By Amjad Javaid Hashmi, Advocate Supreme Court of Pakistan
It is always a guess work whether you and your business enterprise are fully compliant or not to the ordinary tax obligations regime of Pakistan imposed by the Income Tax ordinance, 2001 (the Ordinance). The ordinary scheme of charging, assessing and computing net tax liability is often referred to in the tax practice industry as Normal Taxation Regime (NTR). It is encapsulated in the provisions of section 4 and its three subsections (1)(2) and (3). For the purpose of avoiding any over payment or under payment of taxes under NTR, it is imperative to understand and appraise and correctly apply the principle of tax policy embedded in the provisions of section 4. Three foundational principles underly these three sub-sections of section 4. Sub-section (1) represents the principle of chargeability. Sub-section (2) reflects the principle of computability and sub-section 3 delineates the principle of adjustability.
Now, we advent to an elaborate integration of the principles of chargeability, computability and adjustability principles to assist taxpayers, tax practitioners and adjudicators.
Chargeability
The scheme of chargeability, as outlined in Section 4(1), comprises three components i.e. the basis of taxation, the quantum of taxation and the burden of taxation. Firstly, the component of basis of income states as to why the charge is attracted. Relevant to tax year 2023 it ordains that your income is taxable because it stands at or exceeds the threshold of taxable income of Rs. 600,000/- The unique concept of taxable income and its constituents are further elaborated in the provisions of sections 9, 10 and 11 of the Ordinance. Secondly, the component of incidence/ quantum of tax/charge stipulates as to how much tax is to be paid. It refers to manner of tax computing wherein the First Schedule of the Ordinance provides income brackets and corresponding tax rates for the purpose of its calculation. Thirdly, the component of burden (legal) of taxation ordains that every person enjoying the taxable income Rs. 600,000/- or above will bear the legal responsibility to pay the tax/charge. This threshold does not apply to a company. For a helicopter view of the unique concept of a person and its dozens of permutations, you can refer to the terms of section 80.
Thus, Section 4(1) addresses the core concerns of the taxpayer community: Why tax is imposed, how this tax is determined, and who is responsible for settling the computed tax. These concerns are explained through taxable income, covering every individual or entity, and the prescribed tax rate.
Computability
The scheme of computability as outlined in section 4(2) of the Ordinance provides a structured framework for determining your ultimate tax liability. It stipulates sequential application of two steps of calculation i.e. division and subtraction for correctly computing a taxpayer’s income tax obligation for a specific tax year. While applying the first step, taxable income is multiplied by the respective tax rate(s), yielding the gross tax or preliminary tax liability. In the second step, net tax liability is calculated by subtracting the tax credits—taxes deducted or collected locally or globally from the taxpayer’s specified transactions. The resulting net tax liability is subject to adherence to a specific pattern of adjustment of the taxes collected or deducted at source in a tax year. This brings us to the third principle of adjustability.
Adjustability
The scheme of adjustability as covered in Section 4(3) of the Ordinance encompasses a rigid treatment of one or more tax credits i.e. to arrive at a correct net tax payable as discussed later. These credits fall into three categories: (a) foreign tax credits, (b) motivational tax credits, and (c) transactional tax credits.
i). Foreign Tax Credits (Section 103): The first in sequence category of tax credits to be utilized includes any foreign tax credits authorized under Section 103 of the Ordinance. This provision allows taxpayers to claim a credit for foreign taxes paid on their foreign source income. The Ordinance emphasizes the importance of recognizing and accommodating foreign tax obligations by prioritizing this credit.
ii). Tax Credits under Part X of Chapter III: The second-in-sequence category of tax credits includes those permitted under Part X of Chapter III of the Ordinance. The legislation outlines nine specific types of motivational tax credits, each associated with unique socio-economic initiatives such as pension fund contributions, employment expansion, POS machine installation, targeted investments, and the establishment of industrial undertakings and enterprises engaged in coal mining and software development. To understand the eligibility criteria and prerequisites for claiming these credits, the stakeholders may refer to the respective provisions within Chapter III.
iii). Tax Credits under Sections 147 and 168: Final and third-in-sequence category of tax credits is authorized under Sections 147 and 168. The qualifying elements of these two sections cover tax credits related to the prepaid taxes against specific types of transactions of income or expense. Taxpayers must consult the constituents of the relevant sections to gain comprehensive insight into eligibility requirements.
The significance of this sequential adjustment process lies in its ability to ensure that taxpayers optimally use their tax credits to reduce their overall tax liability. By establishing a distinct order for the application of these credits, the Ordinance provides transparency and structure to the process, assisting taxpayers in navigating the intricate domain of tax credits and minimizing the risk of either overpaying or underpaying their income tax.
Conclusion:
The Income Tax Ordinance, 2001, through its Normal Tax Regime as delineated in Section 4(1)(2)(3), meticulously outlines the sequential steps essential for computing the correct or legal minimum income tax obligation of a taxpayer. It begins with the identification of taxable income and progresses to ascertain chargeability, applicable tax rates, preliminary tax liability, and tax credit adjustments, culminating in the ultimate income tax payable for the tax year. This methodical approach ensures transparency and fairness in determining tax liabilities for both individuals and entities within Pakistan.