ITBAK Pre Budget Proposals 2005 In the name of Allah, the most gracious and most merciful.

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In the name of Allah, the most gracious and most merciful.

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5Pre Budget Seminar

Organized by

Income Tax Bar Association Karachi

Presentation by

Abdul Qadir Memon

April 11, 2005

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At the outset, I would like to take this opportunity to express my gratitude to the ITBA CPE Committee for extending me this invitation to share my proposals for the forthcoming Budget – 2005 with this august gathering.By the Grace of Almighty Allah, the world at large is recognizing the action and policies of the present government. The economic managers and business leaders all over the world are showing great faith and confidence in the present team.

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The macro indicators like arrest of investment stagnation in Pakistan, effort to revive sick industrial units, accumulation of foreign exchange reserves, market driven policies, privatization & liberalization, stable foreign exchange rates, formation of Task Force on Corporate Tax Policy by SECP etc. are showing accomplishment of many milestones.

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The credibility of Government of Pakistan has enhanced many folds globally. The honourable Prime Minister, Ministry of Finance and the team members of the Central Board of Revenue deserve lot of appreciation on not only achieving the above goals but striving hard to bring positive Reforms, through Tax Administration Reform Program (TARP), CARE, STREAM, establishment of LTU, MTU etc. The introduction of Dispute Resolution Committees, withdrawal of frivolous appeals/review of applications and abolishment of mandatory payment before filing of appeals are all steps towards removal of irritants and obstacles in the way of our journey to success.

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Ladies and gentlemen it is my observation that in past we did not witness any meeting with the business and professional leaders in which the government and its team members were not criticized for their failure to remove irritants and anomalies from the fiscal statutes, to create conducive investment environment in the country and to curtail discretionary powers of the revenue officers from the taxation laws.

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Now at least one cannot recall any meeting in which the government and team members of CBR are not praised. What a great change. I mean the government is making headway towards removal of such obstacles as pointed out by the honourable Prime Minister time and again.

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You and I would agree that despite all reforms and achievement of macro economic targets, 1/3rd of our population is still living below the poverty line, although international assistance is available. Our Tax - GDP ratio is still one of the lowest in the world as majority of people in Pakistan are not having proper drinkable water and 59% of the total educated citizens of Pakistan are unemployed.

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According to UNDP’s Human Development Report, we rank a poor 135th on human development index. So the problem of a common man is yet to be resolved.

This is the moment where we have to think, what is wrong with the present system. Are we contributing our due share for the betterment of the society?

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While some responsibility for our present economic ills undoubtedly can be attributed to the policies or lack of policies of the present and past governments, yet it would be unfair to place the whole of the blame on the government. You and I know ladies and gentlemen that government could and would have achieved very much more if it had received the full cooperation of the public in the past. It was rightly said by an eminent political leader and I quote:-

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“A nation’s strength ultimately consist in what it can do on its own and not in what it can borrow from others.”

My Budget proposals are influenced by the views of Mr.Adam Smith, pointed out in the eighteen centuries, in his classic The Wealth of Nation that every state should bear in mind the following four objectives while levying taxes that:-

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1. The taxes must be equitable and fair as between the different classes of society;The convenience of the taxpayer;2. The Government must economize and levy only the minimum tax, which is necessary for the national good; and3. The certainty and clarify.

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For a successful journey towards lasting economic growth and to make our country a better place to live, it is incumbent upon the Government to immediately provide due attention and take appropriate steps for expansion of tax base, reasonable reduction in the tax rates (according to capacity to pay tax), creation of conducive investment environment, curtailment of undesirable discretionary powers from various tax laws, simplification of rules & regulations, removal of irritants and impediments for seeking justice are important steps for Government to take for achieving the above four objectives.

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I am hopeful that following recommendations, if approved by this august gathering and implemented sincerely by the government; will help to enhance economic activities, restore the confidence of the taxpayers on the government, accelerate foreign and local investment and establish credibility of the taxation system of Pakistan.

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Pakistan is undertaking a massive tax reform. Recently the Chairman, Central Board of Revenue while addressing the members of Pakistan Textile Association on 21st March, 2005 stated and I quote:-“All these reforms being implemented at a cost of dollars 150 Million, were aimed at transforming the CBR into an organization fully equipped to take on the challenges of the New World Trade Order.”Unquote

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The lesson taught by the experience of tax reform in many developed countries is that tax changes have very important economic effects. They affect not only taxable income or tax revenues, but also labor supply (especially, secondary earners), savings, investments, and entrepreneur ship and the willingness to take risks. Particularly, the effect of a cut in marginal tax rate is considerably big.

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It is interesting to note that none of the reform guidelines mentions any “ideal” level of taxation. It is necessary to focus on three important principles of tax reform, that is to broaden the tax base while keeping the marginal tax rate low, to promote economic growth, and to simplify the system.

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In my humble view the challenge the government faces is not how to increase current tax revenues, but how to widen the tax base to prevent tax-revenue erosion in the future.On the subject of revitalizing the Japanese economy and put it on a new growth path Mr.Iwamoto said and I quote:-

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“It is necessary to conduct tax system reform, including tax cut. Investment and consumption should be stimulated. It is necessary to cut corporate taxes at first, and after that to broaden the tax base of income tax while reducing the marginal tax rate. To broaden the tax base, the argument should focus on the inequalities of tax burden, such as “Kuroyon,” by keeping track of income more clearly.”

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So my first and foremost budget proposal is Reduction in Tax Rates. The old fashioned fiscal theory that tax rates must be high to provide larger revenue for State has long been discarded. The modern fiscal policy pursued by the most progressive countries is to make revenue grow, not by increasing tax rates but by enlarging the tax base. The major impediment in expansion of tax base in the country is high rates of taxes whether direct or indirect.

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Out of 145 countries of the world, the corporate rate of tax in 138 countries is lower than Pakistan. In almost 83 countries rate of tax ranges between @ 10% to 30% and 39 countries levy corporate tax @ 31% to 35%. On 28th April, 2003 the Saudi Shura Consultative Council slashed the rate of tax from 45 percent to 25% on foreign companies’ profit, to attract more foreign investment. President George W.Bush is pressing the Congress to approve new tax cuts.

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The Finance Minister of France promised tax cuts for corporate and individuals taxpayers. On the other hand in Pakistan the rate of withholding tax has been rising progressively. In 1995, the rate of withholding of tax at the time of import of goods was raised from 2% to 4% of import value and currently it is 6% of the import value.

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The Karachi Declaration of ICC Regional FDI Conference held in Karachi in February 2002, in fact, recommended the reduction of corporate income tax to 16%. As for other countries, it is noteworthy that Singapore decided in 2002 to bring corporate and income tax rates to 20% within three years from current 24.5% and 26% respectively. This will bring Singapore’s direct taxes in line with arch rival Hong Kong, where corporate tax rate is 16%.

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The Worker’s Welfare Fund and Workers Profit Participation Fund are no longer providing any benefit to the workers. On the contrary the contributions to these funds have taken the shape of unnecessary additional levy for the taxpayer and requires to be withdrawn. The law abiding citizens are paying greater cost than evaders. Therefore, in the overall interest of the country and to continue the journey of economic progress, it is strongly recommended to reduce the tax rates as follows:

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The rate of Income Tax for the corporate and non-corporate sectors be reduced by 10%;

The rate of withholding tax on supplies to be reduced to 2% and the sub-section 2 of section 153 be substituted in line with the recent judgement reported as 2005 PTD 194 (SC) as follows:-“the gross amount payable for sale of goods shall exclude the sales tax if any payable in respect of the sale.”

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The present statutory limit of exemption under the Income Tax law be increased from Rs.100,000/- to Rs.200,000/-; andThe Workers Welfare Fund and Workers Profit Participation Funds Laws be abolished.

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The second important task is to broaden the tax base. As per data available the tax payers are less than 1% of the total population. The drive that the Collectorate of Sales Tax (Enforcement) launched last October to identify new taxpayers is reported to have led to the detection of 18,224 cases which need to be registered as taxpayers under the Sales Tax Act. These include different categories of 14,933 distributors, agents and dealers; 2,681 wholesalers; 23 car dealers; and 3,000 retailers is commendable.

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However, I feel complete details and data base of all the owners/ holders of the property (including residential, commercial, industrial), cars, club membership, utilities (including residential, commercial and industrial), vehicles, buses, credit cards, international passports, investment in fixed deposits, bank accounts, national saving schemes and stocks be prepared and on the basis of above information a complete profile may be generated.

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The taxes must be equitable and fair between different classes of society. All the segments of the society including agriculturists should be brought in the tax net. The rule of law should be for everybody and not for the weaker ones. A very big segment of the high placed people is owning enormous wealth, lucrative occupations and enjoying highly luxurious living.

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I believe that assessing the income from four main crops – cotton, rice, sugarcane and wheat – may not be difficult because these are generally sold to registered dealers whether they are ginners, millers, crushers or arthis. Their receipts should be considered authentic documents and taxpayers should be encouraged to obtain them and submit them with their returns.

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Since there is an enormous amount of money to be made on sale/purchase of houses, it is only fair that like any other commercial activity it should bring the government its due share of revenue on house sales in the form of capital gains tax. All the more so because most of those earning fat profits on property sales are not genuine homeowners but speculators, who are there in the market only to earn profits.

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The government may consider to tax the windfall on sale of immovable properties by amending the Constitution of Islamic Republic of Pakistan.

ProposalIt is proposed that effort should be made to reduce the number of exemption and incomes be brought within tax ambit.

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Simplification of documents is third and very important area for brining tax reforms.Mr.Musgrave, in his book on page 158 stated and I quote that:-“One of the strong motivations behind the recent reforms has been to bring about simplicity in tax systems. In the context of tax reform proposals in the United States of America, it has been commented: “what reason is there to expect that good taxation - taxation that is equitable as well as efficient-should offer a haven of simplicity in an increasingly complex world?” This is a non-trival question for developing countries as well.

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Day before yesterday Government has unveiled simple and self compliant draft proposal of Federal Excise Act, 2005 to replace sixty years old complex and cumbersome Central Excise Act, 1944. Government is genuinely making effort to simplify the documents. However I think that taxation laws including forms, statements and other necessary documents may be simplified and must not be as complicated & cumbersome as to cause needless inconvenience and hardships to the taxpayer.

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This is also an impediment in expansion of tax base in Pakistan. There are also a number of short comings in the existing Return forms and statements. I therefore desire that such forms, statements, including acknowledgement receipts of the return etc. be designed in consultation with the mercantile, tax and accounting associations etc.

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At a workshop held in Islamabad on Saturday under the joint sponsorship of the Ministry of Industries, Production and Special Initiatives and the World Bank, representatives from the government and industry deliberated upon the subject of improving investment environment in Pakistan.

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They identified poor law and order situation and the high cost of doing business as the major reasons why foreign investments are not coming in at the desired level. It may be recalled that according to the special task force that prepared a draft industrial policy, made public in January; Pakistan will need nine percent increase in investments in the next 20 – years, 11.5 percent in ten years and 16 percent in five years in order to catch up with other countries of the region. It is therefore evident that there is a lot of catching up to do.

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Royalty under clause (g) includes consideration for “the disposal of any property or right refereed to in sub-clauses (a) through (e).”The gross consideration for royalty income of a non-resident person is taxed at 15%, which is the final tax. To equate the consideration received for disposal of the property or right generating royalty income with the royalty income itself is not equitable.

Royalties

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The gross consideration received on disposal would be taxed at 15% without taking into consideration the cost of acquisition of the property or rights. This is contrary to the provisions relating to disposal of capital assets. Any expenditure incurred to earn royalty should be allowed as expenditure.

Royalties

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Sub-section (13)(a) of section 22 of the Income Tax Ordinance,2001 provides that for the purposes of this section the cost of a depreciable asset being a passenger transport vehicle not plying for hire shall not exceed one million rupees.

Enhancement in cost of private vehicle for tax depreciation

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Proposal

Section 22(13)(a) of the ITO 2001 should be amended by increasing the cost restriction on private vehicles from Rs.1 million to Rs.1.5 million.


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Section 27 provides that a person shall be allowed a deduction for any expenditure (other than capital expenditure) incurred in tax year in respect of:

a) any educational institution or hospital in Pakistan established for the benefit of the person’s employees and their dependents; or

Employee Training Facilities

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b) any institute in Pakistan established for the training of industrial workers, recognized, aided or run by the Federal Government or a provincial Government or a local authority.

c) …………………………………………………..As the above two objectives require expenditure of capital nature the restriction on its allowability is against the very purpose of this provision. No such restriction was imposed in the sub-section 23(i)(xiii), (xiv) and (xv) Repealed Ordinance.


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Proposal

The section 27 be amended so as words and brackets (other than capital expenditure) be removed.


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Sub-section (1) of Section 29 provides that a person shall be allowed a deduction for a bad debt in a tax year, if the following conditions are satisfied:-

(a) the amount of the debt was- (i) previously included in the person’s income from business chargeable to tax or; (ii) in respect of money lent by a financial institution in deriving income from business chargeable to tax;

Admissibility of Bad Debts

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(b) the debt or part of the debt is written off in the accounts of the person in the tax year; and

(c) there are reasonable grounds for believing that the debt is irrecoverable.

In this section a distinction has been made between bad debts of money lending and non-money lending business. Bad debts relating to principal amount have been made admissible only if that bad debt was earlier included in his income from business chargeable to tax.


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Proposalsi) Scheduled banks, approved

leasing companies and approved modarabas be added with financial institution for admissibility of bad debts.

ii) Law should be amended to cover all transactions undertaken under the Ordinary course of business.

iii) Clause (c) of sub-section 1 may be deleted.


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In the provision of sub-section (2) of Section 36, it is important to note that under sub-section (2) of Section 36 for the purposes of determining income on incomplete long-term contracts, the percentage of completion shall be determined by the ratio which the contract costs incurred up to the end of the tax year has with the estimated total cost as “determined at the commencement of the contract”.

Long-Term Contracts

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I feel that considering contract costs as a variable “at the commencement of the contract” for estimating the stage of completion is not appropriate, given the practical considerations whereby with the ongoing progress of the contract, it is invariably desirable to re-estimate the entire costs of the contract until its completion.

Long-Term Contracts

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Proposal

That the word “commencement of the contract” in sub-section (2) of the said section of the Ordinance may be substituted with the words “commencement of the year”.

Long-Term Contracts

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Under Section 37 long term gains derived on the disposal of capital asset held for more than one year are being taxed after 1/4th reduction in the gains as per the Income Tax Ordinance, 2001, unlike a reduction of 3/4th in the gains which remained in operation under the Repealed Ordinance.

Capital Gains

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It is important to point out that the Capital Gains derived on sale of shares of a listed public company is fully exempt up to 30th June, 2007; whereas Capital Gains earned on sale of shares of non-listed company or private limited company are taxable as stated above.

Capital Gains

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Proposal

That the relief of 3/4th in the income/gain be restored.

Capital Gains

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Section 80B of the Repealed Ordinance provided that when interest or profit earned on National Saving’s scheme; account or deposit maintained with any banking company or any financial institutions; or Bonds, Certificates, Debentures, Securities on instruments of any kind issued by any banking company or any company, were subject to tax @10% of such income and tax so deducted was full and final consideration of such income.

Taxability of Interest or Profit

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The Income Tax Ordinance, 2001, however, has not only done away with the exemption but has removed the profit on debt from Presumptive Tax Regime and now such profit is clubbed with other income and taxed at normal rates.

This is a very harsh section and effects widows, pensioners etc., who had invested their saving in these schemes.


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Proposal

That profit on debt should be brought within the ambit of Presumptive Tax Regime to bring in line with the provision of section 80B of the Repealed Ordinance.


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The concept of holding companies has helped many economies of the world to grow. This concept is available in Pakistan but has not grown as required because of certain issues and anomalies relating to holding company concept under the existing laws and regulations in Pakistan. Few of them are as follows:-

Holding Company

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a)Tax on Dividends There is no concept of group taxation in

Pakistan and therefore each company is treated as a separate taxpayer even though it may be a wholly owned subsidiary. When a company declares a dividend and the recipient is not a listed company or an insurance company, the rate of tax to be withheld is 10% of the gross dividend and when the recipient declares a further dividend to its shareholders, it would again be taxed at 10%, resulting in double taxation.

Holding Company

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Proposal: That the dividend paid to the holding companies by its subsidiaries may please be exempted.

Holding Company

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5Holding Company

b) Group Relief

Section 59B of the Income Tax Ordinance, 2002 states that any company, being a subsidiary of a public company listed on a registered stock exchange in Pakistan, owning and managing an industrial undertaking, may surrender its assessed tax loss in favor of its holding company provided such holding company owns seventy-five percent or more of the share capital of the subsidiary company.

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Proposal: That the same provision of law may also be applicable in the case of non-listed companies including private limited companies and also not be restricted to companies engaged in industrial undertaking only.

Holding Company

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In sub-section (1)(b) of section 98 provides that when there is a change in fifty percent or more of the underlying ownership of an entity, any loss incurred for a tax year before the change shall not be allowed as a deduction in a tax year after the change unless the entity:

Change in Control of an Entity

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(a) continues to conduct the same business after the change;

(b) does not, until the loss has been fully set-off, engage in any new business or investment after the change

The second condition practically restricts the new management of the entity to make any further investment or enter into new business to generate income from the investment/ business.


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Proposal

It is proposed that provisions of Section 98(1)(b) be deleted or reconsidered.


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Sub-section 9 of section 101 provides that Rental Income shall be Pakistan-source income if it is derived from the lease of immovable property in Pakistan whether immovable or not; or

From any other interest in or over immovable property, including a right to explore for, or exploit, natural resources in Pakistan.

Geographical Source of Income Gain on alienation of any property or right

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Sub-section (10) of section 101 further states that any gain from the alienation of any property or right referred to in sub-section 9 or from alienation of any share in a company the assets of which consist wholly or principally, directly or indirectly of property or rights referred to in sub-section (9) shall be Pakistan-Source income.


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It is my humble view that there can be no jurisdiction for the taxability of gain on shares of a foreign company located outside Pakistan on the basis of the foreign company’s assets in Pakistan. This law would adversely affect foreign companies operating in Pakistan.


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Proposal

The words “or from the alienation of any share in a company the assets of which consist wholly or principally, directly or indirectly of property” in sub-section (10) may be deleted.


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Under section 109 Commissioner has been empowered to re-characterize a transaction or an element of a transaction or disregard a transaction devoid of economic substance or re-characterize a transaction where form and substance are incompatible. The aforesaid measures could be invoked where the Commissioner may have reasons to believe that such transaction was done in pursuance of a tax avoidance scheme.

Commissioner Empowered to Re-characterize Income & Deductions

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In sub-section (2) of section 109 the definition of tax avoidance scheme caters such transaction of which the main purpose is to avoid or reduce tax. The courts have held that only such transaction can be disregarded which have no commercial purpose. Further, courts have also held that circumventing provisions of law using legal method is permissible and tax avoidance carries different meaning in tax laws.


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Therefore, a transaction, which has commercial purposes beside any objective to avoid or reduce tax, should not be treated as tax avoidance scheme.

Conceptually there is nothing wrong with these provisions as the objective is to forestall “tax avoidance schemes”. But tax avoidance is one’s legal right as held in a number of cases. Tax avoidance through legitimate means (tax planning) is different from tax evasion.


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This provision has even declared “tax avoidance” as illegitimate and forbidden. Not only the taxpayers have been deprived of a lawful right, but the taxation officers have been given unqualified powers to declare whatever they may conceive and label it as a “tax avoidance scheme.” Although this concept has recently been introduced in the number of countries of the world like UK in the year 2000 and is still in it’s infancy. We feel that in Pakistan this discretionary power may be misused.


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Proposal

The operation of this provision may be suspended. Amendment is needed to attract provisions to such transaction only, which has no commercial purpose and value.


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Sub-section (2) of Section 13 of the Repealed Ordinance provided that where the value of any investment or article referred to in clause (aa), (b), (c) or (d), or the amount of expenditure referred to in clause (e) of sub-section (1) is, in the opinion of the Deputy Commissioner, too low, the DC after giving a reasonable opportunity to the assesses of being heard may determine a reasonable value or the amount thereof, as the case may be, and all the provisions of sub-section (1) shall have effect accordingly;

Un-explained Investment etc. deemed to be Income

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whereas sub-section (3) of section 111 which is corresponding section of the Repealed Ordinance authorizes the Commissioner to include the difference in the person’s income chargeable to tax without providing him a reasonable opportunity of being heard while making addition of any amount thereof. We feel this is against the all norms of natural justice.


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Proposal

After the words “the Commissioner may,” the words “after giving to the taxpayer a reasonable opportunity of being heard and “ may be inserted.


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Sub-section 5 of section 122 provides that an assessment order in respect of a tax year, or an assessment year, shall only be amended under sub-section (1) and an amended assessment for that year shall only be further amended under sub-section (4) where, on the basis of definite information acquired from an audit or otherwise.

Amendment of Assessment

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Similarly sub-section (5A) of Section 122 provides that Commissioner may amend or further amend, an assessment order, if he considers that assessment order is erroneous in so far it is prejudicial to the interest of revenue. This power to the Commissioner is against the principles of natural justice as if he is examining the tax records to ascertain whether the assessment order completed is prejudicial to the interest of revenue or not, he should examine all the areas once for all and amend the order accordingly and should not be authorized to again amend the same order.


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The sub-section 4 also provides that Commissioner may further amend the assessment order as many times as may be necessary within six years of the date of original assessment.

This provision of law is against all the norms of justice, equity and fair play.


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i) That once the assessment is amended it may further be amended only when the department acquires definite information, that the income has been concealed or inaccurate particulars of income have been furnished or the assessment is otherwise incorrect.


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Proposalsii) That re-opening of the case should be

made only by the Regional Commissioner of IT after giving proper opportunity to the taxpayer of being heard by issuing specific show-cause notice in this regard. It is against the tenets of justice that the same IT Commissioner who has completed the assessment, re-opens the case on the basis of the same material/evidence which is already available on record and is deemed to have been considered at the time of original assessment.


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Proposals

iii) Moreover where an assessment is required to be amended under Section 122 (5A) that can be amended only once and thereafter this sub-section cannot be invoked.


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Section 132 provides that the Appellate Tribunal shall afford an opportunity of being heard to the parties to the appeal and in case of default by any of the party on the date of hearing, the Tribunal may if deem fit, dismiss the appeal in default or may proceed ex-part to decide the appeal on the basis of available record. This provision of law is in contradiction of Rule 20 of the Income Tax Appellate Tribunal Rules, 1981, which provides that in case of non-appearance of appellant or respondent, the Tribunal may proceed Ex-part and decide the appeal on merits.

Disposal of Appeals by the Appellate Tribunal

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ProposalThat said sub-section (2) may be

substituted with the following:-“The appellate Tribunal shall afford

on opportunity of being heard to the parties and in case of failure to attend the appeal by the person filing the appeal, the Tribunal may proceed ex-part to decide the appeal on the basis of the available record.”

Disposal of Appeals by the Appellate Tribunal

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Section 134A introduced the above mechanism for the first time through Finance Act, 2004.

The original idea of providing taxpayer a forum to resolve tax related disputes and to liquidate arrears of tax was provided in the Sales Tax Law under section 47A through Finance Act, 2003.

Alternate Dispute Resolution

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I feel due to poor drafting of sub-section (6), a number of persons understand that in case the aggrieved person is not satisfied with the orders of the Central Board of Revenue, he may file an appeal or reference against the CBR’s order with the appropriate authority, tribunal or court under the relevant provisions of this Ordinance within a period of sixty days of the order passed by the Board under this section has been communicated to the aggrieved person.


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In the clause 46 of the CBR’s publication Salient Features and Rationale of Proposals for Budget 2004-2005, it is stated that the taxpayers will continue to have the right of appeal if they are not satisfied with the findings of the committee and limitation for appeal shall be extended for the period consumed in alternate dispute resolution process.


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Sub Section (4) of the Section 134 A provides that the Central Board of Revenue may on the recommendation of the committee, pass such order, as it may deem appropriate. In my humble view the recommendation made by the committee should be accepted in a better spirit unless there is any apparent mistake.


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It is provided in sub-section (5) that incase the matter is already sub-judice before any authority or tribunal or the court, on agreement made between the aggrieved person and the Board in the light of recommendations of the committee shall be submitted before that authority, tribunal or the court for consideration and orders as deemed appropriate.


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I feel instead of communicating the agreement to the appellate forum, the appeals filed by the respective parties should be withdrawn.


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Prior to substitution of section 136 of the Repealed Ordinance in the year 2000 the taxpayer or commissioner was allowed to file appeal directly to the High Court against the order of the Income Tax Appellate Tribunal (ITAT). However, now they both are required to apply to ITAT to refer to the High Court any question of law arising out of order of the ITAT. This is creating delay in finalization of pending issues and causing additional cost to the taxpayer.

Direct Appeal to the High Court

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Proposal

It is therefore proposed that the provisions prior to amendment made in the year 2000 in the Repealed Ordinance for Direct Appeal to the High Court may be restored.

Direct Appeal to the High Court

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Sub-section (1) of section 151 provides that different classes of taxpayers paying profit on debts shall deduct tax at the prescribed rates except on profit on loan obtained under agreement between borrower and a banking company or a development finance institution. We all are fully aware that, it is also a general norm that companies grant loans to their sister concerns and subsidiaries.

Profit on Loan Agreements

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In past question of withholding of tax on such loans was raised and it had already been settled and appropriate amendment was also made in the law to exclude such companies from preview of withholding provisions.

ProposalIn clause (d) of sub-section 1 of

section 151 after the words “or a development finance institution” the words “or Inter company loans” be added.

Profit on Loan Agreements

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The Finance Act, 2004 has brought many services under the Presumptive Tax Regime like Commission earned by the Travel Agents etc. On the one hand the taxes deducted on their incomes constitute full and final tax liability and on the other hand their clients while making payments to them are also deducting tax under section 153, which unnecessary creating hardship for them and refund as well.

Exemption from Withholding Tax On Payments Covered Under The Presumptive Tax Regime

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Section 175 provides that in order to enforce any provision of this Ordinance (including for the purpose of making an audit of a taxpayer or a survey of persons liable to tax), the Commissioner or any officer authorised in writing by the Commissioner for the purposes of this section:-

(a) shall, at a times and without prior notice, have full and free access to any premises, place, accounts, documents or computer;

Power To Enter And Search Premises

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(b) may stamp, or make an extract or copy of any accounts, documents or computer-stored information to which access is obtained under clause (a);

(c) may impound any accounts or documents and retain them for so long as maybe necessary for examination or for the purposes of prosecution;


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(d) may, where a hard copy or computer disk of information stored on a computer is not made available, impound and retain the computer for as long as is necessary to copy the information required; and

(e) may make an inventory of any articles found in any premises or place to which access is obtained under clause (a).


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The provision is very harsh in nature. It also provides for action to be initiated by the Commissioner without prior notice, which does not meet the principle of natural justice.


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ProposalAppropriate amendment be made

in this section as to ensure that before any action under this section is taken by the Commissioner he should issue a show cause or prior notice which is properly and duly served on the taxpayer and the access does not extend to entering residential premises.


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Under section 176 the Commissioner can call for any information from any person. By virtue of this section, where a hard copy or computer disk of information stored on a computer is not made available to the Commissioner, he has the power to require production of the computer on which the information is stored and impound and retain the computer for as long as is necessary to copy the information required. We are afraid of misuse of such powers in its application, in reality.

Notice To Obtain Information Or Evidence

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Proposal

This provision of law may be reviewed for reduction of discretionary powers.

Notice To Obtain Information Or Evidence

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Section 177 of the Income Tax Ordinance, 2001 provides that the Central Board of Revenue may lay down criteria for selection of any person for an audit of person’s income tax affairs, by the Commissioner and shall keep the criteria confidential.

Audit

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Sub-section (4) also authorizes Commissioner that he may also select for an audit of the persons income tax affairs, in addition to the selection made in accordance with the criteria laid down by the CBR; having regard to.

Audit

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That parameters and criteria for selection of audit should be System-based.

That Sub-section (4) may be deleted.

Audit

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Section 183 provides a taxpayer who fails to pay any tax (other than penalty imposed under this section) due under this ordinance by the due date shall be liable for a penalty equal to-

(a) in the case of the first default, 05 % of the amount of tax in default;

(b) in the case of a second default, an additional penalty 20 %.

( c) in the case of a third default, an additional penalty of 25 %.

(d) in the case of a fourth and subsequent default, an additional penalty of up to 50%.

Penalty For Non-Payment of Tax

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The above provision of law provides that the Commissioner may impose penalty on the taxpayer between five to hundred per cent in case of first to fourth and subsequent default. However, nothing has been mentioned that what would be the period to justify the levy of additional tax between each of the default.


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At least three months’ time must be provided between each default.

Quantum of penalty may be reduced.


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Advance rulings also share the burden of judiciary and restrict revenue officials from using discretionary and injudicious powers. Government deserves lot of appreciation for introduction of such provisions in the law, which facilitate only to the foreign investors. In my humble view this facility should be available to the local investors as well. There is no provisions in respect of appellate remedy in case an adverse ruling issued by the CBR, which may also be provided.

I am also of the view that Advance Ruling issued should be notified for public interest.

Advance Ruling

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Pakistan is the one of the pioneer countries in the Islamic world to successfully introduce Islamic Banking phenomenon. In past number of provisions have been introduced to provide level playing field to the Islamic Bank/Financial Institutions with Conventional Banks/ Financial Institutions. Recently another mode of Islamic Banking Instruments Murahaba has been introduced. For the interest of reader of this document the following comparison has been made between Islamic and Conventional Banks/Financial Institutions nature of transactions/mode of operation.

Taxability of Murahaba Transactions

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Conventional bank grant loans to their customers for purchase of goods/machinery and are not required to deduct withholding tax on disbursement of such loans; whereas in Murahaba transaction the bank will first buy goods/machinery for its customers and subsequently sell the same goods to them at a agreed price, which constitute cost plus profit. In this way the Islamic Bank is liable to withhold tax first at the time of purchase of goods/machinery on behalf of its customer and secondly while they sell the same goods/machinery to their customers, who withhold tax, which increase the overall cost of transaction.


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In Conventional banking the markup is charged or accrued by the bank according to the time of loan utilized by its customer and offered for taxation purpose; however, in the case of Murahaba the goods is being sold and the receivables for principals as well as profit is accounted for at the time of sale of goods to its customer and as such the entire profit which is recoverable in the many years to come become subject to tax in the year in which the sale of goods/machinery is effected.


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In conventional banking the minimum tax u/s.113 is chargeable on the interest earned by the bank on the loan given to the customer; whereas in the case of Murahaba transactions the minimum tax is chargeable on the sale price of goods/machinery sold to the customer.


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ProposalI therefore proposed that

appropriate amendments in section 113,148,169 and Part-IV of the Second Schedule to the Income Tax Ordinance be made to provide level playing field to the Islamic Banks/Financial Institutions with Conventional Banks/Financial Institution.


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CBR has issued Circular No.14 of 2004 dated July 13, 2004, wherein it is stated that the manufacturers of cooking oil or vegetable ghee or both have been provided a reduced rate of 1% on local purchase of edible oil which too shall constitute final discharge of tax liability of such local purchase. For this purpose a following new clause (13C) has been inserted in Part II of the Second Schedule to the Ordinance.

Reduced Rate of 1% on local purchase of Edible Oil

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“In respect of edible oil purchased locally by manufacturers of cooking oil or vegetable ghee or both, the rate of income tax shall be 1% of the purchase price.”

On examination of above clause, following questions have emerged:-1. Under which provision of law the statement

in lieu of Return of Income under Section 114 would be filed?

2. Under which provision of law the tax so paid on purchase of edible oil would be considered as final discharge of tax liability?


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Appropriate amendments may be made in sections 114 and 169.


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As per Rule 5(b) of the Fourth Schedule to the Income Tax Ordinance, 2001, the Capital Gains earned by General Insurance Companies on sale of stocks/shares and disposal of investments is subjected to tax @ 35% whereas, it is exempted from tax to all other taxpayers. It is proposed that Insurance Companies may also be exempted from levy of income tax on capital gains.

Taxability of Capital Gains on sales of Stocks/Shares earned by the Insurance Companies

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Presentation by Abdul Qadir Memon

At Income Tax Bar Association Karachi

April 11, 2005

ITBAK Pre Budget Proposals 2005 In the name of Allah, the most gracious and most merciful.

Documents

Transcript of ITBAK Pre Budget Proposals 2005 In the name of Allah, the most gracious and most merciful.