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Table of contents
Topics Page No.
• Acknowledgement ....................................................................................03
• Historical Background .............................................................................04
• Chronology Of The Income Tax Law...........................................................05
• The Indian Tax System And Its Reform.......................................................06
Direct Taxes................................................................................08
Indirect Taxes.............................................................................12
• Historical Development of Income Tax Laws In Pakistan ............................15
• Development of Income Tax Law In Pakistan ...........................................16
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ACKNOWLEDGEMENT
We owe our gratitude to Allah Almighty whose shower of blessings and
kindness our parents and respectful teachers has been on us throughout the
working on this project. It is His help that we finally able to compile this
document. We are indebted to our respected teacher Mr. Asghar Iqbal who‘s
indispensable and encouraging comments on various aspects conjoined with
motivation made us come forth holding such as project.
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Over view
The system of governance was instituted in 1858, when the rule of the British East India
Company was transferred to the Crown in the person of Queen Victoria[8] (and who, in 1876,
was proclaimed Empress of India), and lasted until 1947, when the British Indian Empire was
partitioned into five sovereign dominion states, the Union of India (later the Republic of
India) and the Dominion of Pakistan (later the Islamic Republic of Pakistan, the eastern half
of which, still later, became the People's Republic of Bangladesh) plus Nepal, Ceylon (now
Sri Lanka), and Sikkim. At the inception of the Raj in 1858, Lower Burma was already a part
of British India; Upper Burma was added in 1886, and the resulting union, Burma, was
administered as a province until 1937, when it became a separate British colony, gaining its
own independence in 1948.
Income Tax Act of 1922: prevalent in the British Raj and was adopted by the Government of
Pakistan as its Income Tax Law. Income Tax Ordinance, 1979 was the first law on Income
Tax which was promulgated in Pakistan from 1 July 1979 by Government of Pakistan. To
update the tax laws and bring country's law in accordance with international standards,
Income Tax Ordinance 2001 was promulgated on 13 September 2001, which became
effective from 1 July 2002. IT rules 2002 were promulgated by FBR on 1 July 2002 in
exercise of powers granted under section 237 of the Ordinance.
HISTORICAL BACKGROUND
In the pre-partition days, Income Tax was introduced for the first time through Income Tax
Act, 1860. During the period 1860 – 1922, no less than six Tax Acts were promulgated which
remained in force for periods ranging from one year to 32 years. When Pakistan came into
being, the Income Tax Act 1922, was in force and was replaced by Income Tax
Ordinance1979, which has now been repealed by the Income Tax Ordinance 2001, subject to
certain savings (sec. 239).
A brief chronology of the income tax law before independence is given below:
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CHRONOLOGY OF THE INCOME TAX LAW:
1860 Income Tax Act, 1860
Income tax was introduced in India for the first time through this Act, which remained in
force for 5 years. Agricultural income above the annual rental value of Rs. 600 was made
taxable. It remained in force till 1865. No income tax during the period 1865 to 1867.
o 1867 The License Act, 1867
Income Tax was re-imposed, exempting income from agriculture. Income earned over Rs.
200 was taxed at the rate of 2 percent.
o 1868 The Certificate Act, 1868
The Income Tax Act in force was re-named as above.
o 1869 Income Tax Act II, 1869
Agricultural income was again made taxable. Different tax rates on different types of income
were proposed. The Act remained in force for only one year.
During the period 1870 – 1873, income tax was levied through annual legislation, raising
gradually the exemption limit to Rs. 1000. Income tax was withdrawn entirely for the
SECOND TIME in 1873.
o 1877 The License Act, 1877
Income Tax was re-imposed after a period of 4 years. Tax on trade and a cess on land was
imposed.
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o 1886 Income Tax Act, 1886
A new Income Tax, considered a landmark in the taxation history, came into force and
continued till 1918 and during 32 years of its existence only one major amendment was made
in 1903. Agricultural income was properly defined. Tax rebate for Life Insurance was given
and a schedule of rates was provided.
o 1918 Income Tax Act, 1918
Another landmark in the taxation history of sub-continent. Distinction between ―Total
Income‖ and ―Taxable Income‖ was introduced. Procedure was changed. Tax was imposed in
respect of the income earned during the previous income year.
o 1922 Income Tax Act, 1922
To remove the day-to-day difficulties and to centralize the administration of income tax, on
the recommendation of Provincial/All India Committee formed in 1921, this Act came into
being. It provided a complete machinery and procedure of assessment. It also provided that
rates of tax will be fixed every year by the Finance Acts. Drastic changes were made in 1939.
During the World War II (1939-1945) PAYE (Pay As You Earn) scheme was introduced so
that tax reaches the Government immediately to finance the war.
The Indian Tax System and Its Reform
A strong tax system is fundamental to the development of a nation‘s economy. Taxation is,
however, about significantly more than revenue mobilization. The manner in which taxes are
administered and collected, and the uses to which they are put, define the symbiotic
relationship between the state and its citizens—strengthening the former, while making it
necessarily more accountable to the latter.
In India, the tradition of taxation has been in force in one form or another from ancient times.
The word ‗kara‘, which refers to taxes, finds mention in the Srimad Bhagvatam. When
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Chanakya aphorised in the Artha Shastra, ―Kosha moolo danda‖, he made the important point
that the treasury and its inflows are the sources of a government‘s might. Indeed, the Sanskrit
word ‗danda‘, which translates to the sceptre, is the manifest form of a government‘s identity,
consciousness and conscience.
Manu, the ancient sage and law-giver, laid down that traders and artisans should pay one-fifth
of their profits in silver and gold; while agriculturists, depending upon their circumstances,
were to pay one-sixth, one-eighth or one-tenth of their produce. Kalidasa in the
Raghuvanshasays thus of King Dileepa: ―It was only for the good of his subjects that he
collected taxes from them, just as the Sun draws moisture from the Earth to give it back a
thousand fold.‖ In his book Public Finance in Ancient India, the learned author K. B. Sarkar
commends the system of taxation in ancient India: ―Most of the taxes of Ancient India were
highly productive. The admixture of direct taxes with indirect taxes secured elasticity in the
tax system, although more emphasis was laid on direct tax. The tax structure was a broad-
based one and covered most people within its fold. The taxes were varied and the large
variety of taxes reflected the life of a composite population.‖
In the medieval period, the Sultans of Delhi collected taxes under five main categories. The
Mughal emperors granted land revenue rights to a mansabdar in exchange of promises of
soldiers during wartime. The Treaty of Allahabad of 1765 gave the British and the French the
right to collect taxes on behalf of the Emperor. Thus, the British system of collectors of land
revenues was firmly established well before the disintegration of the Mughal Empire after
1857. Public administration in India during the latter half of the nineteenth century saw large
shifts and overhauls in its structures and processes.
In July 1860, James Wilson, the first Finance Member of the Governor-General-in-Council,
quoted thus from the authority of Manu while introducing the act for levying income tax in
the country, ―As the leech, the calf and the bee take their food little by little, even so must the
King draw from his realm, moderate annual taxes.‖ As we proceeded through this century,
the financial obligations of the Raj increased, and the need to revamp the tax system was felt.
In 1919, with the introduction of the federal structure through ‗Diarchy‘, taxes on income and
some other taxes were made a central subject. In 1922, a paradigm shift occurred with the
enactment of a new Income Tax Act that led to the setting up of a comprehensive taxation
system with its own administrative machinery.
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In 1924, a Central Board of Revenue was created to administer central taxes. The attainment
of Independence marked another paradigm shift for taxation. The objective of collecting
revenues was no longer the preservation or advancement of British interests. After a long
hiatus, Indians were going to pay taxes for their own welfare, thus redefining the role of
taxation in the country.
India‘s tax system is based on the assignment of separate taxation rights to the Parliament in
the Centre and to the legislatures in the states. These taxation powers are contained in List I–
the Union List and List II–the State List of the Seventh Schedule to the Constitution of India,
read with the relevant articles that provide the substantive power to levy and collect taxes.
The evolution of the tax system over the last 60 years reflects the changes in India‘s
development strategy, tax legislation, the institutional structure of tax administration and the
role of information technology. The subject of my presentation before you this evening will
attempt to trace the initiatives for tax reform in India over the last decade
Direct taxes
The major direct taxes levied by the Centre are tax on personal and corporate income—
excluding tax on agricultural income for which the authority to levy tax is with the states—
and wealth tax. The indirect taxes levied and collected by the Centre are Central Excise Duty,
customs duty and service tax. A fixed proportion of the taxes collected by the Centre
devolves to the states, based on the recommendations of the Central Finance Commission,
which is set up every five years to review this sharing mechanism. Presently, 32 per cent of
the revenue collected from these taxes is transferred to the states through devolution under
the advice of the 13th
Finance Commission. The inter se share of different states is also
determined on the basis of their recommendations. Although the tax base of the states is
variegated, the mainstay of tax revenues for the state governments is the Value Added Tax, or
VAT, which is levied upon intra-state sale of goods. Sales tax is levied by the states on a few
special category goods, such as petroleum and tobacco. The other important taxes levied by
the states are the state excise on the production, distribution and import into the state of
alcohol and alcoholic liquor, and of opium and Indian hemp; luxury tax; entry tax; taxes on
the transportation of goods and passengers; electricity duty and entertainment tax. Stamp
duty, taxes on land and buildings, tax on agricultural income, and the professional or
employment tax are the other taxes that the states are empowered to levy.
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Taxation has been an important component of the central government‘s policy on macro-
economic management, especially economic growth and its distribution. The tax policy has
also been reviewed and guided at different stages by the reports of expert committees on tax
reform instituted by the Government of India. These reports are a useful guide to the
challenges faced by the country‘s tax system and the responses to them over the last six
decades.
Another important source for analysis is the revenue foregone statement in the receipts
budget, which has been tabled as part of the budget documents since 2006.
India‘s development strategy in the first decades after Independence was based on rapid
industrialization through centrally planned and import substituting growth in heavy industry
owned by the public sector. Scarce resources were to be channelled for this purpose, and the
belief was that manufacturing capacity needed to be regulated and licensed to avoid wastage
of resources. The tax system was therefore tasked with raising resources for the large and
increasing requirements of public consumption and investment while also achieving
redistribution of incomes. This resulted in very high rates for both personal income tax and
corporation tax.
In 1974, the personal income tax had as many as 11 tax brackets, with rates rising from 10 to
97.5 per cent, including surcharges. If the rates had climbed any higher, they would have
gone into orbit! In the case of corporates, a distinction was made between widely and closely
held companies and the tax rate varied from 45 to 65 per cent.
The pursuit of a multiplicity of objectives complicated the tax system with adverse
consequences for its efficiency and equity. Central planning priorities dictated and
legitimized selectivity and discretion in tax policy and administration. Lack of an adequate
information system hampered the implementation, monitoring, review and evaluation of the
discretionary elements of the tax system. Consequently, the system was faced with challenges
of an increased incentive to both avoid and evade taxes in a low probability detection and
ineffective implementation regime that failed to impose penalties within a reasonable time
period.
Different tax enquiry and reform committees were constituted to tackle these systemic
anomalies. In keeping with their recommendations, the marginal tax rates and number of
slabs for personal income tax were substantially brought down in phases, commencing in
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1975, from a low rate of 10 per cent and a high of 97.5 per cent to the present 10 to 30 per
cent. The number of tax brackets was also been brought down from 11 to only 3. In the case
of corporates, the distinction between closely held and widely held companies was scrapped
in 1995, and the rates were moderated from 45 to 65 per cent in 1974 to the present base rate
of 30 per cent.
While moderating the rates, the challenge has also been to rationalize the tax incentives. The
expert committees took stock of the exemptions and concessions that had evolved over the
years and served to erode our tax base. In respect of personal income tax, the first reform in
moderating tax preferences was undertaken in 2006 with the phasing out of tax rebates on a
variety of investments and allowing them, instead, as a deduction from the taxable income
subject to a cap. In the case of corporates, the major tax incentives comprised profit-linked
deductions for specified sectors and underdeveloped areas. To broaden this tax base, a
Minimum Alternate Tax (MAT) was introduced in 1997 in the case of a differential between
the tax on corporate income after availing the incentives and the tax at a specified rate (MAT
rate) on the book profit reported by a company to its shareholders. In later years, companies
paying MAT were allowed to take a partial credit against their tax liabilities in the subsequent
years. The overall MAT rate has been enhanced from 11.33 per cent in 2006 to 20 per cent in
2011, thereby ensuring a threshold level of tax payment by all corporates irrespective of tax
incentives.
As India increasingly looks to develop, and attract funds for, its capital market, capital gains
from its listed securities held for over a year have been exempted from tax for both domestic
and overseas investors. A separate Securities Transaction Tax at the rate of 0.125 per cent on
both the purchase and sale of equities on stock exchanges is levied, however, since October
2004. This measure ensures a steady and administratively simple means of collecting a
minimum level of tax through the stock exchanges.
The increased use of information technology has enhanced the efficiency of the tax
administration in providing taxpayer services as well as in monitoring and reporting financial
transactions in order to bring them to tax. The use of a unique taxpayer identity number,
extensive use of tax deduction at source, electronic reporting by registering authorities of
transactions in real estate, banking and other transactions, electronic payment of taxes,
electronic filing of returns, and the establishment of the Tax Information Network have
strengthened both voluntary compliance as well as the enforcement mechanism. Electronic
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filing of tax returns by companies has ensured a higher level of monitoring and compliance;
and since 2006 has also resulted in a detailed analysis of the revenue foregone on account of
direct tax incentives. These measures, along with a rapid growth in GDP, have resulted in a
steady rise in the direct tax-to-GDP ratio. For the first time in recent decades, the Union
government‘s direct tax collections exceeded the indirect tax collections in 2008, indicating a
structural change towards a more progressive tax structure. In 2010, the overall tax-to-GDP
ratio for the Centre and the states stood at a combined level of 16 per cent.
It is often said that the only thing that you can be sure of about the weather or the tax laws is
that they will change. The Income Tax Act, 1961, that replaced the pre-Independence Indian
Income Tax Act, 1922, has been in effect for almost 50 years and has been amended by as
many as 34 discrete amendment acts besides as many as 51 annual finance acts. These were
required due to policy changes caused by the changing economic environment, increasing
sophistication of commerce, increase in international transactions as a result of globalization,
development of information technology, attempts to minimize tax avoidance and in order to
clarify the statute in relation to judicial decisions. As a result, the basic structure of the
Income Tax Act has become overburdened and its language has become excessively
complex.
In order to revise, consolidate and simplify the language and structure of the direct tax laws,
the draft Direct Taxes Code (DTC) Bill, 2010, along with a discussion paper, was released
in August 2009 for public comments. It is proposed to replace the Income Tax Act, 1961, and
the Wealth Tax Act, 1957, by a single code. In what has been a truly participative legislative
process, over 1,600 sets of comments from a wide range of stakeholders were analyzed; and
valid concerns were responded to in a revised discussion paper that was released.
In the public domain in June 2010. The Direct Taxes Code Bill was introduced in Parliament
in August 2010 and is at present, under examination by Parliament. The DTC attempts to
consolidate and integrate all direct tax laws; simplify the language by using direct, active
speech; usher in stability in the tax rates by incorporating them in a schedule to the code and
not through annual legislation; strengthen taxation provisions for international transactions;
phase out profitlinked tax incentives and replace them with investment-linked incentives for
priority sectors.
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Indirect Taxes
The year 1991 was a watershed in the history of indirect taxes in India. Triggered by a serious
balance-of-payments position and the consequent financial crisis, a process of far-reaching
reform, guided by the recommendations of the Tax Reforms Committee 1991, chaired by Mr.
R. J. Chelliah, was initiated. Until then, the efficiency of the indirect tax system and
compliance levels were severely compromised by very high rates of duty, coupled with a
large number of exemptions for meeting a variety of socio-economic objectives—driven by
policy imperatives similar to those on the direct taxes side. Unduly high dependence on
import duties as a source of revenue was also a characteristic of the system. Such a tax
structure was not conducive to high growth as it engendered a high-cost economy riddled
with tax cascading. It also did not raise adequate revenues commensurate with the tax rates
and effort, thereby having a deleterious impact on the health of public finances.
With the inception of reform, the effort has been to broaden the base and lower the rates—in
keeping with the policy shift in the case of direct taxes. Among the achievements of the
reform process, the most critical has been the shift in the respective shares of direct and
indirect tax collections in the gross tax revenues of the Union government.
The process of replacement of the sales tax with state Value Added Tax, or VAT, began in
2005 with 22 states opting for this transition. By December 2008, all the states had completed
this transition. The adoption of VAT, which applies to the entire value chain for goods,
starting from premanufacturing to retail, has had a very positive impact in mitigating double
taxation and cascading. Rate wars among the states witnessed under the sales tax regime have
ended, and dispersion in rates has been reduced with dual rates. The rate of the Central Sales
Tax has been brought down from 4 per cent to 2 per cent. Coupled with administrative re-
engineering in many states, this reform has generated considerable revenue efficiency, with
almost all the participating states registering double-digit growth in revenue collections.
Although far-reaching, these reforms have not completely eliminated the deficiencies or
inefficiencies in the Indian tax system. There are still a large number and variety of indirect
taxes, especially among those levied by the states. Examples are: sales tax on crude
petroleum and petroleum products, state excise on alcoholic liquor for human consumption,
entry tax, octroi, entertainment tax, taxes on lotteries and gambling, luxury tax, electricity
duty, taxes on the transportation of goods and passengers. In addition, both the Centre and the
states levy cesses and surcharges that are meant to generate resources for a particular
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purpose. Most of these apply to a narrow tax base and are therefore non-VAT type of taxes;
input tax credit is not permitted. This generates cascading and double taxation at many points
in the value chain for the production and distribution of goods and services.
The upshot is that the tax system creates distortions and anomalies for domestic
manufacturing and trade. It has an adverse implication for the export of goods and services in
as much as it does not allow full zero-rating of exports. Moreover, it is wasteful of
administrative resources as a separate administrative mechanism is required for the collection
of many of these taxes. Such an administrative structure has made it near impossible to
optimize tax compliance through the exchange of information about a taxpayer across tax
jurisidictions. For the taxpayer, the compliance cost is high as s/he has to deal with multiple
tax authorities.
The Goods and Services Tax (GST) will mark a very significant improvement over the
existing system, as it will integrate the tax base across the value chain of supply of both
goods and services in the economy. The Empowered Committee of State Finance Ministers
released its First Discussion Paper on the Goods and Services Tax in November 2009.
Thisspelt out the features of the proposed GST and has formed the basis for discussion
between the Centre and the states so far. The paper envisages a destination-based, dual GST
with the Centre and the states simultaneously levying it on a common base. This tax will
replace several indirect taxes currently levied by the Centre and the states, including Central
Excise Duty, service tax, state VAT and Central Sales Tax. Input credit would flow
seamlessly across the value chain in both the central and state components but not across
these two taxes. Exports would be zero-rated. It will apply to all services barring a few to be
specified. A common threshold exemption will apply to both the central and state
components, and dealers with a turnover below it will be exempt from tax. An Integrated
GST (IGST) would be levied on the inter-state supply of goods and services. This tax will be
collected by the Centre so that the credit chain is not disrupted. Accounts will be settled
periodically between the Centre and the states to ensure that the state GST component is
transferred to the destination state where the goods or services are eventually consumed.
The Centre and the states have jointly prepared a draft GST Constitutional Amendment Bill
for this purpose. This bill was introduced in the Lok Sabha in March 2011. It needs to be
passed by a two-thirds majority in both Houses of Parliament and subsequently ratified by at
least half of the state legislatures. It is only after the enactment of this bill that suitable
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legislation for the actual levy of GST can be introduced either in Parliament or in the state
legislatures.
Apart from forging a consensus on the constitutional amendment that will create the legal
framework for the levy of GST, the administrative challenges in its implementation are quite
formidable. The central and state governments will be required to collaborate closely, and not
compete, for the first time—not only in raising tax revenue but also in formulating tax policy
in a harmonized manner through the GST Council. There is likely to be a significant increase
both in the number of taxpayers as well as their size and complexity. The expectation of the
taxpayer community will be of high-quality service delivery by the respective tax
departments so that the compliance burden may be minimized. Above all, they will look for a
similar experience and treatment at the Centre and across the states. For this to happen,
business processes across the two have to be completely harmonized and a single point of
contact has to be made available to the taxpayer. The Centre and the states are agreed that this
will, in turn, require a very strong IT infrastructure. They have already set in motion the
process of designing and implementing the GST Network (GSTN) through a special purpose
vehicle owned jointly by the Centre and the states and for the present, incubated in, and later
assisted by, a technology partner.
The GSTN is being created under the guidance of an Empowered Group chaired by Dr.
Nandan Nilekani. In addition, the key business processes for the two tax administrations are
being jointly designed. And we expect to validate, next month, the concept of a single portal
handling registration, returns and payments across the country, in a pilot project comprising
the Centre and as many as 11 states. Finally, the efficient roll-out and implementation of GST
will require the pooling of intellectual and human capital by the Centre and the states and a
very robust coordination mechanism for conducting their day-to-day activities.
Apart from taking the reform process further, the two initiatives—the introduction of the
Direct Taxes Code and the Goods and Services Tax—present a great opportunity for
synergizing the tax efforts of the central and state governments. In terms of timing, they are
almost synchronized. Besides, they are being launched at a juncture when the IT component
of the tax administration at the Centre as well as in many of the states has already been
substantially strengthened.
I will conclude by highlighting two critical aspects of the important reform process that is
now at hand. These are more in the nature of overarching themes that straddle initiatives in
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both the tax systems. Both these aspects are inextricably intertwined. The first is the
definitive transformation in the basic role of our tax administration—from being an
enforcement-driven system, it is being to transformed into a system driven by a facilitation
motive, imbued with the spirit of providing service to the taxpayer community. The second
aspect, seemingly contradictory but equally critical to the integrity of the reform effort, is to
remain steadfast and firm in weeding out exemptions or incentives that are distortionary and
have caused shrinkage in the tax base.
Historical Development of Income Tax Laws in Pakistan
The primary function of a tax system in a developing country, like Pakistan, is to raise
revenue for the Government to meet expenditure on its development projects and for the
administration of the State‘s day-to-day affairs. The second and, equally important, function
of tax system is to reduce inequalities in the society through a policy of redistribution of
income and wealth by progressive taxation. The third function is to serve as an instrument of
fiscal policy by granting exemptions etc. to promote, encourage or discourage specific
economic activity to achieve rapid social and industrial development in the country. Various
sources are tapped for the purpose in the shape of direct and indirect taxes. The taxes are
imposed by the Legislature by enacting a fiscal statute. One of the direct taxes is the income
tax with which we are presently concerned.
The provisions of a taxing statute can broadly be divided into TWO categories: (1) Charging
provisions which determine the liability to be taxed and (2) Machinery provisions which
provide the machinery for its assessment and collection. These are explained below.
Charging provisions relate to the levy and charge of the tax which usually state (i) on what
matter, goods or income, the tax is to be levied; (ii) in what manner; and (iii) on what rates
and the related matters.
Machinery provisions are of two types:
(a) Assessment provisions which deal with the (i) assessment; (ii) calculation and
quantification of tax to determine the tax due and payable.
(b) Collection provisions relate to the mode and manner of receipts or collection of tax.
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Besides the Act, the Income Tax Law is governed by the Rules and Regulations issued, from
time to time, by the Central Board of Revenue (CBR); Rules or instructions issued by
Government of Pakistan; Income Tax Case-Law; and the Annual Finance Acts.
(Taxing Acts can broadly be divided into three parts and the lines of division have been
sketched by Lord Dunedin in the following words: ―Now there are three stages in the
imposition of a tax; there is the declaration of liability, that is the part of the statute which
determines what persons in respect of what property are liable. Next, there is the assessment.
Liability does not depend on assessment. That ex hypothesis has already been fixed. Lastly
come the methods of recovery, if the person taxed does not voluntarily pay.
DEVELOPMENT OF INCOME TAX LAW IN PAKISTAN
After independence in 1947, the Government of Pakistan adopted the Income Tax Act, 1922
and its provisions were extended to whole of Pakistan, except special areas. This Act
continued for 57 years, till 1979 and was amended a number of times during this period. Each
amending act, in an effort to check evasion of tax, made the law more complicated and
difficulties arose in its day to day working.
1979 Income Tax Ordinance, 1979
To overcome these difficulties, this Ordinance replaced the Income Tax Act, 1922 and was
made effective from 1st July 1979. Self-Assessment Scheme was further broad based.
Changes were brought about every year through Annual Finance Acts. The Income Tax
Ordinance, 1979 remained in force uptil 30th June, 2002.
INCOME TAX ORDINANCE 2001 [Sec. 1 to 3]
Short title, extent and commencement: The Income Tax Ordinance 2001, was enforced on 1st
July 2002. It has repealed the Income Tax Ordinance, 1979 and now forms the main body of
statute law on income tax in Pakistan. It contains 240 Sections, is divided into 13 Chapters
and has 7 Schedules. Each chapter deals with a particular subject. Schedules are a part of the
Ordinance i.e. good statutory laws like sections. While sub-section (2) of Section 1 says that
It extends to whole of Pakistan, this expression is to be read in conjunction with Art. 246 and
247(3) of the Constitution of Pakistan. The result is that the Ordinance is not applicable to
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FATA (Federally Administered Tribal Areas) and PATA (Provincially Administered Tribal
Areas) and Tribal Areas mentioned in Art. 246 of the Constitution.
Role of Definitions: This Ordinance contains 87 words which have been defined vide clauses
(1) to (74) of section 2. These definitions indicate the area and scope of their applicability.
The words specifically defined in section 2 are to be given the meanings assigned to them
unless the context otherwise requires.
The Income Tax Ordinance 2001, forms the main body of the statute law on income tax in
Pakistan. The Income Tax Rules 2002, issued by CBR under section 237 are an integral part
of the main enactment. It is a self-contained code and overrides all other laws on the subject.
(section 3)
Pakistan‘s tax regime : It consists of four main revenue sources:
1. General Sales Tax (GST);
2. Central Excise Duty (CED);
3. Customs Duty ; and
4. Income Tax.
Section 4 of the Income Tax Ordinance 2001, is the charging section that provides authority
and basis for levy and collection of income tax under 5 Heads of Income described in Section
11 viz. (1) Salary, (2) Income from Property, (3) Income from Business, (4) Capital Gains,
and (5) Income from all other sources.
Provincially Administered Tribal Areas: (PATA) (i) the districts of Chitral, Dir and Swat
(including Kalam) the Tribal Area in the Kohistan district, Malakand Protected Area, the
Tribal Area adjoining Mansehra district and the former State of Amb; and (ii) Zhob district,
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Loralai district (excluding Diki Tehsil), Dalbadin Tehsil of Chagai district and Marri and
Bugti tribal territories of Sibi district.
Federally Administered Tribal Areas: (FATA) (i) Tribal Areas adjoining, Peshawar, Kohat,
Bannu and Dera Ismail Khan districts; and (ii) Bajaur, Orakzai, Mohmand, Khyber, Kurram,
North Waziristan and South Waziristan Agencies.
Evolution of Tax Culture in Pakistan It was more than 70 years ago that Schumpeter used the
term ―Tax Culture‖ in his celebrated article ―Economic and Sociology of the Income Tax‖.
Schumpeterian view point is that ―Tax Culture is an expression of human spirituality and
creativity‖. Some work on ―Tax Culture‖ can also be found as undertaken by Armin Spitaler
(1954) and he does have his own perspective while defining this term. Similarly Tax Culture
can be found with the writings of other economists like Pausch (1992), Hartmann and
Harbner (1997). According to Spitalar‘s insight ―Taxation is influenced by economic, social,
cultural, historical, geographical, psychological and further differences prevailing in the
individual countries and their societies‖. Alfons Pausch understands the Tax Culture of the
country as being connected with the personalities, determining the evolution of tax system.
However, the most authoritative work on this term and topic in recent times has come to
limelight of a German Scholar, Birger Nerre of University of Hamburg. According to him,
the topic of Tax Culture appears precisely at the intersection of the disciplines, economics,
sociology and history. In this article as surfaced in the year 2001 naming ―The Concept of
Tax Culture‖, he defines and elaborates the term of Tax Culture by saying: ―A country-
specific tax culture is the entirety of all relevant formal and informal institutions connected
with the national tax system and its practical execution, which are historically embedded
within the country‘s culture, including the dependencies and ties caused by their ongoing
interaction‖. The phenomenon of Tax doesn‘t exist in vacuum or otherwise it isn‘t something
that is abstract. This is rather very much concrete which is rooted in the very fiber of the
society or what Birger Nerre calls it that there is an embeddedness of Tax Culture. Moreover,
the Tax Culture of a country or community isn‘t the outcome of any single factor and the
definitions which outlined such restrictive and narrow approaches have worn out over time.
Now this has commonly shared understanding among the browsers of this topic that Tax
Culture is the sum total emerging out of: 1. Tradition of Taxation, 2. Interaction of Actors
including Politicians, Academics, Tax Officials, Taxpayers, Tax Experts and 3. The Cultural
Values like ―Honesty, ―Justice‖, and ―Sense of Duty‖ etc. This three pronged agglomeration
tends to make out the tax culture of a particular country and this interplay has been vividly
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explained by Mr. Birger Nerre in the instant figure representation. The arrows indicate
interaction between different groups of players as well as between the members of one and
the same group. The author of this representation has shown the direct interaction among all
the groups / actors except between the ―taxpayers‖ and ―academics‖ on the analogy that he
was not sure about the existence of any (Direct) relationship between these two groups.
However, with particular social milieu of Pakistan, you would concur with my observation
that the role of ―tax experts‖ is relatively more crucial and pivotal demanding more
solicitation as without their active participation, concurrence and authentication, any
formulation of opinion or code and any execution of programme of action would doom its
failure. While talking about ―tax‖, we are of course divulging on something which is
intensely ―disliked‖. This is not only the case with Pakistan and Pakistani Taxpayers but this
syndrome is very much there in rest of the parts of the world including country like U.S.
While reading the paper on the ―New Hope for the Future Delivering on Pakistan‘s Economic
Reform‖ this ―disliking‖ of the tax by the Americans was even acknowledged and conceded
by Mr. Thomas W. Simons, Jr. Former U.S. Ambassador to Pakistan. Georgi Boss (1999)
Minister for Taxes & Duties of the Russian Federation remarked that ―There is not any
country where people are happy to pay taxes but they do pay taxes because of their tax
culture‖. However Economic strategy Minister German Graf (2000) is very apt when he
states that he fully understands that ―a tax culture can‘t be inculcated in one year‖. Going into
the inner causation of this phenomenon, Dr. Ignacio Ruiz Jarabo, in his paper presented at the
33rd General Assembly of Inter – American Centre of Tax Administration (CIAT), explicitly
stated that there are factors that render difficult the social acceptance of the tax system,
beginning with the fact that the relationships between the tax administration and the citizen
are marked with a certain level of tension and conflict. According to him, this marked tension
and conflict are due to the fact that taxes are economic burdens of an obligatory nature from
which the taxpayer does not drive a direct, personal and immediate benefit. At this juncture, I
would like to borrow the words of Mr. Alain Zenner, Government Commissioner of Belgium
who‘s very frank and direct in saying ―… the tax administrations too often give me the
impression as if they would only have one important task and that is: taxation ! … taxation is
often seen as a divine mission, an ideal that would justify all means. (However) … this can
last no longer! The mission of the tax administration is not to tax at all costs, but to recover
the fair tax. From there the need to redefine the values that should be complied with by the
tax administration in the exercise of its duties.‖ Before proceeding further, this would be
advantageous to have a cursory analysis of historical developments in to the formal efforts for
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the codification of the taxation laws. First of all, I would like to put the case of Income Tax
and 1860 is the crucial year when the colonial forces promulgated the first Income Tax Act.
This was very much patterned after the scheme of taxation observed in United Kingdom;
however, talking in the perspective of sub-continent, this was a deliberate effort to end the
budgetary deficit which followed the war of independence of 1857. This very Act lasted five
years when this had to be completely withdrawn followed by a Vacuum period of two years
when there was no Income Tax Law in force. However, this was re-enforced with a new title
of The License Tax Act 1867 and this would be for the interest of the participants that income
earned more than Rs. 200 per annum was made taxable at the rate of 2 per cent. Subsequently
developments gave rise to a new Income Tax Act in 1886 which in turn had to give way to
the substituted Income Tax Act of 1918 and during the intervening period only one major
amendment was made in the year 1903. Certain difficulties emanated out of this latest
legislation, where upon Income Tax Act 1922 was promulgated and the same was adopted by
our country after winning independence in the year 1947. This very Act remained very much
in the field to be replaced only by the Income Tax Ordinance 1979. Between 1922 and 1979,
as many as 71 amendment acts were passed by the legislators. Here comes the most
controversial code of Income Tax Ordinance 2001 and this is very unique feature of this
piece of legislation that before the date of its enforcement, the government made as many as
322 changes in it through Finance Ordinance 2002. The controversies over it run through the
areas of typographical errors, drafting blunders, legal lacunas, inconsistencies, conceptual
fallacies / dichotomies so on and so forth. The excise laws goes back to the year 1934 when a
compendium was drafted which agglomerated more than ten separate excise acts which had
grown up piecemeal over many years. Another useful effort was made in the year 1944 when
a consolidated and single enactment saw the light of the day and which still holds the field in
the excise laws to be called as the Central Excise Act, 1944. The custom laws, which in
common parlance, is also termed as the ―Law of Notifications‖ due to the rapidity and
frequency of repeated notifications. This branch of law has been on the statute books for
more than a century. The Sea Customs Act was enacted in 1878. It covered sea side of the
country. Import and export through land routes were dealt under the Land Customs Act, 1924
whereas the air traffic was governed by the rules framed under the Air Ship Act, 1911. The
current Customs Act 1969 consolidated all such laws on the subject into one statute. Last but
not the least is sales tax which according to its contribution in the total revenue qua the
remaining taxes surpasses the all. According to Govt. of India Act 1935, as adopted for
Pakistan on independence, sales tax was a provincial subject. As the exigency of the situation
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demanded, the federal government enacted law called the Pakistan General Sales Tax Act
1948 by virtue of which the sales tax became a central subject. Again this would be
information for the distinguished participants that according to this act, every dealer with an
annual turn over of more than Rs. 5,000 was amenable for assessment. This created
resentment among the dealers where upon a sales tax committee was appointed by the
government and on its recommendations, the Sales Tax Act 1951 was adopted. As against the
levy of sales tax at multiple stages as was the case with the former Act, instead the latter law
accommodated the demand of the traders to levy the sales tax only at one stage. In order to
fashion the sales tax in accordance with the changed economic and social realities, a need
was strongly felt over time to re-enact this branch of the law where upon the instant Sales
Tax Act 1990 came into being. Progression of the sales tax into Pakistan‘s key revenue earner
is more than manifest from the recent statistics released by the CBR. While talking about the
state of taxes in our country, I would quote the data collected by the Chamber of Commerce
& Industry, Karachi in the year 1996, it was found that there were 79 taxes in all, in Pakistan
– 20 federal, 21 provincial, 14 municiple and 24 others. This is again a stark reality that the
major chunk of the effectees belongs to the poor class. Let us see how Mr. Shaukat Aziz, the
highest economic manager in the country enumerates this malady ―a society where a large
segment of the population, particularly the poor, bears the greater burden of cost of
governance while a small group of influential rent seekers reap its benefits is bound to
promote upheavals.‖ Far from suffering from a culture of tax evasion, as somebody quotes it,
Pakistanis, particularly the poor are the most indirectly taxed people in the world. Let‘s go
into some observations regarding the Evolution of Pakistani‘s Tax System as made in the
famous report of Mr. Shahid Hussain, Chairman of The Task Force on Tax Administration
(2000). First, legal and administrative changes are frequent and ad hoc. Taxpayers have
insufficient knowledge of their obligations and tax collectors have substantial discretion.
Second, major tax policy changes are not accompanied by adequate changes in administrative
framework. Third, the relationship between the taxpayer and tax collector is largely adversal.
Fourth, organization, business processes, systems, facilities and budget have not kept pace
with the growing demands on tax administration. Fifth, the management of human resources
is severely deficient. Most tax officials are not paid a living wage; nobody is paid a middle
class wage. For most, honesty is an impossible proposition. Most of the 33000 persons
employed in the tax administration are in lower ranks with low productivity and are a drag on
the system. In particular case of Pakistan, we inherited the legal system of the colonial era
and the tax code is no exception in any way. We will have to appreciate that the colonial
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masters promulgated such fiscal and tax laws which were better suited to their own vested
interests. They extracted maximum out of the minimum from the local populace for
furthering their imperialistic designs. However, after winning independence, this was an
uphill task to refashion and remodel the taxation laws according to our own peculiar socio –
economic and politico, religio – cultural circumstances. Although various efforts were made
and multiple commissions and task forces were constituted but I‘m sorry to say, that all these
exercises could not be channelised for the greater aim of enacting a true and workable tax
code sensitive to the genuine objective conditions of the local population particularly that of
the poor class. Despite of recent additions of withholding, presumptive, capital value and
turnover taxes, the situation has not improved. There are certain salient features of our Tax
Culture and without their proper appreciation and understandings, I‘m afraid; we would
remain yearning for the quest of maximum revenue collection but without the actualization of
the insurmountable targets. This is also heart burning that while formulating tax code in our
country, the experts and legislators either have not taken due care of the sensitivities of our
cultural norms or otherwise they have completely ignored this vital aspect of social reality.
Due to this very reason, the tax code could not ingrain in the attitudes and behaviour patterns
of the taxpayers or in other words what the Birger Nerre called it the process of the
―embeddedness of the tax culture‖ could not be realized. The recent prominent example of
not taking care of the sensitivities of local population of Pakistan can be found in the very
enactment of Income Tax Ordinance 2001 which as the saying goes has been enacted by a
foreigner who was oblivion of the socio economic and political, religion-cultural realities of
the land and its populace. Now the question arises, what are those realities which need to be
understood while enacting any code or formulating any policy in the corridors of tax
administration. Now I try to give a brief account of those features and I would say that the list
is not complete however this would give an understanding for giving due accommodation to
the socio economic and politics, religion-cultural sensitivities very much pervasive in our
society. (1) Tax Illiteracy This is very much known that according to official statistics, the
literacy rate in our country is not more than 36% and in this figuration there are those people
who can merely read or write their names. When this is the state of literacy in our country, we
can very well judge that to what extent our population or otherwise the taxpayers would be
equipped with the proper understandings and education of our tax code. While talking about
the evolution of tax culture of our country, we‘ll have to launch a mass campaign of tax
literacy. (2) Complexity of the Tax Code Keeping the overall low level of literacy among the
population aside, the problem of proper understanding of the tax code due to its intricacy and
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complexity becomes enormous and manifold. A very little effort has yet been made to
simplify the tax code for its easy grasp and smooth application. The prevalent legislation on
taxation is so much complex and difficult that even the tax experts take great pains for its due
comprehension what to talk about the commoners who happened to come across with the
same. A concerted effort with a strong will is abundantly needed to simplify the tax code. For
this, we all of us being the stake holders in the existing tax milieu should share our
responsibility for evolving and proliferating a shorter, easier and simpler tax code. Writing of
texts of law is indeed a difficult task. This is to be conceded that whatever may be the efforts
to simplify the statute, its complexity can‘t be altogether abated, but serious efforts should be
continued to ease down its tone and texture. (3) Warding off Foreign Dictation As we‘re
mostly dependent on foreign loans for the survival of our economy and even for the running
of our day to day state business, we‘ve to take heavy loans. These donor states and
institutions always dole out these loans with a certain package of ―prerequisites and
conditionality‖. We being the recipient country have to surrender, sorry to say, a limb of our
sovereignty and have to make compromises against the interest of our already marginalized
population. So much so the donors impose on us greater burdens to be shifted on the already
vulnerable taxpayers who have been destined to become at their tether end. This would be an
appeal to the people at the helm of affairs to ward off the foreign pressures, to the maximum
possible extent, if not altogether, in order to safeguard the paramount interest of the local
population. (4) Mis-declaration of Income Honest declaration of income is all the more
pivotal when we talk about Income Tax liability. I must concede and realize it to the
respectable participants that we as a nation have not been loyal enough to expose what we
own and what we have. I‘m talking about the growing tendency among the taxpayers
regarding concealment of their true income and mis-declaration on their part while tendering
their ―returns‖. Mr. Vakeel Ahmad Khan, the Member Direct Taxes, Central Board of
Revenue is very right when he says that it is simply not possible for the Government to
reduce the tax rates in the current scenario where the declaration of actual income isn‘t the
norm of the day. Two pronged measures occur to my mind for grappling with the deviant
culture of mis-declaration of income, one which I rate very high and above the other is the
nurturing of moral obligation among us for being true in our affairs qua the country and of
course qua the tax department, the other which I would talk in some detail under a separate
head note is the true enforcement of laws to disdain the tax evaders. Our tax culture should be
based on trust, fairness and mutual respect. (5) Broadening the Base of Taxpaying population
Again I would talk about Income Tax and moot the point which you‘re very well cognizant of
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is it that the total number of income taxpayers in our country approximately makes up one
million. This figure speaks itself that how there is only a meager segment of population
presently in the tax net while there is a more significant strata among population which is
beyond and out of the tax net. According to the statistics of CBR, 36% people in the opulent
areas do not contribute to the national exchequer. So many tax surveys have been conducted
and many amnesty schemes have been introduced to ―grab‖ and ―lure‖ the non taxpaying
community but Mr. Chairman, your Honour being the head of the CBR would concur that the
required targets have yet to see the light of the day. To remain out of the tax net is the
ignominious feature of our tax culture. There may be many causes behind this phenomenon,
some might have been noticed and many may not, but this is crying need of the day to
address the same to tackle with and arrest the tax evading culture. Improvement in the
collection of taxes is so crucial that government can‘t and should not wait, nor will half
measures do. Widening tax net will allow reduction in tax rates, without reducing revenue.
(6) Rampant Corruption in the Tax Administration The melody of corruption is a much talked
of subject in these days. This isn‘t restricted within any circumscribed boundaries or any
specific class of people. Since the tax institutions is part of and linked with the other
institutions, it isn‘t immune from the negative effects permeating in those others. I would not
let myself to raise eyebrows against any specific person or any particular segment; however, I
would be failing in my duty if I do not concede that many of us have not been able to clean
their Augean stables to transform a cleaner and transparent tax culture. Encouragement and
flourishment of tax culture can only take place through the removal of gray areas and
discretionary powers presently used with impunity by taxation officers. Removal of
corruption will ensure wise and prudent expenditure of collected revenue, which will
encourage and mobilize new taxpayers who are hesitant to contribute and continue to remain
outside the tax net. (7) Mistrust and Misgivings about use of Tax Money On the one hand
there is very insignificant population which is in the tax net while on the other, there is a
feeling of mistrust and obscurity among the taxpaying community against the government as
to the fact that the funds generated out of their taxes are not properly used rather they are
mishandled and so to say are bungled. In this background, many taxpayers don‘t feel the
moral obligations to fulfill their part of institutional contract between the state and its citizens
as long as the state doesn‘t fulfill its part in a proper way. The values of integrity, trust,
respect, commitment to service, teamwork, personal responsibility and continuous
improvement should be upheld. (8) De jure Taxation and De facto Taxation By de jure
taxation I mean the tax system and the tax code as it stands and exists which is likely to be
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observed and implemented in the community while by the de facto taxation I amplify the tax
system and the tax organism as it is practiced and followed. I see a visible gap between these
two systems of taxation as one is aspired and the other is in vogue. We should solicit means
and should carve out ways to bridge the gap existing between two systems of tax
administration and tax code. The sooner this dichotomy is resolved, the better it would be for
the introduction of a transparent and true tax culture in our country. The basic principle of
taxation, viz equity, certainty, convenience, economy and simplicity had been ignored prior
to enacting tax laws. (9) Restoration of the Self esteem of the Taxpayer The instances are not
infrequent when the taxpayers have been harassed or blackmailed by the personnel of the tax
machinery. This leads to the feelings of hatred and avoidance on the part of taxpayers and
this attitude has its resultant repercussions on the state interest of maximum revenue
generation. According to rough estimates 73% of the tax is collected through the mechanism
of withholding tax while 13% is voluntarily paid by the assesses with the returns and 14% of
the total tax revenue is collected by the tax machinery working under the aegis of CBR. Mr.
Chairman, frankly I‘m not after your coveted slot but can we dare ask that if this is only that
14% for which is a much extended tax bureaucracy is engaged and again this is the area
where most complaints regarding harassment and abuse of power are emanating . Mr.
Chairman, I would very respectfully submit that now the taxpayers have started questioning
the raison deter of this very large establishment, when the income tax contribution towards
the total revenue from all sources is 16% which is inclusive of income tax deducted at source.
Furthermore, about 80% of the total income tax is paid by 1, 000 multinational companies.
(10) Apprehension of Tax Evaders Although I solicit that taxpayers should have an
independent environment where they could act and pay their taxes without any fear or
coercion, however, by this I do not mean that the taxpayers should be let escort free not to be
answerable to the tax administration. I would add that over the period of time, many deviants
and tax defrauders and hobnobbing and colluding with the tax collecting personnel and the
―middleman‖ to completely evade from the tax net or otherwise to pay minimum tax although
they should pay higher taxes according to the quantum of their income/assets. The existing
cultural realities and social attitudes do warrant for taking a very stringent action against
these delinquents and deviants. The machinery of the state should come into play with full
force against them for bringing them to book. The CBR should come out to liaise with
various departments of the federal and provincial governments, contact private and public
institutions, tap banking sources both at home and abroad, and obtain information from
newspapers, advertisements, informants and third parties on taxpayer‘s incomes,
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expenditures, bank accounts, properties, assets and investments. Certainty of Tax Code /
Legislation I‘ve no hesitation in saying that this has been the common characteristic of our
tax culture that there happen frequent and haphazard changes in the tax code of the country.
Mr. Chairman, let me say who‘s here who doesn‘t understand the vagaries of the
phenomenon of SROs. Even the substantive and procedural parts of the tax legislation have
continually been in the throes of repealing and amendments. My humble request on this
eventful occasion would be to the legislators and the policy makers that please give some
semblance of permanence and perpetuity to the tax code. It is quite apparent that income tax
law has not been enacted with clear objectives and on long term basis. Moreover, there are
abrupt and periodical amendments, which adversely affect the tax collection and business
community. (12) Automation of Tax Machinery A culture isn‘t straight jacket nor is it a
water-tight compartment not to allow fresh intakes. Similar is the case of Tax Culture. We
should always be open ended to give due room to the fresh ideas and to the modern
technology. To be more precise, I‘m talking about equipping the tax administration with the
latest automation and reaping full benefits of the recent age of Information Technology. I
appreciate and understand the constraint of our scarce resources but I would stand for the
conviction and you would agree with me that we will have to leave no stone unturned for
harnessing the best available modern automation infrastructure to meet the challenges of the
day. (13) Advertising Advertising is a persuasion technique that can greatly support the
articulation and development of tax culture. Tax Administration should have an aggressive
communication policy to achieve the voluntary acceptance of taxes. I believe that the
campaign for promoting and developing the tax culture through advertising can remove the
inhibitions and persuade the citizens to promptly pay their taxes. Careful use of contents and
message can obliterate the irritants and can further promote the tax consciousness among
masses. It is obligatory to reinforce in the message, the norms, values and strengths that
govern the tax system, focusing and centering attention on the concepts of transparency,
efficiency, effectiveness, modernization, simplification, honesty, professionalism, ethics and
service. I believe that the information campaign may instill in the taxpayers the spirit for
paying their taxes voluntarily. The best way to promote tax culture in the people is to
convince them that the revenue generated out of their taxes is being used by the Government
honestly and for the greater welfare of the society. The mass media can further build a strong
public opinion for the denouncement of those who happen to evade taxes. Only thus it will be
possible to generate a true interaction between the different social sectors and the tax
administration. The culture can‘t be changed only in a year or in a few years-that is what
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we‘ve to do by promoting a new tax culture but of course we should tread on the right path
not being disillusioned from achieving the object of a prosperous and bright future. I hope
that the theory of tax culture will be able to lower the gap between pure theoretical economic
fiction and cultural reality, particularly in the sphere of taxation.
