Limitations of advance ruling

The surprises of direct tax assessment prove fatal to business enterprises. These arises mostly by application of tax laws by tax collectors, to the facts of a tax payer in a way different than visualised and complied by the taxpayer.
Resident and non-resident taxpayers are equally susceptible to these surprises. The Income Tax Ordinance 2001 (the Ordinance) has introduced the novelty of advance ruling, by the CBR, to mitigate the surprises of non-resident taxpayers. This novelty is stillborn and suffers from a number of limitations.
The section 206A of the Ordinance deals with the subject of advance ruling, while Rule 23lA of the Income Tax Rules 2002 prescribes
the procedure for the purpose. The section 206A restricts the advance ruling for a particular transaction proposed and entered into, by the non-resident taxpayer, with the fallacious assumption that the non-resident taxpayer will be involved in a single transaction without any frequency and multiplicity of similar transactions with a variety of resident persons.
Unfortunately, life does not expect to attract the non-resident for a one-off transaction.
The law prescribes the advance ruling by the CBR for the proposed as well as the executed transaction of a non-resident taxpayer. The section 206A provides the opportunity of advance ruling to a non-resident taxpayer while the rule 231A refers to a "non-resident person" without requiring him to be a taxpayer.
Since the rules are subordinate law, the substantive law of section 206A would govern the advance ruling.
A non-resident intending to enter into a proposed transaction will never be able to file an application under section 206A.
This will be for the simple reason that he has to be a taxpayer in terms of section 2(66) of the Ordinance in order to be eligible to file the application for the advance ruling.
In the case of an intending non-resident, it will rarely be the case that he is a taxpayer under the law.
X Co is a non-resident in Pakistan. There does not exist a permanent establishment of the X Co in Pakistan either. A treaty for the avoidance of double tax between the Government of Pakistan and the country of the resident of the X Co does exist.
It derives income by allowing the Pakistani resident enterprises to use its database housed on a server outside Pakistan. The payments made to the non-resident are small in amount but large in frequency and varied in sources.
The guidance of the Committee on Fiscal Affairs of the Organisation of Economic Co-operation & Development (OECD) on taxation of e-commerce, excludes the rendering of business through a web-enabled database from the definition of a permanent establishment for the jurisdiction where the supporting server is not housed.
The Pakistan source income of a non-resident is extensively defined by section 101 of the Ordinance to include any amount paid by a Pakistan resident person to a non-resident. It is also made taxable in Pakistan in the hands of the non-resident under section 11(6) of the Ordinance.
The treaty provides to tax the Pakistan source business income in the country of the residence of X Co, while the fees for technical services is to be taxed in the country of accrual @ 10% of income. In terms of the treaty, the X Co is confident in its belief that its Pakistan source business income is not taxable in Pakistan but is to be offered to tax in the country of its residence.
This is despite the fact of the definition of Pakistan source income and its taxability under section 11(6).
Its confidence is shattered by the surprise of assessment given by the tax collector of Pakistan.
Following the precedents of the previous years, the tax collectors are expected to treat the subject payments to the non-resident X company as fees for technical services, subjecting it to a 10% tax in accordance with the provisions of the treaty of avoidance of double taxation.
It is also expected that the entire amount paid by the resident enterprises will be disallowed in their tax assessment in terms of section 2l(c) of the Ordinance for their failure to deduct the withholding tax of 10% under section 152 (1), from the payment to the non-resident X Co.
They will also be penalised for their failure to file the advance notice with the Commissioner of Income Tax under section 152(5).
This default must be under the belief that the requirement of deduction of tax @ 30% of payment to non-resident under section 152(2) is not applicable because of the over riding effect of the treaty over the law of Income Tax regarding the country of taxation for the business income of the non-resident in Pakistan.
X Co thought that the provisions of advance ruling under section 206A of the Ordinance were for its rescue.
These would protect its Pakistan resident customers from the illegal burden of taxation without the hassle of the lengthy proceedings of appeals: But that proved to be otherwise, when it found that it provides an opportunity of advance ruling only to a tax payer in Pakistan, which at present it is not, and that it deals with a single transaction not a numerous small amount multi-party regular transaction.
Looking to the utility of the novelty of advance ruling, it is hoped that the legislature would reconsider the law and rules of advance ruling.
It must provide the opportunity of seeking advance ruling to every intended individual whether resident or non-resident and whether for a single specific transaction or to a multiple transactions of similar nature.
The advance ruling must also be rendered on the facts as well as principle of law governing a particular set of transactions.
Besides, the opportunity of review, revision and appeal may also be provided against the advance ruling of CBR.
That way the taxpayer would be able to avoid the surprises of tax assessment for a healthy growth of investment and employment.