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Learning taxation from clergy?

Huzaima Bukhari & Dr. Ikramul Haq

Federal Board of Revenue (FBR) recently sought the guidance of clergy on the issue of taxation of Islamic financial instruments. In this regards, the following Press Release was sent to media by FBR on August 17, 2008:

“Islamic Finance has gripped the world with a strong fervour and passion. The world is recognising the significance of Islamic Finance and it had also been deliberated in 2nd and 3rd Session of UN Committee of Experts for International Co-operation in Tax Matters in their annual meeting held at Geneva. Asian Development Bank (ADB) has also introduced it as an agenda item in its meeting scheduled to be held in October 2008 at Tokyo (Japan).

It will also be discussed in the 5th ATAIC Technical Conference. Realising the importance of this issue, Federal Board of Revenue invited the well-known scholars of international repute Professor Mufti Munib-ur-Rahman and Mr. Mujeeb Baig in the FBR House, Islamabad to enlighten the senior tax officials of the Direct Taxes Wing on the “Tax Treatment of Islamic Financial Instruments”.

Mr. Mumtaz Ahmad, Member (Legal), FBR inaugurated the session while Mr. Irfan Nadeem, Member (Direct Taxes) welcomed the honourable guest speakers. Mrs. Farida Amjad, Chief (International Taxes) introduced the guest speakers to the participants. The guest speakers made a presentation on the Islamic Financial Instruments and enlightened the audience on the basic concept of the riba free instrument.

The session was followed by questions/answers, which lasted for one hour and certain future steps to be taken in this regard as to the tax treatment of the Islamic Financial Instrument were noted down by the Income Tax Policy Section for examination and necessary action at the appropriate time”.

While holding this session, the Muftis or FBR top-ranking officers were not mindful of the fact that in the Income Tax Ordinance, 2001, section 13(7) is the worst example of taxing notional benefit arising out of riba-free or concessionary loans given to employees. 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”.


“(a) benchmark rate” means;

  • 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”.

Section 13(7) read with section 13(14) is against all norms of law, justice and equity. It taxes riba free or concessionary loans given to employees by their employers. 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. Article 77 of the Constitution says that “No tax shall be levied for the purposes of the Federation except or under the authority of Majlis-e-Shoora (Parliament)”. 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].

In the Income Tax Ordinance, 2001 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) of the new Ordinance].

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:

  1. Article 25 of the Constitution, which says that “all citizens are equal before the law and are entitled to equal protection of the 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 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.
  • Article 38(f) requiring the State to eliminate riba as early as possible.

In this society, loan defaulters (covering both genuine bankrupts as well as professional loan-sharks) enjoy immunity from tax. In the name of Islamic mode of financing more room for exploitation is created and harm is inflicted on common man. The so-called sharia-compliant instruments are nothing but a big fraud. The Ulema (sic) get their due share in exploitation by endorsing these instruments under self-created fiqa.

Therefore, all the leading Western banks initiated Islamic banking (sic) in the Middle East in the 1960s and soon spread its vicious, exploitative tentacles all over the world, finding it more profitable as compared to other exploitative banking instruments aimed at robbing the poor and benefiting the rich.

It is undeniable fact that the Muslim world is faced with serious problems of income inequalities and injudicious distribution of wealth amongst the various segments of society. Even in the oil-rich countries, the divide between the poor and the rich is wide.

It is unfortunate that even in the wake of post-colonial period, Muslim rulers and thinkers have failed to evolve a commonly-accepted Islamic tax system in the light of instructions contained in the holy Quran and Sunnah to meet the requirements of the present day world.

There exist unimaginable sectarian divisions, regional and ethnic animosities within the Muslim world. On the one hand, Muslims at large keep on telling the world that they profess faith in one God, one Book and one Prophet and on the other they do not even pause for a while in killing their own brothers and sisters in the name of self-assumed interpretations of various injunctions contained in the holy Quran itself.

The modern day Western civilization has attained social and economic justice-though not completely but to a satisfactory level-by adopting principles of social mobility, opportunities for all, democratic culture and rule of law. All these elements are completely or largely missing in majority of the Muslim States.

The issue of improvement of tax administration and introduction of Sharia taxation with particular reference to Zakat and Usher “to meet the challenges/changes rapidly taking place in the world” cannot be seen in isolation. This goal cannot be achieved without first establishing democratic institutions and culture.

The tragedy with Muslim rulers and their bureaucracies is that they want to do everything without the involvement of the people. In a true democratic dispensation, such programmes of change are unthinkable without the active participation and support of the people for which they are meant.

Since the rulers of Muslim World have little respect for democratic culture and values, they try to impose Western models without following their system to the core. They do not even know whether these models can be introduced in their societies as such, without suitable modifications to conform to local conditions and requirements.

The result is obvious that they utterly fail to implement foreign models because of lack of people’s consent, motivation and participation and due to corrupt, incompetent and inefficient bureaucracies, which are not accountable to any public institutions. Tax officials are no exceptions.

In this scenario, clergy-ridden, despotically-ruled and badly-governed Muslim societies have no future as they have lost the very basic quality of adhering to the higher values of justice and rule of law. If they want to regain the strength they once enjoyed in history, they will have to change themselves by getting rid of monarchs, despotic rulers and religious extremists.

This is the dilemma of every Muslim State today; they want to regain past glory without realising that the world today requires excellence in research and technology, which is not possible in undemocratic environments, for lack of freedom of thought and tolerance towards other thoughts.

In their taxation systems, the Muslim governments have no respect for redistribution of wealth and the sole aim is to collect more and more for the rulers of the day. In Pakistan, the presumptive tax system is the worst example of this phenomenon and in the presence of this undeniable fact, tax officials feel no shame in claiming to promote Shariah taxation! Most of the tax administrators do not even know the basic precepts of Shariah what to talk of devising a tax system based on it.

In the FBR not a single research study has been done by any officer on the issue of taxation of Islamic financial instruments. FBR’s self-styled, self-claimed tax experts are ordinary tax collectors who do not even possess dependable knowledge of tax codes they are supposed to administer let alone, tell the other Muslim countries what is good for them! Tax policy issues should be debated and decided in the Parliament by the representatives of people after taking proper advice of experts in the field.

Everywhere in the world, universities are the main source from where the latest research-for framing laws and policies-on a particular subject emanates. In the Muslim World, our rulers want the tax collectors (who do not possess knowledge or expertise) to prepare tax codes and policies for us and that too with the help of clergy. In any democratic society, this will certainly be considered an encroachment on the rights of people, but in Pakistan this is an accepted norm and the sole prerogative of bureaucrats.

This is the root cause of our decadence. In the entire Muslim World, in including Pakistan, there is not a single institute where research on international taxation or shariah taxation is conducted. The non-existence of Centre of Excellence on Taxation anywhere in the Muslim World is the real cause of concern. FBR instead of wasting time on useless conferences and soliciting (mis)guidance from the clergy, should establish research cell if is really serious to evolve an alternate tax system based on Quran and Sunnah.


The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).

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