By Amjad Javaid Hashmi, Advocate Supreme Court
1. A leading expert on international tax planning Roy Sauder’s has cautioned that amature international tax planning is more likely than not lead to trouble. Yet many men of fortune the world over are fond of laying their hands a bit of international tax planning themselves. To better serve such hobbyists in Pakistan or those truly interested in it as students and tax professionals we have ventured to write this series of four articles for understanding the basic legal frame work of international taxation. We would like to understand, appreciate and focus on four major themes of international taxation as enshrined in the Income Tax Ordinance, 2001 (hereinafter the Ordinance). The themes are: —
(i) The principles for determining the nexus between the territorial source of income and the residential status of such income earning taxpayer and implications of tax rights and obligations flowing out of such nexus.
(ii) The principles for taxing the foreign source income of residents.
(iii) The principles for taxing the Pakistan source income of non-residents.
(v) The principles for avoiding double taxation of the same income source of a resident or a non-resident person in cross-territorial (Pakistan & Foreign) tax jurisdictions according to the dictates of avoidance of double taxation treaties.
2. Determination of nexus between the residential status of tax payer and territorial source of income is central to the subject of international taxation. We would like to begin with the first article in the series to appreciate the set of principles underlying the determination of such nexus and its impact as contemplated in section 101 of the Ordinance. The nexus between the territorial source of income and the residential status of a taxpayer (income earned) in the given tax territory provides a correct context to address the issues of international taxation. Pakistan tax law duly respects this context and is applicable across all sources of income i.e. salary income, annuity income, business income, divided income profit on debt, royalty, fee for technical services, property and capital gains. It also contemplates that the incidence of international taxation is not confined to the five heads of income as provided in section 11(1) of the Ordinance but stretches to all sources of income even when not given in the five heads of income. It is also pertinent that the whole scheme of determination of territorial source of income is framed with due deference to globally recognized principles of (a) taxing resident persons from global sources and (b) taxing non-resident persons from local sources; and are laid down in section 11(5) and (6) of the Ordinance as reproduced below: —
Section 11(5). —The income of a resident person under a head of income shall be computed by considering amounts that are Pakistan source income and the amounts that are foreign source income.
Section 11(6).—The income of a non-resident person under a head of income shall be computed by taking into account only amounts that are Pakistan source income
3. To facilitate correct determination of territoriality of the income source (Pakistan source or Foreign source), the law has laid down three basic tests as contemplated in subsections (14), (15) and (16) of section 101 of the Ordinance. An express line of demarcation has been drawn between foreign source income and Pakistan source income in subsection (16) by stating the principle that “an amount shall be foreign source income to the extent to which it is not Pakistan source of income”. Secondly; it ventures to remove any ambiguity with respect to the classification of the heads of income i.e. business income or a non-business income for the purpose of international taxation. It has been ruled in subsection (15) that it is obligatory upon a tax authority that it should firstly determine whether any non-business income is a Pakistan source income or not. As a second consequential step a tax authority Is further obliged to determine whether such income could be classified under the head of business income for the purpose of international taxation. Thirdly; it expressly qualities the residual source of income which has not been provided in section 101 of the Ordinance. It has been laid down in subsection (14) that any income source is a Pakistan source income if it is paid by (a) resident or (b) by a permanent establishment (hereinafter PE) in Pakistan of a non-resident person.
4. In order to determine the Pakistan source salary income the principle laid down is that any amount received from exercise of an employment with any employer in Pakistan would be a Pakistan source salary income even when it is paid outside Pakistan. The case in point is of a public servant employed in any Pakistan embassy outside Pakistan or the employee of any resident company, firm or a proprietary enterprise or a PE to whom salary is paid outside Pakistan. The second principle is that any person who is paid any salary by the Federal Government or a Provincial Government or a local government would be treated as a Pakistan source salary income, even if the employee exercises his duties of employment outside Pakistan.
5. Business profit and gain of a non-resident person is Pakistan source income to the extents to which it is directly or indirectly attributable to (i) the PE in Pakistan (ii) any business connection in Pakistan. It may be appreciated that the law does not define the expression ‘business connection’. Its import can be ascertained by the judicial findings on it. Sales of goods or carrying out of business activities through a PE would also be treated as Pakistan source income. Independent services, professional services and the services of entertainers (Rahat Ali Khan’s case in point who is resident of Pakistan tax jurisdiction and non-resident to Indian tax jurisdiction) and of sports persons (cricket world cup 2011 players in the context of tax jurisdictions of Bangladesh, India, Sri Lanka and Pakistan) shall be treated as Pakistan source income where the remuneration is paid by a resident person or by a PE of a non-resident person. Gain on disposal of any asset or property used in deriving any business income of a PE of a non-resident person would also be treated as Pakistan source income.
7. Consistent with the principle as laid down for determination of the Pakistan source business income, the income from profit on debt or royalty or fee for technical services if paid by a resident or a PE of a non-resident person shall also be a Pakistan source income. Profit on debt, technical fee paid in respect of any debt used for the purposes of business carried on outside Pakistan through PE or any royalty in respect of any right, property or information used or utilized for the purposes of business carried on by a resident outside Pakistan through a PE would not be treated as Pakistan source profit on debt or Pakistan source royalty.
8. The concept of Pakistan source property income or of gain arising on its disposal is conspicuously wide. Rent received from the lease of immovable property in Pakistan or any other interest in it including the right to explore for or exploit the natural sources in Pakistan would also be deemed to be a Pakistan source property income. Any gain on alienation of any immovable property or right or any share in a company the assets of which consist wholly or principally, directly or indirectly employed in deriving rental income or income from oil exploration or exploitation of natural sources would be qualified as Pakistan source income.
9. The law further contemplates that any gain arising on disposal of shares in a resident company shall be Pakistan source income. Insurance and reinsurance premium paid to “Overseas Insurance and Reinsurance Company” would be a Pakistan source income. Interestingly, in departure from the central and consistent scheme of qualifying the residential status (non-resident person or its PE in Pakistan); the provision simply refers to the location of the recipient company i.e. “Overseas Insurance/Reinsurance Company”. One fails to understand this inconsistency in tax law design and needs urgent attention by F.B.R.