ASSESSMENT OF INCOME

A Criticical Analysis of Income Tax Regime.

( Updated up to Finance Act, 2007 )

Turn Potential into Profit

Small & Medium Enterprise Development Authority
Government of Pakistan

http://www.smeda.org.pk
Lahore Small and Medium Enterprise Development Authority, 6th Floor, LDA Plaza, Kashmir Road. Lahore 54792, Pakistan Tel: 92-42-111-111-456 Fax: 92-42-5896619, Email: helpdesk@smeda.org.pk Karachi Small and Medium Enterprise Development Authority, 5th floor, Bahria Complex-II Moulvi Tameezuddin Khan Road, Karachi Tel : 92-21-111-111-456, 5610432, 5610536, 5610459, Fax: 92-21-5610572 Email: helpdesk-khi@smeda.org.pk Peshawar Small and Medium Enterprise Development Authority, Ground Floor, Statelife Building, The Mall, Peshawar Cantt. Tel: 92-91-111-111-456, 92-91-9213046-7 Fax: 92-91-286908, Email: helpdesk-pew@smeda.org.pk Quetta Small and Medium Enterprise Development Authority, Bunglow No.15-A Chaman Housing Scheme, Airport Road, Quetta Tel: 92-81-831702, 92-81-831623 Fax: 92-81-831922, Email: helpdesk-qta@smeda.org.pk

Disclaimer
The purpose and scope of this information memorandum is to introduce the subject matter and provide a general idea and information on the said area, particularly to service providers. All the material included in this document is based on data/information gathered from various sources and the same has been acknowledged where possible. Although, due care and diligence has been taken to compile this document, the contained information may vary due to any changes in government policies and the actual results may differ substantially from the presented information. SMEDA does not assume any liability for any financial or other loss resulting from this memorandum in consequence of undertaking this activity. Therefore, the content of this memorandum should not be relied upon for making any decision, investment or otherwise. The prospective user of this memorandum is encouraged to carry out his/her own due diligence and gather any information he/she considers necessary for making an informed decision. The content of the information memorandum does not bind SMEDA in any legal or other form. Document Control Document No. Revision Prepared by Approved by Issue Date Issued by Type of document Name of document Document #: Issue Date/Revision

PREFACE.
The income tax had been the principal source of revenue for the federal government and now it stands next to the sales tax. Its contribution to tax revenue stands at 31% in 2005 and its share in the GDP has increased to around 9%. Despite these reassuring statistics, there is widespread disaffection with the tax policy of the government. There is a consensus among a broad spectrum of the stakeholders that the present taxation system breeds mistrust and there is a feel that without a fundamental redesign of the tax policy, the government may find difficulty to meet its ever increasing demands for revenue generation. There are several factors that have resulted in this state of affairs. Some of them are rooted in the income tax legislation, others are an outcome of the constitutional structure of the country and some others are the result of a complex web of lobbying and political compromises. The exemptions allowed to various types of incomes in the second schedule of the income Tax Ordinance 2001 (Ordinance) are examples of political compromises with implications for tax administration which are not within the ambit of the tax authorities. Similarly, exemption allowed to agricultural incomes from federal income taxes is the most glaring example which has its basis in the constitution of the country, that in turn limits the taxpayer's base and increases the burden of tax on the non-agriculture and non-corporate sector. The reason being that the sector creating the great distortion is the agriculture sector by not paying tax proportionately to its share in GDP. It has been felt that agriculture, having 21.5% of GDP, has the lowest contribution of only 1.2% in taxes, which is the main reason for the lowest tax to GDP ratio. Further analysis of revenue collection and exemptions allowed in 2004-05 shows that revenue collection from customs was third in rank at Rs 113.9 bn equal to 19% of total collection made in 2004-05 whereas the loss of revenue occurred to the national kitty owing to duty exemptions was at the top of it at Rs 12.78 bn. Further collection from GST was at the top than other sources of revenue at Rs 239.53 bn equal to 41% of the total revenue generated in 2004-05.

INTRODUCTION OF SMEDA
The Small and Medium Enterprise Development Authority (SMEDA) was established with the objective to provide fresh impetus to the economy through the launch of an aggressive SME development strategy. Since its inception in October 1998, SMEDA had adopted a sectoral SME development approach. A few priority sectors were selected on the criterion of SME presence. In depth research was conducted and comprehensive development plans were formulated after identification of impediments and retardants. The all-encompassing sectoral development strategy involved overhauling of the regulatory environment by taking into consideration other important aspects including finance, marketing, technology and human resource development. SMEDA has so far successfully formulated strategies for sectors, including fruits and vegetables, marble and granite, gems and jewellery, marine fisheries, leather and footwear, textiles, surgical instruments, transport and dairy. Whereas the task of SME development at a broader scale still requires more coverage and enhanced reach in terms of SMEDAs areas of operation.

Along with the sectoral focus a broad spectrum of services are now being offered to the SMEs by SMEDA, which are driven by factors like enhanced interaction amongst the stakeholders, need based sectoral research, over the counter support systems, exclusive business development facilities, training and development, legal and other services for SMEs and information dissemination through wide range of publications.

ROLE OF LEGAL SERVICES CELL

The Legal Services Cell [LSC] is a part of Business Development Division of SMEDA and plays a key role in providing an overall facilitation and support to SMEs. The LSC provides guidance based on field realities pertaining to SMEs in Pakistan and other parts of the world. LSC believes that information dissemination among the SMEs on the existing regulatory environment is of paramount importance and it can play a pivotal role in their sustainable development. In order to facilitate SMEs at the Micro Level LSC has developed user-friendly systems, which provide them detail description of the Laws, and Regulations including the process and steps required for compliance. The purpose of this document is to provide SMEs with information pertaining to a income tax practices for SMEs. Companies interested in enhancing their understanding about the procedures can also use the document

TABLE OF CONTENTS.
S .No. Page No. 1. INTRODUCTION ........................................................................................1 2. The Evolution Of Income Tax Law In The Sub-Continent. ......................3 Pakistan Tax System ..........................................................................5 3. DEFINITIONS. ............................................................................................6 4. HEADS OF INCOME ................................................................................ 11 5. Residential Status Of An Individual.......................................................... 13 Residential status and scope of income............................................. 14 Scope of total income in the case of resident person ......................... 14 Scope of total income in the case of a non-resident .......................... 14 6. WHAT IS ASSESSMENT.......................................................................... 15 7. HEAD OF INCOME: SALARY .............................................................. 16 Value of perquisites ......................................................................... 20 Explanation:..................................................................................... 22 Employee share schemes ................................................................. 23 Explanation: - .................................................................................. 25 8. HEAD OF INCOME: INCOME FROM PROPERTY............................. 27 Section 15 Explained: ..................................................................... 27 Section 16 explained; ....................................................................... 30 9. HEAD OF INCOME: INCOME FROM BUSINESS .............................. 31 Section 18 explained; ....................................................................... 31 Meaning of Business........................................................................ 33 Meaning of Profession or Vocation.................................................. 35 Distinction between business, profession or vocation not significant 36 Speculation Business Income........................................................... 36 Basic principles to arrive at business income.................................... 36 Assessment of discontinued business or profession .......................... 37 Section 19 explained: ....................................................................... 39 Section 20 explained: ....................................................................... 40 Deductions not allowed.- ................................................................. 41 Section 21 explained: ....................................................................... 43 Depreciation. ................................................................................... 44 Section 22 explained: ....................................................................... 46 Initial allowance: ............................................................................. 48 Section 23 Explained: ...................................................................... 48 Intangibles ....................................................................................... 49 Section 24 explained: ....................................................................... 51 Pre-commencement expenditure: ..................................................... 52 Section 25 explained: ....................................................................... 53

Section 30 explained: ....................................................................... 57 10. Major Changes Made In The Ordinance. ................................................. 58 11. HEAD OF INCOME: INCOME FROM CAPITAL GAINS .................. 59 Section 37 explained: ....................................................................... 60 Section 38 explained: ....................................................................... 62 12. HEAD OF INCOME: INCOME FROM OTHER SOURCES ................ 64 Section 39 explained: ....................................................................... 66 Income To Which Section 111 Applies ............................................ 69 Undisclosed incomes/investments (section 111(1)............................ 69 Addition in the year of discovery (Section 111(2) ............................ 70 Rules for determination of property, assets etc ( section 111(5).. ...... 70 Valuation of assets :......................................................................... 70 Deductions from Income from Other Sources................................ 72 Points to remember. ......................................................................... 72 Expenditure allocable to exempt income ( section 67 )..................... 73 Expenditure not admissible ( section 40(5)....................................... 73 Section 40 explained. ....................................................................... 74 13. Clubbing of income .................................................................................... 76 Income from revocable transfer of assets.......................................... 77 Income from assets transferred to minor child ( section 90(4) (a). .... 78 Taxability of Business income of a minor child.............................. 79 Transactions between associates ( section 108 read with section 85 )79 Associates........................................................................................ 79 Instances of AOPs where section 108 can be invoked. ..................... 81 Clubbing where securities are regained (section 112) ....................... 81 Transfer pricing ............................................................................... 81 14. PRESUMPTIVE INCOME........................................................................ 86 15. ASSESSMENT OF INDIVIDUALS .......................................................... 93 Determination of taxable income...................................................... 93 Reduction in tax for salaried tax payers............................................ 94 Calculation of tax liability................................................................ 94 Tax rates for non-resident individuals. ............................................. 94 Special provisions for non-resident salaried individuals ................... 95 Exemption in case of resident individuals in special cases................ 95 16. ASSESSMENT OF ASSOCIATION OF PERSONS ................................ 96 What is an association of persons (AOP).......................................... 96 Principles of assessment of an AOP and its members ....................... 96 Computation of taxable income of AOP........................................... 97 Assessment of members of AOP ...................................................... 97 Provisions relating to averaging ....................................................... 98 Calculation of tax liability of an AOP .............................................. 98

17. ASSESSMENT OF COMPANIES ............................................................ 99 Determination of residential status of a company ........................... 100 Disposal of assets between wholly-owned companies (section 97) . 103 Change in control of a company ( section 98)................................. 103 Minimum tax on companies (section 113 )..................................... 104 Computation of taxable income...................................................... 105 18. UNIVERSAL SELF ASSESSMENT SCHEME ..................................... 106 Section 120 Explained. .................................................................. 106 Best judgement assessment ............................................................ 110 Section 121 Explained ................................................................... 110 Amendment of assessments: .......................................................... 111 Section 122 Explained ................................................................... 113 19. CRITICAL ANALYSIS OF SECTION 122............................................ 115 Revision by the Commissioner....................................................... 117 Section 122 A explained. ............................................................... 117 Provisional assessment in certain cases .......................................... 118 Section 123 Explained. .................................................................. 118 Assessment giving effect to an order. ............................................. 119 SECTION 124 EXPLAINED......................................................... 120 Powers of tax authorities to modify orders, etc............................... 120 Section 124-A Explained. .............................................................. 121 Assessment in relation to disputed property ................................... 121 Section 125 Explained ................................................................... 121 20. AUDIT ...................................................................................................... 122 21. INCOME TAXATION AND NON DOCUMENTED ECONOMY ...... 124 BUSINESS CULTURE. ................................................................ 124 CAUSES OF EVASION:............................................................... 124 APPLICATION OF UNTAXED MONEY..................................... 126 TYPES OF EVASION................................................................... 126 NO ACCOUNT CASES. ............................................................... 127 NET WORTH METHOD .............................................................. 127 WEALTH STATEMENT. ............................................................. 127 Wealth Statement........................................................................... 128 EXPENDITURE STATEMENT. ................................................... 129 SALARY CASES. ......................................................................... 130 RENTAL INCOME. ...................................................................... 130 INCOME FROM OTHER SOURCES. .......................................... 130 LOAN AND CREDITS. ................................................................ 131 CASH CREDITS. .......................................................................... 131 PRIVATE LOANS. ....................................................................... 131 FICTITIOUS OVERHEADS. ........................................................ 132 MISREPORTING.......................................................................... 132 DIVERSION OF INCOME............................................................ 132 OTHER LAW................................................................................ 133 INVESTMENT IN PROPERTY. ................................................... 133

22. CONCLUSION......................................................................................... 134 23. SALIENT FEATURES FOR THE BUDGET 2007 ................................ 136 24. COMPARATIVE SECTIONS................................................................. 140 25. REFERENCES......................................................................................... 150

INTRODUCTION
Taxation should serve as a catalyst for industrial expansion and economic growth. Illdirected, illogical, regressive and unfair tax regulations can cause a great divide between the rich and the poor. The sole stress on indirect taxation [even under the garb of income taxation through presumptive regime on goods and services] without evaluating its impact on the economy is a cause for concern for independent economists. The higher rate of GST [on an imported article of public consumption the effective rate of indirect tax before any further supply is 41.80%. Such a high rate of tax be justified on imported goods] and ever-growing price acceleration in POL products has crippled the purchasing power of the people. Resultantly a large segment of the middle class may be pushed into lower middle class and the total number of persons living below the poverty line, increasing at an alarming pace may be evident. Fixing revenue targets in isolation and without integrated with improved productivity and economic growth, has forced Pakistan into a dilemma, where neither can it afford to give any meaningful tax relief package to the common people, trade and industry [due to huge fiscal deficit] nor can it achieve a satisfactory level of economic growth. This is a vicious circle in which policymakers find themselves trapped. They will have to find ways and means to come out of this tangle and make Pakistan a competitive place where investors find satisfactory conditions to live and invest. In a country where media, misinformation, confusion are compounded with , investors will never venture forward. The CBR, apex administrative revenue authority, Pakistan's trade and industry on following counts, needs to re-assure : levying of sales tax on importers. imposing indirect taxes on good and services under the presumptive tax regime through the Income Tax Law. imposing withholding tax obligations without any facilitation and then taking punitive action or using the same as revenue collection tools; withholding undisputed refunds payable to the taxpayers; making excessive tax demands; and resorting to all kinds of negative tactics and highhandedness to meet its budgetary targets.

Theses actions of the tax machinery are detrimental for economy, social justice, business and industry. The successive governments' onerous tax and regulatory policies have pushed millions of people below the poverty line. We will have to move quickly and decisively to reverse this trend by restoring Pakistan's undeniable geo-strategic and business competitive position in the region. There is an urgent need to take necessary and tough decisions to make Pakistan a respectable place to live, work and invest in.

Through this paper an attempt is made to arrive at the sole point of real assessment to ease the taxpayer. This research paper also suggests some key areas where paradigm shifts are needed at structural and operation level to ensure not only more tax revenue for the State but also social justice, economic equality so that honest taxpayers are not disillusioned by the benefits CBR has been extending to its dishonest friends in trade, business and industry. One of the defining characteristics of a prosperous and growing economy is a flourishing small and medium enterprise (SME) sector. SMEs contribute to economic development in multiple ways, creating employment for expanding rural and urban workforce and providing much needed flexibility and innovation in the economy as a whole. Their ability to diversify economic activity makes a significant contribution to exports and alleviates poverty. Such benefits, however, have not been fully realized in Pakistan as yet. Development of small businesses has long been debated at public and private forums in Pakistan, but until recently the motivation behind these efforts was more socio-political than economic. The main focus of economic policies, budgetary measures and regulatory regime was large scale industry. As a result, structural imbalances were created in Pakistan's business environment, which got skewed unhealthily towards promoting large scale industry.

The Evolution Of Income Tax Law In The Sub-Continent.

In undivided India (now consisting Pakistan, India and Bangladesh) Income Tax introduced for the first time in the year, 1860, vide Income Tax Act, 1860. This was exactly on the same pattern as was prevailing in those days in the United Kingdom. This Act came into force on 13th July1860 and continued for only five years up to 1st August, 1865 when it was completely withdrawn. Major characteristics of this act were that the agricultural income from land, above the rental value of Rs. 600/- per annum was taxable. However, it was re-imposed with certain changes in 1867 and was called The license Tax Act, of 1867 . Income earned over and above Rs. 200/- per annum was taxable at the rate of 2%. In this act agricultural income was exempt from tax. In 1868 , its name was changed to The Certificate Act , 1868. By virtue of this act, not only the exemption limit was raised to Rs. 500/- but the rate of tax was also reduced to 1.6%. In 1869 the Certificate Act was converted again into Income Tax Act-II. Under this law agricultural income was again brought under taxation Moreover, different rate of tax were proposed on different typed on income. This Act remain enforce for only on year and during the next four years, tax was levied by annual legislation. By1872, the exemption limit was gradually raised to Rs. 1,000/- Income Tax was entirely with drawn for the second time in 1873. After a gap of four years, it was re-imposed and termed as The License Act, 1877 . In this law, a tax on trade and a cess on land were proposed. This Act continued upto 1886, although quite a few changes in the working of the Act were made during this period. A new Income Tax Act, which came into force in 1886, is treated as an important landmark in the taxation history of the country. It is due to the fact that it not only continued for a long period of time, as compared to its predecessors, but great improvements in the legislation were also made. A proper definition of agricultural income was provided for the first time and such income was completely exempted from tax. Concession in payment of tax was provided if a person paid life insurance premium, ( this was done in order to encourage the people to save money and invest in properly ). Separate schedule explaining the sources of income and rates of tax was for the first time attached to the Act. This Schedule continued for 30 years. Income Tax Act, 1886, continued upto 1919 and during its life time of 32 years, only one major amendment was made in it in the year 1903. Another important landmark in the taxation history of the sub-continent came in the year 1918, when The Income Tax Act, 1886 was replaced by The Income Tax Act, 1918 . The new Act for the first time introduced distinction between Total Income and Taxable Income . Drastic changes were effected in the procedure for payment of tax. Under the previous Acts, income of the same year was taxed immediately, but in this Act, tax was imposed in respect of the income earned during the previous income year. Unfortunately, it was soon felt that this law had created quire a few difficulties so far as its application was concerned. Day-to-day difficulties made

it essential that not only the improvements in the law must be made, but the administration of income tax must also be centralized. For the removal of these hazards Provincial Committees and then All India Committee was formed in 1921. The purpose of this committee was to revise the whole law regarding income tax and on the report of this committee, the Act ( XI of 1922 was introduced. Income Tax Act, 1922 prescribed a complete machinery and procedure of assessment. However, it provided that rates of tax will be fixed by Finance Acts every year. Wide powers were given to the assessing officers under this Act. Amendments in the Act continued, meanwhile the Government in 1935 formed an expert committee. The purpose of this committee was to investigate the law completely from all possible angles. The committee was asked to give a report about : a) Whether the tax burden imposed by the government is reasonable and justified ? b) Is the income tax administration working efficiently ? The Committee made a thorough investigation into all these matters and then submitted its report in 1936 The World War-II ( 1939-45) necessitated a better system, so that tax can immediately reach the government and in 1944, Pay as You Earn scheme was introduced ( This scheme which still continues in a little different shape requires an early depositing of tax by certain persons ). In 1945, distinction between Earned and Unearned income was made and some concession was provided on the Earned Income After independence from British rule on 14th August, 1947, the Pakistan Government adopted the Income Tax Act, 1922, as amended upto that date. The provisions of the Act were extended to the whole of Pakistan except the special areas. The Income Tax Act, 1922 continued for 57 years till 1979. During this period, as many as 71 amendments were made in the original Act. The purpose of most of these changes was to check evasion of tax. Some of these changes were brought about in a hurry without keeping in mind the frame work of the basic Act. Resultantly the Act became a complicated law and difficulties arose in its day-to-day working. The Government introduced a new income tax law namely Income Tax Ordinance, 1979 , which was enforced from 1 st July, 1979. The Self Assessment Scheme was further broad-based in this Ordinance. However, the job of improving the law continued after promulgation of this Ordinance also. In 1985, the government set up a National Tax Reform Commission to suggest ways and means to improve the existing tax structure in the country. As a result of all these efforts a new Income Tax Ordinance, 2001, has been promulgated and enforced with effect from 1st July, 2002.

Pakistan Tax System

The income tax is administered by the Central Board of Revenue, through Regional Commissioners of Income Tax. They are assisted by the Commissioners, Additional Commissioners, Income Panels, Deputy Commissioners, Assistant commissioners, Income Tax Officers and Inspectors. The Deputy Commissioners are responsible for ascertaining the amount of tax due from the taxpayers in the areas assigned to them. However, the Board and the field formations are being restricted according to international standard by creating functional based, large and medium, tax payers units , with a view to maintain equality, transparency, efficiency and taxpayers friendly environment.

DEFINITIONS.
Following are some important definitions, which have been used in this term paper, and have bearing on the subject matter: -

Tax year (section 2 (68) read with section 74)

Tax year means a period of twelve months ending on June, 30th which is called normal tax year under the Ordinance and is denoted by calendar each year in which the said date falls. For instance, the tax year 2005 which commenced on July, 1 2004, will end on June, 30, 2005. In case of a person has a different accounting period (income year under the repealed Ordinance) from the normal tax year or has been allowed to adopt such a period by the Commissioner under section 74(3), it will be called special tax year , and is to be denoted by the calendar year relevant to normal tax year in which the closing date of the special year falls. One can say that the concepts of assessment year and income year of the repealed Ordinance have been combined into tax year in the new Ordinance by making it both the accounting period and the period for which the law and rates of tax are applicable. This implies that the tax payer will be required to adopt financial year or a special year (as continuation from the repealed Ordinance or with the permission of the Commissioner) for computing his total income. While granting permission for adoption of a special tax year , the commissioner has been empowered to impose conditions that he thinks are necessary. This has been done to ensure that the taxpayer are prevented from application of beneficial tax rates and / or other concessions available for a tax year, by frequently shifting from one tax year to another. The provision for appealing against the decision of the Commissioner for imposing undesired conditions at the time of grant or withdrawal of a special year is another concept of the Income Tax Ordinance, 2001. But obviously this has been done so because in the repealed Ordinance, the CBR had the power to grant special income years while the new law empowers the Commissioner with the same. Hence, in order to check undue use of discretionary powers this was a necessary measure. By introducing the concept of universal acceptance of returns rendering them as assessment orders ( see section 120) the idea of an assessment year was probably not in conformity with the new law. Now the term tax year is the point of reference for computing of income, application of law, calculation of limitation and all such action s to be taken under the Ordinance. In respect of tax year the following points should be kept in mind: a. Normal tax year (a period of twelve months), comments from first day of July and ends on the last day of June. It is also referred to as the financial year for the purpose of section 74.

b. A taxpayer may apply to the Commissioner for a special year (also a period of twelve months) and the same can be granted subject to any conditions that may be imposed by the authority. This has been done as a special year may overlap two different tax years and in the absence of the condition clause, a taxpayer would have been free to adopt beneficial tax rates and law applicable for either of the years. Of course the Commissioner has the power to impose any other condition that he thinks is important for permitting the use of a special year. c. A special year granted by the Commissioner is subject to withdrawal of grant if in his opinion it is no longer feasible but not unless the taxpayer has been notified in writing. Any intervening period, as a result of change of tax year, will be called the transitional year d. A taxpayer may file an appeal against the decision of the Commissioner at the time of granting permission for a special year or withdrawal of the same. Quite interestingly, the new Ordinance has exhaustively enumerated the types of persons that are subject to tax. The definition contained in the repealed Ordinance, was an inclusive one which envisaged, besides the persons mentioned therein, any other meaning which could possibly be assigned to the word person, thus plugging a legal lacuna. Although it is appreciable that all possibilities of categories of person have been covered, but one may conceive of a situation in the future where someone benefits from this short-sightedness and defies the existing law. For example a body of individuals lacking violation to form AOP will escape taxation. Another anomaly that can be deduced form this definition is the fact that artificial juridical person has been mentioned as an off-shoot of association of persons (AOP). This implies that where an entity to which no particular status can be applied has to be in a multiple form in order to qualify juridical person. As per the repealed Ordinance, anyone not falling in the category of an individual , firm , an association of person, a company or a local authority, fell in the ambit of person contained in section 2(32). Now, for e.g Model Town Society, Lahore, is by no stretch of imagination an association of person, ( for AOP it is essential that two or more persons should work together ir order to ear income ). In the 1922 Act a separate category body of individuals was available, which is conspicuous by its absence in the new Ordinance. Under the provisions of the repealed Ordinance, bodies like Model Town Society or Bar Council of Pakistan were artificial juridical persons but what its status is going to be under the new Ordinance, is a debatable issue.

Income section 2 (29).

The Ordinance defines the term Income as : 1[(29) income includes any amount chargeable to tax under this Ordinance, any amount subject to collection 2[or deduction] of tax under section 148, 3[150, 152(1), 153, 154, 156, 156A, 233, 233A and], sub-section (5) of section 234, 4[any amount treated as income under any provision of this Ordinance] and any loss of income but does not include, in case of a shareholder of a 5[ ]company, the amount representing the face value of any bonus share or the amount of any bonus declared, issued or paid by the company to the shareholders with a view to increasing its paid up share capital;]

Broad principles which clarify the concept of income :

A study of the following broad principles will be helpful for understanding the concept of income: Regular and definite source.. The term income connotes a periodical monetary return coming in with some sort of regularity or expected regularity form definite source. This statement, however, be read with reference to the facts of each case. ( 1992 (49) Tax 46 and 1952 (22) ITR 484 ( SC) Different forms of income. Income may be received in cash or in kind. In certain cases when income is received in kind, its valuation is to be made according to the rules prescribed in the Income Tax Rules. If, however, there is no prescribed rule, valuation thereof is made on the basis of market value. Deemed income. Deemed incomes under the statue are at par with real income. ( 1997 SCC 1097 ) Receipt vs. AccrualIncome arises either on receipt basis or on accrual basis. Income accrues to a person without its actual receipt. Moreover, in some cases, income is declared to be Pakistan-source irrespective of its actual accrual or receipt in Pakistan ( 1960 (2) Tax ) Illegal business.The income tax law does not make any distinction between income accrued or arisen from a legal source and income obtained from an illegal source. Both are taxable ( 1927 AC 193 (PC)

Substituted by the Finance Act, 2002. The substituted clause read as follows: (29) income includes any amount chargeable to tax under this Ordinance, any amount subject to collection of tax under Division II of Part V of Chapter X, sub-section (5) of 234 Division III of Chapter XII, and any loss of income; 2 Inserted by the Finance Act, 2003. 3 The figures, commas and word 153, 154 and 156, substituted by the Finance Act, 2005. 4 Inserted by the Finance Act, 2003. 5 The word domestic omitted by the Finance Act, 2003.

Disputed title.. Income tax assessment can not be held up or postponed merely because of existence of a dispute regarding the title of income. The beneficiary will be charged to tax irrespective of the disputed title. Relief or reimbursed of expenses.. Mere relief or reimbursement of expenses is not treated as income, for instance, reimbursement of actual traveling expenses to an employee is not income. Diversion of income by over-riding Vs. Application of incomeIn order to decide whether a particular payment is a diversion of income or application of income, it has to be determined whether the amount sought to be directed reached the taxpayer as his own income or not. To put it differently, it has to be seen whether the disbursement of income made by the taxpayer was a result of fulfillment of an obligation on him or whether income has been applied to discharge an obligation after it reached the assess. Whereby an obligation, income is diverted before it reaches the assessee, it is diversion of income and not taxable; but where the income is required to be applied to discharge an obligation after such income reaches the access, the same is merely an application of income and tax incidence can not be avoided. Surplus from mutual activity A person can not make a taxable profit out of a transaction with himself. Income must, therefore, come from outside. A surplus arising to a mutual concern can not be regarded as income chargeable to tax (on the basis of well established doctrine of mutuality ). A body of individuals, raising contribution to a common fun for the mutual benefit of member, can not said to have earned an income when it finds that it has over-charged members and some portion of contribution raised may safely be refunded.. Commissioner of Income Tax V. Bankipur Club Ltd. ( 1981 2 Taxman 47 ) Temporary and permanent incomefor the purpose of income tax there is no distinction between temporary and permanent income. Even temporary income is taxable. Lump sum receiptIncome whether received in lump sum or in installments, is liable to tax. For instance arrears of bonus paid by an employee, received in lump sum, is income and taxable as salary in the year of receipt. Personal giftsGifts of a personal nature e.g birthday gifts, marriage gifts etc, is not income and, therefore, recipient of such gift is not liable to income tax. Tax free income.. If a person receives tax-free income on which tax is paid by the person making payment on behalf of the recipient, it has to be grossed up for inclusion in his total income. For example, if tax-free salary is receive by an employee tax is grossed up in his salary.

Income can not be taxed twice.. It is a fundamental rule of the law of taxation that, unless otherwise expressly provided, the same income can not be taxed twice. Charge on person.. Income relating to a tax year or years is taxable in the hands of a person. Income can not be taxed in vacuity. Income should be real and not fictional.. Income means real income and not fictional income. A person can not make a profit of trading with himself. Similarly, income does not arise in a transaction between head office and branch office. Likewise income does not accrue or arise at the time of revaluation of assets. Revenue receipts Vs. Capital receipt.A revenue receipt are taxable as income unless it is expressly exempt under the Ordinance. On the other hand, a capital receipt is generally exempt from tax, unless it is expressly taxable. Certain incomes excluded from taxable income There are certain incomes which are expressly declared exempt under sections 41 to 51, section 102 and various clauses of the Second Schedule of Income Tax Ordinance, 2001. Although such receipts fall in the purview of income, these have been specifically exempted and therefore, can not be included in the taxable of a person while determining tax liability under the Ordinance. Burden of Proof. In cases where a receipt is sought to be taxed as income, the burden lies upon the Income Tax Department to prove that it is within the taxing provisions. Where, however, a receipt is in the nature of income, the burden of proof of providing that it is not taxable, because it falls within an exemption provided by the Ordinance, lies upon the taxpayer.

HEADS OF INCOME
As per section 11 of Income Tax Ordinance, 2001, all incomes shall be classified under the following heads: a. b. c. d. e. Salary ( section 12 ) Income from Property ( section 15) Income from Business ( Section 18 ) Capital Gains ( Section 37 ) ; and Income from Other Sources. ( section 39)

The aggregate income under these heads is termed as gross income. This is mandatory that income should be classified in one of the heads specified in section 11. Income under the head Salary can not be classified under any other head. If a particular income does not fall in any of first four head mentioned above, it will wall in the head Income from Other Sources as this is a residuary head that takes care of any income that can not be classified in the heads mentioned from (a) to (d) in section 11.

Total income and its computation (section 2 (69) read with section 10.
Total income is exclusively defined in section 10, as The total income of a person for a tax year shall be the sum of the persons income under each of the heads of income for the year Plainly speaking, total income is sum total of all incomes computed under the different heads of income as reduced by the amounts permissible as deductions, allowances and rebates under various provision of the Ordinance

Exempt income (sections 41 to 53 and Second Schedule)

Sections 41 to 53 and various clauses of the Second Schedule to the Ordinance deal with exemptions available to incomes or class of incomes, or persons or classes of persons specified therein. The incomes or classes of income, or persons or classes of persons specified in these sections and the Second Schedule to the Ordinance shall be

a. exempt from tax under this Ordinance, subject to any conditions and to the extent specified therein; or b. subject to tax under this Ordinance at such rates, which are less than the rates specified in the First Schedule, as are specified therein; or

c. allowed a reduction in tax liability under this Ordinance, subject to any conditions and to the extent specified therein; or d. exempted from the operation of any provision of this Ordinance, subject to any conditions and to the extent specified therein. As per sub-section (2) and (3) of section 53, The Federal Government has been empowered to make amendment in the Second Schedule by: (a) (b) (c) adding any clause or condition therein; omitting any clause or condition therein; or making any change in any clause or condition therein

Subject to condition that such amendments for any financial year are placed before the National Assembly ( for sanction ) The delegation of legislative powers to grant exemption to the Federal Government had been quite a controversial issue under the repealed Ordinance in view of undue privileges to the mighty section of society through infamous SRO system. As a consequence. the National Assembly vide Finance Act, 1994 withdrew these powers by deleting the parallel provision namely sub-section (2) of section 14 of the repealed Ordinance and thus curtailing discretionary powers enjoyed by the administrative authority over national legislation ( a right step towards restoration of legislative authority ). However, the powers enjoyed by the Federal Government were again restored through the Income Tax ( Third Amendment Ordinance, 1994 ), issued by the President of Pakistan on 13th September, 1994 with the condition that the Federal Government shall place before the National Assembly all amendments made by it in the Second Schedule during the financial year. An act passed by the Parliament was blatantly bypassed through a Presidential Ordinance amounting to insult inflicted on peoples verdict.

Residential Status Of An Individual

According to Section 82 of Income Tax Ordinance, 2001, an individual will be Resident in Pakistan in a Tax Year if he/she fulfils the following conditions : a. He/She is in Pakistan in the said year for a period of 183 days, in parts or continuously, or more; or b. He/She is an employee or official of the Federal or a Provincial Government posted abroad. c. It is not essential that the stay should be at the same place. It is equally not necessary that the stay should be continuous. Similarly, place of stay or purpose of stay is immaterial. For computing the number of days, rule 14 of Income Tax Rules, 2002 applies which reads as under : Rule 14 Residential individual : (1) This rule of Income Tax Rules, 2002 applies for the purpose of section 82, which provides for the determination of persons as resident individuals. (2) The following rules apply for the purpose of clauses (a) and (b) of section 82 in computing the numbers of days an individual is present in Pakistan in a tax year, namely :(a) subject to clause (c) , a part of a days that an individual is present in Pakistan ( including the day of arrival in , and the day of departure from, Pakistan ) counts as a whole day of such presence ; (b) the following days in which an individual is wholly or partly present in Pakistan count as a whole day of such presence, namely :i. a public holiday ii. a day of leave, including sick leave. iii. a day that the individuals activity in Pakistan is interrupted because of a strike, lock-out or delay in receipt of supplies; or iv. a holiday spent by the individual in Pakistan before, during or after any activity in Pakistan; and v. a day or part of a day where an individual is in Pakistan solely by reason of being in transit between two difference places outside Pakistan does not count as a day present in Pakistan Where an individual is in Pakistan only for a part of a day, the calculation of physical presence in Pakistan in respect of such broken period should be made on hourly basis. A total of 24 hours of stay spread over a number of days is to be counted as being equal to the stay of one day . Wikkie V. IRC ( 1952 ) AIR 92. A stay by an individual on a ship or on a yacht moored in the territorial waters should be treated as his presence in Paksitan for the purpose of determining his residential status under section 81 read with section 82 and 83.

Residential status and scope of income.

Under the new ordinance, incidence of tax and scope of total income depends upon the residential status of a taxpayer in a particular tax year.

Scope of total income in the case of resident person

According to Section 11(5) of Income Tax Ordinance, 2001, the income of a resident person under a head of income (section 11) shall be computed by taking into account amounts that are Pakistan-source income (section 101) and amounts that are foreignsource income ( section 101(16). In other words a resident person will be chargearble to tax on his total world income. Chapter VII of the Ordinance deals with Geographical Source of Income . This section read in conjunction with Chapter VII and other provisions of the Ordinance provides that a resident person in relation to a tax year will be chargeable to tax in respect of all income from whatever source derived which : a. b. c. d. e. f. g. is received by him in Pakistan. is received on his behalf in Pakistan. is declared to be Paksitan-source income is declared to be received on his behalf in Pakistan. accrues or arises to him in Pakistan. is declares to accrue or arise to him in Pakistan. accrues or arise to him outside Pakistan.

Scope of total income in the case of a non-resident

According to Section 11(6) of Income Tax Ordinance, 2001 The income of a nonresident person under a head of income ( section 11) shall be computed by taking into account only amounts that are Pakistan-source income. It means that total income of a non-resident person in relation to any tax year includes all income form whatever source derived which a. b. c. d. e. f. is received by him in Pakistan. is received on his behalf in Pakistan. is declared to be received by him in Pakistan. is declared to be received on his behalf in Pakistan. accrues or arises to him in Pakistan. is declared to accrue or arise to him in Pakistan.

WHAT IS ASSESSMENT
Assessment of income implies application of law and procedure to arrive at taxable income of the taxpayer. The Income Tax law can be divided in to Substantive and Procedural, followed by Rules. The definitions part, classification of income, etc. have been described in the Substantive Law, procedure for filing of returns, and allied statements, Assessment of Income, have been given in the Operative Law. To arrive at the assessed income, one has to consider both substantive and procedural law. One must consider that the declared income, trading, profit & loss account etc. have been prepared according to International Accounting Standards. In the case of non- documented taxpayers, he must be having common sense and proficient in investigative techniques. Know how of the nature of business is also a good tool for proper assessment.

HEAD OF INCOME: SALARY

The Income Tax Ordinance, 2001 defines Salary under section 12 as : 12. Salary.- (1) Any salary received by an employee in a tax year, other than salary that is exempt from tax under this Ordinance, shall be chargeable to tax in that year under the head Salary. (2) Salary means any amount received by an employee from any employer, whether of a revenue or capital nature, including (a) any pay, wages or other remuneration provided to an employee, including leave pay, payment in lieu of leave, overtime payment, bonus, commission, fees, gratuity or work condition supplements (such as for unpleasant or dangerous working conditions); any perquisite, whether convertible to money or not; the amount of any allowance provided by an employer to an employee including a cost of living, subsistence, rent, utilities, education, entertainment or travel allowance, but shall not include any allowance solely expended in the performance of the employees duties of employment; the amount of any expenditure incurred by an employee that is paid or reimbursed by the employer, other than expenditure incurred on behalf of the employer in the performance of the employees duties of employment; the amount of any profits in lieu of, or in addition to, salary or wages, including any amount received (i) as consideration for a persons agreement to enter into an employment relationship; (ii) as consideration for an employees agreement to any conditions of employment or any changes to the employees conditions of employment; (iii) on termination of employment, whether paid voluntarily or under an agreement, including any compensation for redundancy or loss of employment and golden handshake payments;

(b) (c)

(d)

(e)

(iv) from a provident or other fund, to the extent to which the amount is not a repayment of contributions made by the employee to the fund in respect of which the employee was not entitled to a deduction; and (v) as consideration for an employees agreement to a restrictive covenant in respect of any past, present or prospective employment; any pension or annuity, or any supplement to a pension or annuity; and any amount chargeable to tax as Salary under section 14.

(f)

(g)

(3) Where an employer agrees to pay the tax chargeable on an employees salary, the amount of the employees income chargeable under the head Salary shall be grossed up by the amount of tax payable by the employer. (4) No deduction shall be allowed for any expenditure incurred by an employee in deriving amounts chargeable to tax under the head Salary. (5) For the purposes of this Ordinance, an amount or perquisite shall be treated as received by an employee from any employment regardless of whether the amount or perquisite is paid or provided (a) by the employees employer, an associate of the employer, or by a third party under an arrangement with the employer or an associate of the employer; by a past employer or a prospective employer; or to the employee or to an associate of the employee or to a third party under and agreement with the employee or an associate of the employee

(b) (c)

(6) An employee who has received an amount referred to in sub-clause (iii) of clause (e) of sub-section (2) in a tax year may, by notice in writing to the Commissioner, elect for the amount to be taxed at the rate computed in accordance with the following formula, namely: A/B% where A is the total tax paid or payable by the employee on the employees total taxable income for the three preceding tax years; and is the employees total taxable income for the three preceding tax years.

(7) (a)

Where any amount chargeable under the head Salary is paid to an employee in arrears; and as a result the employee is chargeable at higher rates of tax than would have been applicable if the amount had been paid to the employee in the tax year in which the services were rendered,

(b)

The employee may, by notice in writing to the Commissioner, elect for the amount to be taxed at the rates of tax that would have been applicable if the salary had been paid to the employee in the tax year in which the services were rendered. (8) An election under sub-section (6) or (7) shall be made by the due date for furnishing the employees return of income or employer certificate, as the case may be, for the tax year in which the amount was received or by such later date as the Commissioner may allow.

Explanation:
As per Section 69 of Ordinance, 2001 changeability of income tax on salary can be on accrued basis as well as on receipt basis. Sub-section ( 1 ) charges to tax salary received by an employee. Employee is defined as an individual engaged in employment ( section 2 (20) ). Employment is defined to include a director or other officer of a company, an individual holding a position with an entitlement to a fixed or ascertainable remuneration, and individual holding or acting in any public office ( section 2 (22) . As the definition is inclusive, the term employment has its ordinary meaning. In broad terms, therefore, this section applies to individuals who are employees as ordinarily understood and to persons holding an office. It does not apply to an individual who is providing services as an independent contractor. The compensation received on the termination of employment is also treated as salary and not a capital receipt ( see detailed description of Salary in sub-section (2). Salary is charges to tax in the tax year in which it is received. This is defined in section 69 to include a constructive receipt. Any amount, benefit or perquisite is treated as the receipt of income if it is- (a) actually received by the person (b) applied on behalf of the person at instruction of the person or under any law or ( c) made available to the person. For example, an employee who directs that his salary be paid to a third person does not actually receive the salary, but is treated as having received the salary. Taxation on the basis of receipt of salary may work hardship for an employee where there is delay in payment of his salary because of factors beyond his control, such as the employers financial difficulty. Sub-section ( 7 ) provides the employee with an option or election to be taxed at the rates that would have been applicable if the salary had been paid in the tax year in which the services were rendered.

On the other hand, the receipts rule may be manipulated by directors and other senior executives of a private company. For example, the payment of salary may be deferred to a tax year when the employees other income is low or in losses. An anti-a voidance measure to prevent such manipulations is provided for in section 110 of the Ordinance. Sub-section (2) provides a list of amounts that are treated as salary for the purposes of the ordinance. It is emphasized that this list is inclusive only. Salary may also include any other amount of revenue or capital nature received by an employee from his employment. Sub-Section (3) provides that where the employer agrees to pay the employees tax liability, the amount of salary received by the employee is to be grossed up by the amount of tax paid by the employer. In other words, the employee is treated as having received the gross amount ( before payment of tax ). Sub-section (4) provides that an employee cannot be allowed a deduction for any expenditure incurred in deriving amounts which are chargeable to tax as salary. In other words, the taxable amount under the head of income Salary is the gross amount received by the employee, Sub-section (4) is limited to non-deductibility of expenditures incurred in deriving salary but does not preclude an employee claiming the deductible allowance of Zakat paid as per section 60. Sub-section (5) provides for the receipt of amounts of salary and to the characterization of amounts received as being from employment. The provisions are expressed to apply for the purposes of the Ordinance and are as follows:i) Clause (a) provides that an amount or perquisite shall be treated as received by an employee from any employment regardless of whether it is paid or provided by the employees employer, an associate of the employees employer or by a third party ( i.e. a non-associated person ) under an arrangement with the employer or an associate of the employer. The term Associate is defined in section 85 which specifies a number of persons acting in accordance with the intentions of others or having such relationship as to be treated as associates for the purpose of the Ordinance. Where the amount or perquisite is paid or provided by an associate of the employer or under a third party arrangement, clause (a) rejects any argument that the amount or perquisite may not be included in the employees salary because no employment services have been provided by the employee to the actual person paying the amount or providing the perquisite. Clause (b) provides that an amount or perquisite shall be treated as received by an employee from any employment regardless of whether it is paid or provided by a past or prospective employer. This ensures that an amount or perquisite is treated as derived from an employment ( and therefore as salary). Notwithstanding that the employment has ceased or is yet to commence.

ii)

iii)

Clause ( c ) provides that an amount or perquisite shall be treated as received by an employee from employment regardless of whether it is paid or provided to the employee himself or an associate of the employee ( such as a relative or to any other third party. Where salary is paid to any of these persons, the employee does not actually receive the salary. Clause- C is a constructive receipt rule that prevents any argument that there has been no receipt in this case. It reinforces the general rule in section 69 which stipulates that receipt of income would mean (a) actually received by the person (b) applied on his behalf or (c) made available to him.

Sub-Section (6) allows an employee who has received an amount on termination of employment to elect to pay tax on that amount at the employees average rate of tax over the three preceding years. Under Sub-section (8), the election must be made by the due date for furnishing the employees return or employers certificate, as the case may be, for the tax year in which the amount is received. Sub-section (7) allows an employee who receives arrears of salary in a tax year to pay tax at the rate that would have been applicable if the employee had received the payment in timely manner, if adding this amount in the current year would result in taxation at a higher rate of tax. Under sub-section (8), the election must be made by the due date for furnishing the employees return of income or employers certificate for the tax year in which the amount of arrears is received. However, Commissioner of Income Tax has the powers to allow further time for making the required election by the employee.

Value of perquisites . Section 13. of Ordinance states :

(1) For the purposes of computing the income of an employee for a tax year chargeable to tax under the head Salary, the value of any perquisite provided by an employer to the employee in that year that is included in the employees salary under section 12 shall be determined in accordance with this section. (2) This section shall not apply to any amount referred to in clause sub-section (2) of section 12. (c) or (d) of

(3) Where, in a tax year, a motor vehicle is provided by an employer to an employee wholly or partly for the private use of the employee, the amount chargeable to tax to the employee under the head Salary for that year shall include an amount computed as may be prescribed (5) Where, in a tax year, the services of a housekeeper, driver, gardener or other domestic assistant is provided by an employer to an employee, the amount chargeable to tax to the employee under the head Salary for that year shall include the total salary paid to the domestic assistant such house keeper, driver, gardener or other domestic assistant] in that year for services rendered to the employee, as reduced by any payment made [to the employer for such services.

(6) Where, in a tax year, utilities are provided by an employer to an employee, the amount chargeable to tax to the employee under the head Salary for that year shall include the fair market value of the utilities provided, as reduced by any payment made by the employee for the utilities. (7) Where a loan is made, on or after the 1st day of July, 2002, by an employer to an employee and either no profit on loan is payable by the employee or the rate of profit on loan is less than the benchmark rate, the amount chargeable to tax to the employee under the head Salary for a tax year shall include an amount equal to(a) the profit on loan computed at the benchmark rate, where no profit on loan is payable by the employee, or the difference between the amount of profit on loan paid by the employee in that tax year and the amount of profit on loan computed at the benchmark rate,

(b)

as the case may be. (8) For the purposes of this Ordinance not including sub-section (7), where the employee uses a loan referred to in sub-section (7) wholly or partly for the acquisition of any asset or property] producing income chargeable to tax under any head of income, the employee shall be treated as having paid an amount as profit equal to the benchmark rate on the loan or that part of the loan used to acquire the asset or property (9) Where, in a tax year, an obligation of an employee to pay or repay an amount owing by the employee to the employer is waived by the employer, the amount chargeable to tax to the employee under the head Salary for that year shall include the amount so waived. (10) Where, in a tax year, an obligation of an employee to pay or repay an amount owing by the employee to another person is paid by the employer, the amount chargeable to tax to the employee under the head Salary for that year shall include the amount so paid. (11) Where, in a tax year, property is transferred or services are provided by an employer to an employee, the amount chargeable to tax to the employee under the head Salary for that year shall include the fair market value of the property or services determined at the time the property is transferred or the services are provided, as reduced by any payment made by the employee for the property or services. (12) Where, in the tax year, accommodation or housing is provided by an employer to an employee, the amount chargeable to tax to the employee under the head Salary" for that year shall include an amount computed as may be prescribed.] (13) Where, in a tax year, an employer has provided an employee with a perquisite which is not covered by sub-sections (3) through (12), the amount chargeable to tax to the employee under the head Salary for that year shall include the fair market value of the perquisite, except where the rules, if any, provide otherwise, determined at the

time it is provided, as reduced by any payment made by the employee for the perquisite. (14) In this section,(a) (i) benchmark rate means -for the tax year commencing on the first day of July, 2002, a rate of five percent per annum; and for the tax years next following the tax year referred to in subclause (I), the rate for each successive year taken at one percent above the rate applicable for the immediately preceding tax year, but not exceeding such rate, if any, as the Federal Government may, by notification, specify in respect of any tax year; Services includes the provision of any facility; and Utilities includes electricity, gas, water and telephone.]

(ii)

(b) (c)

Explanation:
Under this section, rules have been framed for the valuation of in-kind perquisites provided by an employer to an employee (see rules 3 to 9 in Chapter II of the Income Tax Rules, 2002. Sub-section (2) makes it clear that this section does not apply to cash allowances and reimbursement of expenditure. Sub-section (5) provides for the valuation of services of a house keeper, driver, gardener or other domestic assistant (such as a cook or security guard) provided to the employee. This sub-section applies where such persons are employed directly by the employer. The taxable value of the perquisite is the total salary (as defined in section (2) paid to any such person for the services rendered to the employee. The taxable value is reduced by the amount (if any) paid by the employee to the employer for the provision of such services. Sub-section (6) provides for the valuation of utilities, including electricity gas, water and telephone. This section applies where the employer contracts for the provision of the utilities to the employee or where the utility provider is the employer. The taxable value of the perquisite is the fair market value of the utilities provided. Section 68 applies for the purpose of determining the fair market value of the utilities provided. In the ordinary case, where an employer has to go to the market place to acquire the utilities provided to an employee, the fair market value would be the cost to the employer of acquiring those utilities. Where the employer is the utility provider, the fair market value would be what it would cost the employee to get the utilities in the market place. The taxable value is reduced by any amount paid by the employee for the utilities.

Sub-section (7) provides for the valuation of a load advanced to an employee after July 01, 2002 by an employer at less than the benchmark rate of profit. The employees salary includes the difference between benchmark rate and less than or no profit on such loan. The benchmark rate has been taken currently at 5% per annum for the tax year commencing on July 01, 2002. For subsequent years it would be 1% above the rate applicable for the immediately preceding tax year. However, Federal Government is empowered to specify the maximum rate under sub-section 14 (a) (ii) of this section. Under sub-section (8), if the employee uses the above mentioned loan to acquire income-producing asset or property ( income of which is chargeable to tax) the employee is treated as having paid to the employer an amount equal to the benchmark rate as profit on the loan. The effect of this provision is to permit an employee who has used the loan to acquire income-producing asset or property to claim a deduction for profit on the basis that the employee has paid the benchmark rate of profit. Sub-section (9) provides for the valuation of a perquisite being the employers waiver of an employees debt. In a tax year, if an employer waives an employees obligation to pay or repay an amount the employee owes to the employer, the employees salary is increased by the amount waived. Similarly, sub-section (10) provides that if the employer pays an employees obligation to another person (such as a loan owed by an employee to a bank), the employees salary is increased by the amount the employer pays. Sub-section (11) provides for the valuation of a perquisite being property transferred or services provided to the employee. The fair market value of the property or services, reduced by any amount the employee pays for the property or services, is included as salary in the year the property is transferred or the services are performed. The term services is defined in sub-section (14) to include the provision of any facility. This would include, for example, the making available of recreational facility ( such as a boat, golf course or tennis court ) to an employee. Sub-Section 13 contains the general valuation rule that is applicable to any perquisite not expressly described in this section. The fair market value of the perquisite (minus any amount the employee pays for it) is generally included as part of the employees salary, except where different basis of valuation are provided in the rules made under this ordinance. The fair market value of a perquisite at a particular time is deter mined under section 68, which takes into account the price which the perquisite would ordinarily fetch on supply in the open market at that time.

Employee share schemes . - Section 14 of the Ordinance, states :

(1) The value of a right or option to acquire shares under an employee share scheme granted to an employee shall not be chargeable to tax. (2) Subject to sub-section (3), where, in a tax year, an employee is issued with shares under an employee share scheme including as a result of the exercise of an option or right to acquire the shares, the amount chargeable to tax to the employee under the head Salary for that year shall include the fair market value of the shares determined at the date of issue, as reduced by any consideration given by the

employee for the shares including any amount given as consideration for the grant of a right or option to acquire the shares. (3) Where shares issued to an employee under an employee share scheme are subject to a restriction on the transfer of the shares (a) no amount shall be chargeable to tax to the employee under the head Salary until the earlier of the time the employee has a free right to transfer the shares; or the time the employee disposes of the shares; and the amount chargeable to tax to the employee shall be the fair market value of the shares at the time the employee has a free right to transfer the shares or disposes of the shares, as the case may be, as reduced by any consideration given by the employee for the shares including any amount given as consideration for the grant of a right or option to acquire the shares.

(i) (ii) (b)

(4) For purposes of this Ordinance, where sub-section (2) or (3) applies, the cost of the shares to the employee shall be the sum of (a) (b) the consideration, if any, given by the employee for the shares; the consideration, if any, given by the employee for the grant of any right or option to acquire the shares; and the amount chargeable to tax under the head Salary under those sub-sections.

(c)

(5) Where, in a tax year, an employee disposes of a right or option to acquire shares under an employee share scheme, the amount chargeable to tax to the employee under the head Salary for that year shall include the amount of any gain made on the disposal computed in accordance with the following formula, namely:

A-B where A option; and B is the consideration received for the disposal of the right or

is the employees cost in respect of the right or option.

(6) In this sub-section, employee share scheme means any agreement or arrangement under which a company may issue shares in the company to (a) an employee of the company or an employee of an associated company; or

(b)

the trustee of a trust and under the trust deed the trustee may transfer the shares to an employee of the company or an employee of an associated company.

Explanation: This section relates to type of perquisite for the purpose of taxation of income under the head Salary. It provides for the valuation of benefit obtained by an employee under an employee share scheme. The value of the benefit determined under this section is treated as the salary of the employee under section (2) . The term employee share scheme covers any agreement under which a company issues its shares to an employee of the company or to an employee of an associated company. It also covers any agreement or arrangement under which shares in a company are issued to the trustee of a trust who further issues the shares to an employee of the company or of an associated company. Sub-section (1) makes it clear that the grant to an employee of the mere right or option to acquire shares is not chargeable to tax. But when an employee actually is issued shares, sub-section (2) applies and the result would be an addition to the employees taxable salary. However, if the option is sold, the difference in surplus will be recognized as income. Sub-section (2) applies where shares are actually issued to an employee under an employee share scheme. Where this occurs, the difference between the market value of the shares at the date of issued and any consideration given by the employee for the shares (including any consideration given for the grant of a right or option to acquire the shares) is included in the income of the employee for that year. Sub-section (3) applies where shares are issued to an employee, but subject to a restriction on their transfer. For example, shares may be non-transferable for three years. In this situation, the employees salary is not increased by the amount determined under sub-section (2) until the tax year that the restriction ends, that is, the year in which the shares become freely transferable. The calculation of the amount to be added to salary is similar to the calculation under-section (2), but fair market value is determined not at the time of issuance but at the time the shares become freely transferable. There is an exception to this rule where the employee is able to dispose of the shares despite the restriction. In this case, the employee is taxable when he disposes of the shares and the fair market value of the shares is determined at that time. Sub-section (4) defines the cost of the shares to the employee, for the purposes of determining cost under the Ordinance. This provision makes clear that the employees cost includes not only consideration given for the shares, as well as for an option to purchase the shares, but also for the amount subject to tax as a result of sub-section (2) and (3). This ensures that the employee is not taxed again on the taxable amount under those sub-sections when the employee subsequently disposes of the shares. Sub-section (5) applies where an employee who has been granted a right or option to acquire the shares under an employee share acquisition scheme disposes of the right or

option during the tax year ( rather than exercising the right). Where this occurs, the gain derived by the employee on disposal is included in salary for the year of disposal. Example. On July 01, 2002, an employee is granted an option to acquire 1,000 shares under an Employee Share Scheme. The option-price is Rs. 1,000 per share which is also the market value of the shares at the time the option is granted. The employee pays Rs. 10,000 for the option. On June 30, 2004, the employee exercises the option, paying Rs. 1,000,000 for the shares. At the time the option is exercised the market value of the shares is Rs. 1,200 per share. Under sub-section (2), the employee is required to include Rs. 190,000 in his salary for the tax year ending in 2004 (Rs. 1,200,000 fair market value minus (Rs. 1,000,000 + Rs. 10,000). Assuming that the employee is not a share-trader ( i.e. a dealer in shares ) if, instead of exercising the option, the employee sells the option on June 30,2004, for Rs. 100,000, then Rs. 90,000 would be included in the employees salary under sub-section (5).

HEAD OF INCOME: INCOME FROM PROPERTY

The Income Tax Ordinance, 2001 defines Income from Property under section 15 as : Income from property.The rent received or receivable by a person for a tax year, other than rent exempt from tax under this Ordinance, shall be chargeable to tax in that year under the head Income from Property.

1. Subject to sub-section (3), rent means any amount received or receivable by the owner of land or a building as consideration for the use or occupation of, or the right to use or occupy, the land or building, and includes any forfeited deposit paid under a contract for the sale of land or a building. 2. This section shall not apply to any rent received or receivable by any person in respect of the lease of a building together with plant and machinery and such rent shall be chargeable to tax under the head Income from Other Sources.

(3A) where any amount is included in rent received or receivable by any person for the provision of amenities, utilities or any other service connected with the renting of the building, such amount shall be chargeable to tax under the head Income from Other Sources 3. Subject to sub-section (5), where the rent received or receivable by a person is less than the fair market rent for the property, the person shall be treated as having derived the fair market rent for the period the property is let on rent in the tax year. 4. Sub-section (4) shall not apply where the fair market rent is included in the income of the lessee chargeable to tax under the head Salary.

Section 15 Explained:
This section provides for the charging to tax of income under the head Income from Property where the rent is otherwise not exempt from tax under this Ordinance. Property for this purpose would only mean land or a building rented out by its owner. However, if the rent includes any amount for the provision of amenities, Utilities or services connected with the renting of the building, that amount shall be separated from rent and charged to tax under the head Income from other Sources. (See sub-section (3A).

Major changes in law as compared to the corresponding provisions of the 1979 Ordinance :
i) The concept of computing income from Property on the basis of Annual Value, which was the sum for which property might reasonably be expected to let from year to year is done away with. Now Income from Property shall be computed on the basis of actual rent received or receivable for the period the land or building remained in the use or occupation of, or right to use or occupy by, the tenant. In consequence, the concept of vacancy allowance ( a deduction for the period the property remained vacant ) is also done away with; henceforth no notional income will be chargeable to tax in respect of any land or building against which no rent is received or receivable by the owner. The rent of land is now chargeable under the head Income from property which was previously chargeable under the head Income from Other Sources. Forfeited deposit under a contract for the sale of land or a building is also chargeable under the head Income from Property. Deductions for expenditures or allowances specifically allowed in computing income form property can now be claimed either on the basis of actually paid or payable for the corresponding tax year. Liabilities in respect of deductions for any expenditure allowed on payable basis are to be included in chargeable income, if not paid within three years.

ii)

iii)

iv)

v)

Sub-Section ( 1) charges to tax rent receivable or received by a person for a tax year. Where the property is owned by two or more persons jointly and their shares in the property are definite and ascertainable, section 66 provides that the persons are to be assessed individually in respect of the income from the property (based on their respective shares in the property). And not as an association of persons. The timing rule under this head of income is stated by the words receivable or received. Any rent receivable or received for a tax year is chargeable to tax in that year. Section 73 of Income Tax Ordinance, 2001, applies to prevent a double derivation for the purposes of section 15. Under section 73, an amount that is taxable on the basis that it has become receivable cannot be taxed again on the basis that it has been received. Similarly, under section 73, an amount that is taxable on the basis that it has been received cannot be taxed again on the basis that it has become receivable. This means that rent is charged to tax in the earlier of the tax year in which it is receivable or in which it is received.

Rent is receivable by a person at the time the person becomes entitled to receive it even if the time for discharge of the entitlement is postponed or the rent is payable in installments. Rent is received by a person when it is actually received by the person or treated under section 69 as being constructively received, that is to say, if the amount is applied on behalf of the person at his instruction or under any law. Sub-section (1) does not apply where the rent is exempt from tax under the Ordinance. The main exemptions applicable under the Ordinance are set out in the Second Schedule. Rent received by the Federal Government, a Provincial Government or a local authority is also exempt from tax under section 49(1) of this Ordinance. Rent is defined in sub-section (2) to mean any amount received or receivable by the owner of land or a building s consideration for the use or occupation of, or the right to use or occupy the land or a building. The definition expressly includes as rent a forfeited deposit under a contract for the sale of land or a building. The section defines rent so that it applies only to amounts received or receivable by the owner of the land or building. Any rent received or receivable by a lessee under a sub-lease of land or a building is taxable under the head Income from other Sources ( see section 39 (1) (e). Also, the section applies only to rent in relation to land or a building owned by the tax payer. The owner may be a legal owner or a beneficial owner. Property held in trust will be assessable in the hands of the beneficiary. Any rent received or receivable by a person from the hire or lese of tangible movable property will be taxable under the head Income from Business if the person is in business (section 18(1) ( c ) refers) or under the head Income from Other Sources if the person is not in such business ( see section 39 ). Sub-section (3) provides that this section will not apply to any rent received or receivable by a person in respect of a lease of a building together with plant and machinery. It is expressly provided that lease rent is taxable under the head Income from Other Sources (see section 39 (1) (f). In this case, the person is entitled to depreciation as specified in section 40(3) of Income Tax Ordinance, 2001. Apart from this exception, section 15 applies to any rent received or receivable by the owner of land or a building even if leasing the land or building is the owners business. However, if any portion of the property is let out not for the purpose of receiving rent but in connection with the running of the business, e.g. letting out shops in a hotel to provide convenience to the customers, the income from such property would fall under the head Income from Business. The taxable amount is the gross amount of rent received less the deductions allowed under section 17. If the rent is less than the fair market rent for the property, sub-section (4) provides that the owner of the property is treated as having derived the fair market rent. The fair market rent. The fair market rent is determined under section 68 and is taken to be the price which the property would ordinarily fetch in the open market. The fair market rule applies in all cases and not just where the land or building is leased to an associate. However, it is provided in sub-section (5) that the fair market rent rule in sub-section (4) does not apply where the lessee is an employee and the fair market rent is included in the employees salary.

Section 16. Non-adjustable amounts received in relation to buildings.- (1) Where the owner of a building receives from a tenant an amount which is not adjustable against the rent payable by the tenant, the amount shall be treated as rent chargeable to tax under the head Income from Property in the tax year in which it was received and the following nine tax years in equal proportion. (2) Where an amount (hereinafter referred to as the earlier amount) referred to in sub-section (1) is refunded by the owner to the tenant on termination of the tenancy before the expiry of ten years, no portion of the amount shall be allocated to the tax year in which it is refunded or to any subsequent tax year except as provided for in subsection (3). (3) Where the circumstances specified in sub-section (2) occur and the owner lets out the building or part thereof to another person (hereinafter referred to as the succeeding tenant) and receives from the succeeding tenant any amount (hereinafter referred to as the succeeding amount) which is not adjustable against the rent payable by the succeeding tenant, the succeeding amount as reduced by such portion of the earlier amount as was charged to tax shall be treated as rent chargeable to tax under the head Income from Property as specified in sub-section (1).

Section 16 explained;
In broad terms, this section has the effect of including as rent certain non- adjustable amounts received by the owner of a building from a tenant. A non-adjustable amount is taken into the owners income from property over a period of ten years (10 per cent per year), beginning with the first tax year of its receipt. If the tenancy ends sooner than 10 years and a part of the amount is refunded, no part of the non-adjustable amount is to be included in the owners income for the year of refund and later years. Should the owner let the building to a succeeding tenant who also pays a non-adjustable amount (called the succeeding amount), then the succeeding amount, reduced by the earlier-included adjustable amount, is treated as rent and included in the owners income.

HEAD OF INCOME: INCOME FROM BUSINESS

The Income Tax Ordinance, 2001 defines Income from Business under section 18 as : Income from business.- (1) The following incomes of a person for a tax year, other than income exempt from tax under this Ordinance, shall be chargeable to tax under the head Income from Business (a) the profits and gains of any business carried on by a person at any time in the year; any income derived by any trade, professional or similar association from the sale of goods or provision of services to its members; any income from the hire or lease of tangible movable property; the fair market value of any benefit or perquisite, whether convertible into money or not, derived by a person in the course of, or by virtue of, a past, present, or prospective business relationship; and any management fee derived by a management company (including a modaraba management company.

(b)

(c) (d)

(e)

(2) Any profit on debt derived by a person where the persons business is to derive such income shall be chargeable to tax under the head Income from Business and not under the head Income from Other Sources. (3) Where a lessor, being a scheduled bank or an investment bank or a development finance institution or a modaraba or a leasing company has leased out any asset, whether owned by it or not, to another person, any amount paid or payable by the said person in connection with the lease of said asset shall be treated as the income of the said lessor and shall be chargeable to tax under the head Income from Business. (4) Any amount received by a banking company or a non-banking finance company, where such amount represents distribution by a mutual fund out of its income from profit on debt, shall be chargeable to tax under the head Income from Business and not under the head Income from Other Sources.

Section 18 explained;
This section provides for the charging to tax of income under the head Income from Business. The purpose is to enumerate the various types of receipts that would fall under the head Income from Business, other than speculation business. The provisions of this are similar to those contained in clauses (a) to (c) of section 22 of the 1979 Ordinance. However, what was generally implied in the earlier provisions has been explicitly provided in this section ( e.g. money lending business and management fee ).

Sub-section (1) charges to tax the amounts specified in clauses (a) to (e) derived by a person in a tax year. The timing rule depends on whether the person is required to account for tax purposes on a cash or accrual basis (see section 32-34). Sub-section (1) does not apply to any amount that is exempt from tax under the Ordinance. The main exemptions applicable under the Ordinance are set out in Part VII of Chapter III (including the Second Schedule), which do not form part of total income. The amounts charged to tax are specified in sub-section (1). Clause (a) by a person at any time in a tax year. Business is defined in section 2 (9) to include any trade, commerce, manufacture, profession, vocation or any adventure or concern in the nature of any trade, commerce, manufacture, profession or vocation or any adventure or concern in the nature of any trade, commerce, manufacture, profession or vocation. The definition expressly excludes any employment as defined in section 2 (22) which includes directorship or management position of a company, any position with fixed or ascertainable remuneration and holding or acting in any public office. The inclusion of a profession in the definition of business means that income from a profession is also taxable under the head Income from Business. Clause (b) charges to tax as income from business any income derived by a trade, professional or similar association from the sale of goods or provision of services to its members. This overrides the doctrine of mutuality that may otherwise have applied to such income. Clause ( c ) charges to tax income from the hire or lease of tangible movable property which is different from the rent of the property taxable under section 15. Clause (d) relates to the fair market value of any benefit or perquisite as a result of business relationship. This clause applies even if the benefit or perquisite cannot be converted to cash. The fair market value of any such benefit or perquisite is determined under section 68, which refers to the open market price of the benefit or perquisite that could be ordinarily fetched at that time. Clause (e) specifically makes fee received by the management company including modaraba Management Company as business income. Sub-section (2) provides that profit on debt is chargeable to tax under the head Income from Business if it is the persons business to derive such income ( e.g, a bank or other financial institution ). This ensures that such income is taxed under section 18 and not section 39 (Income from Other Sources). Sub-section (3) further clarifies that where a scheduled bank, an investment bank, a development finance institution, a modaraba or a leasing company has leased out any asset ( whether owned by it or not ) to another person, the amount paid or payable by that person shall be treated as lease income and chargeable to tax as Income from Business. Similarly, share of profit on debt distributed by a mutual fund will be treated as Income from Business if received by a banking company or a non-banking finance company (sub-section (4) refers).

Meaning of Business : in view of section 2(9) business includes any (a) trade ,(b) commerce, (c) manufacture, (d) profession, vocation or (e) any adventure or concern in the nature of trade, commerce or manufacture. Though the definition is not exhaustive, it covers every facet of an occupation carried on by a person with a view to earning profits. Production of goods from raw-material, buying and selling of goods to make profits and providing services to others are different forms of business , profits arising from which are, therefore, charged to tax under the head income from business or profession. The terms business is of wide important and in financial statues it must be construed in a broader rather than a restricted sense. Significance of profit motive. The word business connotes some real, substantial and systematic or organized course of activity or conduct with a set purpose. The word business is not of large and indefinite import and connotes something which occupies attention and labour of a person for the purpose of profit. Business and rendering services to other. It is not necessary that business should always consist of activities of trade, commerce or manufacture. Even activities of rendering services to others fall within the expression business Business viz-a-viz company.The capacity of a joint stock company, unlike non-corporate entities to carry on business is controlled and guided by its memorandum and articles of association. In deciding whether or not a particular activity of a company constituted business in its hands, it is, therefore, necessary to examine the memorandum and the articles of association of the company. However, existence or non-existence of power in the memorandum of association of a company to carry on a particular activity is not the only decisive factor to ascertain whether the activity constitutes business activity and profit arising there from is chargeable to tax as business profit. For instance, if certain transactions are ultra vires the object clause in the memorandum of association, profits arising therefore, would still be taxable as business. Business includes trade..in view of section 2(9) business inter alia trade is defined by the Oxford Dictionary as the practice of some occupation, business or profession habitually carried on, especially when it is carried on as a means of livelihood or gain. It is held that trade in its primary meaning, is the exchange of goods or goods for money, in its secondary meaning, its repeated activity in the nature of business carried on with a profit motive, the activity being manual or mercantile, as distinguished from the liberal arts or learned professions or agriculture Business includes manufacture .The Oxford Dictionary defines the word manufacture as making of articles or materials by physical labour or mechanical power. It is held that the essence of manufacturing is that something is produced or brought into existence which is different from that what is made, in the sense that the thing produced is by itself commercial commodity which is capable as such of being sold or supplied.

Business includes any adventure in the nature of trade, commerce or manufacture In the light of various decisions of the Superior Courts ( Pakistan Supreme Courts judgement ( 1992 ) 66 TAX 55 ( S.C Pak) + 1992 PTD 621 the following guiding principles can be enunciated while deciding as to whether a transaction of purchase or sale forms an adventure in the nature of trade or investment :

a. the commodity purchased plays an important role in deciding whether a person is indulging in an adventure in the nature of trade or is making an investment. b. Whether the transaction is an isolated one or forms part of a series of transaction showing a tendency to indulge in trade. c. The fact that the property bought has been sold within a short time does not by itself indicate that the transaction is in the nature of trade. d. If land has been purchased or commodity, which normally is not treated as stock-in-trade, has been purchased, the presumption is that the intention was to make an investment and not to indulge in an adventure in the nature of trade. e. If the property purchased is capable of yielding income then again the inference will be that an investment was intended to earn income and is not an adventure in the nature of trade. Therefore, an assessable adventure must have semblance of trade though it need not to have any attributes of trade. The stage at which a speculation becomes a trading venture is not easy to determine. The facts, if examined in detail and in accumulation, can only establish whether the activity was in the nature of dventure in trade, commerce or manufacture or not. The following points or facts merit attention : a. the reason given for the acquisition of assets or goods; b. the quantities and kinds of assets sold. c. The process applied or the changes made before sale ; d. The method of obtaining and effecting sales ; e. The intervals between purchase and sale ; f. The means of financing operations , and g. The connection, if any, between speculation and some acknowledged business activity.

The following case law may be helpful to understand the scope of adventure in the nature of trade and commerce : 1. Sale of right shares purchased as investment is not adventure in the nature of trade ( 1992 ) 66 TAX 55 ( S.C Pak ) + 1992 PTD 621 2. Purchase and sale of agriculture land constituted an adventure in the nature of trade , the profit is liable to be taxed as business income ( 1994 ) 69 TAX 38 ( Karachi High Court ) 3. Mere sale and purchase of shares is not sufficient to constitute adventure in the nature of trade ( 1980 ) 41 TAX 19 ( Karachi H.C ) 4. Number of transaction s are not determining factor; even a single transaction can be held to be adventure in the nature of trade ( 1979 ) 38 TAX 5 ( Karachi H. C ) + PLD 1978 Kar. 673 5. Definition of the word business is not exhaustive ; it has extending force and not a limiting connotation. Determination of venture in the nature of trade depends on circumstances of each cased. Single and isolated business may constitute an adventure in the nature of trade ( 1976 ) 33 TAX 121 ( Lahore H. C )

Business income not taxable under the head Income from Business In the following cases income from trading or business is not taxable under section 18. : Income from house property is taxable under section 15, even if properties constitute stock-in-trade of recipient or the owner of properties is engaged in the business of letting out of properties ( Salisbury House Estate Ltd. V. Fry ( 1930) AC 432 (HL) Capital gains on shares and stocks are taxable under section 37 even if they are derived from shares held as stock-in-trade or the recipient is dealer in shares and stocks ( 1997 ) 77 Tax ( Tribunal ) Profits derived from the aforesaid business activities are not taxable under section 18. Profits and gains of any other business are taxable under this head unless such profits are exempt under the Ordinance.

Meaning of Profession or Vocation

As per section 20 business includes profession and vocation but does not include employment ( 2 (22) ). It means that all the professionals who derive income from profession, other than employment, are chargeable to tax under this head of income.

The definition given in section 2 (9), which is inclusive, does not give any idea about the meaning of word profession or vocation . The word profession implies professed attainment in special knowledge as distinguished from mere skill, special knowledge which is : to be acquired only after patient study and application United States V. Laws ( 1986) 163 Vs 258. Much vocation may fall within the ordinary and accepted use of the word: profession for instance, as those of tax consultants, accountants, architects, engineers, journalists, and so forth. However, whether a person, in any given case, carries on a profession, is a question of degree and always of facts? In the absence of any definition of the word vocation in the Income Tax Ordinance, it implies natural ability of a person for some particular work The word Vocation is analogous to calling means the way in which a man passes his life Partridge V. Mallandaine ( 1886 ) 18 QBD 276. Distinction between business, profession or vocation not significant As profits and gains of a business, profession or vocation are chargeable to tax under the head income from business ( Section 18 ), distinction between business , profession and vocation does not have any material significance, while computing table income under this head. What does not amount to profession may amount to vocation Upper India Chamber of Commerce V. Commissioner of Income Tax ( 1974) 15 ITR 263 all.

Speculation Business Income

Basic principles to arrive at business income (Section 18 read with section 20, 21 and 23) One has to keep in mind the following general principles while computing income chargeable under the head Income from Business 1. 2. 3. 4. 5. Business is to be carried on by the taxpayer. Business or profession should be carried on during the tax year. Income is taxable in the relevant tax year. Tax incidence arises in respect of all business activities. Legal ownership V. Beneficial ownership. Under Section 18, it is not only the legal ownership but also the beneficial ownership that has to be considered. 6. Real profit V. Anticipated profit. The profits which are taxed under section 18 are the real profits and not notional profits. For instance , no person can make profit by trading by himself in another capacity. Therefore, it is wholly artificial to separate the business from its owner and treat them as separate entities, trading with each other and compute fictional profits on the basis of fictional sale which, in truth and in fact, is non-existent. 7. Recovery of sums already allowed deduction. 8. Mode of book entries is not relevant. 9. Legality of business is not relevant and illegal business is not exempt from tax. 10. Commercial principles of computing business are very much material.

Assessment of discontinued business or profession

According to Section-117 of the Ordinance, the person discontinuing such business or profession is required under section 117(1) to give the Commissioner of Income Tax a notice of such discontinuance within 15 days of the date of such discontinuance. the term discontinuance means complete cessation of business or profession. It is different from succession. Discontinuance means disappearance of business altogether while succession implies a change of ownership of business. Where a partnership is dissolved and one partner takes over and continues the business, it is case of succession and not discontinuance-- C.J Sheth V. Commissioner of Income Tax ( 1962 ) 46 ITR 1052. There is no discontinuance if customers are merely informed that business would close on a certain date but the business continues to be transacted, though it may be simply to complete the outstanding contracts. In the case of profession, if a professional gives up his profession or vocation, it amounts to discontinuance. The question whether a professional discontinued his profession depends upon the state of his mind at the time of cessation. Merely he took to the profession later on , once again, it cannot be stated that there was no discontinuance at the time of cessation. For example, a practicing doctor is appointed as Medical Advisor to the Government. Consequently, he stopped practicing. It is a case of discontinuance of profession, even though he may resign later on and start his practice again. In these circumstances, the resumption of the practice amounts to the continuance of the previous one which he had discontinued. Notice of discontinuance ( section 117(1). Any person discontinuing any business should give to the Commissioner of Income Tax a notice of such discontinuance withing 15 days thereof. Failure to give notice attracts penalty under section 188 which can be equal to the tax payable for the tax year in which the business was continued. Mode of assessment of discontinued business or profession ( Section 117 (2)..Under the general scheme of Income Tax Ordinance, income earned during the tax year is assessable in the said year. However, in the case of discontinued business, income earned during the year of discontinuation is assessable in the same year. For example, ordinarily income earned or accrued during the financial year 2004-2005 is assessable on 03-04-2005, assessment of income for the period ending on 03-04-2005 is to be separate and distinct from any other assessment during the relevant tax year. Power to obtain return/s for discontinued business ( Section 117 (3). Where no notice has been given by the taxpayer but the Commissioner has reasonable grounds to believe that a business has discontinued or is likely to discontinued, the Commission may serve a notice on the person who has discontinued the business or is likely to discontinue the business to furnish to the Commissioner within the time specified in the notice a return of income for the period specified in the notice. A return furnished under this section shall be treated for all the purposes of this Ordinance as a return of income, including the application of section 120.

Discontinuation meaning of

OTHER POINTS: The following points merit consideration in respect of this provision of law : Discontinuation of business means complete cessation and disappearance of business. Absence of business activity for some time ( or even for a long span ) does not mean discontinuance. Tax is to be charged according to the rates in force in that tax year. Where any such assessment is made in the case of any association of person or a company, a notice requiring the assessee to furnish the return/s may be served on the principal officer in the case of an AOP and a company. Non-compliance of notice under section 117(3) attracts prosecution. If returns are filed under section 117 (2) or in response to a notice under section 117 (3) , completion of assessment under this section is mandatory. However, if for some reasons, assessments are not completed under this section, the Commissioner of Income Tax can complete them during the relevant assessment year (s).. The purpose of this section is to enable the Commission to complete assessment (s) immediately on discontinuance rater than waiting for the normal time or procedure of assessment.

19. Speculation business. - (1) where a person carries on a speculation business (a) that business shall be treated as distinct and separate from any other business carried on by the person;

(b) this Part shall apply separately to the speculation business and the other business of the person; (c) section 67 shall apply as if the profits and gains arising from a speculation business were a separate head of income;

(d) any profits and gains arising from the speculation business for a tax year computed in accordance with this Part shall be included in the persons income chargeable to tax under the head Income from Business for that year; and

(e) any loss of the person arising from the speculation business sustained for a tax year computed in accordance with this Part shall be dealt with under section 58.

(2) In this section, speculation business means any business in which a contract for the purchase and sale of any commodity (including stocks and shares) is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity, but does not include a business in which (a) a contract in respect of raw materials or merchandise is entered into by a person in the course of a manufacturing or mercantile business to guard against loss through future price fluctuations for the purpose of fulfilling the persons other contracts for the actual delivery of the goods to be manufactured or merchandise to be sold; a contract in respect of stocks and shares is entered into by a dealer or investor therein to guard against loss in the persons holding of stocks and shares through price fluctuations; or

(b)

(c) a contract is entered into by a member of a forward market or stock exchange in the course of any transaction in the nature of jobbing arbitrage to guard against any loss which may arise in the ordinary course of the persons business as such member.

Section 19 explained:
This section provides for the separate computation of the profits or gains from a speculation business under the head Income from Business. The main purpose of this separate treatment is to forbid the set off of loss from speculation business against not only business income but also income under other heads. In the risky speculation business, goods or commodities are not actually delivered and the parties can maneuver tax avoidance; hence this separation. The definition of speculation business is given in sub-section (2). It means a business where the contract for the purchase and sale of any commodity (including stocks and shares) is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity. The definition, however, excludes three types of speculation contracts, namely; a) b) c) Hedging for materials or merchandise; Hedging for stocks and shares; and Hedging for jobbing or arbitrage business.

The acid test between hedging and speculation is that in hedging the quantity contracted by a businessman is more or less the same as the businessman actually deals in, whereas in speculation contracts the goods or commodities are not available but are settled periodically or ultimately according to the date(s) of the notional delivery of contracted goods or commodities.

Deductions in computing income chargeable under the head Income from Business Section 20 of the Ordinance, states : (1) Subject to this Ordinance, in computing the income of a person 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 purposes of business. (2) Subject to this Ordinance, where the expenditure referred to in sub-section (1) is incurred in acquiring a depreciable asset or an intangible with a useful life of more than one year or is pre-commencement expenditure, the person must depreciate or amortize the expenditure in accordance with sections 22, 23, 24 and 25. (3) Subject to this Ordinance, where any expenditure is incurred by an amalgamated company on legal and financial advisory services and other administrative cost relating to planning and implementation of amalgamation, a deduction shall be allowed for such expenditure.

Section 20 explained:
This section specifies the deduction allowed in computing the income of a person chargeable to tax under the head Income from Business. Expenses incurred in earning income which is not chargeable to tax or is exempt from tax cannot be allowed as deductions. There are a number of requirements that must be satisfied before expenditure is deductible under sub-section (1). First, expenditure must be incurred. The incurring of expenditure depends on whether the person accounts for tax purposes on a cash or accrual basis. A person accounting for tax purposes on a cash basis incurs expenditure when the expenditure is paid, whereas a person accounting for tax purposes on a accrual basis incurs expenditure when the obligation to pay the expenditure arises ( also see comments under sections 32-34). Secondly, the expenditure must be incurred to derive income from business chargeable to tax. This means that the expenditure must be incurred to derive an amount taxable under section 18 as income from business. No deduction is allowed for expenditure incurred to derive exempt income ( even if from the carrying on of a business) or incurred for a non-business purpose. While the requirement is that the expenditure is incurred to derive taxable business income, there is no requirement that such income is actually derived. However, it would be rare case where a person incurs only expenditure in a tax year deriving no income at all. Nevertheless, if that occurs and subject to the possible application of the anti-avoidance rules, the expenditure is deductible and would create a loss for the tax year. The only exception to this rule is- if the expenditure is a pre-commencement expenditure amortized under section 25; that is to say where the expenditure was incurred before the commencement of a business such as the cost of feasibility studies, construction of prototypes and trial production activities.

Thirdly, sub-section (1) does not require that an expenditure is incurred wholly and exclusively to derive business income, but instead allows apportionment of expenses between business and non-business purposes. Under sub-section (1), expenditures are deductible to the extent they are incurred to derive taxable business income. This section first provides a general principle of deductibility and then subsequent provisions modify the application of that principle. The general principle is that a deduction is allowed for any expenditure incurred by a person in a tax year to the extent that the expenditure is incurred by the person in deriving income from business chargeable to tax. The timing of the deduction then depends on the useful life of the expenditure. If the useful life is a year or less, then the amount is fully deductible in the tax year in which it is incurred. Where the useful life exceeds one year, the expenditure is depreciated or amortized in accordance with sections 22-24 over its useful life. This basic position is partly modified by section 21 which may disallow a deduction for certain expenditures. It is also modified by sections 26-31. Under these sections, a deduction may be allowed for something that is otherwise not deductible or an outright deduction may be allowed for an amount that would otherwise be depreciated or amortized.

Deductions not allowed.Section 21 of the Ordinance, 2001 states :

(a)

any cess, rate or tax paid or payable by the person in Pakistan or a foreign country that is levied on the profits or gains of the business or assessed as a percentage or otherwise on the basis of such profits or gains; any amount of tax deducted under Division III of Part V of Chapter X from an amount derived by the person; any salary, rent, brokerage or commission, profit on debt, payment to non-resident, payment for services or fee paid by the person from which the person is required to deduct tax under Division III of Part V of Chapter X or section 233 of chapter XII, 6[unless] the person has 7 [paid or] deducted and paid the tax as required by Division IV of Part V of Chapter X; any entertainment expenditure in excess of such limits 8[or in violation of such conditions] as may be prescribed; any contribution made by the person to a fund that is not a recognized provident fund 9[approved pension fund], approved superannuation fund, or approved gratuity fund; any contribution made by the person to any provident or other fund established for the benefit of employees of the person, unless the person has made effective arrangements to secure that tax is deducted

(b) (c)

(d) (e)

(f)

6 7 8

Substituted for the word until by the Finance Act, 2003. Inserted by the Finance Act, 2003. Inserted by the Finance Act, 2003. 9 Inserted by the Finance Act, 2005.

under section 149 from any payments made by the fund in respect of which the recipient is chargeable to tax under the head "Salary"; (g) (h) (i) (j) any fine or penalty paid or payable by the person for the violation of any law, rule or regulation; any personal expenditures incurred by the person; any amount carried to a reserve fund or capitalised in any way; any profit on debt, brokerage, commission, salary or other remuneration paid by an association of persons to a member of the association;

10

[ ] [(l) any expenditure for a transaction, paid or payable under a single account head which, in aggregate, exceeds fifty thousand rupees, made other than by a crossed cheque drawn on a bank or by crossed bank draft or crossed pay order or any other crossed banking instrument showing transfer of amount from the business bank account of the taxpayer:

11

Provided that online transfer of payment from the business account of the payer to the business account of payee as well as payments through credit card shall be treated as transactions through the banking channel, subject to the condition that such transactions are verifiable from the bank statements of the respective payer and the payee: Provided further that this clause shall not apply in the case of(a) (b) expenditures not exceeding ten thousand rupees; expenditures on account of (i) (ii) (iii) (iv)
10

utility bills; freight charges; travel fare; postage; and

Omitted by the Finance Act, 2006. The omitted clause (k) read as follows: (k) any expenditure paid or payable by an employer on the provision of perquisites and allowances to an employee where the sum of the value of the perquisites computed under section 13 and the amount of the allowances exceeds fifty per cent of the employees salary for a tax year (excluding the value of the perquisites or amount of the allowances); 11 Substituted by the Finance Act, 2006. The substituted clause (l) read as follows: (l) any expenditure paid or payable under a single account head which, in aggregate, exceeds fifty thousand rupees A B made other than by a crossed bank cheque or crossed bank draft, except expenditures not exceeding [ [ten] thousand rupees or on account of freight charges, travel fare, postage, utilities or payment of taxes, duties, C [fee], fines or any other statutory obligation;] A The words five hundred rupees or on account of postage or utility bills earlier substituted by the Finance Act, 2002. B The five earlier substituted by the Finance Act, 2004. C The word fees earlier substituted by the Finance Act, 2003.

(v)

payment of taxes, duties, fee, fines or any other obligation;]

statutory

(m) any salary paid or payable exceeding 12[ten] thousand rupees per month other than by a crossed cheque or direct transfer of funds to the employees bank account; and (n) except as provided in Division III of this Part, any expenditure paid or payable of a capital nature.

Section 21 explained:
This section expressly lists a number of expenditures that are not deductible in computing the income from business. The section largely reproduces section 24 of the 1979 Ordinance. Some of the important deductions not allowed under this section are discussed below: Clause (a) makes it clear that the deduction denial rule applies also to foreign taxes, although any foreign income tax paid may be creditable under section 103 which provides that a resident taxpayer who derives foreign-source income chargeable to tax under his Ordinance and has paid foreign income tax shall be allowed a tax credit equal to the amount of that tax paid or the amount of Pakistan tax payable in respect of such income (whichever is less ). Clause (b) provides that taxes deducted at source on the receipts of the taxpayer will not be allowed as expenditure against income from business Such receipts include dividends, profit on debt, receipts for sale of goods and services, export proceeds and prizes, winnings etc. Where tax is not paid or deducted and paid by the person required to make deduction on certain expenses specified in clause the same would not be allowed as deductible expense in the computation of income from business. Such expenses include salary, rent, brokerage or commission, profit or interest on debt, payments to non-resident, payment for services or fee from which deduction of tax at source is required to be made. Section 162(2) provides that even if tax ( not deducted ) is recovered from the recipient of amount or payment, such recovery of tax would not absolve the person who was obliged to deduct tax from disallowance of expense, if any, claimed as a deduction against income from business, unless he has himself paid the required tax. Clause (j) disallows a deduction for certain amounts paid by an association of person to its members. An association of persons includes a firm ( section 80); so the denial deduction rule applies also the payment of the specified amounts to a partner in a firm. The effect of this disallowance rule is to ignore transactions between the association and its members so that the specified amounts are taxed as part of the profits of the association. This clause reproduces section 24 (d) of the 1979 Ordinance.

12

Substituted for the word five by the Finance Act, 2004.

Clause (L) disallows a deduction for any expenditure of a capital nature, other than capital expenditure expressly deductible under Division III of Part IV of Chapter III. Examples of capital expenditure deductible under that Division are the cost of depreciable assets and intangibles that are depreciated or amortized under sections 22 and 24 respectively. Depreciation. Section 22 of the Ordinance, states : (1) Subject to this section, a person shall be allowed a deduction for the depreciation of the persons depreciable assets used in the persons business in the tax year. (2) Subject to sub-section (3), the depreciation deduction for a tax year shall be computed by applying the rate specified in Part I of the Third Schedule against the written down value of the asset at the beginning of the year. (3) Where a depreciable asset is used in a tax year partly in deriving income from business chargeable to tax and partly for another use, the deduction allowed under this section for that year shall be restricted to the fair proportional part of the amount that would be allowed if the asset were wholly used to derive income from business chargeable to tax. (5) The written down value of a depreciable asset of a person at the beginning of the tax year shall be (a) where the asset was acquired in the tax year, the cost of the asset to the person as reduced by any initial allowance in respect of the asset under section 23; or

(b) in any other case, the cost of the asset to the person as reduced by the total depreciation deductions (including any initial allowance under section 23) allowed to the person in respect of the asset in previous tax years. (6) Where sub-section (3) applies to a depreciable asset for a tax year, the written down value of the asset shall be computed on the basis that the asset has been solely used to derive income from business chargeable to tax. (7) The total deductions allowed to a person during the period of ownership of a depreciable asset under this section and section 23 shall not exceed the cost of the asset. (8) Where, in any tax year, a person disposes of a depreciable asset, no depreciation deduction shall be allowed under this section for that year and (a) if the consideration received exceeds the written down value of the asset at the time of disposal, the excess shall be chargeable to tax in that year under the head Income from Business; or

(b)

if the consideration received is less than the written down value of the asset at the time of disposal, the difference shall be allowed as a deduction in computing the persons income chargeable under the head Income from Business for that year.

(9) Where sub-section (3) applies, the written down value of the asset for the purposes of sub-section (8) shall be increased by the amount that is not allowed as a deduction as a result of the application of sub-section (3). (10) Where clause (a) of sub-section (13) applies, the consideration received on disposal of the passenger transport vehicle for the purposes of sub-section (8) shall be computed according to the following formula A x B/C where A B C is the amount received on disposal of the vehicle; is the amount referred to in clause (a) of sub-section (13); and is the actual cost of acquiring the vehicle.

(11) Subject to sub-sections (13) and (14), the rules in Part III of Chapter IV shall apply in determining the cost and consideration received in respect of a depreciable asset for the purposes of this section. (12) The depreciation deductions allowed to a leasing company or an investment bank or a modaraba or a scheduled bank or a development finance institution in respect of assets owned by the leasing company or an investment bank or a modaraba or a scheduled bank or a development finance institution and leased to another person shall be deductible only against the lease rental income derived in respect of such assets. (13) For the purposes of this section, (a) the cost of a depreciable asset being a passenger transport vehicle not plying for hire shall not exceed [one million] rupees;

Provided that the prescribed limit of one million rupees shall not apply to passenger transport vehicles, not plying for hire, acquired on or after the first day of July, 2005. (b) the cost of immovable property or a structural improvement to immovable property shall not include the cost of the land;

(c) any asset owned by a leasing company or an investment bank or a modaraba or a scheduled bank or a development finance institution and leased to another person is treated as used in the leasing company or the investment bank or the modaraba or the scheduled bank or the development finance institutions business; and

(d)

where the consideration received on the disposal of immovable property exceeds the cost of the property, the consideration received shall be treated as the cost of the property.

(14) Where a depreciable asset that has been used by a person in Pakistan is exported or transferred out of Pakistan, the person shall be treated as having disposed of the asset at the time of the export or transfer for a consideration received equal to the cost of the asset. (15) In this section, depreciable asset means any tangible movable property, immovable property (other than unimproved land), or structural improvement to immovable property, owned by a person that (a) (b) has a normal useful life exceeding one year; is likely to lose value as a result of normal wear and tear, or obsolescence; and is used wholly or partly by the person in deriving income from business chargeable to tax,

(c)

but shall not include any tangible movable property, immovable property, or structural improvement to immovable property in relation to which a deduction has been allowed under another section of this Ordinance for the entire cost of the property or improvement in the tax year in which the property is acquired or improvement made by the person; and structural improvement in relation to immovable property, includes any building, road, driveway, car park, railway line, pipeline, bridge, tunnel, airport runway, canal, dock, wharf, retaining wall, fence, power lines, water or sewerage pipes, drainage, landscaping or dam. Section 22 explained: This section allows an annual deduction for depreciation of depreciable assets used in a business during the year. Unlike the 1979 Ordinance, depreciation is not allowed for the whole year if the asset is used for part of the year. In such cases, deduction for depreciation is now restricted to the number of months for which the asset is used in business. An asset is considered a depreciable asset if it is tangible property ( other than unimproved land ) that has a normal useful life exceeding one year, is likely to lose value as a result of normal wear and tear or obsolescence, and is used wholly or partly to derive income from business chargeable to tax.

A depreciation deduction is not allowed for an asset used to derive exempt income. In the 1979 Ordinance, depreciation was deemed as allowed in case of tax holiday companies. No such provision exists in this Ordinance. Sub-section (5) lays down that for the purposes of determining written down value at the beginning of a tax year of an asset acquired during that year, the cost of the eligible depreciable asset shall be reduced by any initial allowance of the first year admissible in respect of that asset. In other cases, total depreciation deductions ( including initial allowance) allowed in all previous tax years shall be reduced from the cost to arrive at the written down value of the asset used in previous tax years. The term depreciable asset does not include property for which a deduction has been allowed under another section of the Ordinance for the entire cost of the property or structural improvement thereon in the tax year in which the property is acquired or improvement is made. The amount of the annual deduction for depreciation is determined by reference to Part I of the Third Schedule to the Ordinance which specifies rates of depreciation for all depreciable assets mentioned in a table. Principally, the rates are the same as in the 1979 Ordinance. If the asset is used tow-thirds in a business and one-third in an activity that produces tax-exempt income, then instead of an annual depreciation deduction of (say ) Rs. 90,000 the adjusted deduction would be Rs. 60,000 rupees (2/3x90,000). Disposal of an asset is provided under sub-section (8). No deduction is allowed for depreciation in the year of disposal. If the consideration received for the asset is greater than the written-down value of the asset at the time of disposal, the excess is treated as business income chargeable to tax in that year of disposal. If the consideration received for the asset is less than the written-down value of the asset, the difference is allowed as a deduction in computing business income for that year. If an asset was wholly used to produce business income, its written-down value is its cost reduced by the total deductions allowed with respect to the asset. If the asset was used only partly to produce business income, its written-down value is its cost reduced not by the allowable deductions, but by the amount of depreciation that would have been allowed if the asset had been wholly sued to produce business income ( see sub-section (9) read with sub-section (3). A depreciation cost limit applies under sub-section 13 (a) to a passenger transport vehicle not plying for hire to one million rupees. The written down value of such vehicle is determined under sub-section (10). For the purposes of section 76 and 77, cost and consideration received is determined under the rules generally applicable under sections 78 and 79 of the Ordinance. The cost of immovable property or a structural improvement to immovable property ( both of which may be depreciable if used in a business ) does not include the cost of the land on which the property or improvement is built. A structural improvement includes a building, road driveway, car park railway line, pipeline, bridge, tunnel airport runway, canal, dock wharf, retaining wall, fence, power lines, water or sewerage pipes, drainage, landscaping, or dam, Under the 1979 ordinance, assets like bridges, pipelines, railway lines, docks and wharves were considered to be plant.

In order to provide level playing field to certain entities doing leasing business (where tax rates differ generally) sub-section (12) stipulates that depreciation in respect of leased assets shall be adjustable against lease rental income of such assets. Thus depreciation on assets owned by an approved leasing company, an investment bank, a scheduled bank, an approved modaraba and a development finance institution and leased to another person is restricted to the extent of the lease rental income derived in respect of such assets. Initial allowance: Section 23 of the Ordinance, 2001 states : (1) A person who places an eligible depreciable asset into service in Pakistan for the first time in a tax year shall be allowed a deduction (hereinafter referred to as an initial allowance) computed in accordance with sub-section (2), provided the asset is used by the person for the purposes of his business for the first time or the tax year in which commercial production is commenced, whichever is later (2) The amount of the initial allowance of a person shall be computed by applying the rate specified in Part II of the Third Schedule against the cost of the asset. (3) The rules in section 76 shall apply in determining the cost of an eligible depreciable asset for the purposes of this section. (4) A deduction allowed under this section to a leasing company or an investment bank or a modaraba or a scheduled bank or a development finance institution in respect of assets owned by the leasing company or the investment bank or the modaraba or the scheduled bank or the development finance institution and leased to another person shall be deducted only against the leased rental income derived in respect of such assets.] (5) In this section, eligible depreciable asset means a depreciable asset other than (a) (b) (c) any road transport vehicle unless the vehicle is plying for hire; any furniture, including fittings; any plant or machinery that has been used previously in Pakistan; or (d) any plant or machinery in relation to which a deduction has been allowed under another section of this Ordinance for the entire cost of the asset in the tax year in which the asset is acquired.

Section 23 Explained:
This section provides an initial allowance (presently @ 50% of cost) for an eligible depreciable asset placed in service in Pakistan for the first time during a tax year. The asset must be wholly and exclusively used to derive business income chargeable to tax,

so that an asset used partly for business and partly for personal purposes would not qualify for initial allowance even though it may qualify as a depreciable asset for normal deduction under section 22. The allowance is not available for any plant or machinery that has been used previously in Pakistan. Sub-section (5) ( C ) refers). The term eligible depreciable asset is defined in sub-section (5) which, in effect, would mean depreciable asset as defined in section 22 ( 15) other than the items listed in clauses ( a ) to (d) of sub-section (5). For example, a road transport vehicle is not an eligible depreciable asset unless it is plying for hire. The amount of the initial allowances is computed under sub-section (2). A percentage of the assets cost (defined according to the rules of section 76), is deductible in the year the asset is placed in service. The percentage (50%) is stated in Part II of the Third Schedule. The initial allowance reduces the cost for the purposes of determining the amount of depreciation allowed under section 22. Where plant or machinery is leased out as eligible depreciable asset by a certain bank, modaraba or a leasing company, initial allowance will be deductible and adjusted only against lease rental income derived in respect of such assets. Intangibles Section 24 of the Ordinance, 2001 states :

- (1)

A person shall be allowed an amortisation deduction in accordance with this section in a tax year for the cost of the persons intangibles (a) that are wholly or partly used by the person in the tax year in deriving income from business chargeable to tax; and that have a normal useful life exceeding one year.

(b)

(2) No deduction shall be allowed under this section where a deduction has been allowed under another section of this Ordinance for the entire cost of the intangible in the tax year in which the intangible is acquired. (3) Subject to sub-section (7), the amortization deduction of a person for a tax year shall be computed according to the following formula, namely: A/B where A B (4) is the cost of the intangible; and is the normal useful life of the intangible in whole years.

An intangible (a) with a normal useful life of more than ten years; or

(b)

that does not have an ascertainable useful life,

shall be treated as if it had a normal useful life of ten years. (5) Where an intangible is used in a tax year partly in deriving income from business chargeable to tax and partly for another use, the deduction allowed under this section for that year shall be restricted to the fair proportional part of the amount that would be allowed if the intangible were wholly used to derive income from business chargeable to tax. (6) Where an intangible is not used for the whole of the tax year in deriving income from business chargeable to tax, the deduction allowed under this section shall be computed according to the following formula, namely: A x B/C where A is the amount of amortization computed under sub-section (3) or (5), as the case may be; B is the number of days in the tax year the intangible is used in deriving income from business chargeable to tax; and C is the number of days in the tax year.

(7) The total deductions allowed to a person under this section in the current tax year and all previous tax years in respect of an intangible shall not exceed the cost of the intangible. (8) Where, in any tax year, a person disposes of an intangible, no amortization deduction shall be allowed under this section for that year and (a) if the consideration received by the person exceeds the written down value of the intangible at the time of disposal, the excess shall be income of the person chargeable to tax in that year under the head Income from Business; or (b) if the consideration received is less than the written down value of the intangible at the time of disposal, the difference shall be allowed as a deduction in computing the persons income chargeable under the head Income from Business in that year. (9) For the purposes of sub-section (8) (a) the written down value of an intangible at the time of disposal shall be the cost of the intangible reduced by the total deductions allowed to the person under this section in respect of the intangible or, where the intangible is not wholly used to derive

income chargeable to tax, the amount that would be allowed under this section if the intangible were wholly so used; and (b) the consideration received on disposal of an intangible shall be determined in accordance with section 77.

(10) For the purposes of this section, an intangible that is available for use on a day (including a non-working day) is treated as used on that day. (11) In this section, cost in relation to an intangible, means any expenditure incurred in acquiring or creating the intangible, including any expenditure incurred in improving or renewing the intangible; and intangible means any patent, invention, design or model, secret formula or process, copyright trade mark, scientific or technical knowledge, computer software, motion picture film, export quotas, franchise, licence, intellectual property], or other like property or right, contractual rights and any expenditure that provides an advantage or benefit for a period of more than one year (other than expenditure incurred to acquire a depreciable asset or unimproved land).

Section 24 explained:
This section is a new provision in Income-tax law and allows an annual deduction for the amortization of intangibles used in a business. The term intangible is broadly defined in sub-section (11) to mean any patent, invention, design or model, secret formula or process, copyright trade mark, scientific or technical knowledge, computer software, motion picture film, export quotas, franchise, license, intellectual property or other like property or right and contractual rights. The definition also includes any expenditure that provides an advantage or benefit for a period of more than one year ( other than an expenditure incurred to acquire a depreciable asset or unimproved land. A deduction is allowed only for an intangible that is wholly or partly used to derive income from business chargeable to tax (sub-section (1) (a). No deduction is allowed for an intangible that is used solely to derive exempt income. An amortization deduction is allowed for an intangible with a normal useful life exceeding one year ( sub-section (1) (b). The cost of an intangible with a normal useful life of one year or less may be fully deductible as an expenditure incurred in deriving income from business under section 20 (Subject to section 21). If an intangibles normal useful life is more than 10 years, or if it is not ascertainable, then it is treated as if it had a normal useful life of 10 years ( Sub-section (4) refers ).

To calculate the annual amortization deduction, the cost of the intangible is divided by the number of years of its normal useful life or 10 years whichever is less. if an intangible is used partly to derive income from business and partly for some other purpose, then under Sub-section (5) the amount of the amortization deduction is limited to the fair proportional part of the amount that would be allowed if the intangible were wholly used to derive income from business. Similarly, if an intangible is used for part of the year, the deduction is restricted proportionately to the number of days used. ( Sub-section (6). However, total deductions allowed for all the tax years cannot exceed the cost of the intangible (sub-section (7) refers). Disposal of an intangible is treated under sub-section (8). No amortization deduction is allowed for the year of disposal. If the consideration received for the intangible is greater than the written-down value of the intangible at the time of disposal, the excess is treated as business income. If the consideration received for the intangible is less than the written-down value of the intangible, the difference is allowed as a deduction in computing business income. If the intangible was wholly used to produce business income, its written-down value is its cost reduced by the total deductions allowed with respect to the intangible. If the intangible was used only partly to produce business income, its written-down value is its cost reduced by the total deductions that would have been allowed if the intangible had been wholly used to produce business income ( subsection (9) (a) refers). Cost in relation to an intangible would mean any expenditure incurred in acquiring, creating, improving or renewing the intangible ( subsection (11) refers ).

Pre-commencement expenditure:
Section 25 of the Ordinance, 2001 states : (1) A person shall be allowed a deduction for any pre-commencement expenditure in accordance with this section. (2) Pre-commencement expenditure shall be amortized on a straight-line basis at the rate specified in Part III of the Third Schedule. (3) The total deductions allowed under this section in the current tax year and all previous tax years in respect of an amount of pre-commencement expenditure shall not exceed the amount of the expenditure. (4) No deduction shall be allowed under this section where a deduction has been allowed under another section of this Ordinance for the entire amount of the precommencement expenditure in the tax year in which it is incurred. (5) In this section, pre-commencement expenditure means any expenditure incurred before the commencement of a business wholly and exclusively to derive income chargeable to tax, including the cost of feasibility studies, construction of prototypes, and trial production activities, but shall not include any expenditure which is incurred in acquiring land, or which is depreciated or amortized under section 22 or 24.

Section 25 explained:
This section is a new provision of the Ordinance which allows an amortization deduction for pre-commencement expenditures Before a business starts operations. It may incur expenses that are wholly and exclusively for the purpose of deriving income from the business chargeable to tax. These expenditures may be amortized on a straight-line basis in accordance with the rate set out in Part III of the Third Schedule which at present is 20%. Examples of pre-commencement expenditures are the cost of feasibility studies, construction of prototypes, and trial production activities, but not any expenditure to acquire land, or that is depreciated or amortized under section 22 or 24. No deduction is allowed under this section if a deduction has been allowed under another section of the Ordinance for the entire amount of a pre-commencement expenditure in the tax year in which it was incurred ( sub-section (4) refers ). The total deduction allowed under this section in the current and all previous tax years is not to exceed the amount of precommencement expenditure (sub-section (3) refers).

26. Scientific research expenditure.- (1) A person shall be allowed a deduction for scientific research expenditure incurred in Pakistan in a tax year wholly and exclusively for the purpose of deriving income from business chargeable to tax. (2) In this section scientific research means any 13[activity] 14[undertaken in Pakistan] in the fields of natural or applied science for the development of human knowledge;

scientific research expenditure means any expenditure incurred by a person on scientific research 15[undertaken in Pakistan] for the purposes of developing the persons business, including any contribution to a scientific research institution to undertake scientific research for the purposes of the persons business, other than expenditure incurred (a) (b) (c) in the acquisition of any depreciable asset or intangible; in the acquisition of immovable property; or

for the purpose of ascertaining the existence, location, extent or quality of a natural deposit; and

13 14 15

Substituted for the word activities by the Finance Act, 2002 Inserted by the Finance Act, 2003. Inserted by the Finance Act, 2003.

scientific research institution means any institution certified by the Central Board of Revenue as conducting scientific research in Pakistan. 27. Employee training and facilities.- A person shall be allowed a deduction for any expenditure (other than capital expenditure) incurred in a tax year in respect of (a) any educational institution or hospital in Pakistan established for the benefit of the persons employees and their dependents; any institute in Pakistan established for the training of industrial workers recognized, aided, or run by the Federal Government 16[or a Provincial Government] or a local authority; or the training of any person, being a citizen of Pakistan, in connection with a scheme approved by the Central Board of Revenue for the purposes of this section.

(b)

(c)

28. Profit on debt, financial costs and lease payments.- (1) Subject to this Ordinance, a deduction shall be allowed for a tax year for (a) any profit on debt incurred by a person in the tax year to the extent that the proceeds or benefit of the debt have been used by the person 17[for the purposes of business]; any lease rental incurred by a person in the tax year to a scheduled bank, financial institution, an approved modaraba, an approved leasing company or a Special Purpose Vehicle on behalf of the Originator for an asset used by the person 18[for the purposes of business]; any amount incurred by a person in the tax year to a modaraba or a participation term certificate holder for any funds borrowed and used by the person 19[for the purposes of business]; any amount incurred by a scheduled bank in the tax year to a person maintaining a profit or loss sharing account or a deposit with the bank as a distribution of profits by the bank in respect of the account or deposit; any amount incurred by the House Building Finance Corporation (hereinafter referred to as the Corporation) constituted under the House Building Finance Corporation Act, 1952 (XVIII of 1952), in the tax year to the State Bank of Pakistan (hereinafter referred to as the Bank) as the share of the Bank in the profits derived by the Corporation on its investment in property made under a scheme of

(b)

(c)

(d)

(e)

16 17

18

19

Inserted by the Finance Act, 2003. Substituted for the words in deriving income chargeable to tax under the head Income from Business by the Finance Act, 2004. Substituted for the words in deriving income chargeable to tax under the head Income from Business by the Finance Act, 2004. Substituted for the words in deriving income chargeable to tax under the head Income from Business by the Finance Act, 2004.

partnership in profit and loss, where the investment is provided by the Bank under the House Building Finance Corporation (Issue and Redemption of Certificates) Regulations, 1982; (f) any amount incurred by the National Development Leasing Corporation Limited (hereinafter referred to as the Corporation) in the tax year to the State Bank of Pakistan (hereinafter referred to as the Bank) as the share of the Bank in the profits derived by the Corporation on its leasing operations financed out of a credit line provided by the Bank on a profit and loss sharing basis; any amount incurred by the Small Business Finance Corporation (hereinafter referred to as the Corporation) in the tax year to the State Bank of Pakistan (hereinafter referred to as the Bank) as the share of the Bank in the profits derived by the Corporation on investments made in small business out of a credit line provided by the Bank on a profit and loss sharing basis; any amount incurred by a person in the tax year to a banking company under a scheme of musharika representing the banks share in the profits of the musharika; any amount incurred by a person in the tax year to a certificate holder under a musharika scheme approved by the Securities and Exchange Commission and Religious Board formed under the Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980 (XXXI of 1980) representing the certificate holders share in the profits of the musharika; or the financial cost of the securitization of receivables incurred by an Originator in the tax year from a Special Purpose Vehicle being the difference between the amount received by the Originator and the amount of receivables securitized from a Special Purpose Vehicle.

(g)

(h)

(i)

(j)

(2) Notwithstanding any other provision in this Ordinance, where any assets are transferred by an Originator, as a consequence of securitization, to a Special Purpose Vehicle, it shall be treated as a financing transaction irrespective of the method of accounting adopted by the Originator. (3) In this section, approved leasing company means a leasing company approved by the Central Board of Revenue for the purposes of clause (b) of sub-section (1); and approved modaraba means a modaraba approved by the Central Board of Revenue for the purposes of clause (b) of sub-section (1).

29. Bad debts.- (1) A person shall be allowed a deduction for a bad debt in a tax year if the following conditions are satisfied, namely:(a) the amount of the debt was (i) (ii) (b) (c) previously included in the persons income from business chargeable to tax; or in respect of money lent by a financial institution in deriving income from business chargeable to tax; the debt or part of the debt is written off in the accounts of the person in the tax year; and there are reasonable grounds for believing that the debt is irrecoverable.

(2) The amount of the deduction allowed to a person under this section for a tax year shall not exceed the amount of the debt written off in the accounts of the person in the tax year. (3) Where a person has been allowed a deduction in a tax year for a bad debt and in a subsequent tax year the person receives in cash or kind any amount in respect of that debt, the following rules shall apply, namely: (a) Where the amount received exceeds the difference between the whole of such bad debt and the amount previously allowed as a deduction under this section, the excess shall be included in the persons income under the head Income from Business for the tax year in which it was received; or where the amount received is less than the difference between the whole of such bad debt and the amount allowed as a deduction under this section, the shortfall shall be allowed as a bad debt deduction in computing the persons income under the head Income from Business for the tax year in which it was received.

(b)

[29A.Provision regarding consumer loans.- (1) A banking company 21[or nonbanking finance company or the House Building Finance Corporation] shall be allowed a deduction, not exceeding three per cent of the income for the tax year, arising out of consumer loans for creation of a reserve to off-set bad debts arising out of such loans. (2) Where bad debt can not be wholly set off against reserve, any amount of bad debt, exceeding the reserves shall be carried forward for adjustment against the reserve for the following years.]
22

20

[Explanation.- In this section, consumer loan means a loan of money or its equivalent made by a banking company or a non-banking finance company or the
Inserted by the Finance Act, 2003. Inserted by the Finance Act, 2004. Added by the Finance Act, 2004.

20 21 22

House Building Finance Corporation to a debtor (consumer) and the loan is entered primarily for personal, family or household purposes and includes debts created by the use of a lender credit card or similar arrangement as well as insurance premium financing.]

Profit on non-performing debts of a banking company or development finance institution:

Section 30 of the Ordinance, 2001 states : (1) A banking company or development finance institution or Non-Banking Finance Company (NBFC) or modaraba shall be allowed a deduction for any profit accruing on a non-performing debt of the banking company or institution or Non-Banking Finance Company (NBFC) or modaraba where the profit is credited to a suspense account in accordance with the Prudential Regulations for Banks or [Non-Banking Finance Company or modaraba] Non-bank Financial Institutions, as the case may be, issued by the State Bank of Pakistan or the Securities and Exchange Commission of Pakistan. (2) any profit deducted under sub-section (1) that is subsequently recovered by the banking company or development finance institution or Non-Banking Finance Company (NBFC) or modaraba] shall be included in the income of the company or institution or Non-Banking Finance Company (NBFC) or modaraba chargeable under the head Income from Business for the tax year in which it is recovered.

Section 30 explained:
This section makes a more liberal provision to allow a deduction in respect of profit ( interest) credited to suspense account in respect of non-performing debt ( loan) of a banking company, a development finance institution, a Non-banking Finance Company or a modaraba in accordance with the prudential regulations issued by the State Bank or the Securities and Exchange Commission. The allowance is in respect of profit (interest ) on debt ( loan) and not the principal amount. The principal amount, being a bad debt, can be claimed as deduction under section 29 of this Ordinance. However, if any amount allowed as a deduction is subsequently recovered in a tax year the same is to be included in the business income of the said banking company, institution or modaraba for that year.

Comparing To The 1979 OrdinanceMajor Changes Made In The Ordinance.

a) b) No specific deductions are now listed under this Ordinance. A general omnibus clause has been inserted to allow any expenditure incurred by the person in the year to the extent to which the expenditure is incurred in deriving income from business chargeable to tax. Expenditure incurred by an amalgamated company on legal and financial advisory services and other administrative costs relating to planning and implementation of such amalgamation is allowed. The term amalgamation has been defined in section 2 (1A).

c)

d)

Special provisions have been made for the treatment of Depreciation; Initial Allowance; Intangibles; Pre-commencement expenditure; scientific research expenditure; Employee training and facilities; Profit non-performing debts of a banking company or development financial institution and Transfer to participatory reserve.

Under the general omnibus clause inserted in this Ordinance, the expenditure must meet the following two tests to qualify for deduction: a) b) The expenditure must be incurred in the year. The expenditure must be incurred in deriving income from business chargeable to tax.

In the 1979 Ordinance, expenditure was allowable if it was incurred for the purpose of business. This expression was much wider in scope than the expression to the extent to which the expenditure is incurred in deriving income chargeable to tax as now appearing in this Ordinance. The words for the purpose of business had been construed by the courts to be for carrying on of the business. Whether the expenditure resulted in deriving any income was not relevant. Under the new provisions, the onus will be on the taxpayer to prove that the outcome of the expenditure resulted in income chargeable to tax. This section is a simplified version of section 23(1) of the 1979 Ordinance. That section had identified 27 specific deductible items of expenditure including a residual deductibility rule applicable to any other expenditure ( other than expenditure of a capital or person nature ) incurred wholly and exclusively for business purposes.

HEAD OF INCOME: INCOME FROM CAPITAL GAINS

The Income Tax Ordinance, 2001 defines Income from Capital Gains under section 37 as : Capital gains.- (1) Subject to this Ordinance, a gain arising on the disposal of a capital asset by a person in a tax year, other than a gain that is exempt from tax under this Ordinance, shall be chargeable to tax in that year under the head Capital Gains. (2) Subject to sub-sections (3) and (4), the gain arising on the disposal of a capital asset by a person shall be computed in accordance with the following formula, namely: AB where A is the consideration received by the person on disposal of the asset; and B is the cost of the asset.

(3) Where a capital asset has been held by a person for more than one year, the amount of any gain arising on disposal of the asset shall be computed in accordance with the following formula, namely: Ax where A is the amount of the gain determined under sub-section (2). (4) For the purposes of determining component B of the formula in sub-section (2), no amount shall be included in the cost of a capital asset for any expenditure incurred by a person (a) (b) that is or may be deducted under another provision of this Chapter; or that is referred to in section 21.

(4A) Where the capital asset becomes the property of the person (a) (b) (c) under a gift, bequest or will; by succession, inheritance or devolution; a distribution of assets on dissolution of an association of persons; or

(d)

on distribution of assets on liquidation of a company, the fair market value of the asset, on the date of its transfer or acquisition by the person shall be treated to be the cost of the asset.

(5) In this section, capital asset means property of any kind held by a person, whether or not connected with a business, but does not include (a) any stock-in-trade (not being stocks and shares), consumable stores or raw materials held for the purpose of business;] any property with respect to which the person is entitled to a depreciation deduction under section 22 or amortisation deduction under section 24; any immovable property; or any movable property excluding capital assets specified in sub-section (5) of section 38 held for personal use by the person or any member of the persons family dependent on the person

(b)

(c) (d)

Section 37 explained:
This section provides for the charge to tax of amounts under the head Capital Gains. Sub-section (1) charges to tax a gain arising on the disposal of a capital asset by a person in a tax year, It does not apply to any capital gain that is exempt from tax under the Ordinance. The main exemptions applicable to capital gains are set out in clauses (110) (111) and 113) and 114 of the Second Schedule to this Ordinance. For an amount to be charges to tax under this head for a tax year, the following conditions must be satisfied. 1) There must be a capital asset. This is defined in sub-section (5) to mean property of any kind. Whether or not connected with a business, except- (a) stock-in-trade, consumable stores or raw materials held for the purpose of business (b) depreciable assets and intangibles admissible for deductions c any immovable property or (d) movable property in the personal use of a taxpayer or any dependent member of his family. However, such property in personal use will not include assets specified in section 38 (5) .In other words, a painting sculpture, drawing, other work of art, a rare manuscript, folio or book, a postage stamp of first day cover, a coin or medallion and an antique will be treated as capital asset for the purpose of computation of capital gain on disposal.

Note: Immovable property had to be excluded from the definition because taxes on capital gains on immovable property fall outside the purview of the Federal Legislative List (Entry No.50) of the Constitution.

2)

The capital asset must be disposed of in the tax year. This means that capital gains are not taxed until they are realized. Disposal is defined in Section 75 to cover the time when the asset is sold, exchanged, transferred or distributed. The concept of disposal is the equivalent of transfer used in Section 27 of the 1979 Ordinance. The definition of disposal in section 75is an expanded version of the definition given in section 27 (2) b i-iv of the 1979 Ordinance. However, some additional conditions have been added. In the case of a compulsory acquisition, the nonrecognition rule applies only where the proceeds are used to acquire a replacement asset of a like kind (section 79 (d). In the case of distribution of assets on liquidation of a company or dissolution of an association of persons, the non-recognition rule applies only where the distribution is in accordance with the interests of shareholders or members in the assets of the company or association, as the case may be ( section 79 (1) (e) and (f). This is to limit the opportunities for value shifting. The disposal of the capital asset must give rise to a capital gain. The treatment of capital losses is in section 59 which makes provision for carry forward of capital losses for a period of six years to be set off against Capital Gains and no other head of income.

Sub-section ( 2 )provides for the computation of the amount of the capital gain. The formula is quite simple: gain is the difference between the assets cost and the consideration the taxpayer receives on its disposal. However where the capital asset has been held for more than one year, only three fourth (75%) of the gain is chargeable to tax as per formula given in sub-section (3). To determine cost of the asset, the general rules of section 76 will apply. However, sub-section (4) provides expressly that all other deductible amounts of expenditure or inadmissible expenditures listed in section 21 are not to be included in cost of the capital asset. In other words, any expenditure incurred by the taxpayer during the period he has held the asset will not be added to the cost of the asset. This prohibition is intended to prevent the non-deductible costs listed in section from becoming implicit deductions by increasing cost and thereby reducing gain on disposal of the capital asset. Sub-Section (4A) further clarifies that cost of a capital asset acquired under a gift, bequest or will, by succession, inheritance or devolution or on dissolution of firm etc. or liquidation of company shall be determined on the basis of fair market value of the asset on the date of its transfer or acquisition by the person becoming the owner of the said capital asset or property. This clarification is based on the provision made in section 29 (1) of the 1979 Ordinance The consideration received on disposal of an asset is determined under section 77 which states that the total amount of money ( or consideration in kind) received at the time of disposal or the fair market value of the asset at the time ( whichever is higher ) shall be treated as the consideration received by the person. A fair market value rule applies to determine consideration in the case of non-arms length disposal of assets (section 78 refers).

Deduction of losses in computing the amount chargeable under the head Capital Gains :
Section 38 of the Ordinance, 2001 states : (1) Subject to this Ordinance, in computing the amount of a person chargeable to tax under the head Capital Gains for a tax year, a deduction shall be allowed for any loss on the disposal of a capital asset by the person in the year. (2) No loss shall be deducted under this section on the disposal of a capital asset where a gain on the disposal of such asset would not be chargeable to tax. (3) The loss arising on the disposal of a capital asset by a person shall be computed in accordance with the following formula, namely: AB where A B is the cost of the asset; and is the consideration received by the person on disposal of the asset.

(4) The provisions of sub-section (4) of section 37 shall apply in determining component A of the formula in sub-section (3). (5) No loss shall be recognized under this Ordinance on the disposal of the following capital assets, namely: (a) (b) (c) (d) (e) (f) A painting, sculpture, drawing or other work of art; jewellery; a rare manuscript, folio or book; a postage stamp or first day cover; a coin or medallion; or an antique.

Section 38 explained:
This section recognizes the fact that sometimes capital assets are disposed of at a loss. It therefore allows a deduction for the capital loss in computing the amount chargeable to tax under the head Capital Gains. The effect of this deduction is to offset gains on the disposal of capital assets with losses from the disposal of other capital assets, but not against any income chargeable to tax under other heads of income ( section 59 refers ). For example a capital loss not fully offset against capital gains in a year may

not be used to offset business income. However, unused capital losses may be carried forward to the next tax year and used to offset against capital gains in that year, and if not fully used, may be carried forward to the following year, and so on No loss can be carried forward for more than six tax years immediately succeeding the tax year for which the loss was first computed ( section 59(2) refers ). Sub-section (2) provides that no capital loss is recognized on the disposal of an asset where a gain on disposal of such asset would not be chargeable to tax. Consequently, if a taxpayer had made a capital gain rather than a loss on disposal of an asset and that gain was exempt from tax, then there is no recognition for any deduction of such loss on disposal of the asset. Computation of the amount of capital loss on disposal of an asset is made in accordance with the formula in sub-section (3). To determine the amount of the loss, the consideration received for the asset is subtracted from its cost. It is noteworthy that the section 37 formula for computing capital gain differs from the section 38 formula for computing loss. The formulae are designed so that the result of the calculation is not a negative number. Thus capital gains must be determined using the section 37 formula and losses determined using the section 38 formula. In the typical case, it would be apparent which sections formula applies because the cost of the asset is either higher or lower than the consideration received on disposal. If the consideration is higher, then a gain has occurred and section 37 applies. If the consideration is lower, then a loss has occurred and section 38 applies Cost and consideration received are determined under the general principles in sections 76-78. Sub-section (4) provides that section 37(4) applies in determining the cost of an asset for the purposes of deducting loss on the disposal of a capital asset. It means that any expenditure incurred by the person which is either non-deductible under section 21 or can be deducted under some other provision will not be included in the cost of the capital asset. Under sub-section (5) capital loss is not recognized on the disposal of some of the specified assets. Thus there is no deduction for the loss arising from the disposal of works of art, books or rare manuscripts, special postage stamps, coins, medallions, antiques etc.

HEAD OF INCOME: INCOME FROM OTHER SOURCES

The Income Tax Ordinance, 2001 defines Income from Other Sources under section 39 as: Income from other sources.- (1) Income of every kind received by a person in a tax year, if it is not included in any other head, other than income exempt from tax under this Ordinance, shall be chargeable to tax in that year under the head Income from Other Sources, including the following namely: (a) (b) (c) (d) (e) (f) Dividend; royalty; profit on debt; ground rent; rent from the sub-lease of land or a building; income from the lease of any building together with plant or machinery;

(fa) income from provision of amenities, utilities or any other service connected with renting of building;] (g) (h) any annuity or pension; any prize bond, or winnings from a raffle, lottery, prize on winning a quiz, prize offered by companies for promotion of sale or cross-word puzzle; any other amount received as consideration for the provision, use or exploitation of property, including from the grant of a right to explore for, or exploit, natural resources; the fair market value of any benefit, whether convertible to money or not, received in connection with the provision, use or exploitation of property; and

(i)

(j)

(k) any amount received by a person as consideration for vacating the possession of a building or part thereof, reduced by any amount paid by the person to acquire possession of such building or part thereof.

(l)

any amount received by a person from Approved Income Payment Plan or Approved Annuity Plan under Voluntary Pension System Rules, 2005;

(2) Where a person receives an amount referred to in clause (k) of sub-section (1), the amount shall be chargeable to tax under the head Income from Other Sources in the tax year in which it was received and the following nine tax years in equal proportion. (3) Subject to sub-section (4), any amount received as a loan, advance, deposit for issuance of shares or gift by a person in a tax year from another person (not being a banking company or financial institution) otherwise than by a crossed cheque drawn on a bank or through a banking channel from a person holding a National Tax Number Card shall be treated as income chargeable to tax under the head Income from Other Sources for the tax year in which it was received. (4) Sub-section (3) shall not apply to an advance payment for the sale of goods or supply of services. (4A) Where -

(a) any profit on debt derived from investment in National Savings Deposit Certificates including Defence Savings Certificate paid to a person in arrears or the amount received includes profit chargeable to tax in the tax year or years preceding the tax year in which it is received; and (b) as a result the person is chargeable at higher rate of tax than would have been applicable if the profit had been paid to the person in the tax year to which it relates, The person may, by notice in writing to the Commissioner, elect for the profit to be taxed at the rate of tax that would have been applicable if the profit had been paid to the person in the tax year to which it relates.] (4B) An election under sub-section (4A) shall be made by the due date for furnishing the persons return of income for the tax year in which the amount was received or by such later date as the Commissioner may allow by an order in writing. (5) This section shall not apply to any income received by a person in a tax year that is chargeable to tax under any other head of income or subject to tax under section 5, 6 or 7.

Section 39 explained:
This section provides for the charge to tax of income under the head Income from other sources which is a residuary head of income. Sub-section (1) states the general principle that income of every kind received by a person, if it is not included in any other head of income in a tax year, is chargeable to tax in that year under the head Income from other Sources. In addition to all kinds of unspecified income, this subsection specifically includes the following types of income (unless any of these types, in certain circumstances, falls under any other head of income:a) Dividend (b) royalty (c) profit on debt (d) ground rent (e) rent from sub-lease of land or building (f) lese income of building together with plant or machinery (g) income from provision of amenities utilities and any other service connected with the renting of building (h) annuity of pension (i) prizes on bonds, quiz-winning companies salespromotion and winnings from raffle, lottery or cross word puzzle (i) consideration for the provision, use or exploitation of property including the grant of a right to explore or exploit natural resources (k) fair market value of benefit received in connection with provision, use or exploitation of property and (i) amount received for vacating the possession of a building or its part, reduced by any amount paid by the person to acquire such possession.

The Superior Courts have also included the following types of receipts under the residuary head Income from other Sources. i) income of an office not amounting to employment. ii) Income, representing NAZRANA received by a Gaddi Nashin of a dargah. iii) Income representing tips received by waiters, taxi drivers etc. iv) Examination fee received by teachers or professors. v) Payments received by non-profession writers for literary works. vi) Income received for allowing use of goodwill. vii) Income from under-writing of shares ( not being the business of under-writer ). viii) Income from providing security to a loan etc. However, sub-section (1) does not apply to any income that is exempt from tax under the Ordinance. It also does not apply to income that is chargeable to tax on a scheduler basis (section 5,6 or 7) or under one of the other heads of income (salary, income from property, income from business, capital gains) (see sub-section (5)). However, any amount received as consideration for vacating the possession of a building or part thereof, reduced by any amount paid by such person, is to be treated as income from other sources. Further treatment of this type of income is given in sub-section (2). An amount is chargeable to tax under this residuary head when it is received. Section 69 applies in determining when an amount is received for the purposes of this section. In other words, if the amount is actually received by the person or applied at his instructions or made available to him, the same will be treated to have been received by the person.

Some important distinctions as to when certain types of income fall under the head income from other sources. As listed in sub-section (1), are noted below: 1) Cluase (a) charges dividend to tax under this head. As all dividends paid by resident and non-resident companies are subject to scheduled taxation under section 5 ( treated as final tax u/s 8), this inclusion applies only to other dividends according to the term dividend defined in section 2 ( 19). Clause (b) charges royalty to tax under this head. Royalty is defined in section 2(54). It will not apply to royalty paid to a non-resident that is chargeable to tax under section 6 and is treated as final tax u/s 8. Clause charges profit on debt to tax under this head, profit on a debt is defined in section 2 (46) .It will not apply to profit on debt received by a person whose business is to derive such income. Such profit is chargeable to tax under the head income form business as clearly stated in section 18 (2). Clause (d) charges ground rent to tax. This reproduces section 30(2) of the 1979 Ordinance and ground rent is intended to have the same meaning as may be assigned in the facts and circumstances of each case. Clause (e) charges rent from the sub-lease of land or a building to tax under this head. The term rent has the meaning in section 2 (49) Rent payable under proper lease (i.e. the lease by the owner) is chargeable to tax under the head income from property in which case definition of rent given in section 15 (2) is to be considered. Clause (f) charges to tax income from the lease of any building together with plant or machinery. Such income is taxed under this head and not the head Income from Property as clearly stated in section in section 15 (3) Clause (g) charges to tax any annuity or pension which is not exempt from taxation. Annuity and pension ( not failing under the head Salary ) are intend to have their ordinary meaning for the purposes of this section. Most of the exemptions are listed in the Second Schedule to this Ordinance. Clause (h) charges to tax any prize on prize bonds, or winnings from a raffle, lottery, prize on winnng a quiz, prize offered by companies for sales-promotion and crossword puzzle. These are subjected to final withholding tax at the

2)

3)

4)

5)

6)

7)

8)

rate of 20% at the time the prizes or winnings are actually paid (see section 156). 9) Clause (i) charges to tax any amount received as consideration for the provision, use or exploitation of property. It is expressly provided that this includes any amount received as consideration for the grant of a right to explore for, or exploit, natural resources. Clause (i) charges to tax the fair market value of benefits received in connection with the provision, use or exploitation of property. The fair market value of a benefit is determined under section 68 which provides that such value shall be the price which the benefit would ordinarily fetch on supply in the open market at the particular time. Clause (k) charges to tax any amount received as consideration for vacating the possession of a building ( or part of a building). The amount is to be reduced by any amount the receipient had paid to acquire possession ( such as a pr4emium while the net amount is chargeable to tax under the head income from other sources sub-section (2) provides that only 10% of the amount is chargeable to tax in the tax year received. The remaining 90% is treated as income in equal amounts over the next nine years. The effect of this rule is to spread the income rateably over a 10-year period. For example, a person is paid Rs. 1,000,000 to give up the right to possession of an office building for the remainder of the lease term. In the year the payment is received and in each of the nine years that follow, income of Rs. 100,000 is to be taken as consideration chargeable to tax.

10)

11)

When a person receives a loan, advance, deposit for issuance of shares or gift from a person other than a banking company or financing institution in a tax year, and the amount is not received by a crossed cheque drawn on a bank or through a banking channel from a person holding a National Tax Number Certificate, then the loan, advance, deposit for issuance of shares or gift is treated as Income from other sources under sub-section (3). An exception is provided in sub-section (4) for advances received by way of a pre-payment for sale of goods or supply of services. Thus, even though the proceeds of a loan typically are not chargeable to tax, one made other than through documented financial channels is taxable as income from other sources. Sub-Section (4A) added to this section provides relief to a person who might be subject to higher rates of tax on receipt of arrears of profit on debt ( interest etc.) derived from Investment in National Savings Deposit Certificates, including Defense Savings Certificates. It states that such person may give a written notice to the Commissioner and elect to be taxed on receipt of arrears of profit on debt at the favourable tax rates that would have been applicable if the profit had been paid in the tax year to which it related. The written notice is required to be given by the due date fixed for furnishing

return of income for the tax year in which amount of arrears is received. The commissioner can also allow further time for such notice election or option by the tax payer under sub section 4 B The section does not cover any income from royalty, fee for technical services or shipping and air transport income of non-residents, which is subject matter of sections 5,6 and 7 of the Ordinance. This section is a modified version of sectio30 of the 1979 Ordinance there has been some expansion in the specific inclusions. Fee for technical services has not been included as it is regarded as business income and chargeable to tax under the head income from business ( Also see section 6 (4)

Income To Which Section 111 Applies

Certain incomes (section 111(1) are to be charged to tax under section 39. For such unexplained income, the most appropriate head of income is section 39. Section 111 deals with incomes from undisclosed sources and if such is undisclosed sources are not identifiable or can not be explained then such sources will be taxed under this head. Undisclosed incomes/investments (section 111(1). The provisions regarding taxability of unexplained cash credits, investments unrecorded assets or expenditure are provided in section 111 of the Ordinance. In order to avoid any legal controversies such deemed incomes for taxation purposes have to be charged under the head Income from Other Sources (section 111(1). The following are treated as income from undisclosed sources: 1. Cash credits. ( section 111(1).(a) Where any amount is credited in the books of a person and the taxpayer offers no explanation about the nature and sources thereof, or the explanation offered by him is not satisfactory. Such Cash credits shall be included in the income of the person in the year of discovery. 2. Un-explained investment, money or valuable article ( section 111(1).(b)Where a person has made any investment or is owner of any money or valuable article and he offers no explanation about it, or his explanation is not satisfactory, such un-explained investment, money or valuable article, shall be included in the income of the person in the year of discovery. 3. Unexplained expenditure . ( section 111(1).(c). Where a person has incurred any expenditure and he offers no explanation about it, or his explanation is not satisfactory, such un-explained expenditure, shall be included in the income of the person in the year of discovery.

4. Understatement of amount of investment, value of article or expenditure. ( Section 111(2)..Where the declare value of any investment, valuable article or expenditure of a person is less than the cost of the investment or valuable articles, or the amount of the expenditure, the Commissioner may, having regard to all the circumstances, include the difference in the persons income chargeable to tax under the head Income from Other Sources in the tax year in which the difference is discovered. Addition in the year of discovery (Section 111(2) This is perhaps the most disastrous provision in the Ordinance. This is an obnoxious provision violating all principles of time limitation and theory of past and closed transaction. This will give a free hand to taxation officer to black mail taxpayers claiming that they have discovered something that relates to a period say, 30 years back and the said amount/investment/valuable articles/expenditure is now taxable in the year of discovery. Section 111 is not applicable on foreign exchange remittance ( section 111(4).. Section 111 does not apply to any amount of foreign exchange remitted from outside Pakistan through normal banking channels that is encashed into rupees by a scheduled bank, and the taxpayer produces a certificate from the said bank. Rules for determination of property, assets etc ( section 111(5).. The CBR, empowered to make rules for the purpose of this section , prescribed rule 228 for valuation of immovable property, motor vehicles etc, under the Income Tax Rules, 2002. Valuation of assets : The valuation of immovable properties for the purposes of section 111 of the Income Tax Ordinance, 2001 shall be taken to be : a. in the case of open plot, the value determined by the development authority or government agency on the basis of the auction price in respect of similar plots in the area where the plot in question is situated; b. in the case of properties given on rent, the value of equal to ten years capitalized value assessed on the annual rental value; c. in the case of agricultural land, the value equal to the average sale price of the sales recorded in the revenue record of the estate in which the land is situated for the relevant period/time ; or d. in any other case, the value of determined by the District Revenue Officer or provincial authority authorized in this behalf for the purposes of stamp duty.

For the purposes of section 111 and subject to sub-rule (2), the value of motor cars and jeeps, shall be determined in the following manner, namely : a. the value of the new imported car or jeep shall be the C.I.F, value of such car or the jeep, as the case may be, plus the amount of all the charges, customs-duty, sales tax, levies octroi, fees and other duties and taxes leviable thereon and the costs incurred till its registration. b. the value of a new car of jeep purchased from the manufacturer or assembler or dealer in Pakistan, shall be the price paid by the purchaser, including the amount of all charges, customs-duty, sales tax and other taxes, levies fees and other duties and taxes leviable thereon and the costs incurred till its registration. c. the value of used car or jeep imported into Pakistan shall be the import price adopted by the customs authorities for the purposes of levy of customs-duty plus freight, insurance and all other charges, sales tax, and other taxes, levies fees and other duties and taxes leviable thereon and the costs incurred till its registration. d. The value of a car or jeep specified in clause (a), (b) and (c) at the time of its acquisition shall be the value computed in the manner specified in the clause (a), (b) or (c) as the case may be, as reduced by a sum equal to ten percent of the said clause for each successive year, up to a maximum of five years, or e. The value of a used car or jeep purchased by an assessee locally shall be taken to be the original cost of the car or the jeep determined in the manner specified in clause (a), (b) or (c), as the case may be, as reduced by a sum equal to ten percent of the said clause for every year, in which it was imported or purchased from the manufacture. In no case shall the value be determined at an amount less than fifty percent of the value determined in accordance with clause (a), (b), (c) or the purchase price whichever is more. For the purposes of section 61, the value of any property donated to a non-profit organization shall be determined in the following manner namely :a. the value of articles or goods imported into Pakistan shall be the value determined for the purposes of levy of customs duty and the amount of such duty and sales tax, levies, fees, octroi and other duties, taxes or charges leviable theron and paid by the donor. b. the value of articles and goods manufactured in Pakistan shall be the price as recorded in the purchase voucher and the taxes, levies and charges leviable thereon and paid by the donor. c. the value of articles and goods which have been previously used in Pakistan and in respect of which depreciation has been allowed, the

written down value, on the relevant date as determined by the Commissioner; d. the value of a motor vehicle shall be the value as determined in accordance with rule, and e. the value of articles or goods other than those specified above, shall be the fair market value as determined by the Commissioner.

Deductions from Income from Other Sources.

Section 40 of the Ordinance, 2001 states that the income chargeable to tax under the head Income from Other Sources is computed after making the following deductions ; General principle of deduction Any expenditure paid by the person in the year to the extent to which the expenditure is paid in deriving income chargeable to tax under this head, other than expenditure of a capital nature. Profit on debt ..A person receiving any profit on debt chargeable to tax under the head Income from Other Sources shall be allowed a deduction for any Zakat paid by the person on the profit under the Zakat and Ushr Ordiance, 1980, at the time the profit is paid to the person.

Income from lease, sub-lease of land or building together with machinery etc.
A person receiving rent from the sub-lease of land or building or income from the lese of any building together with plant or machinery shall be allowed :a. a deduction for the depreciation of any plant, machinery, or building used to derive that income in accordance with section 22; and b. an initial allowance for any plant or machinery used to derive that income in accordance with section 23. Points to remember. The following points may be remembered in respect of deduction against this head of income : No deduction shall be allowed to the extent that the expenditure is deductible in computing the income of the person under another head of income. The provision of section 21 shall apply in determining the deductions allowed to a person under this section in the same manner as they apply in determining the deductions allowed in computing the income of the person chargeable to tax under the head Income from Business

Expenditure is of a capital nature if it has a normal useful life of more than one year.

Expenditure allocable to exempt income ( section 67 )

Any expenditure that is allocable to any income exempt form tax under this Ordinance is not allowable under section 40.

Expenditure not admissible ( section 40(5).

The expenditure, which are specifically disallowed under section 21, are also inadmissible under section 40. Such expenses would not be allowed while computing income under the head Income from Other Sources . Deductions in computing income chargeable under the head Income from Other Sources : Section 40 of the Ordinance, 2001 states : (1) Subject to this Ordinance, in computing the income of a person chargeable to tax under the head Income from Other Sources for a tax year, a deduction shall be allowed for any expenditure paid by the person in the year to the extent to which the expenditure is paid in deriving income chargeable to tax under that head, other than expenditure of a capital nature.. (2) A person receiving any profit on debt chargeable to tax under the head Income from Other Sources shall be allowed a deduction for any Zakat paid by the person under the Zakat and Ushr Ordinance, 1980 (XVIII of 1980), at the time the profit is paid to the person. (3) A person receiving income referred to in clause (f) of sub-section (1) of section 39 chargeable to tax under the head Income from Other Sources shall be allowed (a) a deduction for the depreciation of any plant, machinery or building used to derive that income in accordance with section 22; and (b) an initial allowance for any plant or machinery used to derive that income in accordance with section 23. (4) No deduction shall be allowed to a person under this section to the extent that the expenditure is deductible in computing the income of the person under another head of income. (5) The provisions of section 21 shall apply in determining the deductions allowed to a person under this section in the same manner as they apply in determining the deductions allowed in computing the income of the person chargeable to tax under the head "Income from Business".

(6) year.

Expenditure is of a capital nature if it has a normal useful life of more than one

Section 40 explained.
This section mentions the deductions that are allowed in computing income chargeable under the head Income from Other Sources . Sub-section (1) states the general principle that a deduction is allowed for any expenditure (not being of a capital nature) paid by the person to the extent that the expenditure is paid to derive income chargeable to tax under this head. The words to the extent contemplate apportionment of expenditure paid partly to derive income chargeable to tax under this head and partly for some other purpose (such as to earn income chargeable to tax under another head or exempt income or for personal purpose). Zakat paid by the person under the Zakat and Ushr Ordinance, 1980, at the time of receiving profit on debt, is also deductible under sub-section (2). The following limitations apply to the deductibility of expenditure under this head of income: 1. under sub-section (1) , no deduction is allowed for capital expenditure. An expenditure is of a capital nature if it has a normal useful life of more than one year ( sub-section (6). Consequently, there is no right deduction, or deprecation, or amortisation of such expenditure. An exception to this limitation applies under sub-section (3). A taxpayer is allowed a depreciation deduction for the cost of any plant, machinery, or building which is used for the purpose of deriving income from the lease of the building together with plant or machinery chargeable to tax under sub-section (1) (f) of section 39. the depreciation deduction is computed in accordance with section 22. A taxpayer is also allowed an initial allowance in respect of the cost of any plant or machinery used to derive such income. This means that the initial allowance is computed in accordance with section 23. The limitations in section 23 on the types of plant or machinery that qualify for the initial allowance will also apply for the purpose of sub-section (3). 2. under sub-section (4), no deduction is allowed to the extent the expenditure is deductible in computing income chargeable under another head of income. In other words, if an amount is deductible as a business expenses in determining the amount taxable as business income, it will not be deducted from income treated as income from other sources. Further, if an amount can be deducted under one of the other heads of income, it should be deducted there rather than in computing income from other sources. 3. under sub-section (5) the same prohibition on deductions will apply to income under this head as those listed in section 21 ( deductions not allowed ), applicable in determining the amount chargeable to tax as income from business.

4. under sub-section (6), capital expenditure is taken to mean an expenditure which has normal useful life of more than one year and can not be allowed as deduction under this section.

Clubbing of income .
As a general rule, a taxpayer is taxed in respect of his own income. In some situations, however, the Income Tax Ordinance deviates from this principle and the taxpayer may be taxed, under section 85, 90, 91, 108 and 112 in respect of income that legally belong to some other persons. The basic aim of these provisions is to deal with cases where taxpayers make an effort to reduce their tax burden by transferring their assets or income/s in favour of their family members or by arranging their sources of income in such a manner so as to shift the tax incidence on others, whereas benefit of income, directly or indirectly, is derived by him. Transfer of income without transfer of asset will be taxed in the hands of transferor ( section 90(3) Under section 90(3), income arising to any person by virtue of any transfer when the said asset remains the property of the transferor will be chargeable to tax as the income of the transferor and will be included in his total income. It wil not make any difference whether transfer is revocable or irrevocable. There is no exception to this rule. For this purpose transfer includes any disposition, settlement, trust, covenant, agreement or arrangement ( section 90 (8) (c).

The following points must be remembered while invoking section 90 (3) : This section applies to transfer of income during the relevant tax year and irrespective of the fact whether the transfer was effected before or after the commencement of this Ordinance. This section become operative where any person purports to transfer income arising to him in such a way that , under the instrument of transfer, the income no longer arises to him or is received by him, but the incomeyielding asset remains his property. Though under the arrangement of transfer made by the assessee, the income in law arises to another person, it will be treated as continuing to arise to the transferor himself. However, it must be kept in mind that this section applies only in a case where a transfer of income takes place but the asset remains the property of the transferor. Where there is only a transfer of income, the assessability of the transferor will continue even if the transfer is irrevocable, provided the transferor remains the owner of income-yielding asset/s

Income from revocable transfer of assets

Income from revocable transfer of assets is regarded that of transferor ( Section 90 (1) & 90 (2). All incomes arising to any person by virtue of transfer of assets shall be chargeable to tax as the income of the transferor if: The transfer is revocable ( section 90(1). a. If it contains any provision for the transfer directly or indirectly to the transferor ( section 91 (8) (a) (i). b. It gives, in any way the transferor a right to resume power, directly or indirectly over the whole or any part of the assess ( section 91 (8) (a) (ii). However, even if the transfer is revocable, by virtue of section 91(1) income from the assets of transferee shall not be included in the total income of transferor ( section 91 (2) ) when: a. The transfer is not revocable during the life time of transferee; and b. The transferor derives no direct or indirect benefit from such income. Income from assets transferred to spouse ( section 90(4) (a) & 90 (5) Where any asset is transferred by a taxpayer directly or indirectly to his or her spouse otherwise than for adequate consideration or in connection with an agreement to live apart, any income from such asset should be deemed to be the income of the transferor . Minor child for the purpose of this section does not include a married daughter. For instance Mrs. X transfers 2,000 shares of PTCL to her husband without adequate consideration, dividend income on these shares will be included in the income of Mrs. X.

Other points for consideration: -

Natural love and affection may be good consideration, but that would not be adequate consideration. (1961 (42) ITR (SC). Moreover, relationship of husbad and wife should subsist at the time of transfer of asset and at the time when income accrued. It means that transfer of asset before marriage is outside the scope of this section. Similarly, if transferee, can not be included in the income of deceased transferors heir, as a widow or widower is not a spouse. 1975 (100) ITR 564 ( Guj)

On the basis on various judicial pronouncement, section 90 (4) (a) is not applicable in the following cases : If assets are transferred before marriage. If assets are transferred for adequate consideration. Natural love and affection may be good consideration, but that would not be adequate consideration. By virtue of section 90(6) a transfer shall not be treated as made for adequate consideration if the transferor has provided by way of loan or otherwise to the transferee, directly or indirectly, with the funds for the acquisition of the asset. If assets are transferred with an agreement to live apart. On the date of accrual of income, transferee is not spouse of the transferor. If property is acquired by wife out of sustenance allowance ( for food, clothing and usual household expenses ).

In the aforesaid five cases, income from the transferred asset can not be clubbed in the hands of the transferor. Legal Implication of transferring property by a husband to his wife in lieu of Haq Mehar Haq Mehar ( dower ) is a legal obligation for the husband in a Muslim marriage. Husband often transfer properties to their wives in lieu of Haq Mehar . What are legal implication of such transfer in the light of section 90(4) (a) ? . The CBR in its circular No. 6 1957 dated March 13, 1957 explains the application of section 90(4) (a) in such a case as under : a. For determination of quantum of Haq Mehar the best evidence is the Nikahnama. b. The property transferred in lieu of Haq Mehar should be for adequate consideration, i.e consideration is equal or nearly equal to the value of property. c. If value of property exceeds the quantum of Haq Mehar the income proportionate to the amount exceeding should be added in the total income of the husband. d. A gift of property, whether it is oral or in wirting, by a husband in favour of his wife in lieu of dower is, in the opinion of the majority of the High Courts in the Indo-Pakistan Sub-continent, in the nature of a sale and such a sale deed will require registration if the value of property is Rs. 100 or above under section 17 of the Registration Act.

Income from assets transferred to minor child ( section 90(4) (a).

When an assessee transfers any asset without adequate consideration directly or indirectly, to his /her minor child ( not being a minor married daughter) , any income arising from the assets transferred are to be included in the total income of the transferor. However, income arising from the transferred assets will not be taxable in the hands of the transferor after the minor child attains majority.

Taxability of Business income of a minor child.

Business income of a minor child is taxable in the hands of either of parents ( section 91 ). This section provides that any income chargeable under the head Income from Business ( section 18) belonging to a minor shall be income of the parent of the child with the highest taxable income for that year, except where such income is derived from a business acquired by the minor child through inheritance.

Transactions between associates ( section 108 read with section 85 )

The Commissioner is empowered to distribute, apportion or allocate income, deductions or tax credits in respect of non-arms length transactions between the persons, who are associates within the scope of section 85. The purpose is to arrive at the correct time would have resulted if associates made their transactions on arms length basis. This section covers all kind of transaction that are arranged to avoid proper taxation between associates. While resorting to these actions, the Commissioner may also determine the source of income and the nature of payment or loss as revenue, capital or otherwise. The key word associate is defined /explained in section 85, which reads as under :

Associates
Section 85 of the Ordinance, 2001 defines associates as : (1) Subject to sub-section (2), two persons shall be associates where the relationship between the two is such that one may reasonably be expected to act in accordance with the intention of other, or both persons may reasonably be expected to act in accordance with the intentions of a third person. (2) Two persons shall not be associates solely by reason of the fact that one person is an employee of the other or both persons are employees of a third person. (3) Without limiting the generality of sub-section (1) and subject to sub-section

(4), the following shall be treated as associates (a) (b) (c) an individual and a relative of the individual; members of an association of persons; a member of an association of persons and the association, where the member, either alone or together with an associate or associates under another application of this section, controls fifty per cent or more of the rights to income or capital of the association; a trust and any person who benefits or may benefit under the trust; a shareholder in a company and the company, where the shareholder, either alone or together with an associate or

(d) (e)

associates under another application of this section, controls either directly or through one or more interposed persons (i) fifty per cent or more of the voting power in the company; (ii) fifty per cent or more of the rights to dividends; or (iii) fifty per cent or more of the rights to capital; and (f) two companies, where a person, either alone or together with an associate or associates under another application of this section, controls either directly or through one or more interposed persons

(i) fifty per cent or more of the voting power in both companies; (ii) fifty per cent or more of the rights to dividends in both companies; or (iii) fifty per cent or more of the rights to capital in both companies. (4) Two persons shall not be associates under clause (a) or (b) of sub-section (3) where the Commissioner is satisfied that neither person may reasonably be expected to act in accordance with the intentions of the other. (5) In this section, relative in relation to an individual, means (a) an ancestor, a descendant of any of the grandparents, or an adopted child, of the individual, or of a spouse of the individual; or

(b) a spouse of the individual or of any person specified in clause (a). The provision relating to associates in section 85 are elaborate and detailed. It gives wide powers to treat persons as associates or otherwise in a given set of circumstances. The main idea behind this provision of law is to safeguard the interest of revenue and to ensure proper taxation where transaction are arranged so as to minimize or avoid taxation as per law. It can be understood from a case of a firm ( AOP) for the purpose of section 80 owned by family members. In a firm in which both husband and wife are partners or in a firm in which both of them are partners with a minor child admitted for the benefit of partnership, clubbing of income will be made under section 108 as the purpose of such a firm is to take benefit of section 92(1). Income of husband or wife, as the case may be, shall be included in his or her total income. In the case of a minor child, his share of income from a firm will be clubbed either with his father or mother if both are partners in the same firm.

Instances of AOPs where section 108 can be invoked.

In the total income of a taxpayer, being a partner in a firm, the following shall be added :

a. Share income of spouse from a firm in which the taxpayer is not a partner if the capital contributed in any form, of the spouse in such firm is provided directly or indirectly by the taxpayer ; and b. Share income of a minor child of the taxpayer from a firm in which the taxpayer is not a partner and if the capital contributed in any form, of the minor in which such firm is not provided out of inheritance passed on to him. However, before making such clubbing, the taxpayer should be given a proper opportunity of being heard. Likewise spouse should be given a chance to explain contribution of capital.

Clubbing where securities are regained (section 112)

Where the owner of any security ( it includes stocks and shares ) disposes of the security and thereafter re-acquires the security and the result of the transaction is that any income payable in respect of the security is receivable by any person other than the owner, the income shall be treated, for all purposes of the Ordinance, as the income of the owner and not of the other person.

Transfer pricing
( section 108, 108 read with Chapter VI of Income Tax Rules, 2002 )

Where business is carried on between a resident and a non-resident and due to close business connection between them matter are arranged in such a way so as to produce either no profit or loss other than the ordinary profits to the resident, the Commissioner of Income Tax is empowered to determine the amount of profits which may reasonably be accrued to the resident and include such amount in the total income of resident. For determination of such profits the Commissioner of Income Tax has been provided guidance in section 108 and 109 read with Chapter VI of Income Tax Rules, 2002. These rules read as under : Interpretation.- (1) In this Chapter, (a) comparable uncontrolled transaction, in relation to a controlled transaction, means an uncontrolled transaction that satisfies one of the following conditions, namely:the differences (if any) between the two transactions or between persons undertaking the transactions do not materially affect the price in the open market, the resale price margin or the cost plus mark up, as the case may be; or

(i)

(ii)

if the differences referred to in sub-clause (i) do materially affect the price in the open market, the resale price margin or the cost plus mark up, as the case may be, then reasonably accurate adjustments can be made to eliminate the material effects of such differences; controlled transaction means a transaction between associates; transaction means any sale, assignment, lease, license, loan, contribution, right to use property or performance of services; uncontrolled persons means persons who are not associates; and uncontrolled transaction means a transaction between uncontrolled persons.

(b)

(c)

(d)

(e)

Rule 22. Subject to the other rules in this Chapter, the Commissioner, in applying this Chapter shall also be guided by international standards, case law and guidelines issued by the various tax-related internationally recognized organizations. Rule 23. Arms length standard.- (1) In determining the income of a person from a transaction with an associate, the standard to be applied by the Commissioner shall be that of a person dealing at arms length with a person who is not an associate (referred to as the arms length standard). (2) A controlled transactions shall meet the arms length standard if the result of the transaction is consistent with the result (referred to as the arms length result) that would have been realized if uncontrolled persons had engaged in the same transaction under the same conditions. (3) Subject to sub-rule (6), the following methods shall apply for the purposes of determining an arms length result, namely:(a) (b) (c) (d) the comparable uncontrolled price method; the resale price method; the cost plus method; or the profit split method.

(4) The method in clause (d) shall apply only where the methods in clauses (a), (b) and (c) cannot be reliably applied.

(5) As between clauses (a), (b) and (c), the method that, having regard to all the facts and circumstances, provides the most reliable measure of the arms length result as in the opinion of Commissioner shall be applied. (6) Where the arms length result cannot be reliably determined under one of the methods in sub-rule (3), the Commissioner may use any method provided it is consistent with the arms length standard. Rule 24. Comparable uncontrolled price method.- The comparable uncontrolled price method determines whether the amount charged in a controlled transaction gives rise to an arms length result by reference to the amount charged in a comparable uncontrolled transaction. Rule 25. Resale price method.(1) The resale price method determines whether the amount charged in a controlled transaction gives rise to an arms length result by reference to the resale gross margin realized in a comparable uncontrolled transaction. (2) The following steps shall apply in determining the arms length result under the resale price method, namely:(a) determine the price that a product purchased from an associate has been sold to a person who is not an associate (referred to as the resale price); and from the resale price is subtracted a gross margin (referred to as the resale gross margin) representing the amount that covers the persons selling and other operating expenses and, in light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit; from that amount is subtracted any other costs associated with the purchase of the product, such as customs duty; and the amount remaining is the arms length result.

(b)

(c)

(d)

(3) The resale price margin of a person in a controlled transaction may be determined by reference to:(a) the resale price margin that the person earns on products purchased and sold in a comparable uncontrolled transaction; or the resale price margin that an independent person earns in comparable uncontrolled transaction.

(b)

Rule 26. Cost plus method.- (1) The cost plus method determines whether the amount charged in a controlled transaction gives rise to an arms length result by reference to the cost plus mark up realised in a comparable uncontrolled transaction.

(2) The following steps shall apply in determining the arms length result under the cost plus method, namely:(a) determine the costs incurred by the person in a controlled transaction; and to this amount is added a mark up (referred to as the cost plus mark up) to make an appropriate profit in light of the functions performed and market conditions; and the sum of the amounts referred to in clauses (a) and (b) is the arms length result.

(b)

(c)

(3) The cost plus mark up of a person in a controlled transaction may be determined by reference to:(a) the cost plus mark up that the person earns in a comparable uncontrolled transaction; or the cost plus mark up that an independent person earns in comparable uncontrolled transaction.

(b)

Rule 27. Profit split method.- (1) The profit split method may be applied where transactions are so interrelated that the arms length result cannot be determined on a separate basis. (2) The profit split method determines the arms length result on the basis that the associates form a firm and agree to divide profits in the manner that independent persons would have agreed on the basis that they are dealing with each other at arms length. (3) The Commissioner may determine the division of profits on the basis of a contribution analysis, a residual analysis or on any other basis as appropriate having regard to the facts and circumstances. (4) Under contribution analysis, the total profits from controlled transactions shall be divided on the basis of the relative value of the functions performed by each person participating in the controlled transactions. (5) Under residual analysis, the total profits from controlled transactions shall be divided as follows:(a) each person shall be allocated sufficient profit to provide the person with a basic return appropriate for the type of transactions in which the person is engaged; and any residual profit remaining after the allocation in clause (a) shall be allocated on the basis of division between independent persons determined having regard to all the facts and circumstances.

(b)

(6) For the purposes of clause (a) of sub-rule (5), the basic return shall be determined by reference to market returns achieved for similar types of transactions by independent persons.Cases are in frequent where the non-resident is a holding company of the resident company, or vice versa, the resident company is holding company and the non-resident is a subsidiary, and the profit arising out of transactions between the resident and non-resident is diverted ( in whole or in part ) to the non-resident with a view to escaping Pakistan tax thereon. This section covers all such situations where financial interests of the resident and non-resident are so combined to avoid proper taxation in Pakistan.
i. ii. iii. iv. v. vi. vii. viii. ix. 1997 PTD 13 ( Tribunal ) 1998 PTD 3749 ( Tribunal ) 1987 34 Taxman 34 ( Karachi ) 1996 PTD 244 ( Tribunal ) 1998 PTD 1971 ( Tribunal ) 2000 PTD 299 ( Tribunal ) 2000 81 TAX 95 ( Tribunal ) 1998 PTD 1208 ( Tribunal ) 1998 7 TAX 140 ( Tribunal )

PRESUMPTIVE INCOME
As per general scheme, the Income Tax Ordinance imposes tax on taxable income that is a sum total of all the income chargeable to tax as computed under various heads of income mentioned in section 11 and categorized as total income of an assessable entity { section 4). The Ordinance offers an inclusive definition of the word income in section 2 (29), whereas the expression total income is exclusively defined in section 2 (69) read with section 10. In section 4, the charge in respect of taxable income is expressly declared to be in accordance with, and subject to the provisions of this Ordinance. These words read, in conjunction with the definition of total income in section 2 ( 69) , imply three main things : The income charges is that referred to in section 9 and 10. Full effect must be given to the exemption from tax granted under various provisions of the Ordinance. Income should be assessed under the appropriate head and should be computed as laid down in the Ordinance after reducing the allowances and deductions provided for under different heads of income.

However, there are special provisions in the Ordinance, which clearly deviate from the above rule of computing income, and impose presumptive tax by (i) taking a percentage of gross receipt as net income (ii) treat even purchases as income and (iii) denying deductions of expenses / allowances legitimately admissible from such gross receipts. These incomes are mentioned in sections 5, 6, 7, 169 (b) and 234 (5), and are discussed below : Dividends paid by a resident company ( section 5 ). Every person who receives a dividend from a resident company is chargeable to tax on gross receipt basis, unless the dividend is exempt from tax. Public companies and insurance companies are subjected to tax at the rate of 5% and rest of the shareholders at 10%. The payer company is required to deduct tax at source under section 150 at the time of payment of dividend. Royalty or fee for technical services on income of non-residents ( section 6 ). Tax is leviable @ 15% on gross receipts of every non-resident person who receives any Pakistan-source royalty or fee for technical services. These expressions are specifically defined n sections 2 (23) and 2 (54). The following receipts comprising fee for technical services and royalty are not chargeable to tax under this section : Any royalty where the property or rights giving rise to the royalty is effectively connected with a permanent establishment in Pakistan of the non-resident person ; Any fee for technical services where the services giving rise to the fee are rendered through a permanent establishment in Pakistan of the non-resident person; or Any royalty or fee for technical services that is exempt from tax under this Ordinance.

Any Pakistani-source royalty or fee for technical services received by a non-resident person to which this section does not apply will be treated as income from business , attributable to the permanent establishment in Pakistan of the person. Shipping And Air Transport Income Of Non-Residents { section 7 read with sections 143 & 144 }. Every non-resident person carrying on the business of operating ships or aircraft as the owner or charterer is chargeable to tax, unless income is exempt from tax, in respect of The gross amount received or receivable ( whether in or out of Pakistan ) for the carriage of passengers, livestock, mail or goods embarked in Pakistan ; and The gross amount received or receivable in Pakistan for the carriage or passengers, livestock, mil or goods embarked outside Pakistan.

The rate of tax is : In the case of shipping income 8% of the gross amount received or receivable ; or In the case of air transport income, 3% of the gross amount received or receivable.

Rules 37 and 38 of the Income Tax Rules 2002, specify the format and method of filling of return by owner of a non-resident ship or aircraft. Section 143 and 144 provide for the manner in which returns are to be filed by nonresidents mentioned above and the method of assessment etc. The details are as under :

Non-resident ship owner of charterer ( section 143 ). Before the departure of a ship owned or chartered by a non-resident person from any port in Pakistan, the master of the ship shall furnish to the Commissioner a return showing the gross amount specified in sub-section (1) of section 7 in respect of the ship. Where the master of a ship has furnished a return, the Commissioner will, after calling for such particulars, accounts or documents as he may require, determine the amount of tax due under section 7 in respect of the ship and, as soon as possible, notify the master, in writing, of the amount payable. The master of a ship will be liable for the tax notified and the provisions of this Ordinance will apply to such tax as if it were tax due on the basis of an assessment order. Where the Commissioner is satisfied that the master of a ship or non-resident owner or charterer of the ship is unable to furnish the return required before the departure of the ship from a port in Pakistan, the Commissioner may allow the return to be furnished within thirty days of the departure of the ship provided the non-resident owner or charterer has made satisfactory arrangements for the payment of the tax due under section 7 in respect of the ship. Non-resident aircraft owner or charterer ( section 144 ). A non-resident charterer of an aircraft will be liable for tax under section 7, or an agent authorised by the nonresident person for this purpose, will furnish to the Commissioner, within forty-five

days from the last day of each quarter of the financial year, a return, in respect of the quarter, showing the gross amount specified in sub-section (1) of section 7 of the nonresident person for the quarter. Where a return has been furnished, the Commissioner will, after calling for such particulars, accounts or documents as he may require, determine the amount of tax due under section 7 by the non-resident person for the quarter and notify the non-resident person, in writing, of the amount payable. The non-resident person is liable to pay the tax notified by the Commissioner within the time specified in the notice and the provision of the Ordinance shall apply to such tax as if it were tax due under an assessment order. Where the tax due is not paid within three months of service of the notice, the Commissioner may issue to the authority by whom clearance may be granted to the aircraft operated by the non-resident person, a certificate specifying the name of the non-resident persons and the amount of tax due. The authority to whom a certificate is issued is required to refuse clearance from any airport in Pakistan to any aircraft owned or chartered by the non-resident until the tax due has been paid. Things to remember ( section 8 ). The following principles need to be remembered in respect of income chargeable to tax under sections 5, 6 and 7, discussed above : Tax imposed under section 5, 6 and 7 is the final tax on the amounts in respect of which tax is imposed meaning by that it is full and final discharge of tax liability to the extent of these incomes. Such amount shall not be chargeable to tax under any head of income in computing taxable income to the person who derives it for any tax year. No deduction is allowable under this Ordinance for any expenditure incurred in deriving the amount. The amount chargeable to tax on gross receipt basis can not be reduced by i. any deductible allowance, or ii. set off of any loss. Tax payable by a person under section 5, 6 and 7 is not be reduced by any tax credits provided under this Ordiance. The liability of a person under section 5,6 and 7 will be discharged to the extent that : i. ii. in the case of shipping and air transport income, tax has been paid in accordance with section 143 or 144 , as the case may be; or in any other case, the tax payable has been deducted at source under Division II of Part V of Chapter X.

Importers , other than industrial undertakings, importing goods as raw material { section 148 (7) read with section 169 }. Except in the case of an industrial undertaking importing goods as raw material for its own use, tax collected under section 148 is final tax on the income of the importer arising from such imports. Section 148 authorises the Collector of Customs to collect advance tax from every

importer of goods on the value of the goods at the rate specified in Part II of the First Schedule, re-importation of re-usable containers for re-export qualifying for customs- duty and sales tax exemption on temporary import under the Customs Notification NO. SRO. 344 (1)/95, dated the 25 th day of April, 1995. Importation of certain petroleum products i.e Motor Spirit ( MS ), Furnace Oil ( FO), JP-I and MTBE.

The key words in this section are industrial and raw material since these expression have not been defined in the Ordinance, their generally accepted meaning in the wider sense are to be adopted. Certain contractors and suppliers of goods ( section 153 (6) read with section 169 } ..- The payment received in full or part that are subject mater of deduction at source under section 153 (6) on account of the following are taxable on gross receipt basis without any deduction or set off :
(a)

for the sale of goods; for the rendering of 23[or providing of] 24[ ] services; on the execution of a contract, other than a contract for the 25[sale] of goods or the rendering of 26[or providing of] 27[ ] services,

(b) (c)

Every exporter or an export house making a payment in full or part including a payment by way of advance to a resident person or permanent establishment in Pakistan of a non-resident person for the rendering of or providing of services of stitching, dying, printing, embroidery, washing, sizing and weaving, shall at the time of making the payment, deduct tax from the gross amount payable at the rate specified in Division IV of Part III of the First Schedule. Exporters { section 154 read with section 169 }. Any exporter who is liable to tax deduction under section 154 (1) or (3) falls within the ambit or presumptive taxation. Tax deducted by authorised dealers in foreign currency at the time of realization of foreign exchange proceeds on account of export of goods, is full and final discharge of tax. The same provision applies to sales of goods to an exporter under an inland backto-back letter of credit or nay other arrangement as prescribed by the CBR. The CBR explained in various circulars and circular letters the provisions relating to exporters vis-a-vix presumptive taxation under the repealed law, which are still relevant as provisions of section 80 CC are pari material to this section. The reference to old sections may be read with caparison comparison to new ones .

23 24 25 26 27

Inserted by the Finance Act, 2005. The word professional omitted by the Finance Act, 2002. Substituted for the word supply by the Finance Act, 2003. Inserted by the Finance Act, 2005. The word professional omitted by the Finance Act, 2003.

 Method of pro-ration of Profits between Export Proceeds Falling under Section 80 CC and Local Sales. Section 80 CC of Income Tax Ordinance, 1979, read with paragraph CCCC of Part-I of the First Schedule to the Ordinance provides for presumptive taxation of income of Exporters and where the assessee has no income other than the income referred to in sub-section (1) of section 80 CC in respect of which tax has been deducted under sub-section (5A) of section 50, the tax so deducted is deemed to be the final discharge of his tax liability and assessee is not required to file the return of total income under section 55 of the Income Tax Ordinance, 1979. However, return of income is to be filed in case of assessee derives income from any other source e.g commission brokerage or local sales etc. CBR vide Circular No. 20 of 1992, dated July 1,1992 has provided special treatment to Exporters maintaining books of accounts, which is as under :i. Local sales of goods ( manufactured for export ) as well as waste material not constituting more than 20% of such production, may also be treated as export sales if the assessee opts to pay tax on such sales at the rate applicable to export sales under section 80 CC. Where income from export is inseparable from commission, brokerage and other receipts and the assessee can not prove the extent of over head expenses relating to non-export receipts, allocation of expenses may be made on a pro-rata basis in the same ratio as the receipts not covered by section 80 CC bear to the gross profit on the export sales.

ii.

It is further explained in Circular NO. 8 of 1999 dated 27-7-1999 as under : Taxation of indenting agents { Section 50 ( 5A) and section 80 CC, paragraph CCC and CCC Part-I of First Schedule } Sub-section ( 5A) of section 50 has been amended to provide presumptive taxation of commission received in foreign exchange from foreign principles by indenting agents. The tax would be withheld @ 10% by banks. The tax deducted @ 10% shall constitute final discharge of tax liability in respect of such income from assessment year 20002001. Indirect exporters to be taxed like direct exporters of goods. { Section 50 (5A) and section 80 CCC } . A new sub-section ( 5AA ) of section 50 has been introduced in the Ordinance to provide collection of tax by banks when realizing proceeds of a back to back in land letter of credit opened by a direct exporter of goods in favour of an indirect export for the supply of goods for which the letter of credit has been opened in foreign exchange by a foreign buyer ( in favour of direct exporter ).

The tax shall be collected by the bank at the same rates as applicable to direct exporters of those gods i.e 0.5 , 0.75 or 1% , as the case may be, provided the transaction is supported by a back to back inland letter of credit.

General principles in respect of presumptive income ( section 169 ). The following principles have to be kept in mind in respect of income mention in section 169 (b) and 234 (5) : Income of the person is not to be computed under any head of income. No deduction is allowable under the Ordinance for any expenditure incurred in deriving the income; The amount of income is not to be reduced by : o Any deductible allowance under Part IX of Chapter III; or o The set off of any loss. Tax deducted is not to be reduced by any tax credit allowed under the Ordinance; and No refund of the tax collected or deducted is permissible unless the tax so collected or deducted is in excess of the amount for which the tax payer is chargeable under the Ordinance. Where all the income derived by a person in a tax year are subject to final taxation under the provisions referred to in section 169 (1) under section 5, 6, and 7 , as assessment is treated to have been made under section 120 and the person is not required to furnish a return of income under section 114 for the year; Where a taxpayer, while explaining the nature and source of nay amount, investment, money, valuable articles, expenditure, referred to in section 111, takes into account any source of income which is subject to tax in accordance with the provisions of section 148, 153, 154 , 156 or sub-section (5) of section 234 , he is not entitled to take credit of any sum as is in excess of an amount which if taxed at a rate or rates, other than the rate applicable to the income chargeable to tax under aforesaid sections 148, 153, 154, 156 or sub-section (5) of section 234 would have resulted in tax liability equal to the tax payable in respect of income under any of the aforesaid sections { section 169 (4)

The Income Tax Ordinance, 2001 defines Presumptive Income under section 169 as :
Tax collected or deducted as a final tax. - (1) the above section shall apply where (a) the collection of advance tax is a final tax under sub-section (7) of section 148 [or sub-section (5) of section 234] on the income to which it relates; or the deduction of tax is a final tax under sub-section 28[clauses (a), (b) and (d) of sub-section (1) of section 151, sub-section (1B) of section 152,] 29[sub-section (6)] of section 153, sub-section (4) of section 154, 30[section 155,] sub-section (3) of section 156, 31[ ] 32[subsection (2) of section 156A or sub-section 33[(1) and] (3) of section

(b)

28 29 30 31 32 33

Inserted by the Finance Act, 2006. The word, brackets and figures sub-section (6) or (7) substituted by the Finance Act, 2006. Inserted by the Finance Act, 2006. The words, figures and brackets or sub-section (2) of section 157 omitted by the Finance Act, 2002 Inserted by the Finance Act, 2004. Inserted by the Finance Act, 2005.

233 or clause (a) and clause (b) of sub-section (1) of section 233A] on the income from which it has been deducted. (2) Where section 169 applies (a) the income shall not be chargeable to tax under any head of income in computing the taxable income of the person; no deduction shall be allowable under this Ordinance for any expenditure incurred in deriving the income; the amount of the income shall not be reduced by (i) (ii) (d) any deductible allowance under Part IX of Chapter III; or the set off of any loss;

(b)

(c)

the tax deducted shall not be reduced by any tax credit allowed under this Ordinance; and there shall be no refund of the tax collected or deducted [unless the tax so collected or deducted is in excess of the amount for which the taxpayer is chargeable under this Ordinance.

(e)

(3) Where all the income derived by a person in a tax year is subject to final taxation under the provisions referred to in sub-section (1) or under sections 5, 6 and 7, an assessment shall be treated to have been made under section 120 and the person shall not be required to furnish a return of income under section 114 for the year.

ASSESSMENT OF INDIVIDUALS
Assessment of an individual involves practical application of the various provision of the Ordinance in a given situation. Sections 86, 87 and 88 deal with various principles of taxation of individuals. This chapter deals with reference to various assessment problems, the cumulative impact of the provisions on an individuals assessment. Taxable income of each individual ( treated as a person in section 80 (a) ) is to be determined separately ( section 86). An individual is , therefore, liable to pay tax in respect of the following : A. income earned by the individual himself/herself. B. Share income from AOP ( as defined in section 80(2)(a) C. Income from other sources under sections 90, 91, 108 and 112 If share income at (b) is exempt from tax under sub-section (a) of section 92, it is to be included in the total income by reference to which rate of tax applicable to taxable income of an individual is determined ( section 88 ).

Determination of taxable income

First compute taxable income in the light of provision related to individual heads of income, whichever is applicable. For example if income is from business, gross profit or receipts reduced by legally admissible expenses will be net income chargeable to tax. After computation of total income , excluding incomes to which section 5, 6, 7 or presumptive incomes mentioned in section 169 apply, the following steps are required: 1. Deduct Zakat (section 60) and expenses on personal medical services to the extent mentioned in clause (13) (b), Part A of the Second Schedule to the Ordinance. 2. Rebate/allowances, if any, from section 61 to 64 subject to limitation provided in section 65. 3. Work out payable in the light of Clause 1, Division 1, Part 1 of the First Schedule to the Ordinance. Following points may be kept in mind: Special tax rebate @ 75% of taxable is available to an individual of 65 years of age, having income up to Rs. 2, 00,000. Special rebate of 50% of tax payable by a full time teacher or a researcher, employed in a non profit education or research institution including government training and research institution duly recognized by a Board of Education or a University or the Higher Education Commission after the reduction available to him/her under Clause (1), Part-III, Second Schedule.

Tax rebate @ average rate of tax is allowed on donation, under section 61 and those falling under clause (61) Part-I Second Schedule. However donations mentioned in clause (67), Part-I Second Schedule is exempt without any limits. Straight deduction is allowed for personal medical expenditures by resident individuals as per limits and condition that receipt of medical practitioner must have NTN and complete address.

Reduction in tax for salaried tax payers

Tax liability on income of salaries taxpayers where any income chargeable under the head salary exceeds 50% of total income as determined under clause 1&2 of Division 1 of Part of the First Schedule, is to be reduced at the following rates :

1. Where Income exceeds Rs. 60,000 but does not exceeds Rs. 80,000 70% 2. Where Income exceeds Rs. 80,000 but does not exceeds Rs. 100,000 60% 3. Where Income exceeds Rs. 10,000 but does not exceeds Rs. 150,000 50% 4. Where Income exceeds Rs 150,000 but does not exceeds Rs. 200,000 40% 5. Where Income exceeds Rs200, 000 but does not exceeds Rs. 300,000 30% 6. Where Income exceeds Rs. 300,000 but does not exceeds Rs. 500,000 20% 7. Where Income exceeds Rs500, 000 but does not exceeds Rs. 10, 00,000 10% 8. Where Income exceeds 10, 00,000 5%

Calculation of tax liability

Total income of an individual is chargeable to tax at the rates given in clause 1 of Division 1, Part 1 of the First Schedule

Tax rates for non-resident individuals.

The rate of income tax in the case of a non-resident individual is the same as in the case of resident except of income that fall under section 6 and 7 that are taxed on gross receipt basis in the hands of non-resident. The rate of such incomes are as follows: 1. Rate of tax on payment to non-residents on account of royalty or fee for technical services. 15% of the gross amount of the royalty or fee for technical services 2. Rate of tax on shipping or air transport income of a non-resident person. a. In the case of shipping income 8% of the gross amount received or receivable; or

b. in the case of air transport income 3% of the gross amount received or receivable.

Special provisions for non-resident salaried individuals

Section 50 of the Ordinance, 2001 states that the foreign-source income of an individual ( other than a citizen of Pakistan ), who is a resident individual solely by reason of the individuals employment; and who is present in Pakistan for a period or period not exceeding three years, is exempt from tax under this Ordinance. However, this exemption shall not apply to any income derived from a business of the person established in Pakistan or any foreign-source income brought into or received in Pakistan by the person.

Exemption in case of resident individuals in special cases

Section 51 and 102 of the Ordinance, 2001 states that the following special exemptions exist for resident individuals: 1. Foreign-source income of returning expatriates. .. 2. Foreign source salary of resident individuals.

ASSESSMENT OF ASSOCIATION OF PERSONS

Sections 92 and 93 explain tax liability of association of persons ( AOP) that include firms, Hindu Undivided Families, artificial juridical persons and foreign association ( excluding companies defined in section 80 ). This chapter discusses all aspects of taxation of AOPs i.e provisions relating to averaging ( section 88 ), problems relating to change in its constitution, assessment of its members and carry forward and set-off of its losses. In addition, the provisions applicable to an association of person where one or more members are non-resident are explained in detail.

What is an association of persons (AOP)

Section 80(2) (a) & (c) of the Ordinance provides that the following entities will be treated as AOP: Firm, which means the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Specific reference to the Partnership Act, 1932, is avoided in section 80 (2) ( c ) , although the definition given therein is reproduced from section 4 of the Partnership Act, 1932. Section 4 of the Partnership Act defines partnership as relationship between persons who have agreed to share the profits of a business carried on by all or any of them acting for all . Persons who have entered into partnership with one another are individually called partners and collectively a firm and the name under which their business is carried on is called the firms name. The essential element of a partnership is that it can only be formed for sharing profit of a business only there is no concept of a partnership in any other activity which does not constitute business. Hindu Undivided Family . Any artificial juridical person. Any body of persons formed under a foreign law but does not include a company.

Principles of assessment of an AOP and its members

( sections 92 & 93 ) An AOP, other than a professional firm that is prohibited from incorporating by any law or the rules of the body regulating a profession or where any company is a member, is liable to tax, separately from its members and any amount received by a member as share from AOP, is exempt from tax.

Computation of taxable income of AOP

First determine the gross total income of AOP, after adding back payment/s, if any, made by the AOP on account of profit, brokerage, salary, commission or other remuneration to any members (section 21 (j). Then reduce the gross total income by permissible deductions (see relevant head of income). It is worthwhile to note that if a deduction has been allowed to the AOP, no deduction in respect of the same income or expenditure will be allowed in computing the total income of its members.

Assessment of members of AOP

In case of professional firms and AOP in which a company is member, taxation is to be made in the hands of members as per section 93(3), which says: Tax in the case of a resident member will be levied on the members share in the total income of the association . If AOP suffers loss that can not be set off against any other income of association in accordance with section 56 and the amount of loss is to be apportioned among the members according to their respective interest and they alone will be entitled to set off or carry forward the loss in computing their taxable incomes ( sectoion 93(2). Tax in the case of non-resident will be levied on the members share in so much of the total income of the association as is attributable to Pakistan-source income. If AOP suffers loss that can not be set off against any other income of the association in accordance with section 56, the amount of loss is the is to be apportioned among the members according to their respective interest and they alone will be entitled to set off or carry forward the loss in computing their taxable income. Further is to be limited to the extent it relates to the derivation of Pakistan-source income.

The following points need to be kept in mind: Share of a member in the total income of an AOP is determined by including : o Members interest in the AOP and o Any profit on debt, brokerage, commission, salary or other remuneration received or due from the association ( section 93(6). Income, expenditure and losses of above referred association will retain their character as to geographical source and type of income, expenditure or loss in the hands of the members and are to be treated as having passed through the association on a pro rata basis, unless the Commissioner points otherwise by notice in writing to the association.

Provisions relating to averaging

Section 88 states that if an individual derives exempt share from an AOP (section 92(1) and has taxable income from any other source as well, tax payable will be computed as under : (A/B) x C

Where: A... is the amount of tax that would be assessed to the members for the relevant tax year, if share from AOP were chargeable to tax: B. is the taxable income of the member for the year if share from association were chargeable to tax; and C is the members actual taxable income for the year.

Calculation of tax liability of an AOP

On the total income of a member of an AOP arrived under the Ordinance and specific provision narrated earlier, tax is calculated at rates given in clause 1 and 2 Division 1, Part 1 of the First Schedule to the Ordinance.

ASSESSMENT OF COMPANIES
For the assessment of companies, determination of various withholding obligations and application of tax rates, the following definition of the expression company provided at various places of the ordinance are important: Company as defined under (section 2(12) read with 80(2) (b) Under clause (b) of section 80(2), the expression company is defined to mean the following : (i) a company as defined in the Companies Ordinance, 1984 (XLVII of 1984); (ii) a body corporate formed by or under any law in force in Pakistan; (iii) a modaraba; (iv) a body incorporated by or under the law of a country outside Pakistan relating to incorporation of companies; (v) a trust, a co-operative society or a finance society [or any other society established or constituted by or under any law for the time being in force;]

(vi) a foreign association, whether incorporated or not, which the Central Board of Revenue has, by general or special order, declared to be a company for the purposes of this Ordinance; (vii) a Provincial Government; (viii) a local authority in Pakistan; [(ix) a Small Company as defined in section 2;] Banking Company - section 2(7) This definition covers two types of companies that are: Banking companies as defined in the Banking Companies Ordinance, 1962 (LVII of 1962) Any body corporate which transacts the business of banking in Pakistan;

The business of banking is regulated by the State Bank of Pakistan (SBP) and nobody can undertake the business of banking without obtained a license from SBP. Thus the latter part of the definition certainly points out to those statutory corporations such as National Bank of Pakistan, PICIC, Agricultural Development of Punjab, etc that are not banking companies under the Banking companies Ordinance, 1962, but are given

licenses to conduct business by SBP as they are specifically established under their respective statutes to do so . Financial institution (section 2(24). Does financial institution fall in the definition of company as per section 80(b) (i) The Ordinance says financial institution means an institution notified under the Companies Ordinance, 1984 by the Federal Government in the official Gazette, as a financial institution. The definition does not make it a company defined under the Companies Ordinance, 1984: therefore, it is highly debatable that financial institutions are companies within the scope of the Ordinance. Investment company (section 2(30A). Investment Company means a company registered under the Investment Companies and Investment Advisor Rules, 1971. Leasing Company (section 2(30B). Leasing Company means a company licensed under the Leasing Companies (Establishment and Regulation) Rules, 2000. Private Company (section 2(45). A Private Company means a company that is not a public company. Public Company (section 2(47). A public company means o A company in which not less than fifty percent of shares are held by the Federal Government. o A company whose shares were traded on a registered stock exchange in Pakistan at any time in the tax year and which remained listed on that stock exchange until the end of that year or o A unit trust whose units are widely available to the public and any other public trust The terms company, banking company, investment company, leasing company, private company and public company have been defined above separately and elaborately. The reason for this classification is that certain provisions of the Ordinance apply differently to different types of companies. Whereas there is mention of these terms, the reader must look up for specific definition discussed above. The Ordinance provides its own specific definition of public company that is entirely differently from the Companies Ordinance, 1984. Therefore, any company that does not fall in section 2(47) will automatically be considered as private company within the ambit of section 2(45). These terms should not be equated with those defined in the Companies Ordinance, 1984.

Determination of residential status of a company

Under section 83 a Pakistani incorporated company or any body corporate formed by or under the law or any other company will be resident in a tax year if the management of its affairs is situated wholly or almost wholly in Pakistan in the tax year, or it is a Provincial Government or a local authority in Pakistan.

General principles of taxation of Companies (section 94 to 98). Section 94 to 98 deal with certain principles relating to taxation of companies. These are summaries as under: 1. Companies are to be taxed independently from shareholders. Under section 94(1) a company is to be taxed independently and separately form its shareholders. 2. Taxation of dividend in the hands of companies. A dividend paid by a resident company is taxable on gross receipt basis in the hands of shareholders under section 5 read with Division III, Part 1 of the First Schedule. The rate of tax, where recipient is a public company or insurance company is 5% and in other company 10%. (Section 94 (3). If a non resident company pays a dividend to a resident person it will be chargeable to Income from Business or Income from Other Sources as the facts of the case justify unless the dividend is exempt from tax ( section 94(3). 3. Disposal of business by an individual to wholly-owned company ( section 95). Any transaction that is related to disposal of assets becomes the subject matter of gain or loss. In this section a situation is conceived where transfer of business assets by a resident individual to a wholly- owned resident company will not result in either gain or loss. This section will be applicable only when: The consideration received by the individual is in the form of share or market other than redeemable share/s. At the same time, the fair market value of the share/s should be equivalent to the fair market value of the assets (less any liability that the company agrees to bear ), on the date of disposal. The shares should be of a beneficial nature as soon as they are in possession of the individual. The company should be fully responsible for all the liabilities related to the assets disposed of on the condition that the liabilities should not be in excess of the cost of the assets. The company to which the assets are transferred should not be exempt from tax in the tax year in which disposal takes place. Assets acquired by the company shall be treated as having the same character as before the transfer. When a transfer of assets takes place, the cost in the hands of the company will be: In case of depreciable assets or amortized intangibles, the written down value of the asset or intangible immediately before the disposal. In the case of stock-in-trade, at the value taken for tax purpose under section 35(4) at fair market value. In other cases, the transfers cost at the time of disposal.

A rule to be taken in mind here is that where an individual disposes of assets subject to depreciation ( under section 22), amortization ( under section 24) or pre-commence expenditure ( under section 25) in a tax year, it will not be allowed these deductions from his income in that tax year, clause (e). In the hands of the transferor. The cost of share(s) received will be calculated at the transferors cost (reduced by any liability that the company may undertake) divided by the number of shares, clause (d). Disposal of business by AOP to wholly-owned company (section 96) In this section a situation is conceived where the business assets disposed of by a resident association of persons to a wholly-owned resident company will not result in either gain or loss. This section will be applicable only where: The consideration received by the AOP is in the form of share or shares other than redeemable shares. At the same time, the fair market value of the share/s should be equivalent to the fair market value of the assets (less that the company agrees to bear), on the date of disposal. The shares should be of a beneficial nature as soon as they are in possession of the AOP and each member of the association must have an interest in the share/s in the same proportion to the members interest in the business assets immediately before the disposal. The company should be fully responsible for all the liabilities related to the assets disposed of on the condition that the liabilities should not be in excess of the cost of the assets. The company to which the assets are transferred should not be exempt from tax in the tax year in which disposal takes place.

Assets acquired by the company shall be treated as having the same character as before the transfer. Where a transfer of assets takes place, the cost in the hands of company will be : In case of depreciable assets or amortized intangible, the written down value of the asset or intangible immediately before the disposal. In the case of stock-in-trade, at the value taken for tax purpose under section 35(4) at fair market value. In other cases, the transferors cost at the time of disposal.

A rule to be kept in mind here is that where a company disposes assets subject to depreciation, amortization or pre-commencement expenditure in a tax year, it will not be allowed these deductions from its income in that tax year. In the hands of the transferor, the cost of share/s received will be calculated as the transferors cost (reduced by any liability that the company may undertake) divided by the number of shares.

Disposal of assets between wholly-owned companies (section 97)

In this section a situation is conceived where assets disposed of by a resident whollyowed company to a wholly-owned resident company within a wholly-owned group, will not result in either gain or loss. A wholly-owned group is one where the company beneficially holds all the issued shares of the other company; or a third company beneficially holds all the issued shares in both companies. This section will be applicable only when: Both companies belong to a wholly-owned group of companies at the time of the disposal. The company should be fully responsible for all the liabilities related to the assets disposed of on the condition that the liabilities should not be in excess of the cost of the assets. The company to which the assets are transferred should not be exempt from tax in the tax year in which disposal takes place. Assets acquired by the company shall be treated as having the same character as before the transfer. When a transfer of assets takes place, the cost in the hands of the company will be : In case of depreciable assets or amortised intangible the written down value of the asset or intangible immediately before the disposal; In the case of stock-in-trade, at the value taken for tax purpose under section 35(4) at fair market value. In other cases, the transferors cost at the time of disposal.

A rule to be kept in mind here is that where a company disposes assets subject to depreciation, amortization or pre-commencement expenditure in a tax year, it will not be allowed these deductions from its income in that tax year. In the hands of the transferor, the cost of share/s received will be calculated as the transferors cost ( reduced by any liability that the company may undertake ) divided by the number of shares.

Change in control of a company ( section 98)

The provision contained in this section pertain to a situation where there is controlling change ( an ownership interested in the company held, directly or indirectly through an interposed entity or entities, by an individual or by a person not ultimately owned by individuals ) in a company. In this case the Ordinance disallows any loss prior to change in the ownership as a deduction in the hands of the successor unless the following condition are met : The successor continues to conduct the same business; and

Until the loss has been set off completely, no new business or investment is made with the sole purpose of reducing tax liability by deduction of loss from income of the new venture.

Minimum tax on companies (section 113 )

Minimum tax on the income of certain persons.- (1) This section shall apply to a resident company where, for any reason whatsoever, including the sustaining of a loss, the setting off of a loss of an earlier year, exemption from tax, the application of credits or rebates, or the claiming of allowances or deductions (including depreciation and amortisation deductions) allowed under this Ordinance or any other law for the time being in force, no tax is payable or paid by the person for a tax year or the tax payable or paid by the person for a tax year is less than one-half per cent of the amount representing the persons turnover from all sources for that year. (2) Where this section applies (a) the aggregate of the persons turnover for the tax year shall be treated as the income of the person for the year chargeable to tax;

(b) the person shall pay as income tax for the tax year (instead of the actual tax payable under this Ordinance), an amount equal to onehalf per cent of the persons turnover for the year [; and (c) Where tax paid under sub-section (1) exceeds the actual tax payable under Part I, Division II of the First Schedule, the excess amount of tax paid shall be carried forward for adjustment against tax liability under Part I, Division II of the First Schedule of the subsequent tax year: Provided that the amount under this clause shall be carried forward and adjusted against tax liability for five tax years immediately succeeding the tax year for which the amount was paid.] (3) In this section, turnover means (a) the gross receipts, exclusive of [sales tax and [Federal] excise duty or] any trade discounts shown on invoices or bills, derived from the sale of goods; (b) the gross fees for the rendering of services [or giving benefits], including commissions; (c) the gross receipts from the execution of contracts; and (d) the companys share of the amounts stated above of any association of persons of which the company is a member.

113A. Tax on Income of certain persons.- (1) Subject to this Ordinance, where a retailer being an individual or an association of persons has turnover upto rupees five million for any tax year, such person may opt for payment of tax as a final tax at the rates specified in Division IA of Part I of the First Schedule. (2) For the purposes of this section,(a) retailer means a person selling goods to general public for the purpose of consumption;

(b) turnover shall have the same meaning as assigned to it in subsection (3) of section 113. (3) The tax paid under this section shall be a final tax on the income arising from the turnover as specified in sub-section (2).] 113B. Tax on income of certain retailers.- Subject to this Ordinance, where a retailer of textile fabrics and articles of apparel including ready-made garments or fashion wear, articles of leather including foot-wear, carpets, surgical goods and sports goods, being an individual or an AOP, has turnover exceeding five million rupees for any tax year, such person shall pay final tax at the rate of 1% of turnover. This tax shall form part of the single stage sales tax at the rate 3% of the declared turnover.

Computation of taxable income

First ascertain gross total income under each head of income, ( under section 12Salary, section 15-Property, section 18-Business, section 19 Speculation Business, section 37-Capital Gain and section 39 Income From Other Sources ), excluding income to which section 5 ( Tax on Dividends ), section 6 ( Tax on certain payments to non-residents), section 7 ( Tax on shipping and Air-Transportation ), or section 169 (1) (b) ( Final Tax ) apply. Then deduct admissible deductions. (under sections 20 to 29 and 29-A ). Total income so arrived may be adjusted against loss brought forward, if any. For the total income after adjustment of loss, if any, the following can be deducted: a. Zakat paid. b. Other including workers welfare fund. The total income so reduced will be taxable income chargeable to tax as per rates given in Division II, Part 1 of the First Schedule.

Calculation of Tax liability.

The total taxable income of a company is chargeable to tax according to the rates given in Division II, Part 1 of the First Schedule. From the total tax payable, the tax rebates and credits admissible under section 61,62, 64 and 103 in the manner provided in section 4(3) can be claimed.

UNIVERSAL SELF ASSESSMENT SCHEME,

AS ENUNCIATED IN SECTION 120 Section 120 of the Income Tax Ordinance, 2001 states as : Assessments.- (1) Where a taxpayer has furnished a complete return of income (other than a revised return under sub-section (6) of section 114) for a tax year ending on or after the 1 st day of July, 2002,(a) the Commissioner shall be taken to have made an assessment of taxable income for that tax year, and the tax due thereon, equal to those respective amounts specified in the return; and the return shall be taken for all purposes of this Ordinance to be an assessment order issued to the taxpayer by the Commissioner on the day the return was furnished.

(b)

Notwithstanding the provisions of sub-section (1), the Commissioner may select a person for an audit of his income tax affairs under section 177 and all the provisions of that section shall apply accordingly. (2) A return of income shall be taken to be complete if it is in accordance with the provisions of sub-section (2) of section 114. (3) Where the return of income furnished is not complete, the Commissioner shall issue a notice to the taxpayer informing him of the deficiencies (other than incorrect amount of tax payable on taxable income, as specified in the return, or short payment of tax payable) and directing him to provide such information, particulars, statement or documents by such date specified in the notice. (4) Where a taxpayer fails to fully comply, by the due date, with the requirements of the notice under sub-section (3), the return furnished shall be treated as an invalid return as if it had not been furnished. (5) Where, in response to a notice under sub-section (3), the taxpayer has, by the due date, fully complied with the requirements of the notice, the return furnished shall be treated to be complete on the day it was furnished and the provisions of subsection (1) shall apply accordingly. (6) No notice under sub-section (3) shall be issued after the end of the financial year in which return was furnished, and the provisions of sub-section (1) shall apply accordingly.

Section 120 Explained.

This section is the central piece of the Ordinance providing for in-built universal selfassessment for all taxpayers keeping records. They are under obligation to furnish complete returns of income by the due dates along with all the prescribed annexure,

statements and documents, fully stating in the return-forms all relevant particulars and information specified in the form, duly supported by a declaration of the records kept. Sub-section (1) provides that when the tax payers furnishes a complete return of income ( other than a revised return ) the Commissioner is deemed to have accepted the same and made an assessment of the taxable income and tax payable there on . These would be the same amounts of taxable income or tax payable as shown in the taxpayers return. No assessment order would be issued since clause (b) of this subsection clearly states that the taxpayers return itself will be treated as an assessment order issued by the Commissioner on the day the return was furnished. Sub-section (3) makes it obligatory for the Commissioner to point out deficiencies in the incomplete return and issue notice to the concerned taxpayer calling for the required information, particulars, statements or documents, within the time specified in the notice. The deficiencies in respect of incorrect amount of tax or short payment of tax otherwise payable on the basis of the return are immaterial and need not be specified in the notice. Such notice can only be issued within the financial year in which the return was furnished; otherwise after the end of that year, the return will be deemed to have been treated as a complete return and taken to be an assessment order on the day it was furnished ( sub-section (6) refers ) Sub-section (5) provides that if the taxpayer makes full compliance with the requirements of the notice by the due dates, the Commissioner will accept the return and treat it as complete for the purpose of self-assessment under sub-section (1) without passing an assessment order. However, if the taxpayer fails to make full compliance with the requirements of the notice by the due date, the return shall be treated as an invalid return under sub-section 114(4) to start assessment proceedings against the taxpayer by issuing a formal notice requiring a complete return of income with all the prescribed annexure, statements, documents etc. This section has radically changed the operation of the self assessment scheme under section 59 of the 1979) Ordinance. The new income tax law has brought bring a complete change in the philosophy of income tax proceedings. The salient features are: No assessing officer will determine your income and compute your tax liability. Now you will yourself declare your income and determine your tax liability. Your income tax return shall be accepted without any conditions. There will be no compulsory enhancement of tax liability over previous year to qualify for acceptance. Even your loss return shall also qualify for acceptance. Filing of your income tax return itself will be an assessment order and your eligibility for refund will flow from your tax return. A certain percentage of returns filed shall be selected for tax audit on the basis of risk assessment to verify the accuracy and correctness of your income tax return.

Tax audit will not necessarily mean an amendment of the assessment originally made based by you in your return of income. Your original assessment can only be amended on the basis of information acquired during tax audit or any other source. If selected for audit, there will be no pre-designated auditors to carry out audit. The officials making selection for audit will be different from those who do actual audit. In other words you have no designated Income Tax Officer holding jurisdiction on you.

Thus universal self-assessment in its true sense will be available to all taxpayers irrespective of quantum, status, location or size. This is the first such experience in this part of the world. The new law and the universal self-assessment system will take away the discretionary powers of the tax collectors. However, its salient features, briefly explained above, are not workable without adequate records to support the items reported by you on the income tax return and allied statements. To make the policy work, CBR has envisaged bare minimum books of account; documents and records (that are generally maintained to run business) Universal Self Assessment supplemented by simple laws and a comprehensive and ongoing program of taxpayer education in support and envisaged as the essential ingredients of the tax reform program. A major milestone of the tax reform program has been the introduction of Income Tax Ordinance, 2001. The income tax operating system of passing an annual assessment order has been on the old income tax law has been abandoned and replaced by Universal Self-Assessment System. Now all income for the tax years will be assessed under Universal Self Assessment on the basis of returns filed. All taxpayers automatically qualify for self-assessment under the new system. The returns received are not examined in detail at the time they are received. Cases would later be selected for audit based on risk assessment. A system of universal Self Assessment can not be successful without an efficient audit process for which record keeping by taxpayer is necessary. Record keeping rules and guidelines on record keeping requirements in line with the strategy to implement the new Income Tax Law an structure have been issued by CBR. The record keeping requirements have been kept in simple and easy to ensure that taxpayers are not burdened. The exercise will also help to promote the culture of documentation in the economy. The use of risk assessment methodology will be a key process in enabling the CBR to achieve strategic aim of the risks to be addressed which would include taxpayer attitude, systems with the tax department, tax legally due but not paid ( or delayed ) etc. The identification of the risk assessment in the new system is likely to focus on the examination of new information through survey or liaison with national data bases, banking system, stock exchanges and other financial institutions.

The concept off Audit emanates from provision of Section 177 which empowers the Commissioner to select any person for an Audit having regards to : a. b. c. d. the persons history of compliance or non-compliance with the Ordinance. the amount of tax payable by the person. the class of business conducted by he person; and any other matter that the Commissioner considers relevant.

Audit can be performed by any Taxation Officer or the job can be assigned to a firm of Chartered accountants. Audit under Income Tax Ordinance,, 2001does not automatically necessitate the reopening of assessment and making a substituted assessment. Action under section 122 of the Ordinance, for amendment of assessment shall only be initiated if Commissioner acquires definite information from an audit. Definite information includes information on sales or purchases of any goods, receipts of the taxpayers fro services rendered or any other receipts chargeable to tax and on the acquisition, possession or disposal of any money, asset, valuable articles or investments made or expenditures incurred b the tax payer. There may be various types of audits, namely: a) Refund Audits. b) Issue Oriented Audits (arising from complaints, information, other audits or investigative leads ) c) Comprehensive Audits. d) Tax Fraud Investigations e) Withholding Audits. The movement from assessment to audit is a considerable challenge. This would require devising Audit Methods, Procedures of Audit Selection and Audit Planning.

Best judgement assessment.- Section 121 states that (1) Where a person fails to (a) furnish a return of income as required by a notice under sub-section (3) or sub-section (4) of section 114; or furnish a return as required under section 143 or section 144; or (c) (d) furnish the statement as required under section 116; or

(b)

produce before the Commissioner, or any person employed by a firm of chartered accountants under section 177, accounts, documents and records required to be maintained under section 174, or any other relevant document or evidence that may be required by him for the purpose of making assessment of income and determination of tax due thereon,

the Commissioner may, based on any available information or material and to the best of his judgment, make an assessment of the taxable income of the person and the tax due thereon. (2) As soon as possible after making an assessment under this section, the Commissioner shall issue the assessment order to the taxpayer stating(a) (b) (c) (d) the taxable income; the amount of tax due; the amount of tax paid, if any; and

the time, place and manner of appealing the assessment order.

(3) An assessment order under this section shall only be issued within five years after the end of the tax year or the income year to which it relates.

Section 121 Explained

This newly substituted section of the Ordinance empowers the Commissioner to make a best-judgment assessment on the basis of available information or material for the purpose of determining taxable income of the person and the amount of tax due for payment. Sub-section (1) allows the above mentioned best-judgment assessment only where the person proceeded against has failed to : a. furnish return of income, despite the notice issued by the Commissioner under section 114 (3) especially where a taxpayer has died, become bankrupt, gone into liquidation or is about to leave Pakistan permanently;

b. furnish return of income, despite the notice issued by the Commissioner under section 114 (4) requiring complete return with all the prescribed annexures, statement, document, etc. c. furnish a return under section 143 or 144 showing receipt of nonresident persons business of operating ships or aircrafts, as owner or charterer, or d. furnish the wealth statement under section 116.

Such a best-judgment assessment can also be made where the person does not produce, for audit, accounts, documents or records requiring to be maintained under section 174 or any other relevant document or evidence required by the Commissioner or the authorized auditor under section 177. Sub-section (2) is designed to expedite finalization of proceedings under this section and makes it obligatory on the part of the Commissioner to issue the best judgment order as soon as possible after making assessment of the taxable income and tax liability, giving credit for the tax, if any, already paid by the taxpayer. The Commissioner is also required to state the time place and manner of appealing the assessment order. Sub-section (3) places limitation of the issuance of any best-judgment assessment order. This can only be issued by the Commissioner within a period of five years after the end of the relevant tax year or income year, as the case may be. This section has greatly improved section 63 and 64 of 1979 Ordinance.

Amendment of assessments:
Section 122 of the Ordinance, states as : (1) Subject to this section, the Commissioner may amend an assessment order treated as issued under section 120 or issued under section 121, or issued under section 59, 59A, 62, 63 or 65 of the repealed Ordinance, by making such alterations or additions as the Commissioner considers necessary. (2) An assessment order shall only be amended under subsection (1) within five years after the Commissioner has issued or is treated as having issued the assessment order on the taxpayer.

(3) Where a taxpayer furnishes a revised return under sub-section (6) of section 114 : (a) the Commissioner shall be treated as having made an amended assessment of the taxable income and tax payable thereon as set out in the revised return; and

(b)

the taxpayers revised return shall be taken for all purposes of this Ordinance to be an amended assessment order issued to the taxpayer by the Commissioner on the day on which the revised return was furnished.

(4) Where an assessment order (hereinafter referred to as the original assessment) has been amended under sub-section (1) or (3), the Commissioner may further amend, as many times as may be necessary, the original assessment within the later of (a) five years after the Commissioner has issued or is treated as having issued the original assessment order to the taxpayer; or one year after the Commissioner has issued or is treated as having issued the amended assessment order to the taxpayer.

(b)

[(4A) In respect of an assessment made under the repealed Ordinance, nothing contained in sub-section (2) or, as the case may be, sub-section (4) shall be so construed as to have extended or curtailed the time limit specified in section 65 of the aforesaid Ordinance in respect of an assessment order passed under that section and the time-limit specified in that section shall apply accordingly. (5) An assessment order in respect of tax year, or an assessment year, shall only be amended under sub-section (1) and an amended assessment for that year shall only be further amended under sub-section (4) where, on the basis of definite information acquired from an audit or otherwise, the Commissioner is satisfied that (i) (ii) any income chargeable to tax has escaped assessment; or total income has been under-assessed, or assessed at too low a rate, or has been the subject of excessive relief or refund; or

(iii) any amount under a head of income has been mis-classified. (5A) Subject to sub-section (9), the Commissioner may amend, or further amend, an assessment order, if he considers that the assessment order is erroneous in so far it is prejudicial to the interest of revenue. (5B) Any amended assessment order under sub-section (5A) may be passed within the time-limit specified in sub-section (2) or sub-section (4), as the case may be (6) As soon as possible after making an amended assessment under subsection (1), sub-section 4 or sub-section (5A), the Commissioner shall issue an amended assessment order to the taxpayer stating (a) (b) the amended taxable income of the taxpayer; the amended amount of tax due;

(c) (d)

the amount of tax paid, if any; and the time, place, and manner of appealing the amended assessment.

(7) An amended assessment order shall be treated in all respects as an assessment order for the purposes of this Ordinance, other than for the purposes of subsection (1). (8) For the purposes of this section, definite information includes information on sales or purchases of any goods made by the taxpayer, receipts of the taxpayer from services rendered or any other receipts that may be chargeable to tax under this Ordinance, and on the acquisition, possession or disposal of any money, asset, valuable article or investment made or expenditure incurred by the taxpayer. (9) No assessment shall be amended, or further amended, under this section unless the taxpayer has been provided with an opportunity of being heard.

Section 122 Explained

This section empowers the Commissioner to make all necessary amendments in various types of assessment orders, mainly to safeguard the interest of tax revenue. The Commissioners powers to make amendments not only apply to taxpayers selfassessment under section 120 but also affect the Commissioners own best-judgment assessment under 121. Besides, not only the original assessment can be amended, but the amended assessment can be further amended as many times as may be necessary. Similarly, assessment orders issued under the specified sections of the 1979 Ordinance can be amended by the Commissioner. Any assessment order which is erroneous and prejudicial to the interest of revenue can be amended by the Commissioner. While amending an assessment order, the Commissioner can make all alternations or additions as he may consider necessary to work out correct amount of tax payable by the taxpayer on the basis of amended assessment of taxable income.

The power to amend an assessment is, however, not entirely unlimited. First, subsection (5) lays down the general rule that an assessment order can only be amended if the Commissioner requires definite information to satisfy him that the income chargeable to tax had escaped assessment or the total income was under-assessed. Definite information about an assessment having been made at a low rate of tax or subjected to excessive relief or refund to the taxpayer may also form the basis for Commissioners satisfaction; so will be the definite information that some amount under a head of income was misclassified. Definite information may be acquired by the Commissioner as a result of an audit, or form any other source ( such as third party information ) or investigating activity of the Commissioner but must be specific in nature according to the definition given in subsection (8). However, this general rule would not apply where the Commissioner considers that an assessment order is erroneous in so far as it is prejudicial to the

interest of revenue. In any case, the Commissioner can not make an amendment in any assessment order unless the tax payer has been provided opportunity of being heard. Secondly, an assessment order can only be amended under sub-section (1) within five years after the Commissioner has issued or treated to have issued the original assessment order to the taxpayer or one year after the issuance of the amended assessment order ( whichever is the later ). In other words, there would be maximum period of six years from the date of original assessment under this Ordinance. For example, if a return is filed by the due date on 31-12-2003 or a best judgment assessment is made on 31-12-2003 and an assessment is made on 20-12-2006 ( within the prescribed period of 5 years expiring on 31-12-2008 a further amendment can be made on or before 31-12-2008. However, if the above return was revised on 30-092008, the revised return is considered to be amended assessment ( first assessment ) and a further amendment can then be made up to 30-09-2009. The newly inserted sub-section (4A), however, clarifies that where an assessment was made under any section of the 1979 Ordinance, it can only be amended under this section within the time limit specified in section 65 of the 1979 Ordinance. In such a case, notice for the proposed amendment can be issued within five years from the end of the assessment year in which total income was first assessable. After issuing such notice, amended assessment order can be made within one year from the end of the financial year in which the notice was served. As soon as possible after making an amended assessment, the Commissioner must issue an amended assessment order to the taxpayer in accordance with sub-section (6). An assessment order is treated as an assessment order for all purposes of the Ordinance. This section has enlarged the scope of sections 65 and 66A of the 1979 Ordinance. Note. .Concealment of income or furnishing of inaccurate particulars of such income entails penalty under section 184 which can be equal to the amount of tax sought to be evaded. However, concealment of income or deliberate furnishing of inaccurate particulars of income is no longer a criminal offence which was punishable under section 119 of the 1979 Ordinance with fine or imprisonment up to 5 years (or both).

CRITICAL ANALYSIS OF SECTION 122

SECTIONS 65 & 66-A OF THE INCOME TAX ORDINANCE OF 1979 VS SECTION 122 OF THE INCOME TAX ORDINANCE, 2001.. The Cardinal and prime function to gather and impose Tax by a State is to build funds in an efficient, proficient, skilful, impartial, even-handed, balanced and equitable manner. In present times, its objective is not only to raise the revenue but to achieve the other economic goals, the tax system should be wisely, prudently, judiciously and saliently codified and administered. In the beginning, we embraced Income Tax Act, 1922, which was modified to Income Tax Ordinance, 1979, which was again converted into Income Tax Ordinance, 2001. The final and present reformed shape was got done with the aim of simplicity, clarity and ease, To achieve this purpose, an author was chosen from Australia who could not satisfy the aim and the idea. Every on here criticized the new statute, disregarding this aspect that such composition from an exotic person may incorporate many flaws, faults and imperfections, and it is quiet natural, logical and common to have such inherited defects and for this very reason about 216 amendments were made in 2002 and 2003. There were two important provisions of Additional Assessment under section 65 and Power of Inspecting Additional Commissioner to revise D.C. order under section 66-A under the income Tax Ordinance, 1979, which were attempted to be assembled and congregated under one ceiling or vault of section 122 of the Income Tax Ordinance 2001 with the epithet and title of Amendment of Assessments. Return filed under section 114, is treated as assessment order under section 120 but as per section 122(3), in case the revised return is furnished under section, 114 (6) with in the period of 5 years of the filing of the original return, the revised return will be treated as amended order. It has made the things complicated and complex. The power to amend the Assessment Order under sections 120 and 121 or 2001 ordinance and Sections 59, 59A, 62, 63 & 65 of late Ordinance, and to further amend it, is mostly criticized but this authority was impliedly accessible in old Income Tax Ordinance 1979. The main difficulty and risk is with the abuse of the discretionary power which does not regard the sanctity of past and closed transactions, which is a vested right of the Tax payers. This is obvious infringement and transgression from due process of law and violation of the basic norms of justice. Although about 10 amendments were made in this provision through Finance Ordinance, 2002, Finance Act, 2003 and some SROs under section 240 but still the provision does not adhere to the same features as in old sections 65 and 66-A of the repealed Ordinance. First remonstrance is related to its retrospective operation and office Memorandum dated 11-11-2003 of Law Division, conveying the decision of the President of Pakistan on the representation of the C.B.R, against the order of FTO is relied, which said that the 2001 Ordinance, which came into force on 01-07-2002, does not apply to the Assessment Order for assessment year 2000-2001. The C.B.R has not accepted this verdict and had its own interpretation. Although the pending proceedings under

repealed Ordinance are covered by sub-section (4) of section 239 but fresh notices under section 65 & 66A of late Ordinance are not covered by the saving provision. The substituted subsection (5) and newly inserted subsection (5-A) of section 122 still do not sanction the issuance of notice against Order already completed prior to 1 st July 2002, and one can rely on 1984 PTD ( Trib. ) 147. Art. 264 of the Constitution and section 6 of the General Clauses Act, 1897 evidently provide that a repealing statute cannot refresh any provision of the repealed Law unless a different intention emerges. Section 239 of the new Ordinance does not resist it. It is entrenched principal of law that the past and closed transactions cannot be disrupted or pestered unless permitted by the Law. The Apex Court of Pakistan strongly disapproved the act of disturbing past and closed transactions vide PLD 1969 SC 322. The present sections 122(5), both have laid down some what similar situations, as were present for sections 65 and 66A of the late Ordinance. These provisions cannot be invoked for the Assessment Order being erroneous in so far it is prejudicial to the interest of revenue, by merely alleging. Honble Lahore High Court also emphasized the sanctity of the finalized assessments which cannot be interrupted and roused on mere change, of view, gossips, conjectures or surmises and in the light manner as is being exercised by the taxation officers these days through issuing notice under section 122 indiscriminately and irresponsibly vide its reported judgment 2002 PTD 808. The apex Court has also repeatedly endorsed the view that mere conflict and divergence of opinion cannot give rise to review of the judgment as held in 1993 SCMR 1232. Section 122 (5A) is pari- materia to Sec 66(A) of the late Ordinance, which was inserted through Finance Act 2003, is affective from 1 st July 2003. This provision being procedural in nature cannot be applied retrospectively. The Lahore High Court decision reported as 2001 PTD 1525 very well stands by this view point. The concept of prior approval of IAC in writing to initiate action under section 65 has been eliminated, due to the new idea of every thing to be done with the delegation of power by the Commissioner. The concept of reopening and revising of an assessment order has now been termed as amendment of order under section 122 and is blend of sections 65 and 66-A of the late Ordinance and the power of amendment and further amendment has been given explicitly, whereas it was given in previous Law as impliedly. The only difference lies in limitation that the first amendment has to be made with in 5 years after the issuance of an assessment order and re-amendment with in one year after the issuance of amendment order. The conditions of definite information have now been defined in sub-section (8) of section 122 which may be gathered through audit under section 177 and otherwise, This audit under section-177 has been declared void vide Lahore High Court decision reported as 2005 PTD 152 for the Tax year 2003. Although the department seems aggrieved of this decision, whereas it is the conspicuous fault of it as they selected the return for audit which became non existent under section 120 (I) (b) instead of selection of the person for audit. The definite information acquired under section 122 (8) has been used instead of definite information has come into the possession under section 65 of late Ordinance. This may have some implications. Perhaps it has been tried to eliminate new and fresh definite information. The action under sub-section (5) is restricted to the Commissioner if he is satisfied that there is

escaped assessment, under assessment or assessed at too low a rate, subject of excessive relief or refund, and misclassified head which is now the new amplification. The power of Commissioner to amend or further amend an assessment order under subsection (5A) is restricted to two situations that the order being erroneous in so far as prejudicial to the interest of revenue, which has been added through Finance Act, 2003, which is not applicable for earlier period. Further more the new limitation for re-amending the order is not applicable to section 65. The eccentric demeanor is in regard to the due process of law. Once the Commissioner delegates his power to the taxation officer under section 210 to make the assessment, than he avers under section 122 that the delegated officer applied the law incorrectly, which in fact is his own order as per section III. In this way he becomes the judge in his own cause. Revision by the Commissioner. Section 122A of the Ordinance, empowers Commissioner of Income Tax for revision. The section states as : (1) The Commissioner may , suo moto call for the record of any proceeding under this Ordinance or under the repealed Ordinance in which an order has been passed by any taxation officer other than the Commissioner (Appeals). (2) Subject to sub-section (3), where, after making such inquiry as is necessary, Commissioner considers that the order requires revision, the Commissioner may make such revision to the order as the Commissioner deems fit. (3) An order under sub-section (2) shall not be prejudicial to the person to whom the order relates. (4) (a) The Commissioner shall not revise any order under sub-section (2) ifan appeal against the order lies to the Commissioner (Appeals) or to the Appellate Tribunal, the time within which such appeal may be made has not expired; or the order is pending in appeal before the Commissioner (Appeals) or has been made the subject of an appeal to the Appellate Tribunal.]

(b)

Section 122 A explained.

This section empowers the Commissioner to revise any order passed by his subordinate taxation officer if he considers it appropriate to do so, after calling for the record of proceedings relating to that order and making necessary inquiry to arrive at proper decision for revision of the order. However, the Commissioner is not permitted to revise any such order which may be prejudicial to the person to whom the order relates or : a. if the time which an appeal against the order could be made to the Commissioner ( Appeals ) or the appellate Tribunal has not expired; or

b. if the order is already pending in appeal before the Commissioner ( Appeals ) or the Appellate Tribunal. This section has modified section 138 of the 1979 Ordinance which had provided for revision of orders by the Commissioner, either on his own motion, or on an application made by the aggrieved assessee on payment of tax payable with the return of income, the amount of required fee and within the time limit specified in that section. Although an aggrieved taxpayer is not allowed to invoke jurisdiction of the Commissioner under this section, as a matter of right, there seems no bar on approaching the Commissioner to suo-moto call for the record and revise a patently wrong and prejudicial order against which an appeal may not be preferred. Similarly, any other competent authority may suggest to the Commissioner to revise such an order passed by his subordinate taxation officer.

Provisional assessment in certain cases.

Section 123 of the Ordinance states : (1) Where a concealed asset of any person is impounded by any department or agency of the Federal Government or a Provincial Government, the Commissioner may, at any time before issuing any assessment order under section 121 or any amended assessment order under section 122, issue to the person a provisional assessment order or provisional amended assessment order, as the case may be, for the last completed tax year of the person taking into account the concealed asset. (2) The Commissioner shall finalise a provisional assessment order or a provisional amended assessment order as soon as practicable (3) In this section, concealed asset means any property or asset which, in the opinion of the Commissioner, was acquired from any income subject to tax under this Ordinance.

Section 123 Explained.

This section gives the Commissioner the authority to make a provisional assessment when a concealed asset is impounded by a government department or agency. A provisional assessment order applies to the last completed tax year of the person whose concealed asset is impounded. Where an assessment order has already been issued under section 121 or treated as issued under section 120 for that year, the provisional assessment is treated as a provisional amended assessment order of that assessment order. The term concealed asset means an asset that , in the Commissioners opinion , was acquired using income subject to tax. The existence of a concealed asset suggests that the owner of the asset may also be under-reporting income or not declaring any income subject to tax under the Ordinance. The section requires the Commissioner to finalize the provisional or amended assessment order as soon as practicable

This section substitutes section 60A of the 1979 Ordinance.

Assessment giving effect to an order.

Section 124 of the Ordinance states (1) Except where sub-section (2) applies, where, in consequence of, or to give effect to, any finding or direction in any order made under Part III of this Chapter by the Commissioner (Appeals), Appellate Tribunal, High Court, or Supreme Court an assessment order or amended assessment order is to be issued to any person, the Commissioner shall issue the order within two years from the end of the financial year in which the order of the Commissioner (Appeals), Appellate Tribunal, High Court or Supreme Court, as the case may be, was served on the Commissioner. (2) Where, by an order made under Part III of this Chapter by the Commissioner (Appeals), Appellate Tribunal, High Court, or Supreme Court, an assessment order is set aside wholly or partly, and the Commissioner is directed to make a new assessment order, the Commissioner shall make the new order within one year from the end of the financial year in which the Commissioner is served with the order. Provided that limitation under this sub-section shall not apply, if an appeal or reference has been preferred, against the order setting aside the assessment, passed by a Commissioner (Appeals), Appellate Tribunal or a High Court. (3) Where an assessment order has been set aside or modified, the proceedings may commence from the stage next preceding the stage at which such setting aside or modification took place and nothing contained in this Ordinance shall render necessary the re-issue of any notice which had already been issued or the re-furnishing or re-filing of any return, statement, or other particulars which had already been furnished or filed. (4) Where direct relief is provided in an order under section 129 or 132, the Commissioner shall issue appeal effect orders within two months of the date the Commissioner is served with the order. (5) Where, by any order referred to in sub-section (1), any income is excluded (a) from the computation of the taxable income of a taxpayer for any year and held to be included in the computation of the taxable income of the taxpayer for another year; or from the computation of the taxable income of one taxpayer and held to be included in the computation of the taxable income of another taxpayer,

(b)

the assessment or amended assessment relating to that other tax year or other taxpayer, as the case may be, shall be treated as an assessment or amended assessment to be made in consequence of, or to give effect to, a finding or direction contained in such order.

(6) Nothing in this Part shall prevent the issuing of an assessment order or an amended assessment order to give effect to an order made under Part III of this Chapter by the Commissioner (Appeals), Appellate Tribunal, High Court, or Supreme Court. (7) The provisions of this section shall in like manner apply to any order issued by any High Court or the Supreme Court in exercise of original or appellate jurisdiction.

SECTION 124 EXPLAINED.

This section provides time limit for the issuance of an assessment order or amended assessment order in consequence of a Supreme Court or Tribunals appellate order or an order passed in appeal by Commissioner ( Appeals ) Where direct relief is provided in appeal by Commissioner ( Appeal) or Appellate Tribunal, the Commissioner is required to issue appeal effect order within two months of the date he is severed with the appellate order. Where an assessment is set aside, wholly or partly, and the Commissioner is directed by the appellate authorities to frame a new assessment order, he shall issue the new order within one year from the end of the financial year in which he is served with the appellate order. The time period of two years will apply when in consequence of any finding or direction given by Commissioner ( Appeals ) Appellate Tribunal , High Court or Supreme Court, the Commissioner has to give effect and issue an assessment order or amended assessment order. Where as assessment order is set-aside or modified in appeal, it would not be necessary for the Commissioner to re-issue an new notice or require refurnishing of any return, statement or particulars already filed by the tax payer. He can commence further proceedings from the last stage before the assessment order was set aside or modified in appeal. This section is a modified version of section 66 of the 1979 Ordinance. However, it is further provided that the provisions of section 124 shall in the like manner apply to any order issued by a High Court or the Supreme Court in exercise of its original or appellate jurisdiction.

Powers of tax authorities to modify orders, etc.

Section 124A of the Ordinance states that : (1) Where a question of law has been decided by a High Court or the Appellate Tribunal in the case of a taxpayer, on or after first day of July 2002, the Commissioner may, notwithstanding that he has preferred an appeal against the decision of the High Court or made an application for reference against the order of the Appellate Tribunal,

as the case may be, follow the said decision in the case of the said taxpayer in so far as it applies to said question of law arising in any assessment pending before the Commissioner until the decision of the High Court or of the Appellate Tribunal is reversed or modified. (2) In case the decision of High Court or the Appellate Tribunal, referred to in sub-section (1), is reversed or modified, the Commissioner may, notwithstanding the expiry of period of limitation prescribed for making any assessment or order, within a period of one year from the date of receipt of decision, modify the assessment or order in which the said decision was applied so that it conforms to the final decision.

Section 124-A Explained.

This section provides that if any law point is decided at the level of Appellate Tribunal or High Court, after 1 st July, 2002, in the tax payers own case and an appeal has been filed by the Commissioner in the next forum, the Commissioner may, for the time being, follow the appellate decision on the question of law and accordingly finalize the pending proceedings in the case of same tax payer. However, if such decision of Appellate Tribunal or High Court is reversed or modified, the final order can again be made by the Commissioner in conformity with the final decision within one year from the date of its receipt.

Assessment in relation to disputed property.Section 125 of the Ordinance states that where the ownership of any property the income from which is chargeable to tax under this Ordinance is in dispute in any Civil Court in Pakistan, an assessment order or amended assessment order in respect of such income may be issued at any time within one year after the end of the financial year in which the decision of the Court is made.

Section 125 Explained

A dispute in a Civil Court over the ownership of income-producing property may prevent determination of tax liability arising from such income until the ownership dispute if finally resolved. By the time the ownership of property is determined by the Court, the Commissioner may not have the time prescribed for making an assessment order or amended assessment order. This section overcomes the limitation period and allows the assessment to be made within one year after the end of the financial year in which the Courts decision is made. This section further clarifies section 66(3) of the 1979 Ordinance.

AUDIT
34

[177. Audit.- (1) The Central Board of Revenue, may lay down criteria for selection of any person for an audit of persons income tax affairs, by the Commissioner. (2) The Commissioner shall select a person for audit in accordance with the criteria laid down by the Central Board of Revenue under sub-section (1). (3) The Central Board of Revenue shall keep the criteria confidential.

(4) In addition to the selection referred to in sub-section (2), the Commissioner may also select a person for an audit of the persons income tax affairs having regard to (a) the persons history of compliance or non-compliance with this Ordinance; (b) (c) (d) the amount of tax payable by the person; the class of business conducted by the person; and

any other matter which in the opinion of Commissioner is material for determination of correct income.

35 (5) [After] selection of a person for audit under sub-section (2) or (4), the Commissioner shall conduct an audit of the income tax affairs (including examination of accounts and records, enquiry into expenditure, assets and liabilities) of that 36 [person].

(6) After completion of the audit under sub-section (5) or sub-section (8), the Commissioner may, if considered necessary, after obtaining taxpayers explanation
34

35 36

Substituted by the Finance Act, 2004. The substituted section 177 read as follows: 177. Audit.- (1) The Commissioner may select any person for an audit of the persons income tax affairs having regard to (a) the persons history of compliance or non-compliance with this Ordinance; (b) the amount of tax payable by the person; (c) the class of business conducted by the person; and (d) any other matter that the Commissioner considers relevant. A [(1A) After selection of a person for audit under sub-section (1), the Commissioner shall conduct an audit of the income tax affairs (including examination of accounts and records, enquiry into expenditure, assets and liabilities) of that person.] B [(1B) After completion of the audit under sub-section (1A) or sub-section (3), the Commissioner may, if considered necessary, after obtaining taxpayers explanation on all the issues raised in the audit, amend the assessment under sub-section (1) or sub-section (4) of section 122, as the case may be.] (2) The fact that a person has been audited in a year shall not preclude the person from being audited again in the next and following years where there are reasonable grounds for such audits, particularly having regard to the factors in subsection (1). (3) The Central Board of Revenue may appoint a firm of Chartered Accountants as defined under the Chartered Accountants Ordinance, 1961 (X of 1961), to conduct an audit of the income tax affairs of any person and the scope of such audit shall be as determined by the Central Board of Revenue on a case by case basis. (4) Any person employed by a firm referred to in sub-section (3) may be authorised by the Commissioner, in writing, to exercise the powers in sections 175 and 176 for the purposes of C[conducting] an audit under that subsection. A Earlier sub-section (1A) was inserted by the Finance Act, 2002. B Earlier sub-section (1B) was inserted by the Finance Act, 2003. C Earlier substituted for the words the conduct by the Finance Act, 2002. The word after substituted by the Finance Act, 2005. The word persons substituted by the Finance Act, 2005.

on all the issues raised in the audit, amend the assessment under sub-section (1) or subsection (4) of section 122, as the case may be. (7) The fact that a person has been audited in a year shall not preclude the person from being audited again in the next and following years where there are reasonable grounds for such audits, particularly having regard to the factors in subsection (4). (8) The Central Board of Revenue may appoint a firm of Chartered Accountants as defined under the Chartered Accountants Ordinance, 1961 (X of 1961), to conduct an audit of the income tax affairs of any person and the scope of such audit shall be as determined by the Central Board of Revenue on a case to case basis. (9) Any person employed by a firm referred to in sub-section (8) may be authorized by the Commissioner, in writing, to exercise the powers in sections 175 and 176 for the purposes of conducting an audit under that sub-section.]

Comments :
The purpose of audit of a tax return is to study the income tax affairs of a tax payer. Audit does not imply the definite increase of income. If , in case, as a result of audit, nothing adverse is found, the audit proceedings are dropped, and return remains to be accepted under section 120 ( USAS ). The concept of Universal Self Assessment Scheme is based on the concept of revolutionary vision of trusting the declaration of the tax payers on face value. The idea behind this is o increase the Voluntary Compliance by the tax payers. The Universal Self Assessment Scheme has gained much popularity among the business communitywhere government is benefiting form more member of tax returns and increase in taxrevenue. The old procedure of issuance of separate notices has been done away with.

INCOME TAXATION AND NON DOCUMENTED ECONOMY

BUSINESS CULTURE.
In most of the developing countries, the economy is mostly cash based i.e the transactions are mostly in cash. In such an atmosphere, it not only easy but also safe to conceal the transactions. This feature is one of the most important causes of evasion in developing countries. As a result, two types of economies come into being-the formal economy and the informal economy. The size of each economy depends upon the nature of evasion in the economy and the period for which it has been in practice. In Pakistan even the conservative estimates put the size of the informal economy equal to the formal one. Thus, most of the wealthy people in such economies have two types of wealth- the declared or taxed money and the undeclared or untaxed money. Untaxed money There are three ways this untaxed money is applied. It may be utilized in luxurious living, entertainment, foreign travels etc. It may be applied in creation of non-business assets i.e luxurious houses, fancy cars, jewelry, foreign goods etc. And finally, it may be used to create business assets. It is this money and the transactions with this money that will be discussed in this chapter. Untaxed money applied in business.. One constraint of untaxed money applied in business is that since it is kept outside the books, the transactions made with it, therefore, have to be kept out of the books. That is not all : very often, where the businessman does not want to declare his income earned even with the money in the books, he keeps such transactions also out of books. Unrecorded transactionThus, unrecorded transactions fall into two categoriesbusiness conducted with untaxed money and those conducted with the declared capital. Understatement of revenues.. Sometimes the transactions with the declared capital are recorded but the full profit on those is not fully reported. This is done by either understating the receipts or by inflating the cost of expenses. Other methods. There are many other methods of evasion such as diversion of income, showing taxable income as exempt income etc. However in this chapter the entire discussion would be made on unrecorded and under-recorded transaction.

CAUSES OF EVASION:
Psychological. Income tax is a direct tax. It goes out of the pocket of the taxpayer and it goes long after he has earned it. ( By the time of payment of tax, he may have consumed it ). He can not pass this burden to any one. He has to pay it himself and no one would like to part with his hard-earned money, if he can help it. HistoricalMost of the developing countries were colonies of European powers. Their independence was preceded by a struggle for liberation from the foreign rulers. In this struggle, people were politically taught to disobey the

laws to fail the foreign government. Not paying the taxes was one of such measures. Habits are easy to form but difficult to give up especially when these are beneficial for ones own interest. Religious.. In developing countries, religion plays a very important role. This gives the religious leaders a great influence in the society. In Pakistan, the religious leaders who thrive on the charity of the rich have been of the view that the taxes are the legacy of the colonial days and it is no sin not to pay taxes. This provides a religious approval to evasion and provides a strong justification for ones reluctance to pay taxes. Lack of tax educationIn developing countries, the rate of literacy is rather low and there is no tax education at all. For an uneducated person, it is difficult to understand the need for payment of taxes. No efforts are made, either by the government or by any one in the private sector, to explain to the people the reason for paying taxes. Taxes are treated as punishment. Lack of civic sensePeople in the developing world also lack civic sense. Laws have no sanctity in their eyes. People are all the time thinking about their rights and privileges. Little attention is paid to the obligations. In this frame of mind, parting with money becomes much more difficult. Lack of social taboos.. There is no discouragement from society against violations of law. On the other hand, obedience of law is treated as sign of weakness and those who violate it, are regarded as heroes. In Pakistan a large number of taxpayers who are regularly paying tax, proudly claim before their peers that they are not paying any tax. Cash economyIn an economy which is predominantly in cash, it is not only easy but also safe to conceal income. In such economies, evasion has very conducive atmosphere to thrive. It, therefore, spreads very rapidly. Commercial compulsionWhere a producer or importer hides his transactions, he forces the wholesaler to do the same. The retailers down the line have no choice but to keep those transaction hidden. In order to keep his expenses low, the consumers, too is interested in keeping the transaction hidden. In this culture, it becomes impossible for any one to keep his records straight. Even the honest are forced to follow the suit. Complexity of law.. Since income tax law deals with commercial transactions and has to cover a very wide variety of transactions, it has to be complex. This complexity provides ample justification for the ordinary people to evade it. Tedious procedure : If the law is difficult, the procedure of assessment is even more complex. People would therefore, like to stay away from the tax net as long as they possibly can. High Rates of TaxesAnd last, though not the least, the high rate of tax also provides justification for evading it. Low rates may not promote payment of taxes but high rates are definitely ill-conducive for tax compliance.

APPLICATION OF UNTAXED MONEY.

The untaxed money can be applied in three ways . It may be used to create business assets; it may be applied in the acquisition of non-business assets or finally it may be consumed. Business assets.. Untaxed money in business could be in any of the following forms : a) Un-declared capital assets e.g business premises, factory building, machinery etc. b) Un-declared stock-in-trade, c) Un-declared trade receivables. d) Un-declared bank accounts. Business assets. It may appear in any of the following forms : a) b) c) d) e) f) real estate i.e residential houses, plots, agricultural land. Investment in shares or securities, bonds etc. Jewellery, gold, diamond, precious metals etc. Deposits in banks Foreign exchange in cash or in bank abroad. Symbols of affluence i.e expensive cars, household and personal effects.

Consumption. The third application of untaxed money is in ostentatious consumption. Luxurious living, wining & dining, foreign travels, expensive schools for children ( including foreign education ), membership of expensive clubs etc. consume a large portion of untaxed income.

TYPES OF EVASION.
Non-reporting. In developing countries, most of people would like to remain outside the tax net if they can. Many a person with income exceeding the maximum amount not liable to tax just do not report at all. Once a person fails to file the return for the first year, he often does not file for the next year for the fear that the Department would ask for the earlier year. He then never files. Under-reporting. This is the largest category. Most of the people do file returns but they do not report their income fully. They achieve this end by either omitting one or more sources of income, if they have income from more than one source. Sometimes they report all the sources but understate receipts. Sometimes they report their receipts correctly but claim expenses they have not incurred or they inflate their expenses. Some brave ones do all these things. Misreporting. Sometime, the receipt of money is declared but is declared in the form of exempt income, an inheritance of gift etc. Sometimes, receipts are correctly declared but personal expenses are claimed as business expenses.

Diversion of income. Sometime income is of a nature that it can not be hidden. An attempt is then made to divert it to another person so that the income is divided and the incidence of tax is reduced. Bogus partnership, dummy agencies and outlets are examples of such diversion.

NO ACCOUNT CASES.
Persons deriving income from salary, property, interest, interest on securities, dividends, leasing of land etc. ordinarily do not maintain accounts. Although persons engaged in business are expected to maintain accounts, yet often in the case of small business, they do not. And one businessman gets used to it, he does not still maintain accounts even if his business expends substantially. Sometimes, persons are legally required to maintain accounts and if they do not, they are liable to penalties. But even then, the job of the tax auditor is not over. He still has to determine his income. One way to assess a no-account case is the net-worth method. This method is general and relevant not only to no-account cases but also to account cases. It is applicable to individuals deriving income from whatever source. The other methods are incomespecific, as earners of each type of income employ different types of tricks to conceal their income.

NET WORTH METHOD

Income earned by any person is applied in two main ways. It is either consumed or is used for creating assets. The assets may be income earning i.e business assets ( investments ) or non-income earning ( personal or private ) assets such as household effects, jewellery, cars, etc. Thus, if no one can ascertain his income. In the net-worth method , we obtain the wealth statement of the individual on a particular date and then comparing it with a similar wealth statement of an earlier date, we work out the variation ( increase or decrease in net wealth ) and then we ascertain his expenses for the intervening period to determine his annual income. Thus, for using net-worth method, we require two statement, the wealth statement and the expenditure statement.

WEALTH STATEMENT.
The wealth statement is a statement of assets and liabilities of an individual on a particular date. For income tax purpose, the statement is obtained on the last day of the taxpayers income period. Income tax law usually provides for the filing of this statement either voluntarily or on a notice by the Department. Rules usually prescribe the form of such statement. Even if the law does not provide for this statement and /or the rules do not prescribe its form, it can still be requisitioned as a part of the assessment proceedings. The value of assets mentioned in the statement is historical cost i. the amount the tax payer paid when he purchased the asset. The statement is somewhat on the following lines :

Wealth Statement.
Business capital Capital in proprietorships : Names and addresses Capital in firms etc. Name and addresses. Immovable property. ( including agriculture and land ) Identification NO. Cost including legal charges. Investments ( at cost ) Stocks and shares Debentures and other securities. Mortgages. Unsecured loans Others Motor vehicle ( at cost ) Registration No. make and model Jewellery ( at cost ) Weight and description. Household effects ( at cost ) Furniture and fittings. Electric appliances Electronics Others. Bank Accouts. Savings : Bank , Branch and NO. Current, Bank , Branch and NO Other Bank Deposits, Bank and Branh and No. Post Office account and deposits. Other deposits, Amounts and details. Life Insurance ( premiums paid to date) Policy No. and sum received. Other assets ( at cost ) Assets in the name of dependants. Total Assets.

Less Non-buniness liabilities. Mortgages on property. Unsecured loans Bank overdrafts. Other debts. Net worth

Each of the assets and liabilities appearing in the statement has to be carefully examined.

EXPENDITURE STATEMENT.
The other important element of the net-worth-method is the expenditure statement. It contains non-business or personal expenses. It ought to seek the following details :

House rent ( address and amount ) Electricity, telephone and gas charges. Bills to be produced. Vehicle running expenses ( including repairs ) Salaries of domestic servants. Name, jobs and salaries. Dependants education expenses. Name, school, class and fee etc. Club expenses Name & amount of bills paid. Expenses on marriages of dependants, if any. Foreign travels expenses, if any Self & family passports to be produced Expenses on local travels.. including hotel bills. Entertainment expenses.. including hotel bills, if any. Medical expenses including hotel bills, if any. Gist made, if any.Name and address of the donee and the amount Household expenses ( food and clothing etc ) Number, Names and age of dependents. Any other expenses Detail and amount.. Total Expenses

Net-worth-method is not only useful for No-account cases but also for those individuals who maintain accounts. They too have income which is not recorded and that unrecorded income either goes into consumption or is applied in creation of assets. However, this is only one of the methods of determining true income. We shall explore other methods which sometime prove more useful in various types of No-account Cases.

SALARY CASES.
Salary Certificate.Unless there is an information to the contrary, for the assessment of a salaried person, we normally rely on the certificate of the employer regarding what he receives from him. In the case of government employees or the employees of the government owned corporations, the figures of the salary and perquisites are reliable, yet in the case of private employees, the information, supplied by the employer is usually incorrect. Many perquisites are not reported and sometime even the salary figures supplied are incorrect. A person receiving salary above the taxable limit, ordinarily gets their salary through cheque and, therefore, has to maintain a bank account. Sometime his salary is directly credited by the employer to his bank account. In order to meet any expenditure, such a person has to draw from his bank. It has been found in a large number of cases of such government employees, who are in a position to make money in addition to their salary, do not draw anything from their bank account for months and then suddenly realizing that their bank balance has swollen, they make a big withdrawal. It is, therefore, fruitful to examine the bank account of the employee once in a year.

RENTAL INCOME.
This type of income has quite variety e.g rent of residential house of flat, commercial property, shops, offices, open land, agriculture land, cinemas, factories, etc. The methods employed in each type of property to conceal income are different e.g understatement of rent, disclosure of premises for personal use etc.

INCOME FROM OTHER SOURCES.

Such income can be of many types e.g dividends, interest on securities, interest on bank deposits, income from lending of money etc. Most of the persons earning such income do not maintain accounts. Very often, they are not even assessed and if they are existing tax payers they are not reporting such income. It is, indeed , very difficult to unearth such income. That is why it is said about this type of income that whereas in other cases we try to reach the income through assess, in these cases, we reach the assess through income. If the auditor is dealing with the case of an individual who has not declared his investment in the shares of a company, it is almost impossible to find that information. But if there is a system of collecting of data from the companies about the dividends paid by them during the year, one may reach the persons earning those dividends. Same is the case with money loaned, from where one earns interest. It is the case of the person who is paying interest that we can identify the person receiving it and then reach him to see whether he is reporting his income or not. It is for this reason that tax laws of most of the countries oblige payers of such income to report it to the department. Some laws oblige the payers to deduct tax from such payments. In Pakistan, we first tried the information system. It failed. The information collected never reach the auditor concerned. We then tried, the deduction system, it also failed. The information still could not reach the concerned auditors. Now, we have the system

where under, the tax is deducted at source and is treated as final discharge of tax liability. LOAN AND CREDITS. CASH CREDITS. When a businessman has to make a payment for a purchase or an expense and he finds that there is no cash available in hand or in the bank, he borrows the money. The lender appears in his book as a creditor. However, in many cases, the cash is available with him but it is outside his books ( out of the untaxed profits ). In such cases, the credit is created in the name of a fictitious creditor. Very often, he is a person related to him or a friend who is in a position to explain the possession of money he has advanced e.g a person who has income exempt from tax, a retired person who has received gratuity, provident fund etc, a person whose sons or husband is working in the Middle East and remitting money from there etc. It has repeatedly been held by the Superior Courts that in the case of cash credits, the onus of proof of genuineness of a cash credit lies on the assessee. He has not only to prove the factum of the credit but also that the creditor was in a financial position to lend the money. If a creditor fails in either of the tests, the credit can be adjudicated as fictitious and treated as income of the person in whose books it appeared. It will be appreciated that obtaining of loan by one person from the other involves a series of events i.e the borrower makes a request to the lender, the lender agrees, the borrower then obtain the amount. All these events happen at some time, at some place, in some manner, in presence of someone etc. If the event in fact have taken place , the lender and borrower both would remember all the details. So if the statement of both the person are recorded , in the case of real loans, the statements would tally. If they do not, the loan is fictitious. In one case, a loan of Rs. 2,000,000/- was made by an agriculturist who claimed his income in excess of Rs. 1,00,000 per annum. Enquiries revealed that he had borrowed 5,000,000 from agricultural bank and had defaulted in the payment of installments for the last three years. All his agricultural produce was sold through one commission agent whom the agriculturist owed more than 700,000 and that his account had been in debit for the last many years and interest was being charged on it. PRIVATE LOANS. We are so far dealing with money borrowed by the business of the tax payer. Sometimes he borrows money in his personal capacity for consumption or acquiring personal assets. Such loans appear not in his balance sheet but his wealth statement which is his personal balance sheet. Like business loans, there are also obtained from friends or relatives. These are sometime in cash and sometime through cheques. Sometimes these are genuine and sometimes fictitious. What applies to business loans also applies to these loans and the methods for testing their genuineness or otherwise are the same.

FICTITIOUS OVERHEADS. In all the earlier paragraphs, we discussed mostly either the manufacturing account or trading account. In each type of business, the approach to investigate differed according to the nature of business. Over heads, however, are more or less similar, whatever the business. Income can be understood, not only by suppressing the trading income but also by claiming overheads, not incurred at all or by inflating them. MISREPORTING. Sometimes, income is reported but is claimed to be exempt. If the facts are correctly stated, but the claim is found to be incorrect, it is no offence. All an auditor can do is to deny the exemption. But if the exemption is claimed by misstating the facts, it is evasion and an offence. Sometimes, deduction is claimed in respect of an expenditure, which has in fact been incurred, but is otherwise not admissible. If the facts are correctly stated, all an auditor can do is to disallow it. It does not constitute evasion. However, if an expense was not incurred at all or if incurred for a purpose not admissible for deduction and deduction is claimed on the bases of misstatement of facts, it is an offence. An auditors job is not only to tax the income which is liable to tax and disallow the expenses not admissible but also to take penal action if the facts so warrant.

DIVERSION OF INCOME.
The first desire of the tax evader is to hide his income. If, for any reason, he can not do so, his next anxiety is to fragment it and divert it to someone in his control, i.e his children, dependants, brothers, brother-in-laws etc. This can be achieved in a number of ways :

1. Bogus partnerships. Where an individuals income goes up and with it the rate of tax, very often he brings in partners, who are his children, relatives, or friends. Sometimes , a genuine firm comes into being and sometimes, it is only on paper. In a genuine firm, partner knows that he is partner in the firm, what is his share in profits and also what was his share or profit during the income year. He also knows who are other partners. If he brings in capital, he can explain its source. If he has joined as working partner and not contributed any capital, then he not only works in the business but has some expertise of that business. If he is a sleeping partner then, firstly, the firm was in need of fresh capital and that capital was not available with the existing partners.

2. Business in other name. Very often businessmen starting a new line of business or opening another outlet of the existing business, establish it in the name of a family member or some close relative etc. While examining the case of an individual, it is always beneficial to ask him about the occupation of his children and dependants.

3. Fictitious agencies It is a common practice in the Indo-Pakistan sub-continent that concerns setting up large or running manufacturing concerns appoint firms consisting of the family member of the directors or shareholders as buying or selling agents. In most of these cases, such agencies exist just on papers. 4. Dummy outlets. It has been observed that wholesale and retail selling agents of the multi-national as well as large national companies often setup dummy outlets in the same city and the goods purchased in the name of such dummy outlets are actually sold on the main outlet. 5. Transfer pricing. Multinational companies often transfer the profits of the local subsidiary to a foreign subsidiary set in a tax haven country. The local subsidiary buys the raw material from that foreign subsidiary. The parent company transfers the material to the tax-haven subsidiary at the market price and then that subsidiary transfers that material to the local subsidiary at a big margin. In this manner, the profit as would have arisen to the local subsidiary is transferred to the tax-haven subsidiary and the local tax is substantially reduced. This is very common practice in the drug industry. Thus, where the purchases are being made from a tax-haven country, it calls for a deeper look. The large manufacturing concerns usually advertise their ex-factory prices which can be obtained by the national embassies in the country of manufacture.

OTHER LAW.
The commercial activities of an income tax payers also fall under other laws administered by other departments. Thus, such departments have a wealth of information which is very useful for the purpose of assessment of income tax. If those departments are not forbidden under the law from passing on that information to Income Tax Department, they can be a great help. For example, person importing commercial goods have to pass through the customs regime whose job is to ensure that the goods imported are the same as appear in the invoice that these are in the same quantity as declared etc. Secondly, income tax is a tax which is levied on the income of a person which he has earned during the previous year. Very often, an auditor is examining the income from activities that took place quite long time ago. It is almost impossible for him to go back and find evidence independently. However, there are other departments who are supposed to examine the activities when these are taking place. Thus, they are in a much better position to collect information about those activities at that time which can be used by Income Tax Department later.

INVESTMENT IN PROPERTY.
Residential houses are the major repositories of untaxed wealth. Sometimes such houses are built entirely with untaxed funds. This forces the taxpayer to build the house in the name of a trust-worthy friend or relative. Where it is built in ones own name, the taxpayer, shows it as a standard house while it is actually a very luxurious. That allows him to dump a very large amount of untaxed income in such projects. Clever taxpayers construct houses which look ordinary from outside but are literally palaces inside.

CONCLUSION
Government needs revenue to run the machinery for the regulation of different service providers, for the general benefit of the public. On the other hand, the man, though desirous to live in a smooth society, by its very make is possessive in nature and does not want to part with his belonging no matter how they were acquired. So the law made through consensus, come in and establishes a link beneficial for all individuals, society and the government. However, any law does not work if it is not only accepted by an over whelming majority, but also is acted upon by at least ninety percent of the general public. It has always been the dreams of the lawmakers that the public must respond to the legal obligations voluntarily thus saving the exchequer from incurring much on the controlling and implementing State Organizations. So is the case with the tax collection. Government wishes to have a thinner regulating machinery to collect maximum revenue by ensuring voluntarily compliance from the taxpayers. All said and done, but it is tragic to observe that CBR has yet to finalize a sound basis for taxation. No regular Audit Policy has been made so far. We are going through experiences, years after years. We have not gained the confidence of the taxpayer in real terms. Tax system can be said to be functioning properly only if it: 1. settles assessments promptly i.e within the tax year; 2. collects the determined taxes in time without causing undue hardship to the taxpayers; 3. provides for an independent and efficient appellate machinery to look into the grievances of taxpayers; and 4. quickly disposes cases in appeals and settles claims for refunds.

These goals are yet an unrealized dream of tax reforms initiated by CBR. No programme of resource mobilization of tax can succeed unless: a fair and efficient tax system is evolved; the taxpayers change their attitude towards tax obligations through proper compliance; tax administrators assure that maximum facilitation is extended to taxpayers;

 tax evaders are dealt strictly in accordance with law; and honest taxpayers receive treatment they deserve.

Accountability of tax administrators. No effective mechanism has so far been evolved to effectively check any unfair practices on the part of tax administrators. They are not made liable to punitive actions and/or pecuniary damages even after the final factfinding authority adjudges their actions arbitrary, excessive and beyond their assigned powers. The Federal Tax Ombudsman should be given the statutory power of awarding damages in such instances.

RESTORING THE CONFIDENCE OF TAXPAYERS: Taxpayers must be given adequate rights before the State justifies strict actions for enforcing tax obligations. For restoring confidence of taxpayers the State should promulgate Taxpayers' Bill of Rights in the coming budget that must: safeguard and strengthen the rights of taxpayers; ensure equality of treatment; guarantee privacy and confidentiality of their declaration; provide right to assistance by State in tax matters; guarantee unfettered right of appeal through an independent tax appellate system; and provide facilities for independent review of disputes with tax authorities.

OBJECTIVES OF TAX REFORM AGENDA: There is an immediate need to improve both the system and the human fabric that controls it. The tax system must provide: Rule of law and certainty of tax to be imposed Principles of proportionality, efficiency, effectiveness, flexibility, continuity and equity Tax harmonization. No double taxation or intentional non-taxation Non-discrimination Strict anti-tax evasion rules and protection of honest taxpayers against administrative highhandedness

SALIENT FEATURES FOR THE BUDGET 2007

DIRECT TAXES. A. RELIEF MEASURES: 1. 2. Present corporate tax rate of 35% to continue. Income of Micro Finance Banks (MFBs) exempted from for five years. tax

3.

Withholding tax on passenger transport services reduced from 6% to 2% on the analogy of goods transport services. Exemption under clause (132) of Part I of Second Schedule extended to companies owning and managing Hydel Power Projects situated in AJ&K. Companies operating Hotels in Pakistan or AJ&K are allowed set off of losses arising in Pakistan or AJ&K against income in Pakistan or AJ&K and vice versa as the case may be. Exemption of tax on capital gains extended for further one year. Withdrawal of 2% withholding tax over and above the prescribed rate on supplies for non-disclosure of NTN or CNIC to withholding agent. Mergers and Acquisitions to be treated as non tax event. Withholding tax rate on all exports to be unified @ 1%. Permanent Establishments of non-resident Exploration and Production Companies exempted from withholding tax on supply of crude oil and gas. E&P Companies exempted from WHT on imports (other than vehicles). Review of Law Relating to Holding Companies. 75% share holding required if none of the companies is a public listed limited company. 55% share holding required if one of the group companies is a public listed limited company. Group relief restricted to domestic companies. Companies engaged in trading will not qualify for relief.

4.

5.

6. 7.

8. 9. 10.

11. 12.

Current tax year losses can be surrendered by holding company to a subsidiary or between subsidiaries which fulfill the requirements of share holding; Inter corporate dividend - liable to 10% adjustable withholding tax.

13.

Group Taxation/Relief: For group formation, transfer of shares between companies and the owners in one direction to be treated as non-tax event. Group taxation to be restricted to locally registered companies under Companies Ordinance, 1984 domestic companies.

14.

CNIC to be used for identification purpose, as an alternate, where NTN is not obtained. Replacing Venture Capital Funds with Private Equity and Venture Capital Funds - exemption extended to the Fund upto June 2014. Capital Gains of private limited companies on sale of their assets to private equity and Venture Capital Funds to be taxed @ 10% (reduced tax rate). Income arising on sale of immoveable property to Real Estate Investment Trust (REIT), exempted from tax for three years. Separate tax regime for retailers: Turnover - Upto Rs. 05 million - From 05 to 10 million amount of turnover - Above Rs. 10 million

15.

16.

17.

18.

Rate of Tax 0.5% Rs. 25,000 plus 0.5% of the exceeding Rs. 5 million Rs.50,000 plus 0.75% of the amounting of turnover exceeding Rs. 10 million

19. 20.

Separate Schedule for Banking Companies introduced. Maximum limit of investment in IPOs to avail tax credit enhanced from Rs. 200,000 to 300,000. Presumptive Tax Regime introduced for service providers to exporters/export house under the Trade Policy withdrawn. Set off of brought forwarded losses in the event of amalgamation/merger of companies withdrawn. Withholding tax on sale of goods made adjustable for listed public companies.

21.

22.

23.

24.

Tax in respect of income from construction contracts out side Pakistan to be charged at the rate of one per cent of the gross receipts provided that such income is brought into Pakistan in foreign exchange through normal banking channel. Withdrawal of withholding tax on payments to travel agents on sale of air tickets where withholding tax on commission is already deducted. Payments received by non-resident news agencies, syndicate services and individual contributors/writers not having permanent establishment in Pakistan will not be subjected to withholding tax on services provided. Advertising services provided by owners of newspapers/magazines in the non-corporate sector taken out of Presumptive Tax Regime. Withdrawal of CVT on import of cars and power of attorney executed between first relations. Withholding tax @ 5% on purchase of locally manufactured cars. Federal Excise duty also to be included in the value of goods for withholding tax purposes at the import stage.

25.

26.

27.

28.

29. 30.

B. RATIONALIZATION OF WITHHOLDING TAXES REGIME: 31. Withholding Tax on Imports. For commercial importers covered under PTR, WHT rate reduced from 6% to 5%. For manufacturers a uniform adjustable withholding tax on imports @ 1%. Exemption in respect of imports covered by statutory provisions will continue. Taxpayers having losses or those having paid advance tax eligible for reduced rate exemption certificates on imports. Manufacturer exporters registered with Sales Tax Department not liable to withholding tax on imports. Withholding tax on import of edible oil reduced from 3% to 2%. Import of polyester filament fiber yarn to be subjected to 5% withholding tax.

Import of Bitumen, pesticides/wedicides and FWT to be subjected at reduced withholding tax rate of 2%.

32.

Employers authorized to give credit of tax withheld from employees under different withholding provisions during the tax year. Also authorized to adjust tax credit allowable to salaried taxpayers having salary income only. Ginners provided option to pay WHT at the prescribed rate. Exclusion of companies (Large Import Houses) importing bulk industrial raw material from presumptive tax regime. Professional Firms to be taxed at par with other AOPs.

33. 34.

35.

C. REVENUE GENERATION: 36. Withholding tax on non-corporate commercial and industrial consumers of electricity made minimum tax liability. Withdrawal of exemption to Mutual Fund on CFS interest income. Companies to pay advance tax in the first year of operations.

37. 38.

D. SIMPLIFICATION: 39. Small company redefined with following characteristics; - Paid up capital = 25 (M) - Annual Sales = 250 (M) - Employment Limit = 250 persons Presumptive tax regime for Compressed Natural Gas (CNG) stations and withholding tax @ 6% of gas bill.

40.

E. DOCUMENTATION: 41. Electronic filing of returns and withholding statements for corporate taxpayer made mandatory. Filing of Wealth Statement mandatory for taxpayers having income of Rs. 500,000/- or more Commissioner authorized to call for the Wealth Statement.

42.

F. REVIEW OF EXEMPTION. 43. Clarification amendment made regarding taxation of Regulatory Authorities.

COMPARATIVE SECTIONS

INCOME TAX ORDINANCE, 2001

Sections Particulars SHORT TITLE, EXTENT AND COMMENCEMENT Definitions The Provision of this Ordinance to override other laws Tax on taxable income Tax on dividends Tax on certain payments to non-residents Tax on shipping and air transport income of a nonresident person General provisions relating to taxes imposed under sections 5,6, and 7. Taxable income Total income Heads of income Salary Value of perquisites Employee Share Scheme Income from property Non-adjustable amounts received in relation to buildings Deductions in computing income chargeable under the head Income from Property Income from business Speculation business Deductions in computing income chargeable under the head Income from Business Deductions not allowed Depreciation

INCOME TAX Ordinance, 1979 Sections 1 2 -

Remarks

New

9 80B 80AA, 80AAA 80, 80A

80A, 80AA, 80AAA, 80B 2(44), 11(1) 15 16 19 12(13), 12(15) 20

New New

New -

22 22,36 23

New

24 23(1)(v), The Third

Initial allowance

Intangibles Pre-commencement expenditure Scientific research expenditure Employee training and facilities Profit on debt, financial costs and lease payments Bad debts Profit on non-performing debts of a banking company or development finance institution Transfer to participatory reserve Method of accounting Cash-basis accounting ACCRUAL-BASIS ACCOUNTING STOCK-IN-TRADE Long-term contracts Capital gains Deduction of losses in computing the amount chargeable under the head Capital Gains Income from other sources Deductions in computing income chargeable under the head Income from Other Sources Agricultural income

Schedule 23(1)(v), The Third Schedule 23(1)(xi), 23(1)(xii) 23(1)(xiii), 23(1)(xv) 23(1)(xxi), 23(1)(xxii), 25(a) 23(1)(x), 25(aa) 23(1)(xxi),(x xii), 25(a)

New New

32 New 25(c), etc. 2(12), 27, 28 27 New New

12(16), 12(18), 30 31

Diplomatic and United Nations exemptions Foreign government official

Exemption under

2(1), The Second Schedule Pt1, Cl (1) The Second New section Schedule, Pt1 Cl (16) The Second Schedule, Pt1, Cl (2) 163, The

International agreements

Presidents honors

Profit on debt Scholarships

1.

2.

3.

4. 5. 6. 7. 57A. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Support payments under an agreement to live apart The Second Federal and Provincial Schedule, PtGovernment, and local 1, Cl (88) authority income The Second Foreign-source income of Schedule, Ptshort-term resident IV Cl (26) individuals Foreign-source income of The Second Schedule, Ptreturning expatriates 1, Cl (130A) Non-resident shipping and The Second airline enterprises, (omitted Schedule, Ptby the Finance Ordinance, 1, Cl (141) 2002) Exemptions and t ax 14 concessions in the Second Schedule Exemptions and t ax concessions in other laws Limitation of exemption 151 Set off of losses 34 Carry forward of business 35,38(6) losses Set off of business loss consequent to amalgamation. Carry forward of speculation 36 business loss Carry forward of capital 37 losses Zakat Charitable donations 47 Investment in shares 41A Retirement annuity scheme 44AA Profit on debt 44AAA Miscellaneous provisions relating to tax credits Income of joint owners 21

Second Schedule, Pt1, Cl (12) and Cl (12A) The Second New Schedule, Cl (40) New The Second Schedule, Pt1 Clause (87) New

New

New

Clarification

New

17. 18. 19. 20. 21. 22. 23.

Apportionment of deductions Fair market value Receipt of income Recouped expenditure Currency conversion Cessation of source of income Rules to prevent double derivation and double deductions Tax year Disposal and acquisition of assets Cost Consideration received Non-arms length transactions Non-recognition rules

29(3) 25(a), (aa) 12(8) 11(2)

Rule 8 (III Schedule) New

New and Clarification (Section 11(2), Section 16 Proviso New

24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45.

2(8)(26) 27(2)

46.

47.

Person Resident and persons Resident individual Resident company Resident association of persons Associates Principle of taxation of individuals Deceased individuals An individual as a member of an association of persons Authors Transfer of assets Income of a minor child Principles of taxation of associations of persons Taxation of members of an association of persons Principles of taxation of companies Disposal of business by individual to wholly owned company Disposal of business by association of persons to wholly- owned company Disposal of asset between wholly-owned companies

28(1) 29(2) 27(2)(b), 29(1) 2(32) non-resident 2(30), 2(40) 2(40)(a) 2(31)(40)(c) 2(40(b) 74 33 83 83A 38, 69 38, 69 -

New New New, Clarification

New New

Clarification

New and Clarification. New and reference.

New and reference to 73,

48. 49. 50.

51. 52. 53. 54. 55.

56. 57.

58. 59. 60. 61. 62. 63. 64. 65.

Change in control of an entity Special provisions relating to insurance business Special provisions relating to the production of oil and natural gas, and exploration and extraction of other mineral deposits Geographical source of income Foreign source salary of resident individuals Foreign t ax credit Foreign losses Taxation of a permanent establishment in Pakistan of a non-resident person. Thin capitalization Agreements for the avoidance of double taxation and prevention of fiscal evasion Transactions between associates Re-characterization of income and deductions Salary paid by private companies Unexplained income of assets Liability in respect of certain security transactions Minimum tax on the income of certain persons Return of income Persons not required to furnish a return of income

26(a) 26(b)(c)

12(12) New

12(1), 12(5), 12(10) 163(3), 164 24(e), 12(2), 12(4) etc. 163

New

New

79 16(1) 13 84 80D New

66. 67. 68. 69.

70. 71.

55, 57 Proviso to section 55(1)(C), 143B Wealth statement 58 Notice of discontinued 72 business Method of furnishing returns 55A, 55(2) and other documents Extension of time for 55(3) furnishing returns of other documents Assessments 59, 59(1), 59A Assessments of persons who 63 have not furnished a return

72. 73. 74. 124A 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

86.

Amendment of assessments Provisional assessment in certain cases Assessment giving effect to an order Powers of tax authorities to modify orders, etc. Assessment in relation to disputed property Evidence of assessment Appeal to the Commissioner (Appeals) Procedure in appeal Decision in appeal Appointment of the Appellate Tribunal Appeal to the Appellate Tribunal Disposal of Appeals by the Appellate Tribunal Reference to High Court Appeal to Supreme Court Revision by the Commissioner (Omitted by the Finance Ordinance, 2002) Burden of proof

62, 65, 66A 60A 66, 62BB 66(3) 129, 130. 131 132 133 134 135 136 137 138 Clarificatory66(3)

New but concept was therein the Ordinance New and Clarification

87. 88.

138A 89.

90.

91. 92.

93. 94. 95.

Due date for payment of tax Recovery of tax out of property and through arrest of taxpayer Recovery of tax by District Officer (Revenue) Collection of tax in the case of private companies and associations of persons Recovery of tax from persons holding money on behalf of tax payers Liquidators Recovery of tax due by nonresident member of an association of persons Non-resident ship owner or chatterer Non-resident aircraft owner or chatterer Collection of tax from persons leaving Pakistan

54 93

94 77

92

76 -

80 80A 81, 82

96.

97. 98. 99. 100. 101. 102. 103. 104.

105. 106. 107. 108.

permanently Recovery of tax from persons 93A assessed in Azad Jammu and Kashmir Advance tax paid by the 53 taxpayer Imports 50(5), 80C, 80DD Salary 50(1) Dividends 50(6A) Profit on debt 50(7D) Payments to non-residents 50(3), 50(3A) Payments for goods and 50(4), 80C services Exports 50(5A), (5AA), 80CC Income from property 50(7B) Prizes and winnings 50(7C), 80B Petroleum products 80C, 50(7H) Timing of deduction of tax -

109. 110. 111. 112.

113. 114. 115. 116. 117. 118. 119.

Every subsection of Section 50 at the time of payment/ transaction. Exemption of lower rate 50(4), 50(10) SROs giving certificate Exemption. Payment of tax collected or Section 50(8)(c) deducted Failure to pay tax collected 52 or deducted Recovery of tax from the 52A person from whom tax was not collected or reduced New Recovery of amounts payable under this Division Certificate of collection or 51 deduction of tax Statements 139 to 143 New and Clarification Various subPriority of tax collected or sections deducted Indemnity 161 New Credit for tax collected or deducted 80A, Tax collected or deducted as a 80, 80AA, final tax 80AAA, 80B, 80BB,

120. 121. 122. 123. 124. 125. 126. 127. 128. 129.

130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140. 141.

Refunds Additional payment delayed refunds Representatives Liability and obligations of representatives Records Powers to enter and search premises Notice to obtain information or evidence Audit Assistance to the Commissioner Accounts, documents, records and computer stored information not in Urdu or English language Power to collect information regarding exempt income National Tax Number Card

80C, 80CC, 80DD 96 100 for 102 78 78 145, 146 144, 148, 149 4A 147 New New

164A 143D 108 88, 91 111 109 110 __ 112, 114 115 116 117

142. 143. 144. 145.

Penalty for failure to furnish a return or statement Penalty for non-payment of tax Penalty for concealment of income Penalty for failure to maintain records Penalty for non-compliance with notice Penalty for making false or misleading statements Penalty for failure to give notice Penalty for obstruction Imposition of penalty Prosecution of noncompliance with certain statutory obligations Prosecution for false statement in verification Prosecution for failure to maintain records Prosecution for improper use of National Tax Number Card Prosecution for making false

118 New New

146. 147.

148.

149. 150. 151.

152. 153. 154. 155. 156. 157. 158. 159.

or misleading statement Prosecution for obstructing a taxation officer Prosecution for disposal of property to prevent attachment Prosecution for unauthorized disclosure of information by a public servant Prosecution for abetment Offences by companies and associations of persons Institution of prosecutions proceedings without prejudice to other action Power to compound offences Trial by Special Judge Power to tender immunity from prosecution Additional tax Circulars Income Tax Authorities Appointment of income tax authorities Jurisdiction of income tax authorities/exercise of jurisdiction by successor. Delegation Power or function exercised Authority of approval Guidance to income tax authorities Income tax authorities to follow Orders of Central Board of Revenue Furnishing of returns, documents, etc. Disclosure of information by a public servant Forms and notices; authentication of documents Service of notices and other documents Tax or refund to be computed to the nearest Rupee Receipts for amount paid Rectification of mistakes Appointment of expert Appearance by authorized

124

122

120 123 124

126 127 128 86, 90 3 4 5, 6

New Clarification

160. 161. 162. 163. 164.

5 165A 7 8

New New

165. 166. 167. 168. 169. 170. 171. 172. 173.

150 154 152 153 156 157 New New

174.

175. 176. 177. 178. 179. 180. 181. 182. 183. 184. 185. 186. 187. 188. 189. 190.

representatives Proceedings under the Ordinance to be judicial proceedings Proceedings against companies under liquidation Computation of limitation period Bar of Suits in Civil Courts Appointment of DirectorateGeneral of Inspection Inspection Authorities Jurisdiction of Inspection Authorities Functions and Powers of Directorate (Omitted by the Finance Ordinance, 2002) Brokerage and Commission Transport business Electricity consumption Telephone users Power to make rules Repeal Savings Removal of difficulties
First Schedule Second Schedule Third Schedule Fourth Schedule Fifth Schedule Sixth Schedule Seventh Schedule

158

159 160 162 138L 138N 138O 138P 50(4A) 50(6) 50(7E) 50(7F) 165 166 166 167
First Schedule Second Schedule Third Schedule Fourth Schedule Fifth Schedule Sixth Schedule Eighth Schedule

REFERENCES
Income Tax Act, 1922. Income Tax Ordinance, 1979. Income Tax Ordinance, 2001 Art. 264 of the Constitution General Clauses Act, 1897 Concept of Voluntary Tax Compliance and its Implication in Pakistan., by Gholam Kazim Hosein, New Dimensions of Income Tax Law, by Jameel Ahmed Bhutto. Practical Hand Book of Income Tax, by Dr. Ikram-ul-Haq. Articles from Daily News Papers- The Dawn, Business Recorder, and The News, Encyclopedia Britannica Encyclopedia Encarta Oxford Dictionary.

Case Law Referred

1927 AC 193 (PC) Salisbury House Estate Ltd. V. Fry ( 1930) AC 432 (HL) 1960 (2) Tax ) C.J Sheth V. Commissioner of Income Tax ( 1962 ) 46 ITR 1052 Upper India Chamber of Commerce V. Commissioner of Income Tax ( 1974) 15 ITR 263 all (1976 ) 33 TAX 121 ( Lahore H. C ) PLD 1978 Kar. 673 1979 ) 38 TAX 5 ( Karachi H. C ) ( 1980 ) 41 TAX 19 ( Karachi H.C ) Commissioner of Income Tax V. Bankipur Club Ltd. ( 1981 2 Taxman 47 ) 1984 PTD ( Trib. ) 147 United States V. Laws ( 1986) 163 Vs 258. Partridge V. Mallandaine ( 1886 ) 18 QBD 276. ( 1992 (49) Tax 46 and 1952 (22) ITR 484 ( SC) ( 1992 ) 66 TAX 55 ( S.C Pak ) 1992 PTD 621 ( 1992 ) 66 TAX 55 ( S.C Pak) 1992 PTD 621 ( 1994 ) 69 TAX 38 ( Karachi High Court ) ( 1997 SCC 1097 ( 1997 ) 77 Tax ( Tribunal )

Web Sites Consulted :

www.pakistaneconomist.com/ www.cbr.gov.pk/ www.yahoo.com www.google.com www.taxonline.com.pk/ www.finance.gov.pk www.mypakistan.biz/ www.rahmat.com www.paksearch.com/ www.jang.com. www.dawn.com www.paktax.com. www.businessrecorder.com