DIRECT TAXATION IN PAKISTAN

A course on Income Tax Law

Asim Zulfiqar Ali, LL.B., FCA

1. Course Description

(a) An Introduction to Direct Taxes

Taxes are regarded as a major source of income/revenue for a state to meet its obligations
towards the nation. These taxes are fundamentally utilized by the government for the
purposes of public sector development programs, defense and other areas of mass
importance. In Pakistan, various taxes are in force some of which are regulated by the Federal
Government while some are in the domain of the Provincial Governments. The split between
these is provided for in the Constitution and its rationale and the logic is not the subject
matter of this course.

Taxes are broadly classified into two categories viz. direct taxes and indirect taxes.
Whether these are collected by the Federal Government or the Provincial Government, the
division broadly remains the same. These are both income based and / or asset ownership
based, depending upon the nature and type of the levy. Direct taxes are those where the
incidence is borne by the person from whom the tax is collected whereas, in the case of
indirect taxes, the person from whom the tax is collected acts only as an
agent/intermediary and the incidence of tax is borne by another person (from whom the
tax is eventually collected by the agent in the due course and deposited in the government
treasury). Few examples of direct taxes, collected by the Federal Government, are Income
Tax, Wealth Tax, and Capital Value Tax. Urban Immoveable Property Tax, Professional
Tax and Motor Vehicle Tax etc. are types of direct taxes collected by the respective
Provincial Governments.

Historically, direct taxes (at federal level) have remained in force in Pakistan in the form of
income tax, wealth tax and capital value tax. The wealth tax was abolished by the
government in the year 2000 as part of the reform process whereby the government
introduced a policy of reducing the number of taxes (federal excise duty, an indirect direct, is
also proposed to be abolished gradually under this reform process). Another reason behind
the abolition of the said was that it was not making significant contribution in the exchequer
and in fact the cost of collection was considered to be more than the contribution. There is,
however, a simultaneous criticism on the abolition. People belonging to this school of thought
argue that it was a tax on rich only and its abolition has favoured a particular class and hence
the same is in a direct conflict with the rationale and philosophy of imposition of direct taxes.
This controversy remains unaddressed, however, there are rumours that this might be
reinstated. The significant amount is generated through levy of income tax and during the
year ended June 30, 2010 the government collected around 40% of its aggregate revenues
(both direct and indirect) in the form of this tax. This position, without undermining the
importance of other direct taxes, makes the income tax as the focal point of the government
so far as the policy, legislation and implementation are concerned. Much of the emphasis is
given in increasing the collection, removal of leakages and improvement of business
processes involved in implementation of this tax.
Very recently, (as part of reform process - facilitation), the government has reclassified taxes
into custom duty and inland revenues. Now, for enforcement and collection purposes,
income tax, sales tax and federal excise duty are categorized as inland revenue and
these are be handled by one authority. The purpose is to eliminate the hassle of dealing with
multiple officials especially when in various cases similar aspects/considerations are relevant
for law enforcing authorities.

(b) Income Tax Law in Pakistan History, Evolution & Development

In the Indo-Pak, the history of modern income taxation dates to 1860, although prior to that
license taxes based on profits, trades and professions were in vogue. This tax was introduced
to meet the deficit resulted from the War of Independence and was not intended to be
permanent. The Income Tax Act of 1886 was a general income tax that had been imposed on
the trades by some provinces and its basic scheme, by and large, even survives today. This
law underwent certain changes and finally transformed into the Income Tax Act, 1922 which
was the first legislation so far as the levy of income tax in Pakistan is concerned.

Owing to amendments introduced from time to time the law was consolidated and substituted
by the Income Tax Ordinance, 1979 which remained in force until the year 2002. An analysis
of the provisions of the two legislations shows that the latter, when enacted, was in fact a
redrafted and consolidated version of the former and as such there was no change in the
underlying concept and philosophy. Both the legislations provided that an assessing officer
would determine the income of a taxpayer on the basis of declarations/filings of such
taxpayer.

In the year 1991 the income tax law was amended significantly and a new concept of
presumptive tax regime was introduced. It was a new and unprecedented concept in the
region, shift from the original philosophy and had a set objective. It prescribed a transaction
based tax liability regardless of the fact that the person executing the transaction had earned
any income or not. This scheme was initially conceived to be a stop gap arrangement for
taxing the persons who continuously remained outside the tax net or who could claim refunds
by not disclosing the real income. The idea was to increase the tax collection and eliminate
the refunds. Though the objectives were initially achieved but the scheme changed the overall
nature of the levy. This transformed the levy of income tax into an indirect tax as the
taxpayers begun to shift the levy (incidence being known in advance) onto the customers. The
scheme has its own advantages and disadvantages. No doubt it increased the revenue
collection considerably but it also transformed a direct tax into an indirect tax thus causing a
shift from the underlying principles/rationale. It also discouraged documentation, which is the
backbone for determining the real quantum of income, to a very large extent. From the
governments perspective the advantages outweighs the disadvantages hence it is being
continued even toady. In fact its scope has been enlarged considerably over the last decade.

The concept of assessment/determination of income by a regulator was completely done

away with through promulgation of the presently applicable Income Tax Ordinance, 2001 and
now whatever declaration is filed by a taxpayer the same is taken to have been accepted by
the tax authorities, at the first place. Nevertheless, the tax authorities are empowered to
conduct an audit of a taxpayer and on discovering any under-declaration/mis-declaration they
could amend the assessments to recover the proper amount of tax. The taxpayer, however,
reserves the right of challenging the said action of the tax authorities for which the provisions
of law prescribe appeal fora.
(b) Familiarity with the Legal Framework

(i) Local Income Tax Laws

At present, the income tax law can broadly be classified into two categories viz. (Federal)
Income Tax Ordinance, 2001 and (Provincial) Income Tax Act, 1997 (taxation of agricultural
income). These statutes are a complete code and contain full procedure for computation of
income, collection of taxes, regulation, monitoring, remedies etc. The provincial laws are of a
very basic nature and are based on the principles earlier contained in the Income Tax
Ordinance, 1979.

The presently applicable system of regulating the income tax (at federal level), briefly
discussed above, is fully in line with the concept provided for in OECD (Organization for
Economic Co-operation and Development) guidelines, the system followed in the developed
countries. It rests on the principle of convergence. Historically, there had been wide gaps
between the accounting income and the taxable income. Now these gaps are being reduced
and the taxable income is brought as closer as possible to the accounting income.

The shift was also a part of the governments reform process. In the course of analyzing the
tax administration a necessity of reposing confidence in taxpayers was felt (i) to enhance the
tax collections; (ii) to reduce the deficit of trust between the taxpayer and tax collector; and
(iii) to increase the level of voluntary compliance. Pakistan is the first country in the region to
have successfully implemented this system of taxation. The government feels that the results
achieved through implementation of this system of taxation are encouraging. It is evident
from the fact that the tax collection has increased from Rs 330 billion in the year 2000 to Rs
1,005 billion in the year 2008 (direct taxes - 82 billion to over 400 billion).

The scheme canvassed in the Income Tax Ordinance, 2001 reflects the policies of the
government. The policy is to facilitate the businesses, increase the tax collection through
broadening the tax base, reduction in tax rates, reduction in exemptions, reposition of
confidence in taxpayers and encouraging voluntary compliance. It is this underlying policy
that the government has brought down the tax rates (which were as high as 80% in certain
cases in 1960s and 55% in 2002) to 35%, eliminated exemptions in various cases and
introduced the concept of self assessment without exception. It also contains suitable
provisions, compatible with the business needs, for the taxation of specialized
businesses/transactions. Over the last few years the provisions of law have been amended to a
reasonable extent to align the tax laws with the modern business transactions/needs.

Notwithstanding the aforesaid fundamental changes in the mechanics of implementing the

law, the historical/universal concept of targeting the income, to the levy of tax, remains
unchanged. Similarly, there is no change in the collection techniques and these remain PAYE
(through withholding taxes and advance tax). The law focuses on charging the tax on income
of residents of Pakistan accruing from sources existing both inside and outside Pakistan
whereas in the case of non-residents the tax is payable only on the income accruing from the
territorial jurisdiction of Pakistan. The law provides a complete mechanism for computation
of income, regulation, monitoring and remedies. It also contains provisions for blocking the
aspect of tax planning which is undertaken by the entities to reduce the incidence of tax on
income.
(ii) Agreements for Avoidance of Double Taxation

The aforesaid universally applicable principle of taxing the resident (on world income) and
non-residents (for income accruing in the territory of a state) by any state gives rise to a
possibility of double taxation in the case of residents i.e. once in the other state where the
income is earned (under the principle of territorial jurisdiction) and once in Pakistan (under
the principle of residency). In order to eliminate the incidence of possible double taxation, the
law allows a credit for taxes paid abroad. Besides, there are Agreements for Avoidance of
Double Taxation, which the states sign to limit their rights to tax the income. These
Agreements, generally known as double tax treaties, are a complete code in itself and have an
overriding status vis--vis the local laws. Pakistan has signed double tax treaties with over 50
states. From a practical perspective, an understanding of the philosophy and rationale of these
treaties is essential.

(c) Understanding the Tax Planning

Entities invariably undertake tax planning for the purposes of reducing the incidence of
overall taxation. For entities operating in only one country tax planning is usually carried out
through structuring of a business/transaction whereas for entities operating in more than one
country, double tax treaties are also used for this purpose. In the past, the local entities also
used the presumptive tax regime as a tool for tax planning. That was so because under this
regime the tax liability was predetermined and thus businesses/transactions could be
restructured to reduce the incidence of tax.

The entities endeavour to accrue profits in states with less incidence of tax through adoption
of transfer pricing techniques. The law, therefore, includes anti-avoidance provisions to
address this aspect. It enables the tax administration, of course on the basis of conclusive
evidence, to disregard the avoidance techniques undertaken by the entities to reduce the
incidence of tax and to determine the proper tax liability attributable to the activities carried
out in the state under the principles of arms length transactions. The provisions of law
include the most modern concepts, fully compatible with developed countries, in this respect
and thus reduce the avenues of tax planning to some extent.

Notwithstanding the aforesaid development in the law, it is considered that the tax
administration has not been properly trained to tackle these techniques undertaken by the
entities and hence there still is a reasonable potential for tax planning. The provisions of
certain treaties also leave a lot of room for tax planning because at the time of signing these
treaties the Pakistan perspective was not thoroughly watched.

(d) Role of the Regulator

The provisions of law clearly define the role and the responsibilities of the regulator. The
regulator ensures the collection of tax and the compliance/implementation of law. The
regulator is also authorized to conduct audits in suspected/identified/selected cases. It also
facilitates taxpayers education through issuance of circulars, clarifications and advance
rulings.

Outside the book, it also facilitates in fixation of annual budgetary targets, laying down the
policy and proposes amendments in law to implement these policies. The responsibility of
negotiating treaties with other counties also rests with the regulator.
2. Goals of the course

The goal is not to make the students familiar with the prevailing tax laws only. The students
are meant to be equally familiar with the philosophy and the rationale of taxation as well as
the aspect of tax planning. The strengths and weaknesses of the applicable system would also
be debated. Comparative analysis with the laws in the other states would be carried out to
determine as to where the local law has an edge or where it is deficient. In short, the course
would encompass practical knowledge vis--vis all perspectives whether the student pursues
the career as a tax practitioner, or tax regulator/policy maker or a businessman.

3. Required Texts

i) Law & Practice of Income Tax by Dr. Ikram-ul-Haq;

ii) The Law & Practice of Income Tax by Kanga, Palkhivala and Vyas;
iii) Principles of Income Tax Law with International Tax Glossary by Dr. Ikram-ul-
Haq;
iv) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations
by OECD;
v) Cross Border Transactions and tax Treaties Theory and Practice by Ahmad
Khan;
vi) Commentary of OECD on Articles of model double tax treaty;
vii) Guidelines/Brochures issued by Federal Board of Revenue on various topics and
available (in publication section) on the website: www.fbr.gov.pk;
viii) Important case laws settling basic principles of taxation;

4. Course outline

The course is proposed to be covered during the sessions as under:

Session 1 & 2 Understanding the concept and principles of taxation; types of taxes,
legislative developments and outline of present legislation;

- Understanding the rationale of taxation and its role in the economy;

- Types of taxes viz. direct taxes and indirect taxes and their
concept;
- Direct taxes applicable in the country both at federal and provincial
level;
- Transformation (in practical sense) of direct taxes into indirect
taxes over the last two decades to a very large extent;
- The development and evolution of law relating to direct taxes in
Pakistan (income tax perspective), including the measures for
broadening the tax base and gradual reduction in tax rates;
- An overview of existing legislative framework (income tax
perspective), including its focus, scheme and processes;
- Rules of interpretation of fiscal statutes;

Session 3,4,5 The scheme of taxation contained in the Income Tax Act, 1997 (Provincial)
and the Income Tax Ordinance, 2001 (Federal), its rationale and
philosophy;

- Understanding the present form of taxation, its origin and

necessity;
- Understanding the concept of income;
 - Distinction between real income and deemed income;
- Bifurcation of income into heads and computation of income
under these heads;
- Concept of computation of total income;
- Distinction between resident and non-resident and the need for
such distinction;
- Scope of taxation for residents and non-residents;
- Assessment of income, the role of the regulator;
- Minimum taxation for companies;

Session 6,7,8 Withholding taxes & Presumptive tax regime

- Concept of withholding taxes;

- Effect of withholding taxes (transformation into indirect taxes);
- Role of government machinery in collection of taxes;
- Monitoring of voluntary compliance to withholding provisions;
- Concept of presumptive tax regimes, its rationale and effect on
economy;
- Reality vis--vis the concept/thought behind introduction of
presumptive tax regime
- Legality of presumptive tax regime;

Session 9 Taxation of Specialized Businesses/Transactions

- Need for introduction of provisions for governing the taxation of

specialized businesses;
- The extension in these provisions over the last few years owing to
the need and complexities involved in such businesses;
- Taxation of oil exploration companies, insurance companies and
banks;
- Taxation of leasing transactions;

Session 10 Remedies available under the statute

- Need for incorporating remedies in the law;

- Conventional (historical) appellate forums;
- Federal Tax Ombudsman;
- Out of court settlement, its necessity, importance, advantages and
disadvantages;
- Alternative Dispute Resolution Committee (ADRC) mechanism;
- ADRC whether failure or a success;
- Comparison of ADRC mechanism with other states;
- Judicial response to TAX in recent days;

Session 11 Tax Planning

- Need and concept of tax planning;

- Structuring the transaction/business;
- Concept of tax avoidance and tax evasion;
- Transfer Pricing tool for tax planning;
- Continuous expansion (accelerated depreciation) tool for tax
planning;
- Cross border transactions;
 - Anti tax planning provisions, their need and rationale;

Session 12 Tax incentives and exemptions

- Necessity for introduction of exemptions and incentives;

- Historical perspective of exemptions/incentives;
- Present policy regarding exemptions/incentives;
- International agreements/commitments vis--vis foreign
governments / agencies;

Session 13 Double taxation vis--vis cross border transactions

- The concept/possibility of double taxation on any one component

of income;
- Allowability of credit for tax paid in one state against tax liability
on the same component of income in another state;
- Agreements for Avoidance of Double Taxation;
- The source of Agreements historical perspective;
- Tax sparing cross border transactions only;
- Overriding status of these Agreements;

Session 14 Role of the regulator

- Structure;
- Fixation of Revenue Targets/Budgets;
- Collection of taxes;
- Implementation of law;
- Monitoring;
- Administration;
- Policy making;
- Clarifications/Circulars;
- Addressing the anomalies;

INDIRECT TAXES IN PAKISTAN

A course on Sales Tax, Customs
& Federal Excise Laws
Akhtar Ali, M.A. LL.B

Course Objectives:

The course covers three legislations relating to indirect taxes i.e. The Sales Tax
Act, The Customs Act & The Federal Excise Act with a greater emphasis on
sales tax. While studying Sales Tax Act, students will be introduced to the basic
and universally accepted concepts of value added tax, as practiced in Europe
and most of other countries in Asia and Latin America. This will give an
international perspective to students and broaden their vision and make it easier
for them to understand the rationale behind frequent changes in Pakistans sales
tax, which otherwise may look incoherent and bizarre. The course also intends
to give an insight into evolution and development of sales tax in Pakistan during
last 18 20 years. Basic and fundamental concepts, rationale and functions of
customs duties/tariff and of Customs Act will also be discussed. Basic concepts
of Federal Excise Act and duties will also be introduced. The students, after
studying the course, should be able to know as to which provision of law will be
applicable to a particular situation and how the same has been interpreted by the
courts.

Course Structure:
The course consists of fourteen sessions. Eight sessions have been devoted to
Sales Tax while four sessions are reserved for the Customs Act. Federal Excise
Act will be covered in two sessions.
 THE SALES TAX ACT, 1990

Session I
Nature, importance and gradual spread of Value Added Tax in Europe and
the rest of world; design and implementation issues in VAT.

Development of VAT has taken place in the last 50 60 years. After its
successful introduction in Europe, it has traveled to Latin America and
Asia mainly under influence of international donor agencies which
encouraged developing countries to levy taxes on consumption rather
than on trade. For this purpose, there was no better instrument than VAT
which can be imposed with equal ease both on goods and services. The
spread of VAT therefore needs to be examined in the context of its
efficiency as well as overall international trade agenda.

Session II
Introduction to Sales Tax Act, terminology used and definitions; scope
and payment of tax.
The sales tax like other taxes has its own peculiar terminology which
needs to be understood for better appreciation of the underlying currents
and concepts of the tax. Complications involved in the charging section
and input tax/output tax mechanism also need to be understood. This
session aims at the same.

Session III
Scope and nature of zero-rating, exemptions, Third and Sixth Schedule of
the Act.

Session IV
 Discussion on case law relating to time of supply, value of supply, scope
of tax & input tax/output tax credit.

Session V
Registration, de-registration, book-keeping requirements, audit,
blacklisting & filing of returns.

Session VI
Discussion on quasi-judicial adjudication process, offences, penalties, &
procedure in appeals including provisions relating to criminal
proceedings.

Since quasi-judicial adjudication process is distinct from civil and

criminal judicial processes, it is important to give an overview of the
practices in the quasi-judicial system and a comparison with the criminal
proceedings under the Act. Students need to know the process of issuance
of show-cause notices, hearing proceedings, orders-in-original and
orders-in-appeal etc.

Session VII
Discussion on rules and procedures relating to refund and recovery.

Session VIII
Discussion on Special Procedures for collection and payment of sales tax
for specified sectors.
 THE CUSTOMS ACT, 1969

Session IX
Historical perspective of custom duties in Pakistan.
Definitions and overall scheme of The Customs Act, 1969.
(Section: 2).

Session X
Levy of, exemption from and re-payment of customs duty including
important case law.
(Section: 18, 19, 20, 31A & 35 41).

Session XI
Value of imported goods, mis-declaration, assessment of duty &
warehousing of imported goods.
(Section: 25, 25A, 25D, 32, 32A, 79, 80, 81, 82, 83 & 84 119).

Session XII
Prevention of smuggling; power of search, seizure & arrest.
(Section: 158 178 & 184 192).

THE FEDERAL EXCISE ACT, 2005

Session XIII
Levy, exemption, collection and payment of excise duty.
(Section: 3 16).

Session XIV
First & Second Schedule of the Act and Federal Excise Rules including
special procedures for excisable services.
 COURSE MATERIALS

Relevant course material will be provided to students at the beginning of the

quarter in the form of a packet. Additional readings, if required, will be
provided during the quarter. Mainly, the reliance will be placed on the following
Acts/ material.
The Modern VAT by Liam Ebrill, Michael Keen, Jean-Paul Bodin and
Victoria Summers.
The Sales Tax Act, 1990.
The Customs Act, 1969.
The Federal Excise Act, 2005.
Important reported Case Law.

TEACHING METHODOLOGY & GRADING

The class will generally be taught through a modified Socratic dialogue, though
other methods will also be used. Students must come to each class prepared, and
with all the relevant materials for that day. Students are reminded that the
attendance policy will be strictly implemented, and any student who is more
than 10 minutes late to class may, at the instructors sole discretion, be barred
from sitting in that class. The final grade for the course will comprise of the
aggregate of the following grading instruments:

Class Participation 20%

Assignment 15%
Mid-term exam 25%
Final exam 40%

Guidelines for the above will be provided in class in due course.