Income Tax Law

Definitions

Total income

The total income of a person for a tax year shall be the sum of the person’s
income under each of the heads of income for the year. Following are the
heads specified in the law for this purpose:

(a) Salary
(b) Income from property
(c) Income from business
(d) Capital gains
(e) Income from other sources

Pakistan source income

Income tax ordinance, 2001, has given consideration to the geographical

source of income while taxing any income. In this context the Pakistan-
source income includes the income which a person earns in Pakistan,
irrespective of the fact that where it is actually received.

Foreign source income

This is a new concept, which has been introduced through the income tax
ordinance, 2001. According to the ordinance, an amount shall be foreign
source income to the extent to which it is not a Pakistan source income.
Tax

Tax means any tax imposed under the income tax law. It also includes any
penalty, fee or other charge or any sum or amount leviable or payable under
the income tax ordinance, 2001.

Taxable income

The taxable income of a person for a tax year shall be the total income of the
person for the year as reduced by any deductible allowances. However, the
taxable income should not be below zero.

Taxpayer

Taxpayer means:

i. A person who derives an amount chargeable to tax

ii. Representative of such person
iii. A person responsible to deduct or collect tax and deposit it with the
government under the provisions of the income tax law;
iv. Any person required to furnish a return or pay tax under income
tax ordinance, 2001.

Person

Under the income tax ordinance, 2001, a person includes the following:

i. An individual
 ii. A company
iii. An association of persons incorporated, formed, organized or
established in Pakistan or elsewhere
iv. The federal government, a foreign government, a political sub-
division of a foreign government, or public international
organization.

Company

According to the Income tax ordinance, 2001, ‘company’ means

i. A company as defined in the Companies Ordinance 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 cooperative society or a finance society or any other
society established under law
vi. A foreign association whether incorporated or not, which the
central board of revenue has declared to be a company
vii. A provincial government
viii. A local authority in Pakistan; or
ix. A small company.

Public company

Under income tax law a public company means:

 i. A company in which at least fifty percent of the shares are held by
the federal government or provincial government.
ii. A company in which at least fifty per cent of the shares are held by
a foreign government.
iii. A foreign company owned by a foreign government.
iv. A company whose shares were traded on a registered stock
exchange in Pakistan at any time ins the tax year and which
remained listed on that exchange, at the end of that year: or
v. A unit trusts whose units’ arte widely available to the public and
any other public trust.

Private company

Private company means a company, which is not a public company.

Banking Company

Banking company has the same meaning as in the banking companies

ordinance, 1962 (LVII of 1962) and includes any body corporate which
transacts the business of banking in Pakistan.

Small Company

Under income tax law “Small Company” means a company, which fulfills
the following condition:
 1. It is registered on or after 1st July 2005 under the companies

ordinance, 1984
2. Paid up capital plus undistributed reserves should not exceed twenty
five million rupees
3. Annual turnover should not exceed two hundred million rupees; and
4. The company is not formed by reconstituting or splitting up an
already existing business.

Business

“Business” includes any trade, commerce, manufacture, profession, vocation

or adventure or concern in the nature of trade, commerce, manufacture,
profession or vocation, but does not include employment.

Speculation business

A speculation business means any business in which a contract for the

purchase and sale of any commodity (including stock and shares) is
periodically or ultimately settled otherwise than by the actual delivery or
transfer of the commodity.

Capital Asset

Capital asset means property of any king held be a person. It is immaterial

whether the property is connected with his business or not. However, the
following are excluded form the definition:

i. Any stock in trade (not being stocks and shares), consumable

stores or raw materials held for the purpose of business.
ii. Any immovable property
iii. Personal effects of an individual like jewelry, clothes and
household furniture.
Charitable purposes

Charitable purpose includes relief of the poor, education, medical relief and
the advancement of any other object of general public utility.

Dividend

Dividend includes:

i. Any distribution by a company of accumulated profits to its

shareholders, whether capitalized or not;
ii. Any distribution by a company7, to its shareholders of debentures,
debenture sock or deposit certificate in any form whether with or
without profit, to the extent to which the company possesses
accumulated profits whether capitalized or not;
iii. Any distribution made to the shareholders of a company on its
liquidation out of accumulated profits of the company immediately
before its liquidation, whether capitalized or not;
iv. Any distribution by a company to its shareholders on the reduction
of its capital to the extent to which the company possesses
accumulated profit whether capitalized or not;
v. Any payment by a private company or trust of any sum by way of
advance or loan to a shareholder or any payment by any such
company or trust on behalf, or for the individual benefit, of any
such shareholder to the extent to which the company or trust, in
either case, possesses accumulated profits;
Intangible

Intangible means any patent, invention, design or model, secret formula or

process, copyright and other properties and rights of the same kind. It also
includes any other expenditure-incurred by a business that provides:

i. Benefit or advantage for a period of more than one year; and

ii. The expenditure is not incurred to acquire a depreciable asset or
unimproved land.

Minor child

Under the income tax ordinance, 2001, minor child means an individual who
is under the age of eighteen years. The age is to be determined at the end of
a tax year.

Non-profit organization

Non-profit organization means any person the than an individual which is:

i. Established for religious, educational, charitable, welfare or

development purposes or for the promotion of an amateur sport;
ii. It should be registered under any law as a non-profit organization
and the commissioner of income tax has certified it to be a non-
profit organization for a specified period, under the income tax
ordinance.
iii. Any asset of the organization should not be used for the private
benefit of any other person.
Principal officer

Principal officer used with reference to a company or association of persons

includes:

i. A director, a manager, secretary, agent, accountant or any similar

officer, and
ii. Any person connected with the management or administration of
the company or association of persons upon whom the
commissioner has served a notice4 of treating him as the principal
officer thereof

Resident and non-resident persons

Income tax ordinance, 2001, does not make any distinction on nationality or
domicile basis; rather tax liability of person is dete4mined on the basis of the
fact that whether he is a resident or non-resident person.

It must be noted that:

i. To be a resident or non-resident as used above has nothing to do

with a dwelling place or nationality, rather it is a term purely
designed for tax purposes.
ii. The status of resident or non-resident is always associated with a
particular income year because it may change from year to year.
iii. A person’s status is determined with reference to the period of his
stay (purpose of stay is immaterial) in Pakistan in the tax year.
iv. The federal government is treated as resident.

For the purpose of income tax, all the persons are grouped under two
categories:

i. Residents
ii. Non-residents
Resident individual

An individual will be a resident in Pakistan in any tax year if he fulfils any

one of the following two conditions:
1. He is in Pakistan for a period or periods amounting, in all, to 183 days
or more.
2. He is an employee or official of the federal government or a
provincial government posted abroad in the tax.

Resident company

A company shall be a resident company shall be a resident company for a

tax year if it fulfills any one of the following conditions:

i. It is incorporated or formed by or under any law in Pakistan;

ii. The control and management of the company is situated wholly in
Pakistan at any time in the year; or
iii. It is a provincial government or local authority in Pakistan.

Resident Association of persons

An association of persons shall be resident for any tax year if the control and
management of the affairs of the association is situated wholly or partly in
Pakistan at any time in the year.

Resident persons

A person shall be a resident person for a tax year if the person is:

i. A resident individual, resident company or resident association of

person for the year; or
ii. The federal government.

Non-resident persons

Under the income tax ordinance, 2001, a person shall be a non-resident

person for a tax year if the person is not a resident person for that year.

Non-resident taxpayers
A non-resident taxpayer means a taxpayer who is a non-resident person.

Reasons for distinguishing resident and non-resident person

There are two basic reasons due to which it is necessary to determine

whether a person is a resident or non-resident during the tax year.

Incidence of taxation

The income of a resident person is calculated by taking into account both

the Pakistan-source income and the foreign-source income.
The income of non-resident person is computed by taking into account
only those amounts, which are Pakistan-source income.

Rates of tax

There is a difference in rates of tax for residents and non-residents. This

difference will be discussed in later chapters.

Salary

Salary means an amount received by an employee, from any employment

Stock in trade

Stock in trade means anything produced, manufactured, purchased, or

otherwise acquired for manufacture, sale or exchange and any materials or
supplies to be consumed in the production or manufacture process, but does
not include stock or shares.

Taxation officer

The following are included in the definition of taxation officer:

i. Additional commissioner of income tax.

 ii. Deputy commissioner of income tax
iii. Assistant commissioner of income tax
iv. Income tax officer
v. Special officer
vi. Any other officer with any designation appointed by the central
board of revenue under income tax ordinance, 2001.

Tax year

The concept of tax year has been introduced in income tax law through
income tax ordinance, 2001. Tax year is a period of time for which tax is to
be calculated regarding a person.

The tax year may be of three types:

1. Normal tax year

It is a period of twelve months ending on 30th June and is known by the

calendar year in which the ending date falls. Such a tax year is known as
normal tax year.

2.Special tax year

In case of any person or class of persons or any source of income

Federal Board of Revenue may specify a period of twelve months as their
tax year.

For example, in case of all companies manufacturing cotton textiles

central board of revenue has specified that their tax year will commence
on 1st October and will end on 30th September following

This period of 12 months is tax year for all companies engaged in cotton
textiles manufacturing. Such a tax year is called special tax year and is
known by the calendar year relevant to normal tax year in which the
ending date falls.
 3.Transitional tax year

When tax year of any class of persons or a single person is changed as a

result of an order by the Federal Board of Revenue or commissioner of
income tax, it results in the emergence of a changing period which is
known as “transitional tax year” and is treated to be a separate tax year. It
consists of the period between the end of last year before change and the
start of the changed tax year.

Associates

This term has been introduced by finance ordinance, 2001. Two persons will
be associates where the relationship between the two is such that one may
reasonably be expected to act in accordance with the instructions of other or
both persons may reasonably be expected to act in accordance with the
instructions of a third person, e.g.

1. An individual and his close relative;

2. Members of an association of persons;
3. a trust and any person who benefits from the trust;
4. a company and its shareholder who controls 50% or more voting
power, right to dividend or right to capital.

Royalties

Royalties mean any amount paid or payable as consideration for:

(a) The use of any patent, invention, design or model, secret formula or
process, trademark or any other property or right of this type;
(b) The use of or right to use any copyrights of a literary, artistic or
scientific work including films or videotapes for use in connection
with television or tapes in connection with radio broadcasting.
However, consideration for the sale of cinema autograph films will
not be treated as royalty;
(c) The receipt of, or right to receive, any visual images or sounds or both
transmitted by satellite cable, optic fiber or similar technology in
connection with television, radio or internet broadcasting;
(d) The supply of any technical, industrial, commercial or scientific
knowledge, experience or skill;
 (e) The use of, or right to use, any industrial, commercial or scientific
equipment;
(f) The supply of any assistance that is subsidiary to any property or right
mentioned above;

Industrial undertaking

This definition has been added through finance Act, 2004. An organization
fulfilling the following conditions will be known as industrial
“undertaking”:
1. Organization is set up in Pakistan;
2. It uses electrical energy or any other form of mechanical energy
and employs ten or more persons; or
It does not use electrical or any other form of energy but:
(a) Employs twenty or more persons;
(b) Is engaged in a manufacturing process;
(c) Engaged in ship building;
(d) Engaged in generation, conversion, transmission or
distribution of electrical energy, or the supply of hydraulic
power,
(e) Engaged in the working of any mine, oil well or any other
source of mineral deposits.
Moreover, the central board of revenue can declare any other
organization which does not fall in the orbit of above two types
as ‘ INDUSTRIAL UNDERTAKING”

Agricultural income

The agricultural income means income:

i. Derived from land;

ii. Land is situated in Pakistan; and
iii. Land is uses for agricultural purposes.

Thus, any income derived as rent, revenue, or from sale of any produce,
which is grown on a Pakistani land, is agricultural income. However, it is
necessary to understand that the land must be used for agricultural
purpo9ses, which means that some human lab our and efforts are
necessary to be employed. If a produce is grown wild or spontaneously
on land without any human efforts or labour, it will not be treated as
agricultural income under this definition.

Types of Agricultural Income

Agricultural income has been classified into five categories:

1. Rent or revenue derived from agricultural land.
2. Income derived from such land by agriculture.
3. Income derived from such land by the performance of a process
ordinarily employed by a cultivator or receiver of rent in kind to
render the produce fit for market
4. Income derived from such land by the sale of produce by a cultivator
or receiver of rent in kind.
5. Income derived from any building required for agricultural purposes.

The last category, i.e., income from agricultural building, will be treated
as agricultural income only, if:
(a) Building is in the immediate vicinity of agricultural land.
(b) Building is occupied by the cultivator or the recipient of
agricultural income.
(c) The cultivator or recipient by reasons of his connection with the
land requires it as a dwelling house, storeroom or the out-
building.

Examples of agricultural income

Some examples of agricultural income are as follows:

1. Rent received by lessor of agricultural land.
2. Income received by lessee of agricultural land by cultivation.
3. Income from cultivation of tobacco, wheat, sugarcane, rubber, etc.
4. Income from growing tea.
5. Land revenue assigned to jagirdar.
6. Income from building used for agricultural purposes.
7. Fee paid by tenant for renewal of lease,
8. Income from any land used for carrying on any process necessary to
make the agricultural produce fit for the market.
9. Income from sale of honey or its products.
 10.Receipt of an amount for compromise of a dispute regarding
agricultural land.

Examples of non- agricultural income

Some examples of non-agricultural income are as follows:

1. Income from stone quarries.
2. Income from fisheries and ferries.
3. Income from mining and mining royalties.
4. Income from land used as a market.
5. Income from a flourmill.
6. Income from land used for storing timber.
7. Income received from a cotton-ginning factory.
8. Profits from a contract of cutting and selling trees.
9. Income from sale of earth for brick making.
10.Income from markets.

Examples of partly agricultural and partly non-agricultural income

1. Income of a person who grown tea leaves on his own farms in

Pakistan and then manufactures it into tea.
2. Income of a sugar mill, which grows sugarcane and manufactures
sugar.
3. Income of a cigarette company growing tobacco on its own land and
manufacturing cigarettes.
In all the above cases, growing of crops (tea plants, sugarcane and
tobacco respectively) is an agricultural process fulfilling all the
conditions of agricultural income. The second component of these
incomes is a manufacturing process and thus chargeable to tax under the
head “Income from business and profession”. In determining that part6
which is chargeable to tax, the market value of any agricultural produce
which has been raised by the person or received by him as rent in kind
and which has been utilized as raw material in such business, shall be
deducted and no further deduction in respect of any expenditure incurred
by the person as a cultivator or receiver of rent in kind will be allowed.
Accumulated Profits

The accumulated profits mean:

1. Any reserves maintained by a business out of its profits;

2. All profits of the company up to the date .

3. These profits kept in whatever shape, whethe4r capitalized or not,

will be treated as accumulated profits until their distribution to
shareholders.

Appellate Tribunal

In case of any dispute between the taxpayers and tax department an appeal
can be made to appellate Tribunal. This is the highest judicial authority in
the matters of tax. It consists of judicial as well as accountant members. The
members are appointed by the Federal Government. The decision of the
tribunal on point of facts is final. However, in case of point of law the matter
may be referred to high court.

Approved Gratuity Fund

The government and private organizations maintain gratuity funds for the
benefit of their employees. The amounts in these funds continue to
accumulate from year to year and normally are paid to employees at the time
of retirement. In case of death of an employee during service, the amount is
paid to his family. The employer gets a lot of benefits if the gratuity fund is
approved by the income tax authorities under the income tax ordinance,
2001, the Commissioner of income tax grants such an approval.

Approved Employment Pension or Annuity Scheme

Any employment related retirement scheme which makes pension or annuity

payments to its beneficiaries and is approved under income tax ordinance,
2001, are known as approved employment pension or annuity scheme.
Examples of such schemes include an approved superannuation fund, a
public sector pension scheme, employees old age benefit scheme, etc.

Approved Superannuation Fund

Superannuation funds are also maintained by the organizations to provide

benefit to their employees after retirement. The amount in this fund is
continuously contributed by the employer. These amounts are paid to the
employees as annuities or pensions after their retirement or if they become
invalid before retirement, or to their families in case of death. The present
government has adopted a reasonable and liberal policy for the pension of
widows and orphans of the deceased employees. This amount is also paid
out of the superanmnuation funds. under the income tax ordinance, 2001, the
commissioner of income tax approves such funds in which case the amount
contributed by an employer is treated as business expenditure, resulting in a
decrease in the tax payable.

Assessment

Assessment includes re-assessment and amended assessment and the

cognate expressions shall be construed accordingly.

Assessment Year

Assessment year means the period of 12 months beginning on the first day
of July next following the income year and includes any such period that is
deemed under the provision of this ordinance, to be the assessment year in
respect of tax year.

Association of Persons

Association of persons includes a firm, a Hindu undivided family, and

artificial judicial person and any body of persons formed under a foreign
law. However it does not include a company.