Law 323 tax law (part i & ii) akhtar ali and asim zulfiqar ali
Tax Law Akhtar Ali, M.A. LL.B and Asim Zulfiqar Ali, LL.B., FCA DIRECT TAXATION IN PAKISTAN A course on Income Tax Law Asim Zulfiqar Ali, LL.B., FCA1. Course Description(a) An Introduction to Direct TaxesTaxes are regarded as a major source of income/revenue for a state to meet its obligationstowards the nation. These taxes are fundamentally utilized by the government for thepurposes of public sector development programs, defense and other areas of massimportance. In Pakistan, various taxes are in force some of which are regulated by the FederalGovernment while some are in the domain of the Provincial Governments. The split betweenthese is provided for in the Constitution and its rationale and the logic is not the subjectmatter 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, thedivision broadly remains the same. These are both income based and / or asset ownershipbased, depending upon the nature and type of the levy. Direct taxes are those where theincidence 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 thetax is eventually collected by the ‘agent’ in the due course and deposited in the governmenttreasury). Few examples of ‘direct taxes’, collected by the Federal Government, are ‘IncomeTax’, ‘Wealth Tax’, and ‘Capital Value Tax’. ‘Urban Immoveable Property Tax’,‘Professional Tax’ and ‘Motor Vehicle Tax’ etc. are types of direct taxes collected by therespective 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 thegovernment in the year 2000 as part of the reform process whereby the governmentintroduced a policy of reducing the number of taxes (federal excise duty, an indirect direct, isalso proposed to be abolished gradually under this reform process). Another reason behindthe abolition of the said was that it was not making significant contribution in the exchequerand 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 ofthought argue that it was a tax on rich only and its abolition has favoured a particular classand hence the same is in a direct conflict with the rationale and philosophy of imposition ofdirect taxes. This controversy remains unaddressed, however, there are rumours that this
might be reinstated. The significant amount is generated through levy of income tax andduring the year ended June 30, 2010 the government collected around 40% of its aggregaterevenues (both direct and indirect) in the form of this tax. This position, without underminingthe importance of other direct taxes, makes the income tax as the focal point of thegovernment so far as the policy, legislation and implementation are concerned. Much of theemphasis is given in increasing the collection, removal of leakages and improvement ofbusiness processes involved in implementation of this tax.
Very recently, (as part of reform process - facilitation), the government has reclassified taxesinto ‘custom duty’ and ‘inland revenues’. Now, for enforcement and collection purposes,‘income tax’, ‘sales tax’ and ‘federal excise duty’ are categorized as ‘inland revenue’ andthese are be handled by one authority. The purpose is to eliminate the hassle of dealing withmultiple officials especially when in various cases similar aspects/considerations are relevantfor law enforcing authorities.(b) Income Tax Law in Pakistan – History, Evolution & DevelopmentIn the Indo-Pak, the history of modern income taxation dates to 1860, although prior to thatlicense taxes based on profits, trades and professions were in vogue. This tax was introducedto meet the deficit resulted from the War of Independence and was not intended to bepermanent. The Income Tax Act of 1886 was a general income tax that had been imposed onthe trades by some provinces and its basic scheme, by and large, even survives today. Thislaw underwent certain changes and finally transformed into the Income Tax Act, 1922 whichwas 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 substitutedby the Income Tax Ordinance, 1979 which remained in force until the year 2002. An analysisof the provisions of the two legislations shows that the latter, when enacted, was in fact aredrafted and consolidated version of the former and as such there was no change in theunderlying concept and philosophy. Both the legislations provided that an assessing officerwould ‘determine’ the income of a taxpayer on the basis of declarations/filings of suchtaxpayer.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 theregion, shift from the original philosophy and had a set objective. It prescribed a transactionbased tax liability regardless of the fact that the person executing the transaction had earnedany income or not. This scheme was initially conceived to be a ‘stop gap arrangement’ fortaxing the persons who continuously remained outside the tax net or who could claim refundsby not disclosing the real income. The idea was to increase the tax collection and eliminatethe refunds. Though the objectives were initially achieved but the scheme changed the overallnature of the levy. This transformed the levy of income tax into an indirect tax as thetaxpayers 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 revenuecollection considerably but it also transformed a direct tax into an indirect tax thus causing ashift from the underlying principles/rationale. It also discouraged documentation, which is thebackbone for determining the real quantum of income, to a very large extent. From thegovernment’s perspective the advantages outweighs the disadvantages hence it is beingcontinued 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 doneaway with through promulgation of the presently applicable Income Tax Ordinance, 2001and now whatever declaration is filed by a taxpayer the same is taken to have been acceptedby the tax authorities, at the first place. Nevertheless, the tax authorities are empowered toconduct an audit of a taxpayer and on discovering any under-declaration/mis-declaration theycould 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 provisionsof law prescribe appeal fora.
(b) Familiarity with the Legal Framework(i) Local Income Tax LawsAt 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 agriculturalincome). These statutes are a complete code and contain full procedure for computation ofincome, collection of taxes, regulation, monitoring, remedies etc. The provincial laws are of avery basic nature and are based on the principles earlier contained in the Income TaxOrdinance, 1979.The presently applicable system of regulating the income tax (at federal level), brieflydiscussed above, is fully in line with the concept provided for in OECD (Organization forEconomic Co-operation and Development) guidelines, the system followed in the developedcountries. It rests on the principle of ‘convergence’. Historically, there had been wide gapsbetween the accounting income and the taxable income. Now these gaps are being reducedand the taxable income is brought as closer as possible to the accounting income.The shift was also a part of the government’s reform process. In the course of analyzing thetax administration a necessity of reposing confidence in taxpayers was felt (i) to enhance thetax 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 tohave successfully implemented this system of taxation. The government feels that the resultsachieved through implementation of this system of taxation are encouraging. It is evidentfrom the fact that the tax collection has increased from Rs 330 billion in the year 2000 to Rs1,005 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 thegovernment. The policy is to facilitate the businesses, increase the tax collection throughbroadening the tax base, reduction in tax rates, reduction in ‘exemptions’, reposition ofconfidence in taxpayers and encouraging voluntary compliance. It is this underlying policythat the government has brought down the tax rates (which were as high as 80% in certaincases in 1960’s and 55% in 2002) to 35%, eliminated exemptions in various cases andintroduced the concept of self assessment without exception. It also contains suitableprovisions, compatible with the business needs, for the taxation of specializedbusinesses/transactions. Over the last few years the provisions of law have been amended to areasonable extent to align the tax laws with the modern business transactions/needs.Notwithstanding the aforesaid fundamental changes in the mechanics of implementing thelaw, the historical/universal concept of targeting the income, to the levy of tax, remainsunchanged. 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 incomeof ‘residents’ of Pakistan accruing from sources existing both inside and outside Pakistanwhereas in the case of ‘non-residents’ the tax is payable only on the income accruing fromthe territorial jurisdiction of Pakistan. The law provides a complete mechanism forcomputation of income, regulation, monitoring and remedies. It also contains provisions forblocking the aspect of tax planning which is undertaken by the entities to reduce theincidence of tax on income.
(ii) Agreements for Avoidance of Double TaxationThe aforesaid universally applicable principle of taxing the resident (on world income) andnon-residents (for income accruing in the territory of a state) by any state gives rise to apossibility of double taxation in the case of ‘residents’ i.e. once in the other state where theincome is earned (under the principle of territorial jurisdiction) and once in Pakistan (underthe principle of residency). In order to eliminate the incidence of possible double taxation, thelaw allows a credit for taxes paid abroad. Besides, there are Agreements for Avoidance ofDouble Taxation, which the states sign to limit their rights to tax the income. TheseAgreements, generally known as double tax treaties, are a complete code in itself and have anoverriding status vis-à-vis the local laws. Pakistan has signed double tax treaties with over 50states. From a practical perspective, an understanding of the philosophy and rationale of thesetreaties is essential.(c) Understanding the Tax PlanningEntities invariably undertake tax planning for the purposes of reducing the incidence ofoverall taxation. For entities operating in only one country tax planning is usually carried outthrough structuring of a business/transaction whereas for entities operating in more than onecountry, double tax treaties are also used for this purpose. In the past, the local entities alsoused the presumptive tax regime as a tool for tax planning. That was so because under thisregime the tax liability was predetermined and thus businesses/transactions could berestructured to reduce the incidence of tax.The entities endeavour to accrue profits in states with less incidence of tax through adoptionof transfer pricing techniques. The law, therefore, includes anti-avoidance provisions toaddress this aspect. It enables the tax administration, of course on the basis of conclusiveevidence, to disregard the avoidance techniques undertaken by the entities to reduce theincidence of tax and to determine the proper tax liability attributable to the activities carriedout in the state under the principles of arms’ length transactions. The provisions of lawinclude the most modern concepts, fully compatible with developed countries, in this respectand thus reduce the avenues of tax planning to some extent.Notwithstanding the aforesaid development in the law, it is considered that the taxadministration has not been properly trained to tackle these techniques undertaken by theentities and hence there still is a reasonable potential for tax planning. The provisions ofcertain treaties also leave a lot of room for tax planning because at the time of signing thesetreaties the Pakistan perspective was not thoroughly watched.(d) Role of the RegulatorThe provisions of law clearly define the role and the responsibilities of the regulator. Theregulator ensures the collection of tax and the compliance/implementation of law. Theregulator is also authorized to conduct audits in suspected/identified/selected cases. It alsofacilitates taxpayers’ education through issuance of circulars, clarifications and advancerulings.Outside the book, it also facilitates in fixation of annual budgetary targets, laying down thepolicy and proposes amendments in law to implement these policies. The responsibility ofnegotiating treaties with other counties also rests with the regulator.
2. Goals of the courseThe goal is not to make the students familiar with the prevailing tax laws only. The studentsare meant to be equally familiar with the philosophy and the rationale of taxation as well asthe aspect of tax planning. The strengths and weaknesses of the applicable system would alsobe debated. Comparative analysis with the laws in the other states would be carried out todetermine as to where the local law has an edge or where it is deficient. In short, the coursewould encompass practical knowledge vis-à-vis all perspectives whether the student pursuesthe 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 outlineThe 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-à-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-à-vis foreign governments / agencies;Session 13 Double taxation vis-à-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.BCourse Objectives:The course covers three legislations relating to indirect taxes i.e. The Sales TaxAct, The Customs Act & The Federal Excise Act with a greater emphasis onsales tax. While studying Sales Tax Act, students will be introduced to the basicand universally accepted concepts of value added tax, as practiced in Europeand most of other countries in Asia and Latin America. This will give aninternational perspective to students and broaden their vision and make it easierfor them to understand the rationale behind frequent changes in Pakistan’s salestax, which otherwise may look incoherent and bizarre. The course also intendsto give an insight into evolution and development of sales tax in Pakistan duringlast 18 – 20 years. Basic and fundamental concepts, rationale and functions ofcustoms duties/tariff and of Customs Act will also be discussed. Basic conceptsof Federal Excise Act and duties will also be introduced. The students, afterstudying the course, should be able to know as to which provision of law will beapplicable to a particular situation and how the same has been interpreted by thecourts.Course Structure:The course consists of fourteen sessions. Eight sessions have been devoted toSales Tax while four sessions are reserved for the Customs Act. Federal ExciseAct will be covered in two sessions.
THE SALES TAX ACT, 1990Session – 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, 1969Session – 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, 2005Session – 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 MATERIALSRelevant course material will be provided to students at the beginning of thequarter in the form of a packet. Additional readings, if required, will beprovided during the quarter. Mainly, the reliance will be placed on the followingActs/ 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 & GRADINGThe class will generally be taught through a modified Socratic dialogue, thoughother methods will also be used. Students must come to each class prepared, andwith all the relevant materials for that day. Students are reminded that theattendance policy will be strictly implemented, and any student who is morethan 10 minutes late to class may, at the instructor’s sole discretion, be barredfrom sitting in that class. The final grade for the course will comprise of theaggregate 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.