Anomalies, lacunae and inconsistencies
Huzaima Bukhari & Dr. Ikramul Haq
Huzaima Bukhari & Dr. Ikramul Haq, leading tax consultants, are well-known authors of many books on Pakistani tax laws. They work for a multi-disciplinary firm, HUZAIMA & IKRAM (fax: +92 42 5310721, e-mail: irm@brain.net.pk; website: http://www.paktax.com.pk) which specialises in international tax, intellectual property, corporate and constitutional law and publishes tax books [through sister concern Lahore Law Publications] besides holding courses on a variety of subjects relating to tax laws under the banner of Lahore Institute of Tax Education (LITE).
The Income Tax Ordinance, 2001, which was promulgated in 2001 with tall claims of simplifying tax code, contains a number of anomalies, ambiguities, lacunae and inconsistencies. We have pointed out many of these in our book Law and Practice of Income. In this article three such anomalies are highlighted for the immediate attention of all the stakeholders. These can have very somber ramifications for the taxpayers.
Confiscatory taxation u/s 13(7)
Any law enacted by the Majlis-e-Shoora (Parliament) has to conform to the principles contained in the Constitution of Pakistan, and tax codes are no exception. Any tax levied by the Parliament is to be tested on the touchstone of the fundamental rights enshrined in the Constitution and if it is violative of any provision it would be void ab initio. The State has power to tax its citizens but taxation should not be confiscatory, discriminatory or offensive to any fundamental right guaranteed in Chapter 1 of the Constitution [Article 8 to 28]. It is the duty of the State “to ensure the elimination of all forms of exploitation and the gradual fulfilment of the fundamental principle: from each according to his ability to each according to his work” [Article 3]. This principle has been flagrantly violated by taxing notional income in the hands of a salaried person if his employer extends him a riba-free (interest-free) or concessionary loan [section 13(7)].
Article 8 of the Constitution says that “Any law, or any custom or usage having the force of law, in so far as it is inconsistent with the rights conferred under this Chapter [Chapter 1 relating to Fundamental Rights] shall, to the extent of such inconsistency, be void”. The provision of taxing notional income arising from riba-free or concessionary loans is against the following provisions of the Constitution:
- Article 25 of the Constitution which says that “all citizens are equal before law and are entitled to equal protection of law”. However, this article does not speak about abstract equality, but in fact, proclaims equality before the law. Equal protection of law means that all the persons equally placed should be treated alike both in privileges conferred and liabilities imposed. A reasonable classification should be based on:-
- An intelligible differentia which distinguishes persons or things that are grouped together from those who/which are left out;
- The differentia must have a rational nexus to the object sought to be achieved by such classification.
And
- Article 38(f) requiring the State to eliminate riba as early as possible.
On the one hand there is much talk about Islamizing the economy/banking and on the other expropriatory tax provisions exist that penalise an employee who receives riba-free or concessionary loan. It is worth mentioning that this provision is only meant for the salaried class while all others are left out. In this society loan defaulters (covering both genuine bankrupts as well as professional loan-sharks) enjoy immunity from tax. Recently, the Finance Bill 2004 provided them with unprecedented benefit of non-taxation of remission of loan and mark-up. One class is getting such benefits while the already overtaxed salaried class is being taxed for riba-free loan/concessionary loan where no element of income is involved.
Section 13(7) of the new Ordinance taxing the notional benefit arising out of riba-free or concessionary loans given to employees is violative of Article 25 and 38(f) of the Constitution. It reads as under:
‘Where a loan is made, on or after the 1st day of July, 2002, by an employer to an employee and either no profit on loan is payable by the employee or the rate of profit on loan is less than the benchmark rate, the amount chargeable to tax to the employee under the head “Salary” for a tax year shall include an amount equal to-
(a) the profit on loan computed at the benchmark rate, where no profit on loan is payable by the employee, or
(b) the difference between the amount of profit on loan paid by the employee in that tax year and the amount of profit on loan computed at the benchmark rate, as the case may be.
The expression “benchmark” is defined in sub-section (14) of section 13 as under:
(a) “benchmark rate” means —
(i) for the tax year commencing on the first day of July, 2002, a rate of five percent per annum; and
(ii) for the tax years next following the tax year referred to in sub-clause (i), the rate for each successive year taken at one percent above the rate applicable for the immediately preceding tax year but not exceeding such rate, if any, as the Federal Government may, by notification, specify in respect of any tax year;
This provision of law is liable to be struck down as it is against the basic principles of the Constitution. It is confiscatory and violative of the equality principle. It is also against Article 38(f) that requires the State to eliminate riba as early as possible. This provision of law is also against the declared policies of the government of:-
- providing relief to the salaried class.
- promoting housing industry
- extending affordable loans and advances to low-income groups of society.
Section 13(7) read with section 13(14) is against all norms of law, justice and equity. How can a law fix benchmark rate arbitrarily at 5% for the base year and thereafter provide for an annual increase of 1%, whereas the mark-up rates in the market are declining? Secondly, if an employee has obtained loan at a rate less than 5% how can the law fix it at a higher rate? It is pertinent to mention that the Central Board of Revenue (CBR) under the repealed Ordinance of 1979 issued a Circular Letter 4(8)IT-J/91 dated June 30, 1991 opining that “…it is not desirable to tax such notional income…”.
The facility of interest-free or concessionary loans can be abused by the director/shareholders of private companies or certain persons running family-controlled trusts, but in their case the law provides that such a loan would be treated as dividend as per section 2(19)(e) of the new Ordinance. The whole amount of loan in their case is treated as dividend and a separate block of income that is taxed @ 10%.
In the case of employees/persons having no ownership interest in the business concern, the employer/concern cannot divert income by giving them loans in lieu of dividends and therefore there is no justification to tax such a notional income by treating riba-free or concessionary loan as a perquisite. The idea of taxation of such loans at an incremental rate of 1% every year starting from the base year self-assumed rate of 5% is confiscatory as in many cases the actual rate on which loan obtained may be much lower. Presently the banks are giving loans to credit-worthy parties at as low a rate as between 2% to 3.5%.
The following illustration [based on a real life case] shows financial ramifications of this provision of law in the case of a bank employee earning monthly basic salary of Rs. 10,000 and who has availed the facility of house loan of Rs. 4 million from his employer:
- Mr. ‘A’, employee of a bank, received the following for the tax year 2004:
Rs.
Basic Salary: 120,000
House rent allowance: 54,000
Utilities: 12,000
Medical allowance: 12,000
House loan was taken on 1st July 2002 @ 2% per annum mark-up.
Computation of taxable income and tax payable
Item Amount Exempt Taxable
Basic salary 120,000 Nil 120,000
HRA 54,000 54,000 Nil
Utilities 12,000 12,000 Nil
Medical 12,000 12,000 Nil
Income u/s 13(7) 240,000 80,000 160,000
Total taxable income 2,80,000
Calculation of tax liability
Taxable income: 2,80,000
Tax on Rs. 150,000: 5,250
Tax on 130,000@12.5%: 16,250
Gross tax: 22,500
Tax reduction @30%: (-) 6,750
Net tax payable : 15,750
- Had section 13(7) not been applicable, total tax payable would have been just Rs. 1500.
- Taxable salary is merely Rs. 120,000 whereas notional value of taxable house loan facility is Rs. 160,000. Loan of Rs. 4 million is barely sufficient to purchase/construct a house on a 125 to 250 square yards plot in any average locality.
- The banks’ employees are at par with PIA and Railways who enjoy free/concessional tickets. In their case no income on this account is taxed as the employer is engaged in the business of carriage of passengers. On the same analogy, the banks are engaged in the business of lending and borrowing and therefore their employees should not be taxed for this facility.
The above example clearly exposes the adverse effects of section 13(7) read with section 13(14). There are cases where only due to inclusion of this notional income, a salaried person falls in the category of taxable income of Rs. 600,000 and consequently all the allowances and perquisites in his case become taxable.
It is therefore imperative that this notional income should not be taxed. In case the government (in fact CBR) is bent upon promoting riba despite tall claims of eliminating exploitation from the economy, then the following amendments should be made making the law equitable:–
- Benchmark rate as defined in section 13(14) should not be more than the rate on which loan is obtained by an employee.
- In case rate is lower than the average borrowing rate for such kind of loans in the market, the Federal Government or State Bank should be asked to notify an average rate for the relevant tax year.
- Addition under section 13(7) should not be part of “taxable income” to determine the threshold of Rs. 600,000 for the purpose of rule 9 of the Income Tax Rules, 2002.
- Such a notional income should be taxed as a separate block at a concessional rate not exceeding 5%.
It is hoped that the policymakers at the helm of affairs will take due notice of this unjust and confiscatory provision of law that has disastrous financial ramifications for the salaried persons, who are already facing a tough challenge to survive in their paltry resources. The tall claims of the government to promote riba-free economy, housing industry and to provide housing facilities to all the citizens are in direct conflict with such erratic and confiscatory fiscal provisions which are against the basic principles of Constitution of Pakistan.
Taxation of capital gain on disposal of immovable property
Under the scheme of the Income Tax Ordinance, 2001 [hereinafter: “the Ordinance”], on the disposal of depreciable assets resultant gain or loss is to be taken into account for computing taxable income under the head Business Income for the relevant tax year. Section 22(8) of the Ordinance reads as under:
Where, in any tax year, a person disposes of a depreciable asset, no depreciation deduction shall be allowed under this section for that year and –
(a) if the consideration received exceeds the written down value of the asset at the time of disposal, the excess shall be chargeable to tax in that year under the head “Income from Business”; or
(b) if the consideration received is less than the written down value of the asset at the time of disposal, the difference shall be allowed as a deduction in computing the person’s income chargeable under the head “Income from Business” for that year.
If a building is disposed of and consideration received exceeds both the written down value and actual cost as per new Ordinance not only the terminal profit will be taxed but also the capital gain that is difference between the sale price and original cost as mentioned in section 22(13)(d) of the Ordinance, which reads as under:
“where the consideration received on the disposal of immovable property exceeds the cost of the property, the consideration received shall be treated as the cost of the property”.
Plain reading of the above provision shows that where consideration received exceeds the cost of immovable property then such consideration shall be treated as cost of the property. In other words capital gain on disposal of immovable property will be charged to tax in utter violation of Entry 50 of Federal Legislative List contained in Part I, Fourth Schedule to the Constitution which says that Federation can levy “taxes on the capital value of the assets, not including taxes on capital gains on immovable property”.
In the repealed Income Tax Ordinance 1979, this constitutional command was respected and reflected while defining the term “sale proceed” in the case of a building. The relevant part of Rule 8(5) of the Third Schedule to the repealed Ordinance reads as under:
“Provided that in the case of a building the term “sale proceeds” shall mean an amount equal to the lower of the following, namely:-
- original cost, and
- sale price or fair market value, whichever is higher
The calculation of terminal profit on sale of a building under the new Ordinance and the repealed law is worked out as under:
Under the new Ordinance
Cost of building: Rs. 800,000 in tax year 2003.
Depreciation @5%= Rs. 40,000
Sold in tax year 2004 for Rs. 1,600,000. WDV= Rs. 760,000
Profit to be taxed in tax year 2004: Rs. 16,00,000-760,000= 8,40,000
It includes capital gain of Rs. 800,000 which cannot be taxed by the Federal Government under the Constitution of Pakistan.
Under the repealed Ordinance
Cost of building: Rs. 800,000. Depreciation @5%= Rs. 40,000
Sold in next year for Rs. 1,600,000 (FMV is same). WDV= Rs. 760,000
Profit to be included in total income: Rs. 800,000-760,000= 40,000
It is obvious from the above that due to wrong language employed in section 22(13)(d) of the Ordinance, a blatant violation of Constitution is committed. The correct language of this provision should have been:
“where the consideration received on the disposal of immovable property exceeds the cost of the property, the consideration received shall be restricted to the original cost of the property”.
There is an urgent need to amend section 22(13)(d) with retrospective effect that is from the inception of the new Ordinance so that it conforms to the constitutional command as discussed above.
Time limitation for orders u/s 122(5A)
The new Ordinance has turned out to be a complex document susceptible to increased litigation. Section 122 alone provides unbridled, unfettered and uncontrolled powers to the tax department which are violative of Article 4 and 25 of the Constitution. The power to amend and further amend any order passed is a classic piece of legislation showing how a faulty tax system increases tax burden of the existing taxpayers and leaves unaffected those who are non-filers.
There is no saving provision in section 239 of the new Ordinance for issuance of fresh notices u/s 65 or 66A in respect of any order passed under the repealed Ordinance. Pending proceedings are, however, covered under section 239(4) of the new Ordinance. Hence any notice u/s 122(5) or 122(5A) for any assessments already completed or other orders made that attained finality prior to 1st July 2002 under the repealed Ordinance is void ab initio. The CBR has misinterpreted the law that assessment completed under the repealed law can be reopened/unsettled under section 122(5) or (5A) as a result of amendments made in section 122 vide Finance Ordinance 2002 and 2003. This cannot be done without first saving the retroactive application of section 65 and 66A in the saving clause itself. The interpretation resorted to by the CBR in Circular Letter No. F.4(75)/ITP/2002 dated 28-06-2003 is violative of law
Section 122(5A) [pari materia to section 66A of the repealed Ordinance] inserted vide Finance Act 2003 has not been extended to orders passed under the repealed Ordinance as is the case under section 122(1) read with 122(5). Article 264(a) of Constitution and section 6 of the General Clause Act, 1897 clearly provide that a repealing statute cannot revive any provision of the repealed law “unless a different intention appears”.In the absence of any explicit intention in the saving provision i.e. section 239 of the new Ordinance to retain sections 65 and 66A any action u/s 122(5) or (5A) for assessments completed under the repealed Ordinance prior to 1st July 2002 is unlawful. In section 239 there is no mention that the Legislature wants to revive section 65 or 66A for assessments/orders passed under the repealed Ordinance, hence subsequent amendments in section 122 to this effect by the Finance Ordinance 2002 are to be read and interpreted accordingly. In the light of above, it can be concluded that proceedings initiated u/s 122(5) or (5A) by the Taxation Officers for earlier orders passed before 1st July 2002 and 1st July 2003 respectively are unlawful, coram non-judice and violative of Article 4 of the Constitution of Pakistan.
Section 122(5B) of the Ordinance reads as under:
Any amended assessment order under sub-section (5A) may be passed within the time-limit specified in sub-section (2) or sub-section (4), as the case may be.
Sub-sections (4) and (4A) of section 122 which are relevant for the purpose of section 122(5A) read with 122(5B) read as under:
(4) Where an assessment order (hereinafter referred to as the “original assessment”) has been amended under sub-section (1) or (3), the Commissioner may further amend, as many times as may be necessary, the original assessment within the later of –
- five years after the Commissioner has issued or is treated as having issued the original assessment order to the taxpayer; or
- one year after the Commissioner has issued or is treated as having issued the amended assessment order to the taxpayer.
(4A) In respect of an assessment made under the repealed Ordinance, nothing contained in sub-section (2) or, as the case may be, sub-section (4) shall be so construed as to have extended or curtailed the time limit specified in section 65 of the aforesaid Ordinance in respect of an assessment order passed under that section and the time-limit specified in that section shall apply accordingly.
Sub-section (4A) does not take into consideration time limitation provided in section 66A(2) of the repealed Ordinance which is four years from the date of the order sought to be revised. It only mentions section 65 whereas sub-section (5B) of section 122 clearly mentions action under sub-section (5A) which is equivalent to section 66A. The correct wording of section 122(4A) should have been:
(4A) In respect of an assessment or revision made under the repealed Ordinance, nothing contained in sub-section (2) or sub-section (4), as the case may be, shall be so construed as to have extended or curtailed the time limit specified in section 65 or section 66A of the aforesaid Ordinance in respect of an assessment order passed under that section and the time-limit specified in that section shall apply accordingly.
The underlined portion shows the omission that needs to be inserted by way of a declaratory amendment in the law, which being clarificatory in nature, will be construed retrospective in nature. We hope that anomalies mentioned above will be removed by the concerned quarters in public interest.