1. General: This note contains the comments on the Finance Act, 2022 as passed by the National Assembly. These are summary notes which are to be read in conjunction with the Finance Bill 2022 and the amendment proposed in that bill by the Finance Minister in National Assembly.
An overall impression which appears from the budget proposal is that after failing in expanding the tax base and irresistible powers of retailers and commercial importers and such other lobbies the legislature is trying to collect revenues from the documented assets of existing taxpayers. This is reflected by introduction of deemed rent on local immovable properties and capital value tax on already declared and documented foreign assets.
The anti-documentation theme is also reflected by increase in the gulf of tax incidence between the documented sector and other non-documented sectors. Tax on non-documented sectors has been increased which promotes incentive for non-documentation.
Pakistan is faced with strange policy on the fiscal side. Under the amended scheme as envisaged now sectors like agriculture income, export income, income of commercial importers and retailers are completely out of taxation on net income basis.
This effectively means that of the total GDP of around USD 400 billion at least 50 percent of the income generating activity in that GDP is outside the tax system. This system cannot operate in this manner as incidence on documented sectors has become unbearable.
Beneficial Ownership This term has been borrowed from the Indian Income Tax Act, 1961 where this term has been used for the purposes of deemed dividend under Section 2(22)(e) of that Act. In Pakistan there is a concept similar to Indian Act for the deemed dividend however in the definition of deemed dividend in Pakistan the term beneficial owner is not used.
The term beneficial owner as defined in this section does not carry the meaning as in the Model OECD and UN of Agreements for Avoidance of Double Taxation (treaties). In treaties this term is used with a specific purpose to limit the abuse of the concessionary regime contained in a treaty for a conduit owners or nominees in a jurisdiction. The manner in which this term has been defined is therefore in relation to ownership and control not benefit arising from the asset or investment. This is a very subtle difference that requires clarification from the Board.
In the recently introduced Capital Value Tax 2022 this term has been used with a particular reference. It is our view that the reference in that Act is not in line with the aforesaid definition. Beneficial ownership, beneficial interest and other similar terms in that section relate to benefits arising from the income and the assets and it is not limited to the definition as referred to in the law.
A requirement has been made to maintain the beneficial ownership of the entity/ trust. It is not clear how that ownership structure effects the tax incidence in Pakistan for the reason that in Pakistan taxation is on the basis of legal ownership, not the beneficial ownership as stated above.
Distributors: The insertion of this definition has resolved the issue of distinction between a distributor and commission agent as it has been stated that a distributor is only a person who purchases the goods. This means that the title of goods is transferred is the case of a distributor. .
Fair Market Value: The term fair market value as defined in Section 68 is now applicable for all provisions of the Income Tax Ordinance, 2001 as well as Capital Value Tax 2022. Under that tax there is a capital value tax on capital value of assets held outside Pakistan also. The issue that is expected to arise is the determination of fair market value of immovable properties held outside Pakistan where the cost is not determinable.
The Fair market value for the immovable property in Pakistan will be that determined and prescribed by the Federal Board of Revenue or any other government authority.
Information Technology: This is a very important change. This means that information technology and IT Enabled services will include anything that can be classified, and on a few known have been identified in the definition.
Super Tax: Through the Finance Act 2022 a super tax has been levied on high earning persons for all years to come. This tax is applicable for all persons including individuals. There are two rates. For industries identified in the schedule the rate is 10% of income and for others the rate is provided in the schedule which ranges from 1 to 4%.
This effectively means that the tax rate has been increased by 4% on all income above Rs 300 million.
The tax rate of 10% is only for the tax year 2022 for industries listed in paragraph 17 below.
Nevertheless, in the case of banking companies such tax at the rate of 10% will be charged for the tax year 2023.
The industries which are subject to 10% rate are airlines, automobiles, beverages, cement, chemicals, cigarette and tobacco, fertiliser, iron and steel, LNG terminal, oil marketing, oil refining, petroleum and gas exploration and production, pharmaceuticals, sugar and textiles.
The income for the purposes for the purpose of this tax has been specifically defined. This represent the income for the year before brought forward losses and brought forward depreciation and amortisation.
Nevertheless, in the case of income which is subject to the final tax regime it would represent the imputable income. Imputable income is the worked back income using the tax paid under the final tax regime as the base. For example, in the case of export by a company the tax paid on export of say Rs 5,000,000 will be Rs 50,000 being 1% of the export proceeds. The imputable income in that case will be Rs 172,000 being 50,000 multiplied by 100 and divided by 29 the rate for a company. The tax in that case will be 10% of imputed income being 17,200 only.
This is effectively a retrospective tax for the entities which have a financial year as income year. It is for this reason the banking companies have been excluded from this levy for the year 2022. There can be an argument for retrospectivity however in the past this kind of retrospective application has been held valid.
This super tax is also payable by entities working under special schedules for insurance companies, oil and gas companies etc. there appears to be some confusion on account of the contents of the Seventh Schedule that this tax is chargeable on banks for the tax year 2022. In our view in a practical sense this is not the intention of the law and the same is expected to be clarified.
It is our view that principles for determining income for normal tax are not applicable for super tax. In case if the legislature intends to levy super tax in addition to income tax then the same should be based on principle laid down for normal tax. This special procedure (such as not allowing losses and brought forward depreciation and imputable income) will lead to confusion in implementation and may be challenged for implementation.
Income on foreign transactions: Under this amended provision payment for services, fee for money transfer operations, card network services, payment gateway services, interbank financial telecommunication services have been equated with royalty and technical fees in the manner that all such payments are now subject to tax in Pakistan whether or not such amount is chargeable to tax in Pakistan or otherwise.
Wealth Tax Reincarnated: This is reincarnation of the Wealth Tax Act, 1963. Under this tax capital assets as defined under this section shall be subject to a tax determined on a deemed income of the property as was there under the wealth tax act.
Since this is a pure wealth tax which under the Constitution cannot be levied by the Federal Government under Entry 50 of the Federal Legislative List therefore a roundabout manner of taxing the asset has been adopted by deeming 5 percent of the fair value as a deemed rent and a 20 percent tax will be charged on such deemed rent. This means a straight 1 percent tax on the value of property. It appears that Indian statute introduced tax in the similar tax which was abolished next year.
In our view this roundabout manner cannot defeat the objective of Entry 50 where the right to tax on the capital value of immovable property does not lie with the Federal Government. In the 18th Amendment this matter has been adequately accounted for as after this amendment the right to tax capital value of immovable property does not lie with the Federal Government. Previously the limitation was in relation to capital gain on immovable property. Under the 18th Amendment as a matter of a swap the right to tax capital gain on immovable property has been taken by the Federation whereas the right to tax capital value has been taken up by the provinces.
This tax is leviable only on immovable property in Pakistan and tax on capital value of foreign immovable property has been done by the Capital Value tax 2022.
The legislature intends to develop a concept of deemed income in relation to that property. In the Finance Bill the concept used was deemed rent which has apparently been removed to take this sum out of the annual letting value concept as was there in the case of wealth tax.
In our opinion, this is a futile attempt for the reason that Income Tax Ordinance 2001 does not permit the legislature to treat a sum as income when there is no income in real sense. In this connection it may be considered that Entry 47 of the Federal Legislative List does not permit to treat a deemed sum as income.
In this connection it can be stated that this principle has not been accepted by the Supreme Court of Pakistan in the matter of Elahi Cotton Mills & others. However, a critical examination of that case exhibits that the concept of deemed income as explained in that case does not apply to the situation envisaged in the present law.
This tax is also leviable on agricultural land however an exception has been provided that it would not apply to self-owned agricultural land where agricultural activity is carried on by the person. In a strict sense this tax will be payable on land which is not self-cultivated by the owner. This is a very serious matter for all large absentee landlords where the value of land exceeds Rs 25 million. It is our firm view that this tax cannot be levied by the parliament and the same will be struck down whenever taken up by the competent courts.
On the practical side another problem that is expected to arise is the immovable property owned by a person which is on ‘pugree’ where nominal rent is payable. Under the strict interpretation of law that property will be taxed in the hands of the owner whereas the effective ownership does not lie with him. Furthermore, there is no concept of fair rent under this law. In case if property is on rent then the same falls outside this regime. Fundamental corrections are required notwithstanding the fact that this tax is not in accordance with the Constitution. It is reiterated any property already on rent is not subject to this tax.
In addition to the comments as made above there is a case to argue that this tax is not payable on assets which have been declared under the Asset Declaration laws of 2018 and 2019 for the reason that under such law the amount paid was the final discharge of any liability under the Constitution and such amount were beyond the jurisdiction of the income tax law on account of the overriding principles. This matter is expected to be challenged in the court of law. It is to be understood that Pakistan’s Asset Declaration laws were not similar to India and these had extra curative provisions.
Initial Depreciation: Two major changes have been made in relation to initial depreciation. Firstly, the restriction of 50 percent of the allowance in a year has been removed and secondly the initial depreciation has also been allowed on immovable property and structural improvements to immovable property. This apparently means that if the structural improvements have been made in someone else’s property even then the initial depreciation can be claimed.
Capital Gains: Substantial changes have been made in the provisions relating to income tax capital gains.
Firstly, the taxability of capital gains for immovable property in Pakistan has been separated from immovable property held outside Pakistan. This is important for the reason that under the previous law gain on sale of immovable property after a certain holding period (which is still there) was exempt from income tax in the sense as it was zero rated. Now that zero rating is available only for the property in Pakistan. Property outside Pakistan will be taxable as a normal income or the reduced rate applicable under any agreement for avoidance of double taxation with the jurisdiction where property is situated.
Secondly the concept of a 25 percent reduction on the rate of tax for all income representing capital gains has been removed. Now capital gains are taxable at the normal rate and the reduction of 25 percent which was there for a very long time has been removed. This is fundamentally a wrong step. Under the strict definition of law income representing capital gains especially long-term capital gains are not income under the law. It is for this reason under the UK and other civilised countries capital gains are taxable under a separate legislation. The reduction of 25 percent as prescribed for this reason. It is strongly suggested that long term capital gains in all situations be taken outside the tax ambit. These are not income taxable under the Constitution.
Thirdly, a very old mistake has been corrected. Under the existing law the value of assets on transfer on account of transactions which are not treated as transfers under Section 79 of the Ordinance were deemed to have the value after transfer equal to their fair market value. This was not the correct approach. The values cannot be changed. Accordingly, the incorrect law under subsection (4A) has been removed. These transactions are a gift from a relative as defined in sub section (5) of section 85, bequest or will; (b) by succession, inheritance or devolution; (c) a distribution of assets on dissolution of an association of persons; or (d) on distribution of assets on liquidation of a company,
After a very long-time capital gains on sale of securities after a holding period of six year has been zero rated.
Definition of Individual as Resident: In 2019 the definition of a resident person in the case of an individual was changed to bring it in line with the definition as prescribed in India and other developing countries and in Pakistan as was there prior to 2003. In that definition, in order to determine the residential status in addition to the stay in that particular year the stay in the past three year was also accounted for. This definition was again changed in 2021.
It is common knowledge that the status of being a non-resident is highly abused for obtaining tax concessions especially in the case of a person having residential status in the UAE. In our view that abuse cannot be stopped unless there is some arrangement with the UAE tax authorities to stop the abuse of treaty concession. No effort is being done on that ground and a very large part of income and assets of Pakistan are being parked tax free in the UAE in the guise of UAE tax treaty.
In the Finance Act 2022 an attempt has been made to correct the position however the same is effectively not relevant especially under UAE/Pakistan treaty.
Under the new law a person who is not in Pakistan for less than 183 days can be treated as resident in Pakistan if his stay in any one country other than Pakistan is less than one hundred in 182 days. However, that person will not be treated as a resident in Pakistan if he is treated as a tax resident of any other country.
This amendment is therefore affecting the person who does not stay in one country for 182 days and remain non-resident for all the countries they reside during the year.
This amendment is expected to affect those Pakistani citizens who spend their 365 days partly in North America, Middle East and Pakistan and become non-resident for all the countries. With this reference this is a reasonable law. Practical implementation of this law would however require examination with reference to Agreements for Avoidance of Double Taxation which Pakistan has entered into with various countries especially UAE and in many cases the resident status is granted not necessarily on the basis of stay. Nevertheless this is a reasonable amendment.
Fixed Tax on Retailers: This may be the worst tax regime ever introduced in any country. Under this regime it has been stated that for all retailers and service providers who are not Tier 1 retailers there is no levy of income tax. A certain amount collected by the electricity provider on the basis of electricity bill will be treated as discharge of tax liability under this provision.
The taxes which are to be collected on such retailers are very low. The maximum tax liability for any retailer under this provision will be Rs 360,000 per annum. This effectively means that all retailers except Tier 1 retailers earn an income less than Rs 233,000 per month or Rs 2,8 million per annum. This is a complete discrimination against other taxpayers. This is expected to promote a sense of deprivation for other taxpayers. This needs to be challenged.
Under this provision any retailer who is paying sales tax under the sales tax regime will not be subject to tax.
This measure is against the principle laid down for tax policy in Pakistan which requires documentation and across the board implementation of Value Added Tax Regime. When the legislature itself is promoting non-documentation by prescribing the fixed tax regime for all retailers and service providers then there cannot be implementation of the overall fiscal policy laid down for the taxation regime in Pakistan.
This procedure can only be there for small retailers not across the board implementation as has been done in under the Finance Act 2022.
Cohesive Arrangements: An amendment has been made in Section 109 of the Ordinance which relates to recharacterization. Under section 2(41)(g) of Ordinance permanent establishment (PE) includes a case where there is a deliberate fragmentation of activities to avoid PE. Anti-fragmentation means the measures which are taken to combine the activities of more than one person to determine the cohesive arrangement of activities in Pakistan.
This amendment which has been made with effect from 2018 implies that there would have been some case where such action by the tax officers would have been challenged. In our view the amendment is not required as this is not a case of re-characterisation. It is the first stage implementation and disclosure as fragmentation has been countered under section 2(41)(g) of the Ordinance.
Final Tax Regime-Imputed Tax: This is the best provision introduced in the tax law after almost one and a half decade.
Pakistan is faced with the intellectual tax mistake in the shape of a presumptive tax regime duly endorsed by the judiciary. This system of taxation has no relation with the income actually earned by the taxpayer. In 2019 an attempt was made to undo this procedure partly by substituting the presumptive tax regime by minimum tax regime where actual income was accounted for. Nevertheless, in this Finance Act, 2022 that intellectual crime has been repeated in the case of commercial importers. The amendment as discussed in this clause is a part remedy of this menace.
Under this provision the person subject to presumptive tax is eligible to account for in his wealth the imputed income as calculated under the law [Section 2(28A)] of the Ordinance. This does not make any sense for the reason that presumptive tax in many cases like exports is only 1 percent of the sales which is definitely much less for the computation of actual income. The law has therefore provided that if a person wants to take more credit in the wealth statement or the financial statement then such amounts have to be determined by an audit by the Chartered Accountant. The provision as introduced is the reincarnation of Section 80C (5) of the repealed Income Tax Ordinance and is required to be completely there under the decision of the Supreme Court in the case of Elahi Cotton Mills Limited and others.
It is however suggested that instead of Section 111 of the Ordinance which relates to unexplained income this provision is to be there as a separate section under the Ordinance. In the present position this section will open the windows of corruption and harassment for the reason that it is at present discretionary in the hands of a taxation officer to invoke proceeding under Section 111 of the Ordinance. The taxation officer is entitled to take action or not. This is totally wrong. This provision cannot be left in this manner. The right course is that if a taxpayer considers that his income to be taken in the financial statement is more than the imputable income then the same should be voluntarily filed and that has to be accepted by the legislature unless the taxation officer finds any valid reason for amendment.
It is therefore strongly suggested that a clarificatory circular be issued for this purpose otherwise the doors for corruption will be wide open on account of a valid and appropriate amendment.
Minimum Tax: In the Finance Bill the concept of carry forward of Minimum Tax paid as laid down under subsection 2(c) of the Section was supposed to be abolished. This regressive amendment has not been adopted in the Act.
The Minimum tax paid can be carried forward for the following years however the period of carry forward has been limited to three years against five years in the law.
Another change that has been made is that all imports by industrial undertaking even if subject to collection of tax rate of 5.5 percent remain out of presumptive tax regime. This was actually a mistake which in our view will be deemed to be a clarificatory amendment applicable from the date when this restrictive provision was introduced.
Record of Foreign Income, Expenditure and Assets: This is a patently wrong amendment relating to another patently law relating to foreign assets, expenditure or income. Under that law the foreign income, asset or expenditure can be taxed in the year of discovery even if such asset, income or expenditure relates to a period which is barred by time limitation. This effectively means that a person in Pakistan can be taxed for any foreign asset held by him or his ancestors in 1922. (the year when tax laws were introduced in undivided India) Now the law prescribes that such a person is also required to maintain the accounts and books and records for any foreign income after 1922 when income tax was first introduced in this area.
It appears that this amendment has been made to counter the decision of the appellate authorities who held that a person cannot be asked to maintain records over the period prescribed under the law in Section 174. The amendment in section 174 of the Ordinance has been made to counter that decision. It is our view that practical consideration should prevail and a reasonable time limit has to be introduced for this provision of law.
Capital Value Tax 2022: This is a wealth tax which has been levied on the value of assets in the hands of individual resident in Pakistan for foreign assets. Motor vehicles are subject to tax all situations.
It is named as Capital Value Tax for the reason of giving sanctity under Entry 50 of the Federal Legislative List. Under that list the Federal Government is entitled to levy tax on the capital value of assets excluding immovable property. It is our view that this tax is legally valid except wherever levied on immovable properties whether in Pakistan or outside Pakistan. In case of assets other than motor vehicles this tax is levied on resident individuals only. The value of such assets, other than vehicles, has to be over Rs 250 million.
The immovable properties have been excluded from the purview of taxable rights of the Federation as a subject and that removal is not with respect to the sum taxable by the provinces or otherwise. The immovable properties in provinces can be taxed by the provinces whereas immovable properties outside Pakistan are not taxable in the present set of the Constitution by the Federation.
Foreign assets have been defined under the law means any movable or immovable assets held outside Pakistan, whether directly or indirectly, and includes but not limited to real estate, mortgaged assets, stock and shares, bank accounts, bullion, cash, jewels, jewellery, paintings, accounts and loan receivables, assets held in dependents’ name, beneficial ownership or beneficial interests or contribution in offshore entities or trusts. This definition effectively means that all assets which appear in the wealth statement of a resident person are required to be included whether or not such assets are owned by the dependent or the person is a beneficial owner or has a beneficial interest in such assets.
This definition also includes contribution to the offshore trust. This is not an entirely correct description as contributions in the trust are generally accounted for in the wealth statement of the beneficiary. This therefore means that if such amount is added in the income of the settlor then such amount cannot be again added in the hands of beneficiary.
The term capital value has been defined as cost. However, under the common accounting parlance the cost should effectively be the outlay made by the person. This therefore means that it should cost less mortgages obtained on such properties. This issue is relevant for the reason that in many of the offshore properties the value for the resident person is the price less mortgages obtained.
It is reiterated that immovable properties fall outside the ambit of the right of the Federation therefore this tax has to be contested with respect to immovable properties under the Constitution. Furthermore another matter to be considered is the Asset Declaration Law of 2018 and 2019. These were the special laws where following pertinent commitments were made by the Government of Pakistan:
a) No question will be asked for the source of such assets;
b) No question shall be asked for the manner in which such assets reached the present destination;
c) Such assets and return therefrom are not required to be repatriated to Pakistan. This is a legal protection. There is a special rate for the assets which are to be retained outside Pakistan;
d) The amount paid to the Government of Pakistan with respect to such assets is not a tax under any provision of the Federal Legislative List. This means that amount paid is not tax. ;
e) The amount paid with the declaration is the final incidence under any provision of law in Pakistan as Asset Declaration Law has an overriding effect on the assets declared at that date. The accretion of such assets are subject to Pakistan tax however the corpus is not so chargeable. There is a valid argument that the assets have been ring fenced.
The law has used the term ‘cost’ as the value for the purposes of this law. However the text of the law depicts that in case of foreign assets the amount of cost in the foreign currency shall be converted at the rate prescribed by the State Bank of Pakistan as held on the last day of the tax year. This is however not appropriate for the reason that cost for the Pakistan resident has been crystallised at the exchange rate on which such assets were acquired. When the law has used the word ‘cost’ then under Section 71 of the Ordinance if read in complete context cannot increase by an event that has not taken place in Pakistan. Section 71 of the Income Tax Ordinance 2001.
— (1) Every amount taken into account under this Ordinance shall be in Rupees.
(2) Where an amount is in a currency other than rupees, the amount shall be converted to the Rupee at the State Bank of Pakistan 1 [ ] rate applying between the foreign currency and the Rupee on the date the amount is taken into account for the purposes of this Ordinance.
The term ‘taken into account for the purposes of Ordinance’ means that a transaction has taken place whereby the amount reflected in the foreign currency is changed. If that transaction has not taken place then there is no permission in the law to change the rupee valuation. This therefore means that year by year increase in the capital value of foreign assets is not permissible under the Income tax law and such assets are subject to tax if any on their original rupee cost.
This tax is chargeable from tax year 2022 which in the case of individuals shall only be applicable on assets held as at June 30, 2022. In summary it can be stated that this tax is to be re-examined on the following grounds which may be a basis of challenge in the courts if not resolved administratively:
a) Not applicable on foreign immovable properties;
b) Is applicable on the rupee cost when such assets were acquired by the resident person;
c) Assets declared under the Asset Declaration laws are not subject to another levy;
d) Settlor or contributors of trusts cannot be taxed if the beneficiary is being taxed.
- Rates of Tax: The rate of tax on banks which was enhanced to 42 percent in the bill has been revised downward to 39 percent.
Copyright Business Recorder, 2022