Basic Concepts of Taxation in Pakistan
The Federal levy, tax, on income (Income Tax) is governed by the Income Tax Ordinance, 2001 and Income Tax Rules, 2002. It is an annual charge on income. Every taxpayer, tax consultant in Pakistan should have knowledge of Basic Concepts of Taxation in Pakistan.
The income of a taxpayer includes taxable income, income subject to separate charge and income subject to final tax of a person for a tax year, and also includes global income of the resident person, even if it has already been taxed outside of Pakistan.
In this article {Basic Concepts of Taxation in Pakistan) from now onwards taxable income refers to as taxable income excluding separate block of income subject to fixed tax and income subject to final tax.
“Taxable Income” means total income reduced by:
Donations qualifying for straight deductions; and Following deductible allowances:
- Zakat paid under the Zakat and Ushr Ordinance, 1980; (Zakat paid on a debt, the profit of which is chargeable to tax under the head “Income from Other Sources” is not deductible from total Such Zakat is an admissible deduction against profit on debt);
- Workers Welfare Fund paid under the Workers Welfare Fund Ordinance, 1971 (applies to certain specified industrial establishments); and
- Worker’s Participation Fund paid under the Companies Profit (Worker’s Participation) Act, 1968 (applies to companies only).
What Constitutes Income | Basic Concepts of Taxation in Pakistan
“Total Income” is the aggregate of income chargeable to tax under each head of income:
“Head of Income” – Under the Income Tax Ordinance, 2001, all income are broadly divided into following five heads of income:
- Salary;
- Income from property;
- Income from business; Capital gains; and
- Income from other sources
Generally, income under a head of income is the total of the amounts derived as reduced by the admissible deductions against such income, if any.
Expenditures attributable to exempt income, income subject to separate charge, income subject to final tax (and separate block of income) are not deductible against income chargeable to tax as total income/taxable income.
Chargeable income under each head of income is further dependent on the residential status of a taxpayer.
In case of resident, it is both Pakistan source income and foreign source income, while in case of non-resident it is restricted to Pakistan source income only.
Resident Vs. Non Resident Person | Basic Concepts of Taxation in Pakistan
“Resident” An association of persons is resident for a tax year if the control and management of its affairs is situated wholly or partly in Pakistan at any time in that year;
A company is resident for a tax year if –
- it is incorporated or formed by or under any law in force in Pakistan;
- the control and management of its affairs is situated wholly in Pakistan at any time in the year; or
- It is a Provincial Government or a local Government in Pakistan.
- An individual is resident for a tax year if he/she –
- is present in Pakistan for a period of, or periods amounting in aggregate to, 183 days or more in the tax year; or
- is an employee or official of the Federal Government or a Provincial Government posted abroad in the tax year
Compute the number of days an individual is present in Pakistan?
In order to compute the number of days an individual is present in Pakistan in a tax year, the following rules apply: –
A part of a day 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 presence.
However, a day or part of a day where an individual is in Pakistan solely by reason of being in transit between two different places outside Pakistan does not count as a day present in Pakistan.
Following days in which an individual is wholly or partly present in Pakistan count as a whole day of presence:-
- a public holiday;
- a day of leave, including sick leave;
- a day that the individual’s activity in Pakistan is interrupted because of a strike, lock-out or delay in receipt of supplies; or
- a holiday spent by the individual in Pakistan before, during or after any activity in Pakistan.
Non-Resident
“Non-Resident” An association of persons, a company and an individual are non-resident for a tax year if they are not resident for that year.
“Pakistan source income” is defined in section 101 of the Income Tax Ordinance, 2001, which caters for incomes under different heads and situations. Some of the common Pakistan source incomes are as under: –
- Salary received or receivable from any employment exercised in Pakistan wherever paid;
- Salary paid by, or on behalf of, the Federal Government, a Provincial Government, or a local Government in Pakistan, wherever the employment is exercised;
- Dividend paid by resident company; Profit on debt paid by a resident person; Property or rental income from the lease of immovable property in Pakistan;
- Pension or annuity paid or payable by a resident or permanent establishment of a non-resident;
Another aspect of Basic Concepts of Taxation in Pakistan is to assess what is “Foreign source income” is any income, which is not a Pakistan source income.
“Person” means:
- An individual;
- A company or association of persons incorporated, formed, organized or established in Pakistan or elsewhere;
- The Federal Government, a foreign government, a political subdivision of a foreign government, or public international organization
- “Company” means – A company as defined in the Companies Act, 2017;
- A body corporate formed by or under any law in force in Pakistan;
- A modaraba;
- A body incorporated by or under the law of a country outside Pakistan relating to incorporation of companies;
An amendment has been made through Finance Act, 2013 to enlarge the scope of definition of a Company. Now as per Income Tax Ordinance, 2001 a company includes:
- a co-operative society, a finance society or any other society;
- a non-profit organization;
- a trust, an entity or a body of persons established or constituted by or under any law for the time being in force.
A foreign association, whether incorporated or not, which the Board has, by general or special order, declared to be a company for the purposes of this Ordinance;
- A Provincial Government;
- A Local Government in Pakistan;
- A Small Company
- “Association of persons” includes a firm (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), a Hindu undivided family, any artificial juridical person and anybody of persons formed under a foreign law, but does not include a company.
What is Tax Year | Basic Concepts of Taxation in Pakistan
“Tax Year” is a period of twelve months ending on 30th day of June i.e. the financial year and is denoted by the calendar year in which the said date falls.
For example, tax year for the period of twelve months from July 01, 2010 to June 30, 2011 shall be denoted by calendar year 2011 and the period of twelve months from July 01, 2011 to June 30, 2012 shall be denoted by calendar year 2012. It is called Normal Tax year.
Tax year includes special tax year, which means any period of twelve months and is denoted by the calendar year relevant to the normal tax year in which closing date of the special tax year falls.
For example, tax year for the period of twelve months from January 01, 2010 to December 31, 2010 shall be denoted by calendar year 2011 and the period of twelve months from October 01, 2010 to September 30, 2011 shall be denoted by calendar year 2012.
A person or class of persons may shift from Normal to Special Tax year or vice versa subject to the conditions specified under section 74 of the Income Tax Ordinance, 2001.
Income subject to Separate Charge | Basic Concepts of Taxation in Pakistan
Income subject to a separate charge, which do not form part of total income or taxable income and are subject to tax on the basis of gross income, e.g.:-
- Dividend;
- Royalty of non-resident;
- Fee for technical services of non-resident; Shipping income of non-resident; and
- Air transport income of non-resident.
Income Subject to Final Tax | Basic Concepts of Taxation in Pakistan
Income subject to Final Tax, which are subject to collection or deduction of tax at source and such tax collected or deducted at source is treated as final tax liability in respect of such income e.g.:
Income arising from business on account of:
- Sale of Imported of goods;
- Execution of contracts by non-residents
- Insurance and re-insurance premiums received by non-residents
- Any other amounts received by a non-resident (profit on debt)
- Supply of goods (other than by manufacturers);
- Execution of contracts by a Resident
Services of stitching, dying, printing, embroidery, washing, sizing and weaving
- Media services by non-residents
- Export realization (goods)
- Commission / discount on petroleum products
- Brokerage and commission;
- Plying of goods transport vehicles; and
- Natural Gas Consumption (CNG Stations).
Income arising from other sources on account of:
- Profit on debt; (except derived by a company) and
- Prizes and winnings.
Relation of Income and Tax | Basic Concepts of Taxation in Pakistan
“Separate block of income” are those, which are chargeable to tax under the respective head of
income (salary, business, capital gains and other sources) but for the purposes of calculation of tax such incomes are excluded from the taxable income and tax thereon is calculated and charged at varying rates depending on the nature of each such income e.g.:-.
Income arising from salary in respect of:
- Retirement or termination benefits of an employee;
- Arrears of salary of an employee; and
- Flying and submarine allowance of certain employees.
Income | Basic Concepts of Taxation in Pakistan
Business income:
- From services rendered outside Pakistan;
- From construction contracts executed out-side Pakistan;
- Of certain manufacturers of cooking oil or vegetable ghee or both; and
- Of resident from shipping business.
Capital gains from:
- Sale of securities; and
- Sale of shares or assets by a private limited company to Private Equity and Venture Capital Fund.
“Tax” is the amount computed by applying the applicable rate of tax, on taxable income, income subject to a separate charge, income subject to final tax and separate block of income subject to fixed tax.
“Income tax” payable on taxable income is:
– Gross income tax (Calculated on taxable income by applying applicable rate of income tax); as reduced by the following:-
- Reductions in tax liability; minus
- Foreign tax credit; minus
- Tax credits on donations, investments etc. minus
- Tax credit on exempt share from association of persons
To arrive at the net income tax payable or refundable, income tax payable determined as above is reduced by:
- Advance tax already paid; and
- Adjustable tax paid through deduction at source. (If it is not final tax liability paid through deduction)
- Agricultural Income is chargeable to tax (Agricultural Income Tax) separately by the respective Provincial Governments and hence is specifically declared exempt from levy of tax under the Income Tax Ordinance, 2001. Accordingly such income does not form part of total income / taxable income.
What about Agricultural Income in Pakistan | Basic Concepts of Taxation in Pakistan
“Agricultural income” is defined broadly to include direct and indirect income from land situated in Pakistan used for agriculture purposes. Rental income for the use of cultivated land and rent of a building on or in the vicinity of cultivated land occupied by the cultivator or by the receiver of rental income from cultivated land are some of the examples of indirect agriculture income. Income from fruit or vegetable farming etc. and Sale of trees is exempt in the hands of grower as Agriculture income.
However, Income from sale of trees/vegetables or agri-produce are taxable in the hands of non-growers e.g. “Arthis”.
