Tax exemptions withdrawal bill: an expert opinion

General

A commentary on the economic and financial rationale for the actions proposed to be undertaken by way of Income Tax (Amendment) Bill 2021 with views on the conceptual shortcomings arising from these amendments, if any. For the sake of ease in reading section references and details have been avoided.

Chapters 1

Preamble

The IMF and removal of exemptions

Syed Shabbar Zaidi, the founder was the Chairman of Federal Board of Revenue on July 1, 2019 when Pakistan came under the International Monetary Fund’s (IMF’s) programme. There were detailed discussions on the suggestions and strategies for improving tax collection in Pakistan. Almost all the suggestions and strategies were found to be in the interest of the country. The compliance is encouraging.

One of the subjects that always cropped up during those discussions was the issue of ‘cost of tax exemptions’. This for a layman means that tax that is not being collected on account of certain exemptions from tax provided under the tax laws of Pakistan. The IMF rightly considers that such exemptions are to be gradually withdrawn. The actions undertaken through this bill are an attempt for the same. In the following paragraphs after discussing the main exemptions withdrawn certain matters where a conceptual error and harmful disruption have been made in the system have been identified. It is considered that such matters will be taken into account in the final legislation on the subject. The IMF’s general view may be correct however ultimate decision on these matters is to be taken on the basis of what is feasible and useful for the country. Based on experience, IMF will agree to the same if appropriately apprised.

Monetary effects

There cannot be exact estimation of the monetary effects of these changes; however, in our view there will be no major additional revenue. It is very unfortunate that if revenue is a consideration for withdrawal of exemptions, for example, with respect to inter-corporate group dividend or then such an action should not be carried through in the Act. This is an act against documentation and promotion of large organized businesses which is essential for Pakistan. Furthermore, conditions provided for intangible exports of filing the returns and other compliance are to be introduced for tangible exports where there is completely non documentation for tax purposes. Removal of this distortion will improve exports as there will be proper record keeping. Furthermore there should be immediate action for donations and subscription for unregistered organization which pose a financial security risk for Pakistan, especially under the FATF.

It has been observed that in certain cases the concept of vested rights has been disturbed. Pakistani’s record in this respect is very reasonable. It is therefore suggested that any adventure in this territory be avoided.

Need for the bill

Except for certain places where economic rationale has been disturbed the overall document is reasonable. There is a need to evaluate the monetary consideration and unless there is substantial benefit in the period between June 30, 2021 and the date when this bill will become an act, this legislation should not be passed. It should form part of the Finance Act 2021. In any case almost all the amendment are effective accordingly.

Chapter 2

Amendments in the Ordinance

This chapter deals with the major amendments introduced in the Income Tax Ordinance, 2001. These in effect do not represent withdrawal of exemptions. There are certain effects of withdrawal of exemptions in relation to these amendments however these effectively constitute clarifications, readjustments and introduction of compliance procedures.

Charitable donation

The concept of donation has been clarified. Now voluntary contribution and subscription will also be eligible for benefit for the payer. In addition to eligible persons following shall be added for eligible recipient:

i. person eligible for tax credit under section 100C of this Ordinance;

ii. entities, organizations and funds mentioned in the Thirteenth Schedule to this Ordinance. List is the same as in the past laid down in Clause 61 of the Second Schedule to the Income Tax Ordinance, 2001 which is now called Thirteenth Schedule. Chapter 4 of these notes.

In effect these payments were earlier covered one way or the other. The subject has been simplified.

Penalties

There are many positive changes with respect to the levy of penalty under the Ordinance.

Zero rate tax instead of exemption

In line with international practice and to promote documentation and compliance an appropriate concept of zero rate tax has been introduced. Under this concept instead of exemption a tax credit equal to 100% tax has been introduced for the following sectors:

(a) persons engaged in coal mining projects in Sindh supplying coal exclusively to power generation projects;

(b) a startup as defined in clause (62A) of section 2 for the tax year in which the startup is certified by the Pakistan Software Export Board and the following two tax years;

(c) persons deriving income from exports of computer software or IT services or IT enabled services up to the period ending on the 30th day of June, 2025: Provided that eighty per cent of the export proceeds is brought into Pakistan in foreign exchange remitted from outside Pakistan through normal banking channels. Explanation.- For the purpose of this clause, – (i) “IT services” include software development, software maintenance, system integration, web design, web development, web hosting and network design; and (ii) “IT enabled services” include inbound or outbound call centres, medical transcription, remote monitoring, graphics design, accounting services, HR services, telemedicine centers, data entry operations, locally-produced television programmes and insurance claims processing.

Tax credit under sub-section (1) shall be available subject to fulfilment of the following conditions, namely:-

(a) return has been filed;

(b) tax required to be deducted or collected has been deducted or collected and paid;

(c) withholding tax statements for the immediately preceding tax year have been filed; and

(d) sales tax returns for the tax periods corresponding to relevant tax year have been filed: Provided that nothing contained in this section shall preclude the applicability of section 214C or section 177.

It is strongly suggested that this zero rated concept be introduced for all persons subject to presumptive taxes, including exports. At the moment, the process leads to complete non-documentation.

Reintroduction of Capital Investment Tax Credit for certain industries

The concept of a tax credit equal to 25% of the value of investment has been introduced for capital investment in the undermentioned sectors:

(a) Greenfield industrial undertaking as defined in clause (27A) of section 2 engaged in –

(i) the manufacture of goods or materials or the subjection of goods or materials to any process which substantially changes their original condition; or

(ii) ship-building.

(b) Industrial undertaking set up by the 30th day of June 2023 and engaged in the manufacture of plant, machinery, equipment and items with dedicated use (no multiple uses) for generation of renewable energy from sources such as solar and wind, for a period of five years beginning from the date such industrial undertaking is set up.

Eligible investments are investments made in purchase and installation of new machinery, buildings, equipment, hardware and software except self-created software and used capital goods.

Zero rating for income of charitable and welfare institutions

On an overall basis it transpires that there is no substantial change in the exemption available to charitable institutions and NPOs. The general zero-rating for non-profit organisation as defined in Section 2(36) of the Ordinance has been limited to certain specified kinds of institution as listed below. However, as explained below this change has effectively no consequence.

In this connection, it is highly desired that other non-registered institutions receiving donations should also be taxed or included in the persons required to be tax compliance. This is essentially the objective of FATF.

Section 100C that provided exemption to welfare institutions has been completely rewritten. In our view, there is no material change and various clauses at various places have been placed under the revised section.

Only the following persons shall be subjected to zero rate tax.

(a) persons specified in Table - II of clause (66) of Part I of the Second Schedule to this Ordinance;

(b) a trust administered under a scheme approved by the federal government and established in Pakistan exclusively for the purposes of carrying out such activities as are for the welfare of ex-employees and serving personnel of the federal government or a provincial government or armed forces, including civilian employees of armed forces and their dependents where the said trust is administered by a committee nominated by the federal government or a provincial government;

(c) a trust;

(d) a welfare institution registered with provincial or Islamabad Capital Territory (ICT) social welfare department;

(e) a not for profit company registered with the Securities and Exchange Commission of Pakistan under section 42 of the Companies Act, 2017;

(f) a welfare society registered under the provincial or Islamabad Capital Territory (ICT) laws related to registration of co-operative societies;

(g) a waqf registered under Musalman Waqf Validating Act, 1913 (VI of 1913) or any other law for the time being in force or in the instrument relating to the trust or the institution;

(h) a university or education institutions being run by non-profit organisation existing solely for educational purposes and not for the purposes of profit; (i) a religious or charitable institution for the benefit of public registered under any law for the time being in force; and

(j) international non-governmental organisations (INGOs) approved by the federal government.

Apparently there is a fundamental change by way of deletion of zero rating for NPO’s however in substance there is no change as all NPO’s are either trusts or societies registered under the societies’ regulations.

The following income of such institutions remain eligible for zero rating: (a) income from donations, voluntary contributions and subscriptions;

(b) income from house property;

(c) income from investments in the securities of the federal government;

(d) profit on debt from scheduled banks and microfinance banks;

(e) grant received from federal, provincial, local or foreign government;

(f) so much of the income chargeable under the head “income from business” as is expended in Pakistan for the purposes of carrying out welfare activities: Provided that in the case of income under the head “income from business”, only so much of such income shall be eligible for tax credit under this section that bears the same proportion as the said amount of business income bears to the aggregate of income from all sources; and

(g) All income of the persons mentioned in clauses (a), (b) and (h) as above.

Eligibility for tax credit shall be subject to the following conditions:

(a) return has been filed;

(b) tax required to be deducted or collected has been deducted or collected and paid;

(c) withholding tax statements for the relevant tax year have been filed;

(d) the administrative and management expenditure does not exceed 15% of the total receipts: Provided that clause (d) shall not apply to a non-profit organisation, if- (i) charitable and welfare activities of the non-profit organisation have commenced for the first time within last three years; or (ii) total receipts of the non-profit organisation during the tax year are less than one hundred million rupees;

(e) approval from the Commissioner has been obtained as per requirement of clause (36) of section 2: provided that the condition of approval in respect of persons mentioned in Table – II of clause (66) of Part I of the Second Schedule to this Ordinance, shall take effect from the first day of July, 2022 and the requirements of clause (36) of section 2, shall not be applicable for earlier years;

(f) none of the assets of trusts or welfare institutions confers, or may confer, a private benefit to the donors or family, children or author of the trust or his descendants or the maker of the institution or to any other person: Provided that where such private benefit is conferred, the amount of such benefit shall be added to the income of the donor; and

(g) a statement of voluntary contributions and donations received in the immediately preceding tax year has been filed in the prescribed form and manner.

Surplus funds of these institutions shall be subject to tax at the rate of 10% only if funds or monies are–

(a) not spent on charitable and welfare activities during the tax year;

(b) received during the tax year as donations, voluntary contributions, subscriptions and other incomes;

(c) which are more than 25 percent of the total receipts of the non-profit organisation received during the tax year; and

(d) are not part of restricted funds. Explanation.- For the purpose of this sub-section, “restricted funds” mean any fund received by the organisation but could not be spent and treated as revenue during the year due to any obligation placed by the donor or funds received in kind.

Chapter 3

Exemptions withdrawn

General Comment

Many exemptions have been withdrawn. In the following paragraphs only the relevant and substantial amendments have been discussed. Furthermore, the cases of exemptions withdrawn where a policy error has been made have been identified. Prime Minister, Cabinet and the Parliament would have to look into these matters.

Inter-corporate dividend for group companies

This is the most misunderstood subject in corporate taxation in Pakistan. After a detailed deliberation involving State Bank of Pakistan, Securities & Exchange Commission of Pakistan and Federal Board of Revenue a comprehensive framework has been developed for group taxation. This framework is in line with international best practices and economic realities. One of the main feature of group taxation or group tax relief is that there is no inter-corporate dividend within group companies. This has been laid down in this clause. This clause was earlier spoilt by the amendment frequently made on the basis of inadvertent and incomplete understanding of law by the FBR and the then policymakers. The original clause was corrected in 2019. It is now proposed to be withdrawn. Withdrawal of this clause means that policymakers have no idea about group companies’ structure and corporate finance. It appears that due to an inadvertent understanding IMF personnel have also been misguided on this matter. It is urged to the organised corporate sector to explain the policymakers that some vested interests are intentionally creating disruption in the development of big business group in organised sector. This clause if withdrawn will be detrimental to documented economy. Consistency is being spoiled for the sake of complacency. It is to be appreciated that this is not an exemption. It is a prerequisite for formation of groups in the industrial sector. The action undertaken is completely non-comprehensible.

Income from corporate agriculture

A proposal to delete this exemption is also a reflection of lack of understanding of the primary economics of the country and the prevalent laws. Those who have suggested should know the reason for insertion of this clause. In Pakistan agriculture income cannot be taxed. This exemption stated that income from company engaged in agriculture will also be exempted. This is based on economic rationale as well as the decisions of the superior courts. It has been held that when the primary source is not chargeable to tax the secondary source by way of dividend can also not be taxed. Notwithstanding the legal aspect, it will be suicidal for agriculture sector which is facing severe institutional problem if in this country it is decided that agriculture income by non-corporate sector will be exempt from federal income tax whereas corporate sector will be taxable. This fallacious action is required to be immediately withdrawn.

Capital gains on disposal of export processing zone entities

This exemption has also been withdrawn without understanding the concept for which this clause was inserted. Entities in EPZ are outside the ambit of taxation in Pakistan. They are taxed by way of a sum paid before export to EPZ Authority. These entities are not registered under the corporate laws of Pakistan. This exemption is effectively a clarification. There is no sense in undertaking this act as it will be an exercise in futility.

Royalties and technical fees earned by Pakistan

This exemption has also been wrongfully withdrawn. This shows complete lack of understanding the existing provision. This is the best exemption laid down in the law. It exempts Pakistani persons and enterprises the income earned abroad for providing patent and technical fees. For example, if companies like Packages Ltd provides such services abroad then they are not taxed on that income. This withdrawal is totally unjustified and reflects lack of clarity on the matter.

Income of power generation projects

Agreements for power generation projects and exemption for their income is detrimental to economy of Pakistan. These agreements are per se US $ denominated bonds issued to these enterprises. There is a need to amend all such agreements. Government is doing a remarkable step in revising these agreements with consent. There should have complete withdrawal of exemptions laid down under Clause 132 of the Ordinance; however, being a sovereign commitment, Government of Pakistan on the basis of its consistent policies should not withdraw exemptions under the existing agreements which are an obligation unjustified but legally enforceable. It is a completely justified action that no exemption will be available for agreement undertaken after July 1, 2021.

Income of approved loan agreements

There is practically no change however instead of ‘income’ words profit on debt and capital gains have been used. Capital gains on loan should not be exempted.

This clause is applicable to private sector also, however, there is effectively no loan except of government owned entities which have been exempted under this clause. It is considered that private sector loan exemption be withdrawn. It is completely discretionary.

The other exemption under Clause 90 for such loans has rightly been withdrawn. It was discretionary.

Sale of immovable property to REIT

Income from sale of immovable property to a REIT is exempt from tax. This clause is not related to income of REIT that remains exempt. This clause was inserted to promote REIT.

There is no case for withdrawal of such exemption as such income is anyway not chargeable to tax after a certain holding period.

Income of Modaraba

This exemption is conceptually wrong. There cannot be any distortion in tax incidence only for the reason that business has been designed in compliance to certain divine revelations. It has been correctly withdrawn. Furthermore, this system became effectively useless after compulsory distribution of 90 percent of profit with a dividend rate of 25%. A correct step

Income of venture capital fund

This exemption practically remained in effective on account of complicated procedures at SECP. There is a case for inclusion of this exemption along with income of Collective Investment Scheme as both are essentially same products.

Mutual funds

The income of mutual funds is exempt from tax if 90% of their income, as reduced by capital gains is distributed. This exemption is laid down under Clause 99 of Part 1 of the Second Schedule to the Income Tax Ordinance, 2001. Furthermore, by way of exemption under Clause 103 capital gain of such mutual funds is also exempt if such funds are money market funds. It is proposed to delete the exemption under Clause 103. Henceforth all funds have been equated as far as exemption is concerned.

Income from OGDCL Bonds

There was no reason for this exemption. However now there is no case for withdrawal of exemption once given. This will erode confidence of non-resident investors who were entitled to that exemption. The answer is the redemption of Bonds if possible.

Special purpose company under securitization process

This exemption has wrongly been withdrawn. It is not an exemption. It is a mode of recognizing a pass through entity. This withdrawal is to be withdrawn.

Income of LNG terminal operators

There was no case for exemption for this activity; however, once exempted there should not be any withdrawal of exemption unless the existing contract expires. This is simple concept of vesting rights. These actions destroy Pakistan’s investment climate.

Income of persons of tribal area

This exemption was not justified at the first place however the same cannot be withdrawn before the expiry of the date prescribed at present which in June 30, 2023.

148

Pipeline project of oil and gas extracting companies

Withdrawal of the right for similar tax as is for oil and gas extraction business for pipeline operation should not be withdrawn. There is no economic rationale. This will create nothing except complication. No additional revenue.

Contracts executed outside Pakistan

Income from contracts executed outside Pakistan is exports and should have been zero-rated. However in Pakistan on tangible exports are considered as exports. There is a 50% reduction in the rates for income from foreign contract. It is proposed that such concession be withdrawn. This is completely non-comprehensible. This should be immediately changed.

Same is the case of foreign income of Pakistan Cricket Board.

Revaluation and devaluation in case of entities under the Fifth Schedule

This exemption has rightly been withdrawn. However it has to be ensured that provisions of the Fifth Schedule are subject to Mining Act, 1948. If such a right is laid down in that act then the same would have to be retained.

9B

Below ground installations

Below ground installations in petroleum business are allowed 100% depreciation throughout the world. Same is the case in Pakistan. This exemption is proposed to be withdrawn which represents improper understanding of business. Similarly deletion of Rule 4 of the Fifth Schedule is not to be withdrawn as it is practice internationally and this is only a timing difference.

Other amendments

Definition of industrial undertaking

The discretionary powers of the federal government to declare an entity as industrial undertaking have rightly been omitted.

First Year Allowance

The concept of First Year Allowance in addition to initial depreciation has rightly been omitted.

Chapter 4

THE THIRTEENTH SCHEDULE (See section 61)

1. any sports board or institution recognised by the federal government for the purposes of promoting, controlling or regulating any sport or game

2. The Citizens Foundation.

3. Fund for promotion of science and technology in Pakistan.

4. Fund for retarded and handicapped children.

5. National trust fund for the disabled.

6. Fund for development of Mazaar of Hazrat Burri Imam.

7. Rabita-e-Islami’s project for printing copies of the Holy Qura’an.

8. Fatimid Foundation, Karachi.

9. Al-Shifa Trust.

10. Society for the Promotion of Engineering Sciences and Technology in Pakistan.

11. Citizens-Police Liaison Committee, Central Reporting Cell, Sindh Governor House, Karachi.

12. ICIC Foundation.

13. National Management Foundation.

14. Endowment Fund of the institutions of the Aga Khan Development Network (Pakistan listed in Schedule 1 of the Accord and Protocol, dated November 13, 1994, executed between the Government of the Islamic Republic of Pakistan and Aga Khan Development Network.

15. Shaheed Zulfiqar Ali Bhutto Memorial Awards Society.

16. Iqbal Memorial Fund.

17. Cancer Research Foundation of Pakistan, Lahore.

18. Shaukat Khanum Memorial Trust, Lahore.

19. Christian Memorial Hospital, Sialkot.

20. National Museums, National Libraries and Monuments or institutions declared to be National Heritage by the Federal Government.

21. Mumtaz Bakhtawar Memorial Trust Hospital, Lahore.

22. Kashmir Fund for Rehabilitation of Kashmir Refugees and Freedom Fighters.

23. Institutions of the Aga Khan Development Network (Pakistan) listed in Schedule 1 of the Accord and Protocol, dated November 13, 1994, executed between the Government of the Islamic Republic of Pakistan and Aga Khan Development Network.

24. Azad Kashmir President’s Mujahid Fund, 1972.

25. National Institute of Cardiovascular Diseases, (Pakistan) Karachi.

26. Businessmen Hospital Trust, Lahore.

27. Premier Trust Hospital, Mardan.

28. Faisal Shaheed Memorial Hospital Trust, Gujranwala.

29 Khair-un-Nisa Hospital Foundation, Lahore.

1. Sind and Balochistan Advocates’ Benevolent Fund.

2. Rashid Minhas Memorial Hospital Fund.

3. Any relief or welfare fund established by the Federal Government.

4. Mohatta Palace Gallery Trust.

5. Bagh-e-Quaid-e-Azam project, Karachi.

6. Any amount donated for Tameer-e-Karachi Fund.

7. Pakistan Red Crescent Society.

8. Bank of Commerce and Credit International Foundation for Advancement of Science and Technology.

9. Federal Board of Revenue Foundation.

10. The Indus Hospital, Karachi.

11. Pakistan Sweet Homes Angels and Fairies Place.

12. Al-Shifa Trust Eye Hospital.

13. Aziz Tabba Foundation.

    1. Sindh Institute of Urology and Transplantation (SIUT) Trust and Society for the Welfare of SIUT.

14. Sharif Trust.

15. The Kidney Centre Post-Graduate Institute.

16. Pakistan Disabled Foundation.

17. Sardar Trust Eye Hospital, Lahore.

18. Supreme Court of Pakistan – Diamer-Bhasha & Mohmand Dams – Fund.

19. Layton Rahmatullah Benevolent Trust (LRBT).

20. Akhuwat.

21. The Prime Minister’s Covid-19 Pandemic Relief Fund-2020.

22. Ghulam Ishaq Khan Institute of Engineering Sciences and Technology (GIKI).

23. Lahore University of Management Sciences.

24. Dawat-e-Hadiya, Karachi.

25. Baitussalam Welfare Trust.

26. Patients’ Aid Foundation.

27. Alkhidmat Foundation.

28. Alamgir Welfare Trust International.

29. Prime Minister’s Special Fund for victims of terrorism

30. Chief Minister’s (Punjab) Relief Fund for Internally Displaced Persons (IDPs) of KPK

31. Prime Minister’s Flood Relief Fund 2010 and Provincial Chief Minister’s Relief Funds for victims of flood 2010

32. Waqf for Research on Islamic History, Art and Culture, Istanbul

Provided that the federal government shall have the power to add, amend or omit any entry in this Schedule.”

Copyright Business Recorder, 2021