“Services” & immovable property income taxation

Flagrant Constitutional violations

Huzaima Bukhari & Dr. Ikramul Haq

The taxation of “services” mentioned in section 153(1)(b) of the Income Tax Ordinance, 2001 [“the Ordinance”] with effect from tax year 2020 is subjected to “minimum tax regime” in cases where tax is deducted/deductible or normal tax regime, whichever is higher. Earlier, it was either under the presumptive tax regime or normal tax regime. Taxation of “services” under presumptive tax regime waserroneously assumed/justified on the basis of judgement of Supreme Court in Elahi Cotton Mills Ltd. and others v. Federation of Pakistan through Secretary Finance, Islamabad [(1997) 76 TAX 5 (S.C.Pak)]. This judgement mandated the National Assembly to levy tax under Entry 52, Part I of the Fourth Schedule to the Constitution of the Islamic Republic of Pakistan [“the Constitution] in lieu of Entry 47 that deals with “tax on income other than agricultural income”. This judgement never considered the taxing of “services” on gross receipt basis treating is as “deemed income”. It held intra vires deemed incomes under sections 80C [imports] and 80CC [exports], and turnover tax under section 80D under the repealed Income Tax Ordinance, 1979 [“repealed Ordinance”]. Section 80D [retained as section 113 of the Ordinance] is distinguishable from minimum tax regime introduced by Finance Act, 2019 on “services”, taxing these on net income basis but treating liability to the extent of tax withheld as minimum liability.  

The taxing “services” on gross receipt basis at a fixed rate, whether under the presumptive tax regime or minimum tax regime, falls outside the ambit of Federal Legislative List. It is specifically assigned to the Provincial Legislature under the Constitution (Eighteenth Amendment) Act, 2010 [“18th Amendment”]. The Federal Board of Revenue (FBR) and others defending it on the basis of Elahi Cotton Mills case must remember that the said judgement was delivered before the 18th Amendment. Taxing “services” in indirect taxation mode even before the 18thAmendment was a provincial subject. The FBR was collecting it on behalf of provinces and after deducting service charges was giving the collection to provinces directly and not through Article 160 of the Constitution under National Finance Commission (NFC) Award.

The 18th Amendment made it explicitly clear that on “services” even the Federal Government cannot levy any duty or indirect tax. The levy of federal excise duty [FED] on “services” after Sindh Sales Tax on Services Act, 2011 was held unconstitutional by the Sindh High Court in Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)]. It is thus clear that levy of income tax on “services” on gross receipt basis, under direct or indirect tax, income tax, sales tax or federal excise duty is in gross violation of Article 142(c) of the Constitution, as in pith and substance it will be “tax on services” and not “income tax on “services”. In other words, net income of “services” (professionals and others) alone can be taxed under Entry 47 of the Federal Legislative List.

The judgement by Sindh High Court in Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)] considered the following important constitutional issue:

“Where lies the legislative competence to impose a fiscal levy (whether tax or duty) on the rendering or providing of services? Does it lie solely with the Federation, which presently levies a duty in terms of the relevant provisions of the Federal Excise Act, 2005 (“2005 Federal Act”)? Or does it vest only in the Provinces, where a tax is levied in terms of their respective statutes, being here the Sindh Sales Tax on Services Act, 2011 (“2011 Provincial Act”)? Or, as some have contended before us, does the taxing power vest simultaneously yet exclusively in both the Federation and the Provinces? Or (finally) is it that the taxing power is common and concurrent?”

The main conclusion by the Sindh High Court in the above case was:

“The 18th Amendment, by inserting the “exception” into entry No. 49 radically altered the position. The taxing power in relation to the aforesaid taxing event was “shifted” and “transferred” to the Provinces and now vests in them alone. This follows also from the constitutional principles noted above, namely that under the scheme of our Constitution there is only a division of a taxing power and not a sharing thereof, and that for two taxing powers to have the same taxing event can mean only that the taxing powers are also the same”.

[underlined by us for emphasis]

This issue of division of taxing powers for the same taxing event was highlighted in Sales tax on restaurants under the Finance Act, BusinessRecorder,November 8, 2019 as under:    

The imposition of 7.5% sales tax on restaurants through Finance Act 2019 by the National Assembly, energetically defended by the Chairman of Federal Board of Revenue (FBR), is patently unconstitutional being in violation of Article 142 of the Constitution of Islamic Republic of Pakistan [“the Constitution”]. It is also the worst manifestation of federal fiscal highhandedness. After Constitution (Eighteenth Amendment) Act, 2010 [18th Amendment], the federal government cannot levy sales tax on services. This right exclusively vests with provinces under Entry 49, Part I of the Fourth Schedule to the Constitution, which says: “Taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed, except sales tax on services”. 

[underlined by us for emphasis]

The United Nations classifies ‘restaurant’ as service activity under International Standard Industrial Classification of all Economic Activities (ISIC). Since the adoption of the original version of ISIC in 1948, an overwhelming number of countries around the world have used ISIC as their national activity classification or have developed national classifications derived from ISIC. ISIC provides guidance to countries in developing national activity classifications and has become an important tool for comparing statistical data on economic activities at the international level. Needless to say that amendment made in Chapter 98 (services) of the Pakistan Customs Tariff, excluding restaurants from the list of services, by the National Assembly through Finance Act, 2019 was unconstitutional.

Unfortunately, till today the issue of levying sales tax on restaurants by the Federal Government has not been taken up by any province by approaching the Supreme Court of Pakistan having original jurisdiction under Article 184(1) of the Constitution in any dispute between any two or more Governments (that covers Federal Government and the Provincial Governments). As evident from above, Federal Government by an Act of National Assembly can only levy sales tax on services performed/rendered in Islamabad Capital Territory (ICT), but the Finance Act 2019 extended it on restaurants all over Pakistan. In the same manner levying income tax on gross receipt of all kinds of “services” as minimum tax liability in 2019 with effect from tax year 2020 is in utter violation of the Constitution as elaborated in great detail by the Sindh High Court in Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)] that entries in Federal Legislative List cannot be shared between Federal and Provincial Governments. It is a cardinal and well-established principle that the “entries contained in the Federal Legislative List of the Constitution are mutually exclusive” [Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)].

Since 2011, there have been serious disputes between Sindh Revenue Board (SRB) and FBR and these resurfaced when sales tax on restaurants was imposed by the National Assembly through Finance Act, 2019. The same is the case with taxing “services” on gross receipt basis as minimum tax in certain cases by the Federal Government. The issue remains unresolved until today as nobody has raised the point that taxation of services under the income tax law on gross receipt basis, presumptive and/or minimum tax regime, in pith and substance, is in violation of the Constitution, especially when by 2019 all the provinces have already enacted their own laws levying sales tax on services. The taxation of “services” in the same mode by the Finance Act, 2019, though giving it name of income taxation, is a flagrant violation of Entry 49 of the Federal Legislative List as elaborated by Sindh High Court in Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)].

Subject to the Constitution, Article 142(a) says, “Majlis-e-Shoora [Parliament] shall have exclusive power to make laws with respect to any matter in the Federal Legislative List”. However, it has no authority to enact laws with respect to matters not enumerated therein or expressly excluded from the said list, such as income tax on agricultural income and sales tax on services under Entries 47 and 49, respectively, of Part I of Legislative List. Paragraph (b) of Article 142 says: “Majlis-e-Shoora (Parliament) and a Provincial Assembly shall have power to make laws with respect to criminal law, criminal procedure and evidence”.

As argued above, if the Federal Government starts treating tax on gross receipts of “services” as tax on income, whereas nothing to this effect was held by the Apex Court in Elahi Cotton Mills Ltd. and others v. Federation of Pakistan through Secretary Finance, Islamabad, then what will be the sanctity of division of taxation powers between the Federation and the provinces provided in Article 70(4) read with Article 142(c) of the Constitution of Pakistan? 

In the wake of 18th Amendment, the main entries related to imposition of taxes in Part I of the Federal Legislative List are:

• Duties of customs, including export duties (Entry 43)
• Duties of excise, including duties on salt, but not including duties on alcoholic liquors, opium and other narcotics (Entry 44)
• Taxes on income other than agricultural income (Entry 47)
• Taxes on corporations (Entry 48)
• Taxes on sales and purchase of goods imported, exported, produced, manufactured and consumed, except sales tax on services (Entry 49)
• Taxes on the capital value of assets, not including taxes on immovable property (Entry 50)
• Taxes on mineral oil, natural gas and minerals used in generation of nuclear energy (Entry 51)
• Taxes on the capital value of assets, not including taxes on immovable property (Entry 50);
• Taxes on the production capacity of any plant, machinery, undertaking or installation in lieu of one or more taxes (Entry 52); and
• Terminal taxes on goods or passengers carried by railway, sea or air, taxes on the fare and freights (Entry 53).

The 18th Amendment omitted two very important entries from the Federal Legislative List entitled ‘Duties in respect of succession to property’ [Entry 45] and ‘estate duty in respect of property’ [Entry 46] meaning by that the provinces alone can levy these taxes. It also amended Entry 50 replacing the phrase ‘not including taxes on capital gains on immovable property” with “not including taxes on immovable property”. The omission of Entries No. 45 and 46 was of no practical importance because long ago the federal government withdrew progressive taxes like Estate Duty and Gift Tax.

Entry 50 of the Federal Legislative List, as amended by the 18thAmendment, reads as under:

“50. Taxes on the capital value of the assets, not including taxes on immovable property”.

Prior to the amendment, the language of Entry 50 of the Federal Legislative List was:

“50. Taxes on the capital value of the assets, not including taxes on capital gains on immovable property”.

[underlined by us for emphasis]

Historically, capital gain on disposal of immovable property fell outside the ambit of Income Tax Ordinance, 2001 and the same position prevails after the 18th Amendment. Section 37(5)(c) of the Income Tax Ordinance, 2001 before amendment provided that “capital asset does not include any immovable property”. However, after misinterpretation of amended Entry 50 of the Federal Legislative List, the Finance Act 2012 removed these words to bring gain on disposal of immovable property, including agricultural lands, within the ambit of income tax.

The phrase “not including taxes on immovable property” in Entry 50 cannot be read to “include taxes on capital gains on immovable property”. Plain reading of Entry 50 of Federal Legislative List, as it stands now, confirms that the National Parliament can levy taxes on capital value of moveable assets but has no authority to levy taxes, including capital gain tax, on immovable property. It is obvious that taxes include tax on capital gains. The following cases discuss taxation powers between federation and federating units before and after the 18Amendment:

1. Messers Sui Southern Gas Ltd & Others v Federation of Pakistan & Other 2018 SCMR 802.
2. Pakistan through Chairman FBR and others v Hazrat Hussain and others (2018) 118 Tax 260 (S.C. Pak)].
3. WAPDA v. Collector of Central Excise and Sales Tax (2002 PTD 2077
4. Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)].

The Punjab Assembly has correctly read Entry 50 of Federal Legislative List and levied tax on gain of immovable property in 2013 through section 9 of Finance Act 2013. If the federal government is of the view that its interpretation of Entry 50 of Federal Legislative List is correct it should refer the matter to the Supreme Court.

The above authoritatively establishes flagrant violation of taxation powers by the Federal Government under the Constitution in respect of “services” and gain of immovable property. The Federal Government has been brazenly encroaching upon the rights of the provinces by levying presumptive taxes on services under the Income Tax Ordinance, 2001 prior to 18th Amendment. This malpractice on the part of Federal Government continues even till today after clear judgements of Supreme Court and High Courts as mentioned in above cases. Sadly, even after this highhandedness in levying unjust taxes and denying the provinces their legitimate shares, the Federal Government has miserably failed to reduce the burgeoning fiscal deficit—that has increased to a monstrous level of Rs. 3.38 trillion for the fiscal year ending on June 30, 2020 [8.1% of GDP].

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