Any law enacted by the Majlis-e-Shoora (Parliament) has to conform to the principles contained in the Constitution of Pakistan, and tax codes are no exception. Article 77 of the Constitution says that "No tax shall be levied for the purposes of the Federation except or under the authority of Majlis-e-Shoora (Parliament)".
Any tax levied by the Parliament is to be tested on the touchstone of the fundamental rights enshrined in the Constitution and if it is violative of any provision it would be void ab initio.
The State has the power to tax its citizens but taxation should not be confiscatory, discriminatory or offensive to any fundamental right guaranteed in Chapter 1 of the Constitution [Article 8 to 28]. It is the duty of the State "to ensure the elimination of all forms of exploitation and the gradual fulfilment of the fundamental principle: from each according to his ability to each according to his work" [Article 3].
In the Income Tax Ordinance, 2001 [hereinafter "the new Ordinance"] this principle has been flagrantly violated by taxing notional income in the hands of a salaried person if his employer extends him a riba-free (interest-free) or concessionary loan [section 13(7) of the new Ordinance].
Article 8 of the Constitution says that "Any law, or any custom or usage having the force of law, in so far as it is inconsistent with the rights conferred under this Chapter [Chapter 1 relating to Fundamental Rights] shall, to the extent of such inconsistency, be void". The provision of taxing notional income arising from riba-free or concessionary loans is against the following provisions of the Constitution:
1. Article 25 of the Constitution which says that "all citizens are equal before law and are entitled to equal protection of law". However, this article does not speak about abstract equality, but in fact, proclaims equality before the law. Equal protection of law means that all the persons equally placed should be treated alike both in privileges conferred and liabilities imposed. A reasonable classification should be based on:
An intelligible differentia which distinguishes persons or things that are grouped together from those who/which are left out;
The differentia must have a rational nexus to the object sought to be achieved by such classification.
And
2. Article 38(f) requiring the State to eliminate riba as early as possible.
On the one hand there is much talk about Islamizing the economy and on the other expropriatory tax provisions exist that penalise an employee who receives riba-free or concessionary loan. It is worth mentioning that this provision is only meant for the salaried class while all others are left out. In this society loan defaulters (covering both genuine bankrupts as well as professional loan-sharks) enjoy immunity from tax. Recently, the Finance Bill 2004 provided them with unprecedented benefit of non-taxation of remission of loan and mark-up. One class is getting such benefits while the already overtaxed salaried class is being taxed for riba-free loan/concessionary loan where no element of income is involved.
Section 13(7) of the new Ordinance taxing the notional benefit arising out of riba-free or concessionary loans given to employees is violative of Article 25 and 38(f) of the Constitution. It reads as under:
'Where a loan is made, on or after the 1st day of July, 2002, by an employer to an employee and either no profit on loan is payable by the employee or the rate of profit on loan is less than the benchmark rate, the amount chargeable to tax to the employee under the head "Salary" for a tax year shall include an amount equal to-
(a) the profit on loan computed at the benchmark rate, where no profit on loan is payable by the employee, or
(b) the difference between the amount of profit on loan paid by the employee in that tax year and the amount of profit on loan computed at the benchmark rate, as the case may be.
The expression "benchmark" is defined in sub-section (14) of section 13 as under:
(a) "benchmark rate" means --
(i) for the tax year commencing on the first day of July, 2002, a rate of five percent per annum; and
(ii) for the tax years next following the tax year referred to in sub-clause (i), the rate for each successive year taken at one percent above the rate applicable for the immediately preceding tax year but not exceeding such rate, if any, as the Federal Government may, by notification, specify in respect of any tax year;
This provision of law is liable to be struck down as it is against the basic principles of the Constitution. It is confiscatory and violative of the equality principle. It is also against Article 38(f) that requires the State to eliminate riba as early as possible. This provision of law is also against the declared policies of the government of:-
1. providing relief to the salaried class.
2. promoting housing industry
3. extending affordable loans and advances to low-income groups of society.
Section 13(7) read with section 13(14) is against all norms of law, justice and equity. How can a law fix benchmark rate arbitrarily at 5% for the base year and thereafter provide for an annual increase of 1%, whereas the mark-up rates in the market are declining? Secondly, if an employee has obtained loan at a rate less than 5% how can the law fix it at a higher rate? It is pertinent to mention that the Central Board of Revenue (CBR) under the repealed Ordinance of 1979 issued a Circular Letter 4(8)IT-J/91 dated June 30, 1991 opining that "...it is not desirable to tax such notional income...".
The facility of interest-free or concessionary loans can be abused by the director/shareholders of private companies or certain persons running family-controlled trusts, but in their case the law provides that such a loan would be treated as dividend as per section 2(19)(e) of the new Ordinance. The whole amount of loan in their case is treated as dividend and a separate block of income that is taxed @ 10%.
In the case of employees/persons having no ownership interest in the business concern, the employer/concern cannot divert income by giving them loans in lieu of dividends and therefore there is no justification to tax such a notional income by treating riba-free or concessionary loan as a perquisite. The idea of taxation of such loans at an incremental rate of 1% every year starting from the base year self-assumed rate of 5% is confiscatory as in many cases the actual rate on which loan obtained may be much lower. Presently the banks are giving loans to credit-worthy parties at as low a rate as between 2% to 3.5%.
The following illustration [based on a real life case] shows financial ramifications of this provision of law in the case of a bank employee earning monthly basic salary of Rs 10,000 and who has availed the facility of house loan of Rs 4 million from his employer:
Mr. 'A', employee of a bank, received the following for the tax year 2004:
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Rs
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Basic Salary: 120,000
House rent allowance: 54,000
Utilities: 12,000
Medical allowance: 12,000
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House loan was taken on 1st July 2002 @ 2% per annum mark-up.
Computation of taxable income and tax payable
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Item Amount Exempt Taxable
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Basic salary 120,000 Nil 120,000
HRA 54,000 54,000 Nil
Utilities 12,000 12,000 Nil
Medical 12,000 12,000 Nil
Income u/s 240,000 80,000 160,000
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13(7)
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Total taxable income 2,80,000
Calculation of tax liability
Taxable income: 2,80,000
Tax on Rs 150,000: 5,250
Tax on 130,[email protected]%: 16,250
Gross tax: 22,500
Tax reduction @30%: (-) 6,750
Net tax payable: 15,750
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Had section 13(7) not been applicable, total tax payable would have been just Rs 1500.
Taxable salary is merely Rs 120,000 whereas notional value of taxable house loan facility is Rs 160,000. Loan of Rs 4 million is barely sufficient to purchase/construct a house on a 125 to 250 square yards plot in any average locality.
The banks' employees are at par with PIA and Railways who enjoy free/concessional tickets. In their case no income on this account is taxed as the employer is engaged in the business of carriage of passengers. On the same analogy, the banks are engaged in the business of lending and borrowing and therefore their employees should not be taxed for this facility.
The above example clearly exposes the adverse effects of section 13(7) read with section 13(14). There are cases where only due to inclusion of this notional income, a salaried person falls in the category of taxable income of Rs 600,000 and consequently all the allowances and perquisites in his case become taxable.
It is therefore imperative that this notional income should not be taxed. In case the government (in fact CBR) is bent upon promoting riba despite tall claims of eliminating exploitation from the economy, then the following amendments should be made making the law equitable:--
1. Benchmark rate as defined in section 13(14) should not be more than the rate on which loan is obtained by an employee.
2. In case rate is lower than the average borrowing rate for such kind of loans in the market, the Federal Government or State Bank should be asked to notify an average rate for the relevant tax year.
3. Addition under section 13(7) should not be part of "taxable income" to determine the threshold of Rs 600,000 for the purpose of rule 9 of the Income Tax Rules, 2002.
4. Such a notional income should be taxed as a separate block at a concessional rate not exceeding 5%.
It is hoped that the policy-makers at the helm of affairs will take due notice of this unjust and confiscatory provision of law that has disastrous financial ramifications for the salaried persons, who are already facing a tough challenge to survive in their paltry resources.
The tall claims of the government to promote riba-free economy, housing industry and to provide housing facilities to all the citizens are in direct conflict with such erratic and confiscatory fiscal provisions which are against the basic principles of the Constitution of Pakistan.
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