PAKISTAN: SIGNIFICANT TAX DEVELOPMENTS

Dr. Ikramul Haq[1]

Visiting Mauritius for the second consecutive year to attend 6th IFA Conference 2012 is indeed an honour and great pleasure. The experience of last year was rewarding and invaluable—interacting with people from various backgrounds and varying skills gave me new insights into the unexplored areas of taxation.

It is a matter of great fortune that I am again addressing an august gathering and sharing some recent significant tax developments that took place in Pakistan.

This presentation will discuss the following taxes that are levied by the federal government and collected through apex revenue authority, Federal Board of Revenue [1](FBR):

Direct Taxes:

• Income Tax Ordinance, 2001
• Capital Value Tax (CVT)

Indirect Taxes:

• Sales Tax Act 1990.
• Customs Act, 1969
• Federal Excise Act, 2005

CHANGES IN INCOME TAX

Finance (Amendment) Ordinance, 2012 has inserted Eighth Schedule in the Income Tax Ordinance, 2001 for capital gain tax (CGT)

The President of Pakistan on 24 April 2012 promulgated the Finance (Amendment) Ordinance 2012. It salient features are:

• The revised capital gains tax (CGT) regime will improve documentation and collection from investments made in the stock exchanges.
• FBR collected merely PKR 418 million from the CGT during 2011, reflecting low collection as compared to the projected revenue of PKR 4 billion.
• Under the revised CGT regime, stock market would attract new investment which would further increase revenue collection.
• Where a person has made any investment in the shares of a public company traded on a registered stock exchange in Pakistan from the date of coming into force of the Eighth Schedule [inserted on 24 April 2012 through a Presidential Ordinance] till June 30, 2014, enquiries as to the nature and sources of amount invested shall not be made provided the amount remains invested for a period of 120 days in the manner as may be prescribed and tax on capital gains, if any, has duly been discharged in the manner laid down plus a statement of investments is filed with the Commissioner along with the return of income and wealth statement for the relevant tax year within the due date as provided in section 118 of Income Tax Ordinance, 2001.
• The amount of investment shall be calculated in the prescribed manner, excluding market value of net open sale position in futures and derivatives, if such sale is in a security that constitutes the said investment.
• Where a person has made any investment in the listed securities, enquiries as to the nature and source of the amount invested shall not be made for any investment made prior to the introduction of Eighth Schedule, provided that a statement of investments is filed with the Commissioner along with the return of income and wealth statement for tax year 2012 within the due date as provided in section 118 of Income Tax Ordinance, 2011 and in the manners prescribed and the amount remains invested for a period of 45 days up to June 30, 2012, in the manner as may be prescribed.
• Capital gains on disposal of listed securities shall be computed and determined under Eighth Schedule and tax thereon shall be collected and deposited on behalf of taxpayers by National Clearing Company of Pakistan Limited (NCCPL) in the manner prescribed. The NCCPL shall develop an automated system. The Central Depository Company of Pakistan Limited shall furnish information as required by NCCPL for discharging obligations under this Schedule.
• The NCCPL shall issue an annual certificate to the taxpayer on the prescribed form in respect of capital gains subject to tax under this Schedule for a financial year provided that on the request of a taxpayer or if required by the Commissioner, NCCPL shall issue a certificate for a shorter period within a financial year.
• Every taxpayer shall file the certificate along with the return of income and such certificate shall be conclusive evidence in respect of the income under Eighth Schedule to the Income Tax Ordinance, 2001.
• The NCCPL shall furnish to the FBR within thirty days of the end of each quarter, a statement of capital gains and tax computed thereon in that quarter in the prescribed manner and format.
• Pakistan Revenue Automation Limited (PRAL), a company incorporated under the Companies Ordinance, 1984 or any other company or firm approved by the FBR and any authority appointed under section 209 of this Ordinance, not below the level of an Additional Commissioner Inland Revenue, shall conduct regular system and procedural audits of NCCPL on quarterly basis to verify the implementation of Eighth Schedule and rules made under this Ordinance.
• The capital gains computed under Eighth Schedule shall be chargeable to tax at the following rates:
  • If holding is for more than 12 months:                                               NIL
  • If holding is for more than 6 months but less than one year:             7.5%
  • If holding is for less than 6 months:                                                   10%

CRITICS: According to many experts, the Finance (Amendment) Ordinance, 2012 is certainly very pleasing for the stock markets but has left people outside the financial world, questioning why fat-cat investors need to be given further protection from scrutiny of the origin of their funds. In a nutshell, the Ordinance has suspended provisions of the Income Tax Ordinance, 2001 that allow tax authorities to inquire where money invested in the stock market has come from.

DEFENDERS: For advocates of the move, including the Securities and Exchange Commission of Pakistan, the benefits are clear: money from outside the formal, documented sector will be invested in the stock market, providing a boost to the market, the tax authorities — because the investments will be taxed — and for the ultimate goal of increasing documentation of the economy.

NEUTRALS: Cautiously, the move can be welcomed, distasteful as it may be for law-abiding, taxpaying citizens. Encouraging money from the ‘informal’ or undocumented economy to enter the formal economy is a process that should be encouraged. And every modern economy needs capital markets where businesses can go to raise capital. In the Pakistani context, though, simply making it easier for money to flow into the stock market is no panacea. Because of the lack of tax incentives and the increased regulation of listed companies, many businesses prefer to remain outside the market so the increased funds for investment available from moves like the Finance (Amendment) Ordinance, 2012 will unlikely help promote the fundamental purpose of the stock market. Ultimately, there is a broader question at stake here: do amnesties or suspensions of tax law actually lead to positive long-term changes from a societal point of view? A well-functioning and robust stock market is necessary but without additional reforms and changes, the Ordinance may reinforce the perception that the government has other motives in mind. For instead of having the SECP and the FBR publicly list the benefits that would accrue to the state and society, the government chose to move through a presidential ordinance on the eve of a parliamentary session. Even good ideas need to be explained transparently and fully.

TAXABLE LIMIT/TAX RATES

Basic income tax exemption limit for salaried and non-salaried individuals for tax year 2012 has been enhanced from PKR 300,000 to PKR 350.000. In tax year 2010, it was PKR 180,000. Association of Persons (AOP)—it includes partnership firms as well—from tax year 2010 are subjected to 25% flat rate of tax. Earlier, tax rates for AOPs were the same as applicable in the case of individuals (from lowest slab of 5% to highest of 25%).

For companies, tax rate is 35% and dividends are taxed at the rate of 10% as full and final tax in the hands of individuals and in the case of corporate bodies as a separate block of income.

In case tax liability is less than 1% of total turnover, minimum tax applies. Minimum tax rate has been increased from 0.5% to 1% of turnover in tax year 2011.

TAX CREDIT

Tax credit equal to 100% of the tax payable is available to a newly established company.

Tax credit equal to 100% of tax payable for equity investment in balancing, modernization, replacement, or for expansion of the plant and machinery already installed, in an industrial undertaking.

For companies getting enlisted on any registered stock exchange, rate of tax credit has been enhanced from 5% to 15%.

MINIMUM TAX REGIME

For service sector, including professionals, six percent tax collected or deducted at source is minimum tax. Now the companies have been excluded from minimum tax regime. In case of other taxpayers, there will be no refund of 6% tax withheld even if there is loss or liability is less than that.

EXPANSION IN WITHHOLDING TAX REGIME

All kinds of cash transactions in banks have been subjected to withholding tax at the rate of 0.03%.

All kinds of imports have been subjected to withholding taxes, even if raw material is meant for manufacturer’s own use [rate is 4% (isn’t this 5%) of import value assessed by Collector of Customs].

3.5% withholding tax imposed on agricultural produces, except where grower is supplying directly.

PAYMENTS TO NON-RESIDENTS

The standard rate of withholding tax while making payment to a non-resident person has been reduced from 30% to 20%.  The following are reduced rates:

• Tax on dividend income :                             10%
  • Royalty :                                                         15%
  • fee for technical services;                              15%
  • Salary:                                                domestic rates
  • Rent                                                    domestic rates

In case of Avoidance of Double Taxation Treaty (DTA), the rate in DTA applies if beneficial.

Profits transferred by a branch of a foreign company out of Pakistan are treated as dividends and chargeable to tax at 10% as final tax.

Rate of 6% applies for construction, assembly or installation projects and 5% on contract for advertisement services rendered by TV Satellite Channels. This is full and final tax.

Persons making payment to a non-resident no more required to give a notice to the Commissioner of Income Tax if withholding tax is at a reduced rate under a tax treaty. In all other cases where tax is not to be withheld, prior clearance is required. The Commissioner is legally bound to pass an order within 30 days of receipt of intimation.

FILING/COMPLIANCE REQUIREMENT

Holders of commercial or industrial connection of electricity where the amount of annual bill exceeds rupees one million, compulsorily required to file return of income.

Individuals having income from business between PKR 300,000 and PKR 350,000 to file return of income despite having zero rate tax.

Threshold for compulsory filing of wealth statement and its reconciliation increased from PKR 500,000 to PKR 1,000,000.

Monthly, instead of quarterly statements of withholding tax, are to be filed.

Statements to include Computerized National Identity Card (CNIC) or National tax Number (NTN) of the persons from whom tax was withheld/collected.

Annual withholding tax statement to be filed by employers for tax withheld, and also for employees earning non-taxable salaries.

MISCELLANEOUS

Adjustment period of minimum tax extended from 3 to 5 years.

Non-resident taxpayers having permanent establishment in Pakistan shall not be entitled to Advance Ruling.

Banks have been allowed 5% provision of total advances to small and medium enterprises (SMEs). Earlier this limit was only 1%.

Rate of tax on dividend received by a bank from its asset management company enhanced from 10% to 20%.

CHANGES IN SALES TAX

Rate of sales tax reduced to 16% from 17%

Several exemptions have been withdrawn notably:

• Bricks, building blocks, and ready mix concrete;
• Aircraft & ships, machinery for pilotage &
• towage, air navigation equipment;
• Bull-dozers, harvesters, CNG Euro-2 buses, trucks for highways;
• Agricultural machinery; and
• CNG kits & cylinders.

Zero rating facility withdrawn on CNG buses in CBU (completely built unit) or CKD (completely knocked down) condition, trucks & dumpers, trailers & semitrailers, road tractors, etc.

Restriction of claiming input tax up to 90% of output tax on fixed assets and capital goods stands withdrawn.

Returns can also be revised after approval from the Commissioner.

No refund of sales tax is admissible, if incidence of sales tax has already been directly or indirectly passed on to the consumer.

Specific and express provisions introduced for inadmissible claim of input tax credit against invoices issued by suspended or blacklisted parties.

Withdrawal of sales tax exemption on plant, machinery, equipment, etc. relating to specified sectors/industries/capital goods.

CHANGES IN FEDERAL EXCISE

Special excise duty leviable at the rate of 2.5% on imported and manufactured goods abolished across the board.

Rate of Federal Excise Duty (FED) introduced on aerated waters and fruit juices, etc. reduced to 6% of retail price.

Rate of duty on various types of cement slashed from Rs. 700 PMT to Rs. 500 PMT.

Rate of duty enhanced on locally produced cigarettes, unmanufactured tobacco and filter rods of cigarettes.

FED abolished on 15 different types of goods including solvent oils, other fuel oils, greases, MBTE, viscose staple fibre, motor cars, air-conditioners, deep freezers, etc.

FED in sales tax mode imposed at the rate of 8% ad valorem on white crystalline sugar to substitute sales tax.

FED on services rendered or provided by property developers and promoters stands withdrawn

CHANGES IN CUSTOMS

Transit fee: For the first time transit fee is levied on any goods or class of goods in transit across Pakistan to a foreign territory at such rates as the Federal Board of Revenue (FBR) may, by notification in the official Gazette.

Power to prohibit, withdrawn on import or export of goods on the belief that the importer has submitted false statements.

Duty drawback facility allowed for supplies against international tenders.

Enhancement of time limit from 3 years to 5 years for issuance of show cause notice on account of audit.

One year time period for refund, to be reckoned from the date of the decision of the appropriate authorities.

Regulatory duty abolished on a number of items.

Incentives to local industry by reduction of duty through a concessionary notification

Customs duties on various non-essential and luxury items have been increased. Import of machinery and essential food items remains in concessionary mode.

CASE-LAW DEVELOPMENT

Brief facts:

EFU Insurance Pakistan [EFU] neither deducted tax while making payments to non-resident companies [having Double Tax Agreements (DTAs) with Pakistan] nor sought prior clearance from the Commissioner. The Commissioner started penal proceedings which were challenged in High Court by way of writ petition on the following grounds:

• Treaty provisions override domestic law; and
• Payments to non-resident companies, having no PE in Pakistan, were exempt under DTAs.

Department’s view:

• Section 101(13A) deemed any amount paid on account of insurance or re-insurance as ‘Pakistan-source’ income.
• Since EFU did not deduct tax while making payment mentioned in section 101(13A) read with section 152(1AA) and 152(5), penal action was correctly initiated.

• It was incumbent upon EFU to intimate the Commissioner even if payments were exempt under DTA.

Counter arguments by taxpayer:

• EFU countered by relying on American Express Bank Karachi v. Commissioner of Income Tax (2009 PTD 1791) that “provisions of the treaty prevail over provisions of the Income Tax Ordinance—it is a settled law that special laws prevail over general laws“.

• In Mountains Estate Mineral Enterprises v. Commissioner of Income Tax (2008 PTD 1087) it was held that “where no PE in Pakistan exists, business income is exempt and no tax can be levied under domestic law“.

• Provisions of the treaty have an overriding effect over domestic tax laws. Payment of re-insurance premium could not be taxed as ‘Pakistan-source’ income even under a deeming provision.

• Since payments to the non-resident enterprises were not liable to tax in Pakistan, there was no legal obligation to deduct tax at source or seek approval from Commissioner.

Court’s ruling:

• Court held that “the question of deduction of tax does not arise where the payments made to the non-residents are exempt from tax under any provision of applicable DTA”.
• It is also a settled law that in the case of an enterprise of contracting State with which Pakistan has a treaty, provisions of the treaty will determine the rights and obligations of the said non-resident company.
• Although the provision of section 152(5) of the Ordinance directs a taxpayer to seek approval from the Commissioner before remitting any payment to a non-resident without deduction of tax, however, it does not entail any penal consequences if the approval is not obtained.
• While interpreting the statutes, the court has to find out as to what was the intention of the legislature. Intention is the essence of the statute—Legislature has not made section 152(5) mandatory.
• Department’s view that by using the word “shall” in section 152(5), the legislature has made it mandatory is incorrect. The provision does not specify any consequences of not following the requirement of informing the Commissioner if the person chooses to make the payment without deduction of tax.
• Merely on the basis of the use of the word “shall” it could not be construed that it is a mandatory provision of law—we hold that it is a directory provision.

Comments:

• EFU did not press non-discrimination provision in DTAs providing that non-resident ‘nationals’ [expression includes legal persons] could not be subjected to any taxation [section 101(13A) or any requirement connected therewith [section 152(5)] as no such taxation or condition was imposed on Pakistani nationals by the other contracting states.
• The Court also did not take cognizance of the matter from this perspective.

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[1] Established under Federal Board of Revenue Act, 2007, for text visit  www.fbr.gov.pk

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Dr. Ikramul Haq, Advocate Supreme Court,heads HUZAIMA & IKRAM (Taxand Pakistan), a leading tax firm having international standing (www.huzaimaikram.com). He is a well-known author specialising in international taxes, constitutional and human rights laws. He also served for 12 years as Deputy Commissioner of Income Tax in Federal Board of Revenue.