‘Subversion’ of tax treaties?

Pakistan’s tax system is increasingly trapped in a contradiction that can no longer remain unnoticed. On the international plain, the State signs Avoidance of Double Taxation Agreements (DTAs) promising certainty, reciprocity and protection against discriminatory taxation. Domestically, however, legislative amendments and administrative practices are steadily narrowing those very commitments. The result is a structural divergence between treaty obligations and municipal tax enforcement.

This divergence carries consequences far beyond technical tax disputes. It risks projecting Pakistan as an unreliable treaty partner and undermines confidence among cross-border investors who rely upon treaty guarantees while structuring commercial arrangements.

The most persistent manifestation of this contradiction arises from amendments made in section 152 of the Income Tax Ordinance, 2001 governing withholding obligations on payments to non-residents. Section 152(5) now requires a payer intending to remit an amount without deduction of tax to furnish prior notice to the Commissioner Inland Revenue, even where taxation is restricted or eliminated under a binding tax treaty.

In principle, treaty protection should operate automatically once eligibility conditions are satisfied. Instead, the amendment converts treaty entitlement into an administrative permission. Subsections (5A) and (6) of Section 152 further reinforce this transformation by effectively equating treaty relief with an exemption certificate issued at the discretion of the tax administration.

Although subsection (5A) provides that the Commissioner must decide the matter within thirty days—failing which a certificate is deemed issued—practical experience reveals a different reality. Applications frequently remain pending, objections are raised at advanced stages, or certificates are subsequently modified or withdrawn.

Meanwhile, commercial remittances remain stalled because banks, acting under Chapter 14 of the State Bank of Pakistan’s Foreign Exchange Manual, insist upon documentary clearance before processing payments abroad.

The consequence is the creation of an interlocking regulatory structure in which treaty relief exists formally but becomes operationally dependent upon administrative approval. Payments to non-residents are thus exposed to delay, uncertainty and litigation despite treaty protection.

Such a framework directly collides with Article 24 of most DTAs concluded by Pakistan, based on the UN and OECD model conventions. The provision prohibits a contracting state from subjecting nationals of the other state to taxation or connected requirements that are more burdensome than those imposed on its own nationals in similar circumstances. When treaty-protected payments are subjected to procedural barriers not applicable domestically, the violation is not merely administrative; it becomes discriminatory in substance.

Ironically, Pakistani law itself recognizes treaty supremacy. Section 107 of the Income Tax Ordinance accords overriding effect to agreements entered into for avoidance of double taxation. The provision employs a sweeping non obstante clause declaring that treaty arrangements and implementing notifications shall have effect notwithstanding anything contained in any other law for the time being in force.

The legislative intention is unmistakable. DTAs determine allocation of taxing rights, Pakistan-source income of non-residents, and entitlement to relief from taxation. Once invoked, treaty provisions prevail over inconsistent domestic law.

Yet subsequent amendments diluted this clarity. Section 107(2) made treaty relief subject to section 109, introduced as part of anti-avoidance reforms. Section 109 empowers the Commissioner to re-characterize transactions, disregard arrangements lacking economic substance, or treat structures as tax avoidance schemes.

Anti-avoidance measures are not objectionable per se. Every modern tax system incorporates safeguards against abuse. The difficulty arises where such provisions are drafted broadly enough to place treaty relief itself under suspicion. Section 109(3) explicitly includes within the definition of reduction in tax liability situations where tax otherwise payable becomes unavailable due to treaty protection. In effect, the treaty benefit is indirectly treated as a potential avoidance outcome.

This approach reverses the logic of international taxation. DTAs are negotiated sovereign commitments, allocating taxing jurisdiction between states. Treating treaty relief as presumptively abusive risks converting negotiated rights into administratively rationed concessions.

The distortion deepened further through amendments redefining permanent establishment (PE). Clause (g) inserted in section 2(41) expanded the concept from the treaty-based notion of a fixed place of business to a broader formulation encompassing places used within cohesive business operations carried out by associated persons.

Accompanied by explanatory provisions covering supply arrangements, installation activities and complementary business functions, the amendment effectively allows aggregation of activities that treaties themselves may treat separately. Corresponding changes in sections 109 and 152 reinforced this expanded interpretation.

The cumulative effect is significant. Domestic law begins to redefine core treaty concepts unilaterally while maintaining formal adherence to treaty language. This trajectory raises serious concerns under international law, particularly the Vienna Convention on the Law of Treaties, 1969, whose principles reflect settled customary norms governing treaty performance.

Article 26 embodies the doctrine of pacta sunt servanda, requiring treaties to be performed in good faith. Article 27 expressly prohibits a state from invoking internal law as justification for failure to perform treaty obligations. Article 29 confirms that treaty commitments apply throughout the territory of a contracting state.

Read together, these provisions leave little interpretive flexibility. A state cannot dilute treaty commitments through domestic drafting techniques or administrative mechanisms that neutralize agreed allocation of taxing rights. The issue therefore transcends statutory interpretation. It concerns treaty fidelity.

Fortunately, the remedy already exists within Pakistan’s treaty network itself through Article 25—the Mutual Agreement Procedure (MAP). The provision allows a taxpayer who considers that actions of one or both contracting states result in taxation contrary to treaty provisions to present the case before the competent authority.

Crucially, the right operates irrespective of domestic remedies. Treaty protection does not require exhaustion of local appellate processes before engagement at the international level.

Despite this, taxpayers and advisers in Pakistan rarely invoke MAP at an early stage. Litigation typically remains confined within domestic forums where disputes become prolonged contests over withholding procedures or administrative discretion rather than treaty allocation of taxing rights.

Equally, treaty partners seldom raise systemic concerns unless disputes escalate diplomatically. Institutional silence has therefore enabled incremental erosion of treaty discipline.

The broader economic implications are unavoidable. Cross-border investment decisions depend heavily upon predictability of tax outcomes. When treaty entitlements become conditional upon discretionary certification or expansive anti-avoidance interpretation, perceived legal risk increases substantially.

Pakistan cannot simultaneously promote investment treaties, bilateral economic cooperation and international integration while allowing domestic enforcement mechanisms to undermine negotiated tax certainty.

Importantly, the solution does not necessarily require new legislation. The legal architecture already exists.

Section 107 provides treaty primacy within domestic law. DTAs contain non-discrimination guarantees and dispute resolution mechanisms. International law imposes obligations of good-faith performance. What remains deficient is institutional alignment between statutory drafting, administrative conduct and treaty hierarchy. Where conflict arises, response must operate on parallel tracks.

Domestically, taxpayers should challenge withholding demands and jurisdictional overreach by invoking section 107 alongside constitutional principles governing lawful taxation and legislative competence. Courts, historically protective of charging provisions, must ensure harmonious interpretation consistent with treaty obligations.

Internationally, competent authorities should be approached under MAP at an early stage rather than as a remedial afterthought once litigation fatigue sets in.

Pakistan’s treaty framework was designed to prevent double taxation, facilitate economic cooperation and promote investment flows through certainty of fiscal treatment. When treaty relief is administratively filtered or procedurally constrained, the erosion becomes systemic rather than incidental.

The difficulty confronting Pakistan’s tax system today is therefore not absence of treaty law but weakening treaty discipline. Municipal amendments and expansive enforcement practices have gradually produced a parallel regime—one that acknowledges treaties formally while narrowing their operation in practice.

Such contradictions ultimately carry reputational costs. Treaty partners evaluate not only statutory language but also enforcement behaviour. Investors assess whether negotiated protections operate automatically or depend upon administrative tolerance.

If Pakistan intends to retain credibility within the international tax order, treaty commitments must function as binding law rather than negotiable concessions.

Treaties are not diplomatic ornamentation. They are enforceable legal instruments integrated into domestic law through section 107 of the Income Tax Ordinance itself. Their faithful performance is a legal obligation grounded both in municipal statute and international law.

Restoring coherence requires administrative restraint, careful legislative drafting and judicial vigilance to ensure that domestic enforcement remains aligned with sovereign commitments already undertaken.

Absent such discipline, the contradiction between treaty promise and tax practice will continue to widen—with consequences not merely for taxpayers, but for Pakistan’s standing as a predictable jurisdiction in the global economic system.

This is a serious departure capable of rendering Pakistan as an unreliable treaty partner state, and violator of international binding agreement. Strangely, not a single non-resident or resident taxpayer has raised this issue. Even the experts in tax, constitutional and international public law have failed to point it out till to this day.

Copyright Business Recorder, 2026