Managing revenue shortfall: FBR should tax beneficiaries of loan write-offs: analysts

The Federal Board of Revenue (FBR) can easily manage its revenue shortfall for annual budgetary target by collecting income tax from the beneficiaries of loan write-offs. Although the Board has powers to charge income tax from the beneficiaries.
The revenue body has put this option aside and contemplating other resources including imposition of RGST and broadening tax base of salaried class to enhance its revenue collection, analysts said while talking to Business Recorder on Thursday.
They said every year banks provided for non-performing loans and the interest related to such loans where the loan was not paid by the loanee within a certain period of time. There are three categories of loans, (i) sub-standard, (ii) doubtful, (iii) loss depending upon the period of default.
In the Seventh Schedule to the Income Tax Ordinance, 2001, the bad debts classified as 'sub-standard' is not allowable as an expense. However, the bad debts classified as 'doubtful' and 'loss categories' are admissible as deduction subject to one per cent of the total advances as per balance sheet date in case of corporate loans, and in case of SMEs and consumer loans such deduction is admissible up to five per cent of the advances wef Tax Year 2011.
They further said some of these loans were subsequently recovered and added back to income wherever recovery was affected. However, some of these loans and the amount of interest related to such loans is actually 'write-off' and in this respect the State Bank of Pakistan (SBP) has issued a circular No 29, dated October 15, 2002 wherein guidelines for write-off of irrecoverable loans and advances have been issued.
Through Finance Act, 2004, the clause (3A) was also incorporated in Part-IV of the Second Schedule to the Income Tax Ordinance, 2001 wherein effect was also given to the circular ibid where such loans and the interest related to such loans is 'write-off' under the scheme of the SBP envisaged in the said circular.
Analysts said the principal amount of loan and the interest related to such loan, which was written off by a bank in the case of a taxpayer, could be disallowed by the department to the extent of loss declared by such taxpayer and the addition on account of such loans were to be resulted in income. Therefore, the same was to be restricted only to the extent of loss declared for the year or brought forward loss from the previous years.
To a question, they said the provisions of sub-section (5) and (5A) of section 34 and section 70 of Income Tax Ordinance, 2001 would not apply to any benefit derived by way of waiver of profit on debt or the debt itself under the SBP, Banking Policy Department's Circular No 29 of 2002, dated October 15, 2002, to the extent not set off against the losses under Part VII of Chapter III.
Furthermore, they said the restriction has been placed on the addition of section 34(5), 34(5A) and section 70 to the extent of loss declared for the year or loss brought forward from the previous years. They said the provisions of section 34(5), 34(5A) and 70 deal only with such situation where any expense has been allowed for the past on accrual basis or even otherwise and subsequently the same expense is recouped/recovered such as the write-off of any interest or benefit as related to such expenses is subsequently accrued to the taxpayer, the same is to be added back.
They said the section 34(5), 34(5A) and section 70 did not cater for the principal amount of debt, which has been written off because these sections deal only with the expense.
But there is no such situation with regard to the principal amount of debt because the principal amount of loan has not been routed through the profit and loss account of the taxpayer. Therefore sections 34 & 70 are not applicable to the write-off of principal amount of loan. If at all, this amount is liable to tax, the Board has to look into some other provision of the law for its taxability, they maintained.
Replying to a question, they said several tax practitioners were of the view that this principal amount of written-off loan is taxable under section 18(1)(d). However, the same tells that: "The following incomes of a person for a tax year, other than income exempt from tax under this Ordinance, shall be chargeable to tax under the head "Income from business. "The fair market value of any benefit or perquisite, whether convertible into money or not derived by a person in the course of, or by virtue of, a past, present, or prospective business relationship."
Moreover, analysts said the receipt of loan from a banking company did not affect the manufacturing/trading and profit and loss accounts of the taxpayer as it is an item of the balance sheet of the taxpayer, (loanee) appearing as liability on the credit side of the balance sheet. Therefore, its write-off should not be taxable u/s 18(1)(d) under normal circumstances.
However, the circular No 29, dated October 15, 2002 creates certain obligations and rights for both the banking company and the taxpayer, paying the loan. It gives rise to three categories of loans and specifies certain conditions for paying a certain percentage of loan/interest within a certain period of time, the balance amount of loan is written off by the banking company. So this circular is beneficial to both the taxpayer as well as the banking company and this transaction is affected by both the banking company and the taxpayer (loanee) under "business expediency". Therefore, any benefit arising from this transaction as waiver of principal amount of loan of the taxpayer would fall under section 18(1)(d) and as such the waiver of principal amount of loan would also be taxable in the hands of the taxpayer. These provisions of section 34(5), 34(5A) and section 70 would be applicable to the waiver of interest mark-up being a recouped expenditure.