Budget Briefing 2008 - I

The Bill seeks to expand the definition of "Dividend" as defined in Clause (19) of Section 2 by proposing insertion of a new Sub-clause (f). While profit of a branch of a foreign company operating in Pakistan was always subject to tax in Pakistan like any other corporate entity, the same after-tax profit when remitted was not again liable to tax.
1. AFTER-TAX PROFIT OF A BRANCH OF A FOREIGN COMPANY LIABLE TO TAX ON REMITTANCE SECTION 2, CLAUSE (19)(F)The proposed amendment now seeks to tax remittance of after-tax profit apparently on the analogy of tax on dividend in the hands of shareholders out of after-tax profits of a corporate entity. The applicable rate of tax on remittance of profit would be 10 percent.
It may be recalled that even tax on dividend from a corporate entity was, over the years, demanded by various quarters to be conferred tax exemption on the grounds that it is double taxation as, such dividend is nothing but appropriation of after-tax profits of an entity.
This argument was often repelled by contending that the company is an entity independent of its shareholders, ie owners and therefore, there is no double taxation in view of two separate beneficiaries of income liable to tax under the two different heads of income.
The proposed tax on remittance of after-tax profit of a branch of a foreign company operating in Pakistan fails even on the aforesaid test of two beneficiaries receiving two forms of income - company earning profit as business income and its shareholders receiving the same income in the form of dividend.
We do not find justification in this new imposition because of the fact that a branch has no existence of its own independent of its head office or an affiliate of which it is a branch. The beneficiary is the same as also the nature of income which does not change by merely expanding the statutory definition of dividend.
In view of this, therefore, it is difficult to discern a conceptual justification or rationale to impose a tax when a branch legitimately seeks to remit its after-tax profits. Viewed from another prospective, this new tax cannot be seen as a legitimate attempt to curb remittance of profits by a branch as a measure of foreign exchange conservation, for, the avowed policy of the Government over the years and more particularly in recent years has been encouragement of foreign investors to remit capital and also profits thereon.
2. INDUSTRIAL UNDERTAKING IN SPECIFIED RURAL AND UNDER DEVELOPED AREAS ENTITLED TO FIRST YEAR ALLOWANCE (FYA)
SECTION 23A
THIRD SCHEDULE PART II: It is widely recognised that a process of industrialisation needs to be accelerated in rural and under developed areas to serve the wider objectives of economic development. As one of the measures towards this end, a new Section 23A is sought to be introduced to bring in the incentive of FYA.
The proposed Section seeks to entitle an industrial undertaking to claim FYA on plant, machinery and equipment if such undertaking is setup in rural and under developed areas as may be specified in due course. FYA would be allowed in lieu of initial allowance (of depreciation) at the rate of 90 percent of the cost of "eligible depreciable assets" of an industrial undertaking owned and managed by a company when such assets are put to use after 01 July 2008.
It may be noted that the qualifying date of 01 July 2008 is with reference to the first time use of the qualifying assets regardless of the date of setting up of an industrial undertaking or the date of incorporation of a company.
3. ACCUMULATED BUSINESS LOSS OF NON-BANKING FINANCE COMPANIES (NBFCS), MODARABAS OR INSURANCE COMPANIES TO BE AVAILABLE FOR SET OFF IN THE EVENT OF AMALGAMATION:
SECTION 57A, SUB-SECTION (2A) In an attempt to facilitate corporate consolidation through amalgamation of NBFCs, modarabas or insurance companies, the first ever fiscal step in the tax regime was initiated through the Finance Ordinance, 2002 by introducing Section 57A of the Ordinance.
The Finance Act, 2007 brought in a significant change whereby in the event of amalgamation of two or more companies, the assessed loss of the amalgamating company or companies only for the tax year is allowed to be set off against business profits and gains of the amalgamated company. As a consequence, accumulated losses preceding the tax year in which the amalgamation takes place stand lapsed.
The Bill now proposes to revert back to pre 2007 position in so far as NBFCs, modarabas, or insurance companies are concerned. The proposed Sub-section (2A) provides that in the event of amalgamation of the said entities, accumulated business loss (excluding speculation business losses) shall be allowed to be carried forward and set off against the business profits and gains of the amalgamated company.
This right of carry forward and set off shall be available to the amalgamated company upto a period of six tax years immediately succeeding the tax year in which the loss of an amalgamating company or companies was first computed.
4. THIN CAPITALIZATION RULE EXTENDED TO A BRANCH OF A FOREIGN COMPANY IN PAKISTAN SECTION 106, SUB-SECTION (1)The concept of thin capitalisation was first introduced by the Finance Ordinance, 2002 whereby deductibility of profit on debt was restricted in the hands of the borrower if the debt to equity ratio exceeded the prescribed limit ie 3:1 ratio. The scope of this Section is now proposed to be extended to a branch of a foreign company operating in Pakistan.
As stated earlier, since this Section was restricted to a "foreign-controlled resident company", the provision was couched using the term "foreign equity", as defined in the said Section itself, in relation to debt. Since the said definition remains unchanged, despite proposed expansion of the provision to a branch, it would appear that the balance of head office account in the books of account of a branch would partake as "foreign equity" although not statutorily supported by the said term as defined. An appropriate amendment in the said definition, therefore, appears to be necessary.
5. MINIMUM TAX PROVISION WITHDRAWN SECTION 113: The provision for minimum tax was introduced for the first time by the Finance Act, 1991. Minimum tax was payable by every company resident in Pakistan at the rate of 0.5 percent of its turnover, should the actual tax liability be less than the amount of such minimum tax.
The Finance Act, 2004 subsequently amended the aforesaid original provision whereby, in the event of minimum tax exceeding the actual tax payable for a tax year calculated on profit basis, the tax payer was entitled to carry forward the excess amount of the minimum tax paid for adjustment against the actual tax liability for the subsequent five tax years.
The Bill proposes to entirely withdraw the minimum tax provision. It may not be out of place to mention that provisions governing minimum tax were originally introduced as one of the single most effective expedients of resource mobilisation in view of the paltry contribution of direct taxes by a substantial number of entities even in the corporate sector.
The current budget formulated in the backdrop of serious resource constraints now proposes to withdraw minimum tax provision which seems to be inconsistent with the ground realities. The provision was already reasonably rationalised when the Finance Act, 2004 permitted adjustment of the minimum tax paid in the following years in the event of profit, thereby making the impact of minimum tax less painful in view of the permitted adjustment. A resource-constraint budget seeking to do away altogether the said provision from the tax regime does not appear to be quite understandable.
6. MINIMUM TAX PAYABLE BY BUILDERS AND DEVELOPERS SECTION 113C: Undoubtedly, there are certain sectors of business in our country whose contribution to direct tax revenue is far from satisfactory. The proposed insertion of this new Section also seems to be driven by the fact that persons engaged in the business as builders and developers ought to contribute to direct tax revenue a certain minimum regardless of their bottom line.
The Bill proposes to impose a minimum tax based on a fixed amount of tax in case of a builder, at the rate of Rs 50/- per square feet of covered constructed area and that for a developer, at Rs 100/- per square yard on the area of land developed.
The scope of the proposed provision is wide enough and shall be applicable to any person including an individual, an association of persons (AOP) or a company engaged as a developer of land for residential, commercial or industrial purposes or a builder engaged in construction of houses, commercial or industrial property.
7. INVESTMENT TAX ON UNDISCLOSED INCOME SECTION 120A: Once again the tax history in Pakistan has repeated itself. Over time, various governments did introduce one or the other form of tax amnesty scheme under various nomenclatures. This time round the Bill proposes to introduce an enabling provision which shall empower the Board to make a scheme of whitening undisclosed income which the Bill conveniently and euphemistically refers to as "investment tax on income".
Although the full scope and implications of this provision would not be known until the entire framework of the scheme is formulated and issued by the Board, at this stage, however, the Bill proposes to provide yet another opportunity. Needless to emphasise that each such opportunity in the past was proclaimed as the final and last opportunity by the sitting government and its Finance Minister, yet again, the Bill provides for declaration of undisclosed income representing any amount or investment made in movable or immovable assets.
It is also not revealed at this stage from the Bill what the tax rate shall be as the cost of making a clean breast of oneself. However, the Finance Minister indicated a rate of 2 percent in his budget speech. The underlying objective, though suspect, appears to be the consequence of yielding to the powerful lobbies who may have evaded their due amount of taxes in the past and may now wish to bring it to surface.
It may be pertinent to emphasise that ever since the first scheme of declaration of black and ill-gotten money was introduced by the 1958 Martial Law regime, followed by another in 1969, repeated on a confined scale in 1976, followed by a yet another scheme in 1985 commonly referred to as "Whitener Bond Scheme", an amnesty for voluntary disclosure in 1997 and the amnesty scheme of 2000, the Bill now proposes that declarants of such undisclosed income who shall have paid tax in accordance with the scheme and the rules shall be entitled to incorporate in their books of account such undisclosed income which is represented in tangible form.
The term "undisclosed income" is proposed to be defined to mean any income including any investment which may be deemed as income pursuant to Section 111 of the Ordinance or any other deemed income for any year or years which may have escaped taxation. Sub-section (3) of the proposed Section further seeks to give immunity from any liability on account of any tax, charge, levy, penalty of prosecution in respect of such undisclosed income.
Time and again, on each occasion, whenever any amnesty scheme was launched and implemented, honest tax payers and organised sectors of business who demonstrated a responsible tax behaviour had reasons to express their resentment by asserting that each such scheme puts premium on dishonesty and honest tax payers were left clamouring for having been meted out an unfair treatment to their great detriment. Only a naïve citizen would tend to believe that this scheme too would be the last and final in the annals of tax history of Pakistan.
8. CERTAIN CLARIFICATORY AMENDMENTS IN RESPECT OF PAYMENT TO A NON-RESIDENT SECTION 152, SUB-SECTION (7)In Clause (a) of Sub-section (7) of this Section, the Bill proposes to insert the words "and is supported by import documents" as a consequence of which Sub-section (5) of this Section which does not apply to payment on account of import of goods is subjected to a yet another condition, which was in any case implied without even the proposed amendment that there shall be proper import documents to support a payment pertaining to import of goods.
An explanation is also proposed to be added, in Clause (b) of this Sub-section which is totally misplaced in so far as it appears from the construction. Instead of inserting the explanation proposed to be made in Clause (b), this should have been at the end of Section 152 so as to be pervasive to the entire said Section.
The explanation is to the effect that all modes of payments to non-residents are subject to the withholding tax provisions embodied in Section 152 and therefore, regardless of the mode of remittance, be it through foreign currency accounts or secondary source of payment through exchange companies, payment to a non-resident shall suffer withholding tax as provided in the Ordinance.
Whatever be the objective underlying the proposed amendments in Clause (a) of Sub-section (7) and the proposed explanation sought to be inserted for amplifying mandatory deduction of withholding tax regardless of the mode of remittance, the practical effectiveness of these amendments would remain a moot point, whether any surreptitious payment purportedly on account of import of goods, invariably through secondary sources would come within the withholding tax net or not, despite the fact that those are not absolved any way from the provisions of withholding tax regardless of the mode of remittance.
9. WITHHOLDING TAX PROVISION FOR PAYMENT OF GOODS AND SERVICES RATIONALIZED SECTION 153, SUB-SECTIONS (5), (6A), (6B) & (9) Withholding and final tax regime with regard to payment on account of goods and services has undergone various changes in the preceding years. Presently, a company being a manufacturer, in its capacity as a recipient is not subject to Final Tax Regime in respect of taxes withheld on account of supply of goods Individuals and AOPs being manufacturers, in their capacity as recipients, are subject to the Final Tax Regime.
The Bill now proposes to replace the words "a company" in place of the words "any person" in Sub-section (6A) and also seeks to omit Sub-section (6B). The cumulative effect of the aforesaid two amendments maintains the existing legal position with regard to excluding the applicability of the Final Tax Regime to a company, being manufacturer, and retaining the applicability of the said provision in respect of individuals and AOPs, being manufacturers.
By a yet another amendment proposed to be made, Clause (e) of Sub-section (5) is sought to be omitted with a consequential amendment in Clause (b) of Sub-section (9) of this Section whereby a "small company" as defined in Section 2 of the Ordinance shall now be included in the list of prescribed persons liable to deduct tax from prescribed payments.
Until now, individuals and AOPs were not categorised as withholding tax agents in view of the provisions of Sub-section (9) of this Section. The Bill now proposes to expand the category of prescribed persons as withholding tax agents by seeking to insert Clause (g) and Clause (h) in Sub-section (9) whereby an AOP having turnover of Rs 50 million or above and an individual having turnover of Rs 25 million or above shall henceforth be obliged to act as withholding tax agents while making payment on account of sale of goods, rendering or providing of services or on the execution of a contract.
In order to avoid any potential ambiguity, the term "manufacturer" for the purposes of this Section is proposed to be defined as any person who is engaged in production or manufacturing of goods in a manner such that any process, assembling, mixing, cutting, packing, repacking or preparation of goods transforms or changes an article or produce so as to become capable of being put to use in a different or distinctive manner.
10. PAYMENT TO NON-RESIDENT MEDIA PERSON TO SUFFER WITHHOLDING TAX SECTION 153A: The Bill proposes to introduce a new Section which provides that payment for advertisement services by any person to a non-resident media person would be subject to withholding tax at the rate of 10 percent. The proposed provision shall be applicable for such advertisement services relayed from outside Pakistan. The tax withheld at the prescribed rate of 10 percent shall be deemed to be the final tax liability of such non-resident media person.
11. TAX ARREARS SETTLEMENT INCENTIVES SCHEME SECTION 146B: In order to facilitate settlement of arrears of tax, enabling provision is being proposed to empower the Board to prepare scheme for waiver of additional tax and penalty and make rules for its implementation. Similar provision already exists in the ST Act.
12. AMENDMENTS IN CERTAIN DEFINITIONS SECTION 2 CLAUSES (5B), (30A), (30B), (35B), (47A), (47B)In order to update the definitions of certain companies and organisations that are governed by other statues, definitions of the following have been updated as under -
"Asset Management Company" means an asset management company as defined under the Non Banking Finance Companies and Notified Entities Regulations, 2007. "Investment Company" means an investment company as defined under the Non Banking Finance Companies (Establishment and Regulation) Rules, 2003. "Leasing Company" means a leasing company as defined under the Non Banking Finance Companies and Notified Entities Regulations, 2007.
"Non Banking Finance Company" means NBFC as defined under the Non Banking Finance Companies (Establishment and Regulation) Rules, 2003. "Real Estate Investment Trust (REIT) Scheme" means REIT Scheme as defined under the Real Estate Investment Trust Regulations, 2008. "Real Estate Investment Trust Management Company (REITMC)" means REITMC as defined under the Real Estate Investment Trust Regulations, 2008.
13. ELECTRONIC RECORD SECTION 2 CLAUSES (19B), (19C), (19D), (19E) SECTION 174, SECTION 237A, To keep pace with the rapid development in electronic mode of record keeping, the Federal Board of Revenue has recently adopted significant measures like enabling electronic filing of returns and statements by the corporate sector. To provide validity and authenticity to this mode of record keeping and data transmission, it is proposed that the Board may require any person to use its information system and electronic resource or to supplement its manual business process and substitute its paper based record by electronic record.
It is further proposed that electronic record maintained, received, filed or requisition through the electronic resource of the Board shall be sufficient and conclusive with regard to its validity authenticity and integrity for the purpose of the Ordinance.
It is further proposed to insert a new Sub-section (5) in Section 174 (which deals with requirement for maintenance of record) to empower the Commissioner to require any person to install and use an electronic tax register for the purpose of storing information regarding any transaction that has a nexus to the tax liability of such person.
In this regard, definitions of electronic record, electronic resource and telecommunication system have been incorporated in the law. Further certain specific terminologies defined in the Electronic Transactions Ordinance, 2002 have been adopted for the purposes of the Ordinance.
14. ELIGIBLE PERSON SECTION 2, CLAUSE (19A)The definition of eligible person for the purpose of Voluntary Pension System Rules, 2005 has been expanded to include an individual Pakistani who holds a National Identity Card for Overseas Pakistanis.
15. LOCAL GOVERNMENT SECTION 2, CLAUSE (31A)A general amendment has been proposed to replace the term "Local Authority" wherever appearing in the Ordinance with the word "Local Government" to bring it in line with the change in the governance pattern of the government whereby Local Authorities like Municipal Corporations and Development Authorities have been replaced by District Governments.
16. LIMIT FOR SALARY PAYABLE BY CROSSED CHEQUE SECTION 21, CLAUSE (M)Presently any salary exceeding Rs 10,000 per month that is not paid by a crossed cheque or direct transfer of funds to the employee''s bank account is not allowed as an admissible deduction for tax purpose. It is now proposed that the limit of Rs 10,000 per month be enhanced to Rs 15,000 per month.
17. EXEMPTIONS AND TAX PROVISIONS IN OTHER LAWS SECTION 54: This section provides that no provision in any other law that provides for an exemption from any tax imposed, a reduction in the rate of tax, a reduction in tax liability or an exemption from the operation of any provision of the Ordinance would have any legal effect unless such exemption is provided in the Ordinance.
Through a proviso inserted in this Section, it was stated that if any exemption was available under any other law before this Ordinance came into force then such exemption would be available unless withdrawn.
It is now proposed that this proviso be omitted meaning thereby that any exemption from Income-tax would only be available if it is provided in the Ordinance itself. We noted that certain exemptions like exemption to the State Bank of Pakistan and pension of a former president of Pakistan that was provided under a specific statute have now been proposed to be inserted in Part I of Second Schedule.
However, if there are exemptions from Income-tax that remain provided under other statues that have not so far been incorporated in the Ordinance then such exemptions would no longer be available.
18. TAX CREDIT ON CHARITABLE DONATIONS SECTION 61: A person is entitled to a tax credit in respect of any donation paid to certain organisations established and run by the Federal Government, Provincial Government or Local Government and to any approved non-profit organisation.
The tax credit is allowed as a deduction from the tax liability of the donor of an amount which is calculated by applying the persons effective tax rate to the donation given during a tax year. However, the donations that are eligible for tax credit in the case of an individual or AOP cannot exceed 30% of the taxable income and in the case of company 15% of the taxable income of the company for the tax year.
It is now proposed that the aforesaid ceilings of 30% and 15% be reduced to 10% for all persons. It is worth mentioning that availability of tax credit is considered a vital incentive in inducing persons specially the corporate sector to donate generously for charitable purposes that contributes tremendously towards the welfare of the down trodden. The proposed reduction in the maximum eligible ceilings of donations may turn out to be a major disincentive in mobilising donations especially in the corporate sector.
19. TAXABILITY OF AMOUNT PAID ON ACCOUNT OF INSURANCE OR RE-INSURANCE PREMIUM SECTION 101, SUB-SECTION (13A) SECTION 152, SUB-SECTION (1AA)AND (1B)A new Clause (13A)is proposed to be inserted in section 101 which deals with geographical sources of income. It is proposed that any amount paid by an insurance company to an overseas insurance or re-insurance company on account of insurance or re-insurance premium would be treated as Pakistan source income.
Insurance companies would be required to withhold tax at the rate of 5% of the premium in terms of Sub-Section (1AA) that is proposed to be inserted in Section 152. The tax so withheld is proposed to be treated as full and final discharge of tax liability in respect of the premium received by the overseas insurance or re-insurance company.
It may, however, be noted that any benefit available to the overseas insurance or re-insurance company under any Double Taxation Treaty (DTT) between the country of its residence and Pakistan would continue to be available in terms of Section 107 of the Ordinance which provides that the provisions of DTT would override the provisions of the Ordinance.
20. FILING OF RETURN OF INCOME AND WEALTH STATEMENT SECTION 115: Presently a salaried taxpayer is not required to furnish a return of income if he has no income other than salary and his employer has filed the annual statement of deduction of income tax from salary as required under the law.
On the other hand Section 116 which deals with requirement to file wealth statement states that a resident taxpayer filing a tax return and having a declared income of Rs 500,000 or more is required to file a wealth statement.
In view of the above, in the case of a salaried taxpayer having taxable salary of Rs 500,000 but having no other income who was not required to file a return (by virtue of his employer having filed the annual statement of deduction of tax), an ambiguity prevailed whether such salaried individual is required to file a wealth statement or not.