Lacunae in Pakistani income tax laws

Since the last decade it has been observed that a lot of improvements have been made in the Income Tax Ordinance 2001 (hereinafter referred to as the "I. T. Ord") and related Income Tax Rules 2002 (hereinafter referred to as "I. T. Rules"). But there is still a lot to do to make it rational and reasonable by removing the following lacunae/deficiencies:
01. Chargeability of income tax
01.01 The income tax that is being charged under the I.T Ord and related I. T. rules, is in violation of the Constitution of the Islamic Republic of Pakistan as the Constitution allowed "tax on income" and not "tax on losses", while even the I. T. Ord has clearly mentioned under Section 4 that "tax on taxable income", but is practically charging income tax even on losses.
01.02 It has been noted that the Federal Board of Revenue (FBR) is taking income tax deducted at the source of the taxpayers as revenue/income of the government, which is absolutely wrong because technically income tax deducted at source by the paying party from the payment made to the taxpayer is a sort of advance income tax and not income tax earned by the government and hence it is a liability to pay back to the taxpayer in case of assessed loss.
01.03 The government has introduced the final tax regime with the objectives (a) to avoid evasion of income tax in the Income Tax Return by decreasing income and increasing expenses (b) to make the tax system easy and fast (c) to avoid contact between the taxpayer and tax authority and (d) the government and the taxpayer should not be a loser, as a result the tax will be more or less the same in the final tax and normal tax. There was no intention to charge income tax when the taxpayer has suffering losses. But what is happening is that the exporter is suffering losses and the tax deducted by bank on export proceeds are being taken as final tax. There is no rational in this and is against the principles of taxation and in violation of the Constitution of the Islamic Republic of Pakistan. Final tax may be considered only when the taxpayer earns profit and if the taxpayer is suffering losses, the tax deducted at source should be refunded.
01.04 Minimum tax/Turnover tax (1% on gross turnover/sale) was introduced to overcome the emergency of the government at that time, which should be for a year or two. But the minimum tax under Section 113 of the I. T. Ord has become permanent tax and even its base is being broadened every year, as a result tax is being charged on losses, which is again in violation of the Constitution of the Islamic Republic of Pakistan and is against the fundamental rights of the citizen.
01.05 The I. T. Ord has clearly defined the terms: head of income (income reduced by deductions) - section 11; total income - section 10; taxable income - section 9; and tax on taxable income - section 4. But income tax is being charged for the majority of taxpayers on gross income without deduction of the necessary related expenses, as a result income tax is being charged on losses which is against the fundamental rights of the citizens of Pakistan and also against the Constitution of the Islamic Republic of Pakistan.
02. Surcharge on income tax
02.01 A surcharge shall be payable by every taxpayer at the rate of 15% of the income tax payable for the period from 15th March 2011, to 30 June 2011 as stated in Section 4A of the I. T. Ord while Clause 11 of Part III of the Second Schedule attached to the I. T. Ord wrongly interpreted Section 4A as the amount of surcharge payable in the income tax liability for the tax year 2011 and shall be computed on the proportionate amount of income tax liability for three and a half months. According to Clause 11, if the taxpayer has no income during the period from 15th March 2011 to 30th June 2011, even then he has to pay surcharge, which is against Section 4A of the Income Tax Law.
03. Tax on dividend income is not final tax for a company
03.01 What is the rational in not covering, under the final tax regime, a company receiving dividends as stated in Sections 5 and 8 of the I. T. Ord. This restriction discourages companies from making investment in other companies and hence the stock exchange has not been flourishing since 2007.
04. Head of income - salary
04.01 Taxability of the compensation received by an employee on the termination of his service/employment in the shape of a golden handshake, gratuity etc as a separate block at his/her three preceding year's average tax rate may be opted by the taxpayer and should be clearly covered in the I. T. Ord instead of restricting it to Circular No 1 of 1965, dated 1st July 1965, which is still valid. This is necessary to avoid confusion among taxpayers and the tax authority and to save retired employees from hardship. (Refer to Section 12(1)(e) (iii) and 12 (6) and also refer to 95 ITL 34 p20)
04.02 According to Section 12 (4) of the I. T. Ord "no deduction shall be allowed for any expenditure incurred by an employee in deriving amounts chargeable to tax under the head salary". Which means income tax will be charged on gross salary which is in violation of the Constitution of Islamic Republic of Pakistan and against the fundamental rights of the citizens of Pakistan. Tax should be charged on gross salary after deduction of at least necessary expenses like rent, food, cloth, utilities, domestic servants, children's education, health, insurance, mark up if any etc which may be taken as a percentage of gross salary without going into its details, as was done for the existing rent allowance, medical allowance etc. This is how the government can do justice with the white-collar employees. Likewise the 'salary exempt' limit of Rs 350,000 should be reworked and revised based upon the above formulae.
04.03 According to Section 13 of the I. T. Ord and Rule 5 of the I. T. Rules, the value of the conveyance provided by the employer to the employee shall be included in the income of the employee and equals 5% of the cost to the employer for acquiring the motor vehicle, when the vehicle is partly for personal and partly for official use. This treatment does not sound good and rational because if the vehicle was purchased by the employer in 2005 at the cost of Rs 1 million and the employee will take 5% on Rs 50,000 in the Tax Year 2011 while its WDV in the tax year is Rs 209,715 after 20% depreciation. It is suggested to make a depreciation slab for 10 years that will apply 5% to make this treatment logical.
05. Head of income - income from property
05.01 There is no justification for deleting Section 17 of the I.T.Ord relating to deductions in computing income chargeable under the head "income from property", because how can a taxpayer earn income from property without making expenses on acquiring and maintaining such a property. At least necessary expenses like repair, property tax, annual ground rent, mark-up on loan acquired for property purchase/renovation, legal expenses must be allowed to be deducted from the rent actually received. Same as deduction is allowed under income from other sources under Section 40 of the I. T. Ord.
05.02 Rent income upto Rs 150,000 is exempted to an individual or association of person provided he/she does not derive taxable income under any other head of income as stated in Section 15(7) of the I. T. Ord which is again not logical, because if an individual whose major income is salary has been given exemption upto Rs 350,000, then why only Rs 150,000 has been given as exemption to one whose only income is rent. It is suggested that this exemption should also be up to Rs 350,000 for the sake of justice.
06. Head of income - income from business
06.01 According to Section 20 of the I.T. Ord, in computing, the income of a person is chargeable to tax under the head "income from business" for a tax year, a deduction shall be allowed for any expenditure incurred by the person in the year "wholly and exclusively for the purpose of business". There is no rational for adding "wholly and exclusively for the purpose of business" as it is practically impossible to prove it and it is debatable and opening the door to corruption.
06.02 Under Section 21 (m) of the I. T. Ord , any salary paid or payable exceeding Rs 15,000/- per month other than by a crossed cheque or direct transfer of funds to the employee's bank account, will not be allowed to be deducted in computing the income of a person under the head "income from business". The question is what is the basis of taking the figures of Rs 15,000. To make it rational and justifiable it is suggested to take this figure equals to 1/12th of the tax-exempt limit of salary say Rs 29,167 or Rs 30,000, then it would support the system.
06.03 According to Section 22 (2) of the I. T. Ord , the depreciation deduction for a tax year shall be computed by applying the rate against the written down value (WDV) of the asset at the beginning of the year. This treatment is of the stone ages and has been adopted without realising that the underreducing balance method, WDV will become zero after 66 years plus there are complications in its working. This is an IT era and an era of making works simple and fast. So it is suggested that the straight-line method may be used by applying a depreciation rate on cost instead of on WDV then the WDV would become zero in 5 years and it would also make work simple and fast. Further, usually an asset is workable for 5 to 10 years then it needs replacement so the straight-line method will support this reality.
07. Appellate tribunal
07.01 Under Section 130 of the I.T. Ord, the Appellate Tribunal shall consist of a chairperson and such other judicial and accountant members as are appointed by the Federal Government with regard to the needs of the tribunal. While the criteria described for appointment of the accountant member is an officer of the Inland Revenue equivalent in rank to the Chief Commissioner or a Commissioner of the Inland Revenue or Commissioner of Inland Revenue (Appeals) with at least 5 years experience as Commissioner or Collector. One can't understand what is the logic behind appointing the Commissioner or Chief Commissioner in place of an accountant member while a judicial member from the High Court is understandable. It is suggested that a Chartered Accountant with at least 10 years experience as a Tax Consultant be appointed as an accountant member. Further, since decisions of the Appellate Tribunal on an appeal shall be final, except where point of law is involved under Section 133 of the I.T. Ord, it is also advisable to add one more seat from the tax department as the criteria described above to strengthen the decision.
08. Exemption from specific provisions
08.01 As per clause 59(iv) of Part IV of the Second Schedule attached to the I.T. Ord, tax at source will not be deducted under Section 151 from income or profit paid on DSC (Defence Saving Certificates), saving account, TFC etc where such a deposit does not exceed Rs 150,000. This is a joke because one can guess how much would be the profit on such certificates that amount to Rs 150,000. I suggest it should be up to Rs 1.5 million then an investment climate would be encouraged and the basic purpose of this exemption would be served.
Conclusion One will have to appreciate that the Income Tax Ordinance 2001 and the related Income Tax Rules 2002 have been framed in such a way that all head of income cover each and every corner of income, so it is complete in all respects but the problem is that these laws are not being implemented and monitored in letter and spirit due to vested interests and the element of corruption involved. I can say with confidence that if these laws were implemented and monitored in its letter and spirit then the tax-to-GDP ratio in Pakistan would be the highest in the world, even with the existing exemptions, tax concessions, allowances and tax credit.
Presumptive tax, final tax and turnover tax have their merits under the existing circumstances but these should not be applicable when taxpayer is incurring losses because tax should be on income and not on losses as required under the Constitution of the Islamic Republic of Pakistan. These laws are so strong with the tools of audit, monitoring, appeals, alternate dispute resolution that the taxpayer cannot cheat anyone by showing bogus losses and the tax authority cannot cheat the taxpayer through injustice.