Tax System

A.   TAX PAYABLE

1)  Company Tax

The corporate tax rate for tax year 2015 has been reduced to 33%. However, this relief in tax rate is not available to banking companies, which will continue to be taxed at 35%. The tax rates are summarized as follows:

• Small company: 25%                  • Modaraba: 25%

• Banking Company: 35%              • All other companies: 33%

The term ‘public company’ implies a company listed on any stock exchange in Pakistan or one in which not less than 50% of the shares are held by the federal government or a public trust.

The final tax regime (FTR) for resident taxpayers, a presumptive tax scheme where taxes are withheld at the source on the sale of goods and execution of contracts or collected at the time of import (for other than industrial raw materials), is considered a final tax liability in respect of income arising from the sale, contract, or import. In the case of exports, tax collected at the time of realisation of foreign-exchange proceeds is treated as final tax for that income.

The FTR is also applicable to non-resident taxpayers, at their option. However, it is only applicable in cases of receipts on account of the execution of a contract for construction, assembly, or installation, including a contract for the supply of management activities in relation to such project as well as certain contracts for services and contract for advertisement services rendered by television satellite channels.

Taxation of a permanent establishment (PE) of a non-resident

The following principles shall apply in computing taxable income of a PE:

·         It is a distinct and separate entity dealing independently with the non-resident of which it is a PE.

·         In addition to business expenditure, executive and administrative expenditure, whether incurred in Pakistan or elsewhere, will be allowed as deductions.

·         Head office expenditure, including rent, salaries, travelling, and any other expenditure that may be prescribed, shall be allowed as a deduction in proportion to the turnover of the PE in the same proportion as the non-resident’s total head office expenditure bears to its worldwide turnover.

·         Royalties, compensation for services (including management services), and interest on loans (except in banking business) payable or receivable to or from PE’s head office shall be considered in computing taxable income of PE.

·         No deduction will be allowed for any interest paid on loans acquired by a non-resident to finance the operations of a PE (or for the insurance premium in respect of such loans).

Branch Profits Tax

The rates of tax for a branch of a company incorporated outside Pakistan are the same as those applicable on resident companies, other than banking companies (i.e. 35%, except for tax year 2015 where 33% is applicable). Tax at the rate of 10% is levied on the transfer of profits to the head office, with an exception for companies engaged in the oil and gas exploration and production business.

Payments to a branch in Pakistan of a non-resident are subject to deduction of tax at source on the same basis as a resident in the case of sale of goods, rendering of professional services, and execution of contracts. In other circumstances, a reduced/0% withholding tax (WHT) certificate can be obtained from the Commissioner of Income Tax.

Pakistan has signed agreements for avoidance of double taxation with over 60 countries.

Minimum Tax

Where the tax payable by a company is less than 1% of the turnover, except where the company is in a loss position before charging depreciation and other inadmissible expenses, the company is required to pay a minimum tax equivalent to 1% of the turnover.

Tax paid in excess of normal tax liability can be carried forward for adjustment against tax liability of a subsequent tax year. However, such tax can only be adjusted against tax liability of the five tax years immediately succeeding the tax year for which the amount was paid.

Sales Tax / Value Added Tax

VAT (locally termed as ‘sales tax’) is ordinarily levied at 17% on the value of goods, unless specifically exempt, after allowing related input credits. Telecommunication services (VAT on services is a provincial levy) are levied VAT at the rate of 19.5% by Sindh, Punjab and Khyber Pakhtunkhwa.

Significant zero-rated goods are as follows: • Supplies and repair and maintenance of certain ships and aircraft; • Supplies to diplomatic missions and diplomats; • Supplies of raw materials, components, and goods for export processing zones; • Supplies of locally manufactured plant and machinery to export processing zones and supplies of certain specified machinery to the exploration and production sector; • Supplies to exporters.

Significant exemptions are as follows: • Live animals and live poultry; • Live plants; • Vegetables, pulses, edible fruits (excluding imported fruits), certain spices, sugar cane, edible oils, etc; • Milk preparations; • Newsprints, newspapers, journals, periodicals, and books; • Agricultural produce not subjected to any process.

Highest Retail Price

Presently, manufacturers of goods subject to duty on retail price basis are required to pay duty at the highest retail price where more than one retail price is fixed by the manufacturers for any particular brand or variety of such goods.

Through the Finance Act, 2014, FBR has been authorised to specify zones or areas only for the purposes of determining highest retail price for any brand or variety of goods. This seems to be a positive amendment aimed at resolving the long outstanding grievance of such manufacturers with regard to payment of duty on highest retail price without taking into account geo-economic factors.

OTHER TAXES ALTERNATE CORPORATE TAX

A new concept of ACT has been introduced. ACT is applicable from Tax Year 2014. Under the concept, the minimum tax liability in case of a company is higher of tax on accounting income or the corporate tax liability determined under the Ordinance at the rates prescribed in the law.

Tax liability under the Ordinance includes ‘minimum tax on turnover under section 113 of the Ordinance. ACT, if payable, shall be for the accounting year ended December 31, 2013, June 30, 2014, or any period relevant to tax year 2014.

This concept is applicable for all companies except insurance companies, companies engaged in exploration and production of petroleum, and banking companies, as per Fourth, Fifth and Seventh Schedule to the Ordinance respectively.

Under the newly inserted section 113C, the ACT, being the tax determined on accounting income, has been prescribed at 17% of such income.

The ACT is not applicable to: • Exempt income; • Income taxable under FTR; • Gain on disposal of listed securities subject to tax under the Eighth Schedule; • Income entitled to 100% tax credit on account of equity investment; • Income of non-profit organizations, trusts or welfare institutions to whom tax credit is available under section 100C of the Ordinance; and,  •Where a company sets up an industrial undertaking, between 1 July 2014 and 30 June 2017, it will be subject to a reduced rate of tax under clause (18A) of Part II of the Second Schedule.

Excise Duty

Federal excise duty (FED) is levied at the rate of 17% on certain types of manufacturing, import of goods, and rendering of services, except telecommunications services, which are charged at the rate of 18.5% (previously it was 19.5%). FED on telecommunication services, under the constitution, is to be levied and collected by the provinces.

However if it is not levied by provinces at their specified rates, FED will be charged at 18.5%. Sindh, Punjab, and Khyber Pakhtunkhwa provinces have promulgated their statute, and others are expected to follow.

PROPERTY, WATER AND CONSERVANCY TAXES

Above taxes levied and collected by Provincial government and cantonments annually.

STAMP DUTY

In the case of sale or transfer of immovable property, stamp duty is payable (with varying rates on the basis of location of the property) on the value of the property.

2)  Determination of Taxable Income

Depreciation

Normal depreciation is allowed at the following prescribed rates by applying the reducing-balance method.

All depreciable assets put into service for the first time in Pakistan during a tax year, other than road transport vehicles not plying for hire, furniture (including fixtures), plant and machinery used previously in Pakistan, or plant and machinery for which a deduction has been allowed under another section of this ordinance, for the entire cost of the asset, shall be entitled to an initial allowance at 25% of the cost of the asset, except for buildings, for which the rate is 15%.

Book depreciation need not conform to tax depreciation. Unabsorbed tax depreciation not set off against the income of the year is carried forward and added to depreciation of the assets of the same business in the following year. Tax depreciation can be carried forward without limit until fully absorbed.

Stock / Inventory

Inventories are to be stated at the lower of cost or market. The first in first out (FIFO) and average methods are accepted. Conformity of methods used for book and tax reporting is desirable, and the method used should be consistently applied.

CAPITAL GAINS ON IMMOVABLE PROPERTY

Capital gain on the sale of immovable property, on which depreciation is not allowed, is taxed at the rate of 10% if disposed of within one year and 5% if disposed of within two years. However, if the retention period is more than two years, the gain is not taxable. Over and above, additional 0.5% withholding tax is levied on sale of property which is adjustable income tax.

CAPITAL GAINS ON DISPOSAL OF SECURITIES

A gain on the sale of securities was subjected to tax by Finance Act, 2010 in case such securities were held for less than 12 months. Through the Finance Act, 2014, the gain arising on disposal of securities with holding period of 12 to 24 months has also been taxed and as such, zero rate of tax is now applicable only where the holding period of securities exceeds 24 months.

Holding Period              Tax Rate

0 – 12 months              12.5%                

12 – 24 months   10%

Over 24 months  0%

Dividends

Dividend income is subject to WHT of 10% or a lower tax treaty rate. The deduction at source shall be the full and final discharge of tax liability on dividend income.

Stock Dividends

A company which is quoted on the Stock Exchange Bonus shares issued by a quoted company: • Must be issued to a shareholder only after collecting tax equal to 5% of the value of the bonus shares to be issued to the shareholder (including 5% bonus shares withheld as above) within a prescribed time; • For purpose of determining value of bonus shares, the ‘day-end price on the first day of closure of books’ is prescribed to be used; • The above referred tax is to be collected by the company within 15 days from the first day of closure of books; • In case the shareholder fails to make payment of 5% tax within 15 days or the company fails to collect the tax within 15 days, the 5% bonus shares withheld by the company will be deposited by the company with the Central Depository Company of Pakistan Limited or any other entity prescribed by FBR; • The bonus shares deposited with CDC or other entity, as mentioned above, will be disposed in the mode and manner to be prescribed by FBR, and the proceeds shall be paid on behalf of the shareholder by way of credit to the Federal Government.

A company which is not quoted on the Stock Exchange A company not quoted on the Stock Exchange which issues bonus shares to its shareholders will deposit tax, within 15 days of the closure of the books, at 5% of the value of the bonus shares on the first day of closure of books, whether or not tax has been collected from the shareholders by the Company. Rules are to be issued by FBR for determining the value of bonus shares of unquoted securities. • Before the issuance of bonus shares, the company liable to deposit tax shall be entitled to collect and recover the amount of tax deposited from the shareholder on whose behalf the tax has been deposited; • In case a shareholder neither makes payment of tax to the company nor collects his bonus shares, within 3 months of the date of issuance of bonus shares, the company may proceed to dispose bonus shares to the extent it has paid tax on shareholder’s behalf.

INTEREST INCOME

Interest earned by a company is taxed as its income from other sources. Interest earned by a nonresident company without a PE in Pakistan attracts WHT at the rate of 10%, except where a lower rate is provided in the related DTT, which is also the final tax on such income.

Losses

Operating losses may be carried forward and set off against the profits of the succeeding six years of the same business in which the losses were incurred. Unabsorbed depreciation can be carried forward indefinitely.

Carried forward losses of an entity in the case of group relief cannot be utilised if the ownership of the holding company is reduced to less than 55% and 75% if one of the companies is a listed company or none of the companies is a listed company, respectively.

Business losses can be carried forward up to a period of six years in the case of the amalgamation of two companies, with the condition that the same business is continued for a minimum period of five years.

The carrying back of losses is not permitted.

INCENTIVES

Tax credits and incentives Any relief from Pakistani income tax that is provided in any other law and not provided for in the Income Tax Ordinance or a treaty is not valid.

Tax exemptions Profits and gains derived from an electric power generation project set up in Pakistan are exempt from tax. Profits and gains derived by a company from the export of computer software, information technology (IT) services, or IT enabled services are exempt from tax through 30 June 2016.

Small companies

Activities of small companies are encouraged with a reduced income tax rate of 25%. A small company has been defined to mean a company that: • Is registered on or after 1 July 2005 under the Companies Ordinance, 1984; • Has a paid-up capital plus undistributed reserves not exceeding 25 million Pakistani rupees (PKR); • Has an annual turnover not exceeding PKR 250 million; and, • Is not formed by splitting up or the reconstitution of business already in existence.

Charitable donations credit

Companies are allowed a tax credit equivalent to 20% of their taxable income in respect of donations to: • Any board of education or university in Pakistan, established by or under federal or provincial law; • Any educational institution, hospital, or relief fund established or run in Pakistan by federal government, provincial government, or local government; and, • Any non-profit organisation.

3. Foreign Tax Relief

Where a resident taxpayer derives foreign-source income on which foreign income tax is paid within two years from the year in which it is derived, the taxpayer is allowed a tax credit equal to the lower of:

(i)           The foreign income tax paid; or,

(ii)         (ii) The Pakistan tax payable in respect of that income.

However, foreign tax paid is not refundable.

4. Corporate Groups

A locally incorporated holding company and subsidiary of a 100% owned group may be taxed as one group by giving an irrevocable option for taxation as one fiscal unit. The relief is not available for losses prior to formation of the group.

The group is available if the companies are designated as entitled to avail group relief by the Securities and Exchange Commission of Pakistan.

Any company that is the subsidiary of a holding company may surrender its loss for the year to its holding company or its subsidiary, or between another subsidiary of the holding company, provided that the holding company directly holds 55% or more capital of the subsidiary if one of the companies is a listed company. However, if none of the companies is a listed company, the holding requirement is 75% or more.

The loss can be surrendered for a maximum of three years, and the required holding is for at least five years.

5. Related Party Transactions

The tax authorities have the power in respect of a transaction between associates to distribute, apportion, or allocate income, deductions, or tax credits between such associates to reflect the income that would have been realized in an arm’s-length transaction.

6. Personal Tax

The tax rates listed below are applicable from 1st July 2014. If more than 50% of an individual’s income is derived from employment, the following tax rates apply to income other than certain investment income

For other individuals, including self-employed individuals, the following tax rates are applicable to their income other than certain investment income.

Individuals are subject to withholding tax at source on income at the following rates.

7. Treaty & Non – Treaty Withholding Tax Rates

Pakistan has signed a tax treaty with the following countries: Austria, Azerbaijan, Bahrain, Bangladesh, Belarus, Belgium, Bosnia and Herzegovina, Brunei, Canada, China, Denmark, Egypt, Finland, France, Germany, Hungary, Indonesia, Iran, Ireland, Italy, Japan, Jordan, Kazakhstan, Korea (Republic of), Kuwait, Kyrgyzstan, Lebanon, Libya, Malaysia, Malta, Mauritius, Morocco, Nepal, Netherlands, Nigeria, Norway, Oman, Philippines, Poland, Portugal, Qatar, Romania, Saudi Arabia, Serbia, Singapore, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Syria, Tajikistan, Thailand, Tunisia, Turkey, Turkmenistan, Ukraine, United Arab Emirates, United Kingdom, United States, Uzbekistan, Vietnam, and Yemen.