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Income Tax Ordinance, 2001

Advance tax or extortionate money

Huzaima Bukhari & Dr. Ikramul Haq

After the Second World War, the provision of advance tax [now encased in section 147 of the Income Tax Ordinance, 2001 [hereinafter “the Ordinance”] was introduced as a measure to combat inflation and to squeeze large part of the unprecedented amount of money then in circulation, but, like many other innovations in tax legislation it has outlived the exigency which gave it birth, noted by tax scholars Mr. N. A. Palkhivala and B.A. Palkhivala in their classical work The Law and Practice of Income Tax, Seventh Edition at page 1063.

In Pakistan until assessment year 1995-1996, three specific characteristics were the hallmarks of advance tax, viz.

  1. Advance tax was paid by the taxpayer on the basis of last declared/assessed/estimated income for that assessment year;
  2. Credit for any advance tax collected for an assessment year was accounted for in that year and not the year of collection; and
  3. 6% mark-up on the amount retained as advance tax was paid to the taxpayer at the time of assessment thereby compensating his cost of funds or opportunity cost for the period his money remained with the government.

With increasing pressure on Federal Bureau of Revenue (FBR) for achieving assigned targets (fixed with utter disregard for ground realities), panic-struck measures were adopted to display a high level of efficiency by foolhardy bureaucrats and one by one the following features started unfolding:

  1. Credit for advance tax was being taken in the year of collection;
  2. Calendar year as income year was done away with resulting in many taxpayers having to pay tax for a period of 18 months;
  3. Basis for determining tax shifted from income to ‘turnover’; and
  4. Compensation was no longer payable.

These measures clearly imply that even today, FBR’s pride in achieving collection targets is not based on the figures for the past closing year alone but inclusive of the future closing year or years as well e.g. during fiscal year 2011, the banks are paying advance tax for 2012. Advance tax paid for tax year 2011 till 31st December 2010 will be given credit when returns are filed in September 2011. In this way, the government utilises billions of rupees of the banks paid by them against their future liabilities!

Any hope of positive changes re advance tax, through the introduction of the Ordinance, 2001 were shattered in that all existing ailments were merely repackaged with new terminology and concepts that remain tantalizing for the minds of both the taxpayers as well as officials. All provisions of the repealed Ordinance regarding basis of computing advance tax stand as before, including non-payment of compensation.

The concept of advance tax clearly envisages a pre-assessment situation in the case of a taxpayer. Thus, if at the time of filing a return under section 120 (incidentally resulting in automatic assessment under the universal self-assessment scheme) the law specifically provides for taking credit for all taxes paid until the date of filing the return. This implies that if any outstanding balance of tax remains, it should be either refunded or adjusted in the subsequent installments of advance tax for the next tax year. However, the FBR stalwarts have always interpreted this law negatively in case of taxpayers and much to their own advantage. Para 4 of Circular No. 2 of 2004 dated 25.5.2004 which merits attention reads as under:

“4.       It is also clarified that in case of taxpayers having special *income year, the credit for payment of advance tax, shall be allowed in respect of the quarters falling within such income year e.g. in case of a company closing its accounts on December 31, 2004, the credit for advance tax shall be allowed for tax year 2005 in respect of advance tax paid for the quarters, ending March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004.”                                            

(Emphasis is ours)

            *Should have been ‘tax year’

Under which law have these instructions been issued? In the first place, ‘income year’ no longer exists and secondly, there is clear indication of straining the law to the extent of distorting the very basis of giving credit for advance payments. These instructions totally disregard payments made in 2003. What was the fate of those installments? Why should a company allow credit to be taken (of the three quarters falling in 2004) for a tax year that was yet to come? This merely shows that:

  • the term ‘tax year’ is a definition subject to the whims of FBR;
  • in reality, the Department failed to grasp its meaning as laid down in the statute;
  • the taxpayer will have to adjust his accounts according to the defective language of the circular;
  • there will always be overlapping of two or more tax years; and
  • there is no relevance of tax year as it will be the Department deciding for which tax year, credit may be taken.

If this remains the position, then what is the sanctity of allowing a taxpayer to maintain so-called special tax years ending on dates other than 30th June because according to his understanding, his accounting period, both for maintaining accounts and assessment of income, will remain a period of twelve months distinct from the financial year. And above all, why should he let the department exploit his advance tax paid on, say 15.03.10 and 15.06.10 for a period of 18 and 15 months respectively? It is quite surprising that FBR, in total contravention of existing law has the audacity to suggest which quarters’ credit would be allowable despite the non-relativity of an advance payment with the tax year in question.

FBR’s interpretation is patently unlawful as it gives the Department an opportunity to retain taxpayer’s money beyond twelve months’ time. The concept of advance tax in itself is tortious as businessmen are out of money, hampering their cash flow and depriving them of circulating the amount to earn more profits. Adding insult to injury, FBR wants to utilize that money without paying any compensation. Before 1997, the Department under the law was bound to pay 6% compensation on deposit of advance tax. Not only has the 6% compensation been withdrawn but on top of that in case of a taxpayer maintaining calendar year as tax year, the last two installments of March and June would be retained for 18 and 15 months respectively till the return becomes due on 30 September. There cannot be a worst scenario than this that a person is deprived of his money in the name of advance tax for such a long period of time without any compensation.

Advance tax was a temporary measure in the wake of the Second World War as British imperialists were running short of money. Unfortunately, this has been made a permanent feature of law by our local ‘gora sahibs’ who believe in utilizing citizens’ money without any return to them. This has changed the face of income tax into a criminal levy or bhatta (extortion) forcefully recovered by modern day dacoits who call themselves “tax collectors”!

What would be the position of adjustment of tax liabilities against excessive payment of advance tax? Does it mean that there will be point-blank refusal to adjust such payments on the grounds that they are not related to the immediately succeeding year but a subsequent one? Suppose if a deduction of tax is made from payment of a future contract (assuming it does not fall in the presumptive tax regime) to be executed after two years, the taxpayer has no right to claim its credit after a lapse of two years and must take credit in the year in which the deduction is made? What would be the position if instead of income he incurs loss in a return filed two years later? How would he justify his entitlement to the refund?

The Department has proved again and again that it merely wants to create confusion and utter uncertainty. Their own (mis)understanding about the new Income Tax Law is complicating matters rather than simplifying them. There was nothing in the repealed Ordinance to give rise to such interpretation although even then, we had strongly agitated the amendment in law where credit for advance tax was taken by the Department in the year in which it was received rather than carrying it forward to the relevant assessment year. History is witness that a few high-ups in the bureaucracy serving their own self-interests have played havoc with the income tax law and procedure creating gaping lacunae and unleashing a reign of mismanagement just to show that they have proved ‘more than efficient’ in achieving given targets; or was it to cover up their incompetence?


The writers, tax lawyers and authors of many books, are Adjunct Professors at Lahore University of Management Sciences (LUMS).

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