In my pre-budget article, namely three pillars of Investment budget, I suggested that the bill must concentrate on three aspects, land, labour and capital.
A little has been done from the land aspect; from the labours perspective merely the exemption limit has been raised to Rs100, 000.00 and as far as capital is concerned, the rest of the amendments, omissions and new entries are meant for restoration of the confidence of the existing investors which in turn portray a dazzling picture of Pakistani tax culture before the prospective taxpayers, if the amendments are practised according to their spirit. Apart from this, cross referencing and other mistakes crept even into the Finance Bill.
This article is an endeavour to provide a mirror image to the stakeholders of Finance Bill 2004 in respect of direct taxation.
The majority of amendments in section 2 are meant for harmonisation of Income Tax Ordinance, 2001 with non-banking Finance Companies (Establishment and Regulation) Rules, 2003. Incorporation of the word insurance is meant for promoting the sector and may be State Life Insurance Company is on the top priority list of privatisation commission.
The concept of expenditure incurred in deriving income from business chargeable to tax is under severe criticism prior to the promulgation of Income Tax Ordinance, 2001. The common misunderstanding about the phrase expenditure incurred in deriving income from business is that it means expenditure shall become inadmissible where no income is derived from business.
This misconception is the sole creation of not understanding the word income defined in section 2, whereby the definition of income includes loss of income.
The phrase chargeable to tax has an overriding effect even after the omission of sub-section (2) of section 55 in respect of tax exempt entities. By virtue of this phrase tax exempt entities cannot carry forward their loss in post exemption period. The Finance Bill seeks to replace the phrase expenditure incurred in deriving income from business chargeable to tax with wholly and exclusively for the purpose of business in sub-section (1) of section 20.
The Finance Bill also seeks to amend similar amendment in sub-section (1) of section 23 and clause (a), (b) and (c) of sub-section (1) of section 28 but fails to consider the impact of similar phrase in sub-section (3) of section 22, clause (a) of sub-section (1) of section 24, sub-section (5) of section 25 and sub-section (1) of section 26.
CASH EXPENDITURE LIMIT: The law enjoyed a very strict control over cash expenditure, prone to be fictitious, exceeding Rs5,000.00, incurred by the taxpayer through clause (l) and (m) of section 21.
The Finance Bill seeks to enhance this limit to Rs10,000.00 may be by keeping an eye over the reduction in purchasing power of the currency with the passage of time or any subjective basis.
DEPRECIATION AND INITIAL ALLOWANCE: The concept of allowable depreciation revolves around the theme of purchase year proportionate depreciation and sale year no depreciation. The Finance Bill seeks to reintroduce the old theme of purchase year full depreciation and sale year no depreciation enunciated in Income Tax Ordinance, 1979.
This theme is based on the ground realities and accepts the fact that taxation officer cannot ascertain the period of use of asset during the year of purchase and sale; hence, both the parties need to bear at any one point of time, that is, during the year of purchase by the revenue, and during the year of sale by the taxpayer.
Finance Bill also seeks a correction in sub-section (10) in section 22, whereby the formula for consideration received on account of vehicle not plying for hire [Costly passenger transport vehicle not plying for hire - Rs one million] shall now become amount of received on disposal divided by Rs One million and multiplied by actual cost of acquisition.
The phrase, as used in sub-section (1) of section 23, wholly and exclusively used by a person in deriving income from business chargeable to tax is replaced with a typically new phrase specifying the purpose and timing of allow ability. The Finance Bill seeks to incorporate the phrase used by the person for the purpose of his business or the tax year, in which commercial production is commenced, whichever is later. Professionals know the fact that commencement date can easily be ascertained from the business commencement certificate obtained by public limited company under the Companies' Ordinance, 1984 and not in any other case.
PROVISION REGARDING CONSUMER LOAN: According to the exceptional treatment of section 29A, banking companies are allowed to claim the expense of bad debt, in respect of consumer loan, on provisional basis to the extent of three percent of income. The scope of this section has been extended to Non-Banking Finance Companies and House Building Finance Corporation.
It is worthwhile here to note that the phrase used in sub-section (1) of section 29A is 3% of income not amount of consumer loan.
The Finance Bill also seeks to define the ambit of the term consumer loan which means loan for personal, family or household, debt created through credit cards or similar arrangements and insurance premium financing.
ECONOMIC PERFORMANCE: The concept of economic performance is attached with the concept of liability. This concept is in addition to the accounting concept of crystallisation of liability and is the subject of heated debate. Finance Bill seeks to do away with this concept.
REDUCING THE SPIRIT OF SECTION 54: The purpose of section 54 is to enable the tactical level tax managers to quantify the quantum of loss of revenue due to the exemptions provided in other laws. Instead of ascertaining the exemptions provided in other laws a proviso was added to section 54 which provides that exemption shall continue be enjoyed by the entities under their respective laws as before the promulgation of Income Tax Ordinance, 2001. The Finance Bill now seeks to incorporate the phrase reduction in tax rate, tax liability and exemption.
It seems that the tactical tax managers are reluctant to dig out the exemptions and other fiscal incentives provided in other laws and relied over the strategy that future laws must comply with this section.
GROUP RELIEF: At last the concept of group of companies with proper categorisation of holding and subsidiary has been incorporated in this piece of legislation with true spirit apart from the practical difficulties. The legal status of listed public limited company and a pre-requisite investment threshold of 75% share capital are necessary for a company to fall within the ambit of holding company definition.
As far as subsidiary company is concerned, its core activities must fall within the definition of undefined industrial undertaking. It is worthwhile here to note that the definition of industrial undertaking sought to be included in section 148 by Finance Bill 2004 is restricted to that section only.
This piece of legislation, namely Income Tax Ordinance, 2001, is in a continual process of harmonisation of accounting principle and investment holding period of five years is no exception.
Professional accountants know that as per International Accounting Standard [IAS] number 27 a subsidiary should be excluded from consolidation control is intended to be temporary because the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future and are recognised in accordance with IAS 39.
A subsidiary company can transfer its assessed loss for a tax year to the holding company for adjustment against its income from business. The assessed loss must not include the brought forward loss.
The holding company can carry forward the loss for following two periods. However, the holding company is required to hold the investment in 75% share capital for five years and the subsidiary company must not change its line of business activity for five years.
In case, the holding company reduces its investment and it falls below 75% of share capital during a tax year, the holding company must offer for tax the portion of profit adjusted against subsidiary's loss.
Nonetheless, in case the transferred losses cannot be adjusted against the holding company's income from business for three tax years, the subsidiary company shall be allowed to carry forward the losses in accordance with section 57. Nevertheless, the subsidiary company is not allowed to transfer the assessed losses for more than three tax years.
Around the globe the purpose of such provisions relating to surrendering of loss is to provide immediate relief to the group company in the shape of compensation which is an exempt receipt and normally equals to the amount of tax payable by subsidiary or tax saved by holding company. In furtherance, such provision allows to and from movement of loss, that is, from subsidiary to holding and vice versa.
These two important points are missing in the suggested amendments:
UNEXPLAINED INCOME OR ASSETS: Prior to the amendment in section 74 by virtue of amendment through finance ordinance, 2002 [FO 2002], the concept or term of financial year lies at the heart of section 74. After the amendment through FO2002, the term financial year has been made redundant. The tactical managers had not tried to replace the term financial year, spread all over the ordinance, with the term tax year at the time of recommending the amendment in section 74 through FO 2002.
Instead, they relied over copying old sub-section (8) as sub-section (10) in the amended section 74. This term is still undefined and may become a most powerful weapon in litigation being interpretation which favours the taxpayer, not the revenue.
This term is also crept into the amendment in sub-section (2) of section 111. Owing to the practical difficulties encountered by the tax department in including the unexplained income or asset in the person's income chargeable to tax in the tax year in which it was discovered by the commissioner, the Finance Bill seeks to include the unexplained income or asset in the person's preceding financial year's [tax year] income chargeable to tax.
The Finance Bill, 2004 seeks to replace sub-section (4) for two purposes. Firstly, to de-categorizer hundi's as foreign remittances in the light of various judgements of honourable ITAT and secondly to incorporate the concept of limitation period of five years introduced through circular number 8 of 2003.
MINIMUM TAX: Section 113 is the indirect tax @0.5% on turnover in our direct tax legislation which levies tax on income. The Finance Bill seeks to treat such tax as advance tax which can be used to reduce any of the five future tax year's normal tax liability under Division II of Part I of 1st Schedule. After this amendment, the tax under section 113 can not be viewed as an indirect levy but a penalty requiring early payment of tax just because the taxpayer has sustained a loss, off set the carried forward loss with current tax years income, claimed tax credits or rebates, claimed allowances or deductions and finally claimed exemption under any provision of Income Tax Ordinance, 2001!
WEALTH STATEMENT: The wealth statement is a key source of discovering unexplained income or assets and is to be submitted by every resident taxpayer, including companies. However, where a person, whose entire income consists of income under the head salary, is not required to furnish the wealth statement in case the last declared or assessed income is Rs200, 000 or more.
The Finance Bill, 2004 seeks to replace both the criterions with a blanket criterion of furnishing wealth statement in case the last declared or assessed income is Rs500, 000.00 or more. It is worthwhile here to note that a best judgement assessment can be made in case of failure to furnish a wealth statement.
REVISION, AMENDMENT AND DELEGATION BY THE COMMISSIONER: Revision of any order under section 122A can be done by the commissioner, subject to condition that such revision is not prejudicial to the person to whom order relates, either by the bringing a matter into the knowledge of commissioner by the taxpayer, commissioner's sub-ordinate or by commissioner him/herself.
The Finance Bill seeks to restrict the concept of revision of order on the own motion of commissioner by inserting the phrase suo motto.
Under sub-section (5) of section 122, the commissioner can amend or further amend an assessment on the basis of definite information which satisfies the commissioner about the fact that income chargeable to tax has escaped assessment, income is under assessed, income is assessed at too low rate, excessive relief or refund is awarded and finally where any amount is misclassified. Such definite information may be acquired from an audit or otherwise. Under the repealed income tax ordinance, 1979 [Repealed ordinance or RO], such powers are exercised by additional commissioners. The Finance Bill, 2004 seeks to restore the position under repealed ordinance by inserting sub-section (1A) in section 210.
ADDITION IN APPEALABLE ORDERS LIST: Under the repealed ordinance, honourable courts of justice, in various cases, laid down a principal that expenditure cannot be termed as inadmissible where section 52 and 86 [Additional tax] of the RO has been invoked. However, section 162 enunciates the fact that tax needs to be recovered from the person who have been paid without deduction or collection of tax.
This recovery does not release the liability of WHT agent and commissioner may impose additional tax or disallow the expense of such person. Hence, section 162 can be termed as a major shift in the policy or scheme of Income Tax Ordinance, 2001.
It is worthwhile here to note that the commissioner is empowered to pass an order in respect of recovery of tax from the recipient. The Finance Bill seeks to make such order appealable before commissioner appeals.
MANDATORY PAYMENT FOR FILING APPEAL: It is the most warmly welcomed amendment which intends to embrace the judgement of court of justice in which it was declared that such payment of tax is unconstitutional. I think mere omission of clause (b) of sub-section (2) of section 127 although portrays a impressive picture but would not absolve the person from payment of tax assessed by commissioner.
This omission needs to be supplemented by a stay of recovery powers to commissioner appeals similar to sub-section (5) of section 131.
ALTERNATE DISPUTE RESOLUTION SYSTEM: This is another welcome amendment with some practical hitches. It is evident from the recent past that professional accounting community with sound integrity has always denied to become a part and parcel of any such statutory obligation. However, the community is always a helping hand.
Nevertheless, the community might be available for giving expert opinion and conducting audit if a corresponding amendment will be made in section 177. In furtherance, it might seem more practical that if the whole process is designated to an unconcerned commissioner, similar to the concept of peer or cold review in audit, who will submit his or her findings, in consultation with the committee, to the CBR.
ESTIMATION OF QUARTERLY ADVANCE TAX AND ADDITIONAL TAX: It is still not known, what is the intention behind the omission of sub-section (4) of section 147? Either merely removing the turnover base payment of advance tax or absolving companies and AOP's from payment of advance tax or both - Cat is yet to come out of the bag.
Apart from this the concept of estimation of advance tax has been incorporated. A taxpayer is allowed to pay the revised liability of advance tax in accordance with the estimate submitted to the commissioner. It is requested that a taxpayer needs to be allowed to file the revised estimated at least four times, similar to the concept of amendment in assessment as many times, to encourage transparency. This will increase the onus over taxpayer to be cautious and avoid unnecessary additional tax @12% where the estimated tax may fall below 80% of actual tax liability.
RATE OF ADDITIONAL TAX AND COMPENSATION: In the wake of reduced interest rates, the rate of additional tax has been reduced by 6%, that is, from 18% to 12% while the rate of compensation for delayed refund has been reduced by 11%, that is, from 15% to 6%.
The additional tax needs to be reduced to a similar extent of 11% as in the case of compensation.
PRESUMPTIVE TAX REGIME: It is evident from the scheme of Income Tax Ordinance, 2001 that it is based on the premise of blind faith over taxpayer subject to a deterrent of audit for intentional dishonesty. It is also evident from the recent past that tax policy is moving towards a progressive tax regime by reducing the list of transactions under the presumptive tax regime. However, the Finance Bill, 2004 is a major shift in policy and it seems that our tax policy is again inclined towards presumptive tax regime.
Presumptive tax regime seems to be the most dominant part of our direct tax structure after the amendments seeks by Finance Bill, 2004. The sanctity of section 169 which provides for the concept of full and final discharge of tax liability will spread all over the ordinance after the amendments sought.
Section 113A is a major shift of policy within presumptive tax regime whereby even the tax paid by the retailers, having the turnover of Rs 5 million, @ 0.75%, instead of deduction by a WHT agent, is a full and final discharge of tax liability.
The term retailer means a person selling goods to general public for the purpose of consumption; however, the term turnover has the same meanings as assigned in section 113. The phrase division III of Part III of first schedule, as used in section 113A, needs to be replaced with division IA of Part I of first schedule.
Collection of tax at the import stage of edible oil, petroleum products, brokerage or commission, payments to travel agents and insurance agents has now been included in the presumptive tax regime list. As far as petroleum product is concerned, the amendment requires deduction of tax by the seller of petroleum products.
The word deduction needs to be replaced with the word collection. For instance a petroleum company sells petrol to a petrol pump worth Rs100.00 and normally collects Rs99.00 being 1% commission. Now the petroleum company shall collect Rs99.10 because as per the circular of CBR under section 50 of the repealed ordinance, whereby tax shall only be collected to the extent of commission.
Similarly, tax shall be deducted @ 10% on commission portion only, which is 6% in case of domestic and 9% in case of international air tickets as defined in the circular of CBR under section 50 of the repealed Income Tax Ordinance, 1979.
Amendment sought in section 169(1) in respect of section 233 contains wrong sub-section (3) that needs to be sub-section (4). In furtherance, one wonders why section 113A is not been included in section 169 list. Apart from this, section 223 (4) and section 156A has not been considered as amendment in section 115(4).
(The writer is an international tax advisor.)