where applicable, would be net o f taxes and duties:

Allocation of loan proceeds (Table C)

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(4) Consultants’ Services

(5) Training

(6) Incremental Administrative

(7) Refund o f Preparation and Operating Costs

6.10 -- 8.00

5.00 -- 5.00

2.50 -- --

2.90 I __ Advance

(8) Unallocated

Use of statements of expenditures (SOEs):

Withdrawals (Documented and under Statement of Expenditures): Disbursement would be fully documented except for those expenditures under contracts not exceeding the equivalent of: (i) US$200,000 for works and goods; (iii)US$lOO,OOO for services for consulting firms; (v) US$50,000 for services o f individual consultants; (vi) training and (vii) incremental operating costs o f Program Management Unit. Such disbursement would be made against Statement o f Expenditures (SOEs), the documentation for which would not be submitted to IDA but retained by the CBR and made available during the course of project supervision.

0.00 I --

Special account: To facilitate disbursement, a Special Account would be established under the terms and conditions acceptable to IDA. The Special Account would be opened and maintained by CBR and would be used for payments for all the eligible foreign and local expenditures. The Special Account would be replenished on a monthly basis or whenever 20% o f the outstanding Special Account has been utilized, whichever occurs first. The Special Account will have an authorized allocation o f USD 10 million for advance.

Total Financing DFID Grant IBRD Loan Government Contribution

Total Project Costs

Retroactive Finance: Retroactive financing upto an amount of USD 2,500,000.00 million would cover

78.50 24.4 23.00 23.00 -- __ 24.4 23.10 - _- 149.00 -- --

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eligible expenditures for Project activities after July 1,2004.

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Annex 7: Project Processing Schedule PAKISTAN: Pakistan Tax Administration Reforms Project

Project Schedule Planned Actual Time taken to prepare the project (months)

First Bank mission (identification)

1 Appraisal mission departure I 0 1 /04/2004 I 06/04/2004 I 06/03/2004 08/04/2003

Negotiations

Planned Date of Effectiveness

Prepared by: Government O f Pakistan - Central Board of Revenue

0911 Of2004 0 113 112005

Preparation assistance: Project Preparation Facility (PPF) No. Q309-PAK advance US$2.9 million

Bank staff who worked on the project included:

Michael Engelschalk William Mayville Arturo Jacobs Zubair Khan Tax Economist Erik Puskar Haseeb Ahmed Michel Zarnoweciki Amer Durrani Trade & Transport Asya Akhlaque Zia Aljalaly Social Development Shabana Khawar Operations & Finance Rim Mehmood Amir Munir Hardware Systems Asif Ali Akhta.r Hamid Mi Awais Chau-Ching Shen Hasan Saqib Financial Management Rubina Geizla Quamber Team Assistant Kadija Jama Team Assistant

Tax Policy & Administration Human Resource & Training

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Annex 8: Documents in the Project File* PAKISTAN: Pakistan Tax Administration Reforms Project

A. Project Implementation Pian Borrower Project Implementation Plan

B. Bank Staff Assessments Pre-appraisal Aide Memoire Appraisal Mission Aide Memoire Economic Impact Assessment Financial Cost Benefit Assessment Tax Policy Impact Analysis

C. Other

Financial Sector Deepening and Intermediation Banking Sector Technical Assistance Revenue Administration Reform Project - Bulgaria Second Tax Administration Modernization Project - Russian Federation Tax Administration Reform Project - Jamaica Tax Administration Modernization Project - Hungary Modernization o f Customs Administration Project - (ADB) *Including electronic files

PIFRA-I

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Annex 9: Statement of Loans and Credits PAKISTAN: Pakistan Tax Administration Reforms Project

19-Jul-2004 Difference between expected

and actual Original Amount in US$ Millions disbursements' - _ _ - - -. . . -.

ProjectlD FY Purpose IBRD IDA GEF Cancel. Undisb. Orig FrmRev'd PO78997 2004 Sindh On-Farm Water Management Project 0.00 61.14 0.00 0.00 59.28 0.00 0.00 PO82621 2004 PO10556 2004 PO82977 2004 PO83370 2004 PO71454 2003 Po74858 2003 PO77288 2003 Po74797 2003 PO81909 2003 PO55292 2002 PO71092 2001 PO56213 2001 PO35823 2001 PO49791 1999 PO10500 1998 PO38015 1997

NWFP Community Infrastructure 11 ( CiP2) 0.00 37.10 HIGHWAYS REHAB 50.00 150.00 Second Poverty Alleviation Fund Project 0.00 238.00 PK Public Sect Capacity Building Project 0.00 55.00 AJK Community infrastructure 8 Services 0.00 20.00 HIV/AIDS Prevention Project 0.00 27.83 National Education Assessment System 0.00 3.63 Banking Sector Technical Assistance 0.00 26.50 Partnership for Polio Eradication 0.00 20.00 BSRPP 0.00 300.00 NWFP ON-FARM WATER MANAGEMENT PROJECT 0.00 21.35 TRADE 8 TRANSPORT 0.00 3.00 GEF-Protected Areas Management Project 0.00 0.00 POVERTY ALLEVIATION FUND 0.00 90.00 Natl Drainage Pmg 0.00 285.00 IMPR FIN REP 8 AUDIT 0.00 28.80

50.00 1367.35 Total:

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

10.08 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.24 0.00

36.58 206.08 244.78

53.72 20.13 38.70 3.80

25.12 0.90

111.37 21.12 0.80

10.84 3.76

' 70.27 14.30

0.00 0.00 4.73 0.00

41.16 0.00 0.00 0.00 5.48 0.00 7.32 0.00 0.18 0.00

15.37 0.00 1.09 0.00

-204.62 0.00 -3.08 -0.25 0.49 0.00 1.44 0.00 1.67 0.00

76.03 38.67 14.49 14.83

10.08 0.24 921.56 -3825 53.04

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PAKISTAN STATEMENT OF IFC's

Held and Disbursed Portfolio

In Millions US Dollars Mar - 2004

Committed Disbursed IFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic ABN AMRO PAK 1995

1996 1995 1991 1995104 1993 1993197101 2003 1991 2001 1990192196 2002 1995 1996 2003 1995 1994197100 2002 2002 1994 1994 1983102 1965187191194195 1994 2001 1996

A E S La1 Pir AES Pak Gen Abamco Mgmt Askari Bank BRRIM BSJS Fund CDCPL Crescent Bahuman Dewan Salman Engro Chemical Eni Pakistan FIIB Fauji Cement First UDL Gul Ahmed KCT Kohinoor Maple Leaf Metropolitan Bnk Micro Bank Network Leasing Orix Finance PI&CL PPL Packages Regent Knitwear Sarah Textiles Soneri Bank Uch Power Union Bank - PAK

Total Portfolio:

15.00 23.73 12.68 0.00 6.00 0.00 0.00 0.00 7.50

30.00 0.00

27.00 0.77

15.59 0.00

13.50 7.75

11.25 1 1.72 3.00 0.00 2.03 0.00 0.23 0.00 0.00 8.3 1 1.60 3 .OO

54.05 2.00

0.00 9.50 9.50 0.29 0.00 0.76 0.60 0.16 0.00 1 .oo 3.90 0.00 0.00 0.00 0.00 4.10 0.00 6.30 0.00 0.00 2.71 0.00 0.58 0.00 6.63 0.26 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 4.00 0.00 0.00 0.00 0.00 6.67 0.00 1 S O 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

16.10 0.00 0.00 0.00 0.00 0.00 1 S O 0.00 0.00 0.00 0.00 0.00 0.00

12.92 0.00

10.17 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2.80 0.00 0.00

59.18 0.00

15.00 23.73 12.68 0.00 6.00 0.00 0.00 0.00 7.40

30.00 0.00

27.00 0.77

15.19 0.00

13.50 7.75

11.25 11.60 3.00 0.00 0.00 0.00 0.23 0.00 0.00 8.3 1 1.60 3.00

43.96

0.00 9.50 9.50 0.29 0.00 0.76 0.60 0.16 0.00 0.00 3.90 0.00 0.00 0.00 0.00 4.10 0.00 6.30 0.00 0.00 2.71 0.00 0.58 0.00 6.63 0.26 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 4.00 0.00 0.00 0.00 0.00 6.67 0.00 1.50 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

16.10 0.00 0.00 0.00 0.00 0.00 1 S O 0.00 0.00 0.00 0.00 0.00 0.00

12.92 0.00

10.17 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2.80 0.00 0.00

44.14 0.00 2.00 0.00 0.00

256.71 46.29 12.17 102.67 243.97 45.29 12.17 87.63

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic 2004 Dewan SME 2.00 0.00 1.10 0.00

Total Pending Commitment: 2.00 0.00 1.10 0.00

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Annex 10: Country at a Glance PAKISTAN: Pakistan Tax Administration Reforms Project

POVERTY and SOCtAL Pakistan

2003 Population, mid-year lm//hons) GNI per capita (Affaes methodr US$) GNI (Affas method, US$ billionsl Average annual growth, 199743

Populatlon i%t Labor force (%)

Most recent estimate (latest year available, 1997-03)

Poverty f% utpapulation bebw nabonal poverty h e ) Urban population (% oftotelpopu/ation) Life expectancy at birth (yeam) Infant mortality (per l,oOo/ive births) Child malnutritmn (% of children under 5) Access to an improved water source (% ofpopu/atran) Illiteracy (% ofmulabon ege ISJ Gross primary enrollment (% ofschod-age populatmJ

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1983

GBP (US$ billionsj Gross domestic investnienWGBP Exp~rts of goods and s e r v d G D P Gross domestic savings/GI)P Gmss national savingdGDP

Current account balancelGDP interest paymentdGDP Total debffGDP Total debt servicelexports Present value of debtfGDP Present value of debuexports

28 7 18 8 1 I .9 7 7

17.0

-0.6 1 1

41.9 20.9

1983.93 1993-03 [avetage annual growthJ GDP 5.8 3A GDP aer caoita 3 1 0.9

148 4 430 84 0

2 4 3 2

33 34 64 76

90 59 73 84 62

1993

51 5 20 8 16 3 14 7 20 8

6 5 1 5

47 7 23 9

2002

2 8 0.4

South Asia

1,425 51 0 726

1 8 2 3

28 63 68 48 84 42 95

103 88

2002

58.9 14.7 18,7 14.4 18.1

2.7 1 3

57 1 21 .o 44.9

195,2

2003

5.8

Low. income

2,3f0 450

1,038

1.9 2.3

30 58 82 44 75 39 92 99 85

2003

68.8 15 5 20.5 15,6 22.2

6.1 1.1

52.7 16.7

2003-07

6.1

Life expectancy

T I

GNI Gross per +-- primary capita enrollment

1 Access to improved water source

Pakistan _.^IC__

. Low-inwme gmup

Trade I

Indebtedness

Pakistan I *-*- 3 3 3.7 I Lowinwme gmup I

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Private consumption General government consumption imports of goods and sewices

Manufacturing

(average annual growth) Agriculture Industry

Services

Private consumption General government consumption Gross domestic investment Imports of goods and services

Manufacturing

1983 1993

30.3 25.0 22.1 24.7 15.3 16.7 47.7 50.3

80.8 72.2 11.4 13.1 23.0 22.4

1983-93 1993-03

4.4 3.5 7.1 3.6 6.6 4.1 5.7 4.1

4.3 3.5 6.6 1.3 4.9 0.7 3.2 0.0

2002

23.2 23.3 16.1 53.5

74.4 11.3 19.0

2002

-0.1 5.4 5.0 4.1

1.4 13.5 -3.0 4.5

2003

23.3 23.5 16.4 53.2

72.7 11.7 20.4

2003

4.1 5.4 7.7 5.3

-0.6 10.4 10.5 13.9

Growth of investment and GDP (5() 20

10

0 98 W 01 02 03

-20

b "*_i GDI *GDP

-lo i

Growth of exports and Imports (X)

4Q T I

. . . . . . . . . . . . . . . . . . . . . . .~ ..,.. . . ~ . . . . . . . . . ". . . . . . . . . . ,- - - - ., ,~ ...,.. ,....

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Pakistan PRICES and GOVERNMENT FINANCE

Domestlc prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplusidefidt

TRADE

(US$ millions) Total exports (fob)

Cotton Rice Manufactures

Total imports (cif~ Food Fuel and energy Capital goods

Export price index (1995=100) Import price index (1995=100) Terms of trade (199S100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ mi//ions) Conversion rate (DEC, /oca//US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment Portfolio equity

World Bank program Commitments Disbursements Principal repayments Net f low Interest payments Net transfers

1983

5.3

1983

2,694

1,881

1983

3,420 6,593

-3,173

-421 3,416

-1 78

2,758 12.7

1983

12,026 351

1,145

1,343 63 14

277 350 -87 30 0

306 144 34

110 42 68

1993

9.8 8.7

18.1 -2.4 -8.1

1993

6,782 271 317

3,723 10,049 1,290 1,578 3,409

88 96 92

1993

8,339 12,856 -4,517

-1,498 2,688

-3,326

2,682 644

1,360 25.9

1993

24,546 2,624 2,683

2,383 343 45

361 1,011

710 306 270

625 598 1 02 416 206 210

2002

2.7 3.1

19.5 0.2

-6.7

2002

9,140 18

448 5,368 9,432

413 2,664 2,594

80 90 89

2002

11,056 11,646

-590

-2,319 4,500

1,591

1,685 -3,276

4,997 61.6

2002

33,672 2,749 5,394

2,850 367 111

1,495 781

-515 368

-491

736 961 318 643 160 483

2003

3.1 4.6

20.8 1.1

-4.5

2003

10,889 49

555 6,653

11,333 587

3,097 3,392

89 101 88

2003

13,686 14,047

-361

-2,210 6,775

4,204

1,475 -5,679

10.243 58.6

2003

36.132 2,695 5,869

3,028 373 1 30

1,038 -133 -530 612

-394

498 145 357

-212 147

-358

Expolt and Import levels (US0 mlll.)

12,500 T I 1 o . m

7,500

5 . m

2.500

0

I O3 I 07 M W W 01 02

L3Expork Dimports

Current account balance to GDP (76)

lo T

10 1

1 Comporitlon of 2003 debt (US0 mlll.)

A - IBRD B - IDA D - Other multilateral F - Private C - IMF

E ~ Bilateral

G - Short-term

Development tconomics Yl1 IIW

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