Understanding Income Tax: Overview and Principles in Pakistan

1. BASIC CONCEPT COMMON RULES AND UNDERSTANDING INCOME TAX STRUCTURE AND OPERATION Presented by: M. Rehan Siddiqui Partner CHARTERED ACCOUNTANTS Karachi Tax Bar Association Professional Development Program Contact Address: 4th Floor, Central Hotel Building Civil Lines, Mereweather Road Karachi - Pakistan Phone: 021 – 35644872-7 Fax: 021 – 35694573 E-mail: aar@mimandco.com

2. Objective The objective of this presentation is to discuss and develop some of the fundamental principles of taxation as applicable both under the direct and indirect taxes in Pakistan

3. Contents • Concept of tax • Types of taxation • Reason for taxation and • History and evolution of taxation • Structure of income tax law • Returns and rates of Tax • Operation of income tax law • General provisions • Withholding Taxes

4. Contents • Penalties • Tax Credits • Exemptions and Concessions • Payment of Refunds • Sales Tax and Federal Excise Duty (FED)

5. CONCEPT OF TAX-GENERAL

6. CONCEPT OF TAX - GENERAL TYPES OF TAXATION • FEDERAL TAXINCOME TAXSALES TAX / VAT*FEDERAL EXCISE*CUSTOM DUTY*WEALTH TAX ZAKAT • PROVINCIAL TAXPROPERTY TAXPROVINCIAL EXCISEWATER TAXCUSTOM DUTYUSHER/DHAL/ABIYANA & A HOST OFOTHER TAXES * In certain countries these taxes are imposed on the Provincial / State Level.

7. CONCEPT OF TAX - GENERAL WHY TAXATION :- • Every country needs funds • For Running the Government & Establishment • For Defence • For Future Developments Programmes (Contd....)

8. CONCEPT OF TAXEVOLUTION OF INCOME TAX - HISTORY Pakistan adopted the Income tax Act, 1922 when it became Independent in 1947 and this Act was followed upto 1979 when a new Income Tax Ordinance, 1979 was promulgated. The concept of the Income Tax Ordinance, 1979 was very much the same as the Act of 1922 but was brought into a serial order till a new Law called the Income Tax Ordinance, 2001 was enacted which came into force from 2003. (Contd....)

9. CONCEPT OF TAXEVOLUTION OF INCOME TAX- HISTORY PROGRESSIVE TAX REGRESSIVE TAX PROPORIONATE TAX INCOME TAX SALES TAXEXCISE TAXCUSTOM DUTY SHARE OF TAX

10. POWER TO TAX • Entry No. 47 and 48 of the Federal Legislature List as contained in Part- I of the Fourth Schedule to the Constitution of Pakistan, 1973, empowers the Federal Government to impose tax on income and corporations respectively. • Entry No. 49 of the said list also empowers the Federal Government to levy taxes on the sales and purchases of goods imported exported, produced, manufactured or consumed in Pakistan. (Contd....)

11. TERROTORIAL JURISDICTION OF TAX LAWS • The tax laws extends to whole of Pakistan. The territories of Pakistan under the Constitution means: • The four provinces viz Balochistan, KPK, Sindh and Punjab; • The Federal Capital; • The Federally Administered Tribal Areas; and • Such states or territories as are or may be included in the territories of Pakistan, by accession or otherwise. • However, any Federal law, including tax laws do not automatically apply to FATA and PATA unless the president or the governor with the approval of the president respectively direct that a particular legislature is in force to the respective Federally or Provincially administered tribal area.

12. SPECIAL PROVISIONS OF LAW TO PREVAIL OVER GENERAL PROVISIONS • Where a law provides for a specific treatment in respect of a particular category of, say, income, person, or class of persons, the same would prevail over the general provisions of the law.

13. STRUCTURE OF INCOME TAX LAW

14. STRUCTURE OF INCOEM TAX LAW The Income Tax Ordinance, 2001 has 240 Sections, Seven Schedules which are govern by 232 Rules. SECTION Section guides about the nature of taxable income, charge liability of tax on income. SCHEDULE Schedules provides special guidance in respect of tax rates applicable on certain income and talks about special exemptions and reduction in rate of taxes that are available to certain classes of persons or income. Apart from this, schedules are also stipulates special rules for computing the Profits & Gain and other special privileges for banking, insurance, business exploration & production of petroleum and exploration and extraction of mineral deposits (other than petroleum) RULES Rules deals in computing taxable income.

15. INCOME – GENERAL MEANING • All receipts by a person does not necessarily constitute “income” • Generally, income connotes a periodical monetary return, “coming in” with certain regularity from a definite source [Commissioner Income Tax, Bengal V. Shaw Wallace, (AIR 1932 PC 138)] • Generally, capital receipts are not taxable unless they are specifically provided in the tax law to be taxable. • Revenue receipts are generally almost always taxable (being income) unless they are explicitly provided as not to be taxable.

16. INCOME – GENERAL MEANING • Following may be the distinguishing criteria between capital and revenue receipts:- • Receipt from circulating capital versus receipt from fixed capital • Receipt from source of income versus receipt in lieu of source of income • Payer’s motive ignored - receipt in the hands of the recipient is relevant • Lump sum payment is not the determining factor between capital and revenue receipt

17. INCOME – GENERAL MEANING • Certain capital receipts deemed as “income” for tax purposes include: - • Golden handshake payments on termination of services • Gain on disposal of capital assets, including jewellery, painting manuscripts etc. • Certain revenue receipts which should otherwise be taxed but not taxed include: - • Agricultural income • Profit and gains derived by electric power generating projects

18. INCOME UNDER THE ORDINANCE • As per Section 2(29) of the Ordinance, income has the following scope: • Income as understood in normal parlance • Any amount chargeable to tax under the Ordinance • Any amount subject to collection or deduction of tax under the Ordinance as a final discharge of tax liability • Any amount “treated” as income under the Ordinance • Loss of income is also income

19. “NON INCOME” VS. “EXEMPT INCOME” VS “INCOME TAXABLE AT 0%” • As discussed above, certain income may not be income and therefore are not taxable. • Other category of receipt may be income but provided to be exempt from tax, as in the case of Second Schedule to the Ordinance • There may be some other receipts which are taxable at 0%

20. CLASSES OF INCOME VS HEADS OF INCOME • There are different classes of income, including: - • Salary (Arising out of employment) • Income from property (being rental income from immovable property) • Royalty (on account of use of or right to use intellectual property) • Profit on debt/interest (on funds lended to others) • Dividend (from shares held by the investor)

21. CLASSES OF INCOME VS HEADS OF INCOME • There are only five heads of income in which each of such class of income is to be classified. These heads are: - • Salary • Income from Property • Income from Business • Capital Gains • Income from Other Sources • Categorization of a particular class of income into a particular head of income is dependent on the person who is deriving such income and therefore may differ from one person to another.

22. EXPENDITURE – GENERAL MEANING • The term “expenditure” means “spending” or “paying out or away”, i.e., something that goes out of the coffers of the taxpayer. It means something which is gone irretrievably [B. K. Khanna & Co. (P.) Ltd. V. CIT [2000] 113 Taxman 164 (Delhi)] • Expenditure, not being capital or personal expenditure, is an allowable deduction to the taxpayer in the tax year. • Capital expenditure, in the form of depreciable assets and intangibles, is allowed in the form of depreciation and amortization.

23. SCHEMES OF TAXATION • Broadly, there are two schemes of taxation: - • Final Tax Regime Whereby tax is levied on the gross amount, without allowability of any expense • Normal Tax Regime Whereby bottom line income, after allowing for all admissible deductions, are taxed at applicable rates.

24. PERSONS LIABLE TO TAX • The Ordinance tends to tax the income derived by a person • Following are the main categories of persons • Federal Government • Foreign Government • Political sub division of a Foreign Government • International Organization • Individuals • Association of persons • Companies

25. TAX YEAR • Income derived by a person in tax year is taxable • Normal tax year is from 01 July to 30 June • Adopting any other 12 month period may be allowed which is called as the special tax year. • The Government has prescribed special tax year for certain persons, including: - • Insurance Companies • Companies Manufacturing Sugar • Companies Manufacturing Jute Goods • All Persons Manufacturing Rice • Interim period between the normal tax year and the special tax year is called the transitional tax year.

26. PERSON LIABLE TO FILE RETURN OF INCOME

27. PERSON LIABLE TO FILE RETURN OF INCOME

28. RATE OF TAX ON INCOME CHARGEABLE TO TAX

29. RATE OF TAX ON INCOME CHARGEABLE TO TAX The rate of taxes are provided in the First Schedule of the Income Tax Ordinance, 2001.

30. OPEATION OF INCOME TAX LAW

31. OPEATION OF INCOME TAX LAW

32. FILILG OF INCOME TAX RETURN SECTION 114 As per the provision of section 114 a person shall declare his annual income in the prescribed form which shall be accompanied by such annexure, statement or documents. An individual having salary, business income and association of person are require to file their return of income on or before September 30th after closing of financial year which was ended on June 30th. A company shall file its return of income on or before December 31st after closing of financial year which was ended on June 30th.

33. DEEMED ASSESSMENT SECTION 120 • 120. Assessments • Return filed by a taxpayer under section 114 is deem to be an order. • Selection of case for Audit under section 177 may be conducted by the Commissioner of Income Tax. • The return filed can be disqualify under section 120 if the deficiencies has not been removed which were pointed out by the Commissioner of Income Tax.

34. SELECTION OF RETURN FOR AUDITSECTION 177 • 177. Audit • The Commissioner of Inland Revenue may call for any record or documents including books of accounts maintained by taxpayer person for conducting audit of the income tax affairs of the person. • The Officer Inland Revenue subordinate officer of Commissioner of Inland Revenue who delegated his power to him in order to verify records. (Books of accounts) • The Officer Inland Revenue after conducting audit confront the taxpayer those additions which were came to surface during audit proceedings.

35. REVISION BY THE COMMISSIONERSECTION 122(5A) • The Commissioner may call any record in respect of return filed under section 120. • Verification of records the Commissioner may amend the basis of computing income for the purpose filing return adopted by the taxpayer. • The Commissioner has the power to amend the return for five years from the financial year in which the return was filed.

36. PROVISIONAL ASSESSMENT SECTION 122(C) • The Commissioner may require any person to file the return of Income. • In case the return not file by the person the Commissioner may issue provisional order on the basis of information available on records. • After issuing provisional order the taxpayer has sixty days to file the return in case to annulled the provisional order. • In case sixty days time elapsed the provisional order becomes the order and the tax liability work out by the Commissioner becomes payable to a taxpayer.

37. GENERAL PROVISIONS

38. The section 57 of the Income Tax Ordinance, 2001 allow taxpayer to carry forward its business loss to next tax year after setting off against the person’s income chargeable under the head income from business for that year. A person cannot set off or carry forward speculation business losses against the income, which is other than speculation business income chargeable to tax for that year. A person also cannot set off or carry forward capital losses against the income, which is other than capital gains chargeable to tax for that year. CARRY FORWARD OF BUSINESS LOSSES (Contd....)

39. Every taxpayer whose income was chargeable to tax for the latest tax year is require to pay advance tax under section 147 of the Income Tax Ordinance, 2001. Where a taxpayer is an Association of Persons & Company shall pay advance tax on the basis of following formula. (A x B / C) - D A is the taxpayer’s turnover for the quarter B is the tax assessed to the taxpayer for the latest tax year; C is the taxpayer’s turnover for the latest tax year; and D is the tax paid in the quarter for which a tax credit is allowed under section 168, other than tax deducted under section 155. ADVANCE TAX UNDER SECTION 147 (Contd....)

40. An individual taxpayer shall pay advance tax for a tax year on the basis of the following formula. (A / 4) - B A is the tax assessed to the taxpayer for the latest tax year or latest assessment year under the repealed Ordinance; and B is the tax paid in the quarter for which a tax credit is allowed under section 168 other than tax deducted under section 149 or 155. ADVANCE TAX UNDER SECTION 147 (Contd....)

41. ADVANCE TAX UNDER SECTION 147 • The Finance Act, 2010 has introduced advance tax on Capital Gains earn by a taxpayer on sale of securities.

42. WITHHOLDING TAX PROVISIONS

43. Determine nature of payment / receipt Determine applicable withholding tax provision including applicable rate and double tax treaty provisions (if applicable) Determine status of payer as ‘withholding agent’ (prescribed person) Determination of status of recipient – liable or exempt from withholding tax Payment, deduction / collection (or non-deduction/collection) of tax Timing of deduction / collection Deposit of tax and issuance of certificate Reporting Monitoring of withholding taxes. DETERMINE WITHHOLDING TAXPROVISION FOR MAKING PAYMENT

44. PENALTIES FOR NON DEDUCTION OF TAX

45. Disallowance of expense - Section 21(c) Recovery of tax not deducted from payer - Section 161 Recovery of tax not deducted from recipient - Section 162 Default surcharge for delayed deposit of tax deducted / collected KIBOR + 3% - Section 205(3) 19% 161(1A) Penalty - Section 182(1) Entry 5 - 5% additional 25% & 50% for second & third default Entry 15 - 25,000 or 10% of tax, whichever is higher REPERCUSSIONS FOR DEFAULTIN WITHHOLDING TAXES

46. PENALTY PROVISIONS The Income Tax Ordinance, 2001 penalized a taxpayer for non compliance of statutory obligation as under: -

47. TAX CREDIT

48. Section 61 of the Income Tax Ordinance, 2001 has allowed a taxpayer to claim tax credit against the total tax liability for a tax year. Charitable Donation A person shall be entitled to a tax credit in respect of any sum paid or any property given as donation to an approved institution under section 2(36)(c). Where a person is an individual or Association of Persons can claim tax credit up to 30% of the taxable income and 20% in case of companies. Formula A/B x C A is the amount of tax assessed to the person for the tax year before allowance of any tax credit under this part; B is the person’s taxable income for the tax year; and C Total amount of person’s donations including the fair market value of property TAX CREDIT (Contd....)

49. Investment In Shares A person other than company shall be entitled to claim tax credit in respect of the cost of acquiring new shares offer to the public by a public limited company or share acquired from the privatization commission of Pakistan with the condition that the buyer is the original allottee of the shares. A person can claim cost of shares up to 10% of the taxable income or 300,000/- Rupees or actual cost which ever is lower. Formula A/B x C A is the amount of tax assessed to the person for the tax year before allowance of any tax credit under this part; B is the person’s taxable income for the tax year; and C Total amount of person’s investment TAX CREDIT (Contd....)

50. Contribution To An Approved Pension Fund An eligible person deriving income chargeable to tax under the head salary shall be entitled to a tax credit in respect of any contribution or premium paid in a tax year in approved pension fund under the Voluntary Pension System Rules, 2005. Formula A/B x C A is the amount of tax assessed to the person for the tax year before allowance of any tax credit under this part; B is the person’s taxable income for the tax year; and C Total contribution or premium paid in a year TAX CREDIT (Contd....)