income tax act 2001
Federal law enacted on October 27, 2001, and amended on March 22, 2003. It establishes direct taxation and superannuation contributions for individuals aged 45 years or above to the government, at a rate of 20% (Rs300 each) from its source, including earnings and profits from business activities, regardless whether they have been declared or not. The new legislation was designed to bring more revenue into the budget and enhance general welfare. At present, both corporate financial reporting and contribution rules and procedures are governed by the Federal Board of Revenue as well.
A separate provision has been made under this act for “family incomes”, i.e. an individual's monthly earned wages and allowances. However, these provisions cannot be used for determining family incomes under Section 3B of this act. The introduction of section 2 (a) of this act provides that no child of a taxpayer below 18 years can make any deductions therefrom in respect of their expenses. Section 1B has also added specific qualifications to qualify for exemption or reduction of tax liability under the said sections. This article discusses the main features of the income tax law of Pakistan under Part-1 of Chapter 5: General Provisions pertaining to non-taxable sources of revenues.
1. What is an income?
The term income refers to the money received from different sources (such as salary, gains from sale of assets, sales of goods etc), whether through personal savings or investments. These may include remuneration such as salaries, profit from property sales, interest on bank deposits, interest on capital markets, dividends etc. The word ‘income’ is synonymous with gross income or net income and means any or combination of these two or the sum total of such receipts from the various sources. Income may also mean what we consider our own. For example, let us take a person earning Rs 5000 per month as his/her own investment and receiving all the benefits from it. That same person would make the sum total of those payments from the various sources Rs 60000. This is known as his/her annual income during the year. If we add up all the amounts he/she earns from the various sources by deducting them and dividing them by his/her number of days worked in a given period (say 12 days), then that would give him/her total monthly income for the entire year. Let us assume we work 10 days in a week, which means that the total day's work is 5 x 10 = 40 days of his/her working hours. We have to subtract the amount of time spent by the employee while performing some activity such as travelling when doing daily job activities not mentioned above. Then the resulting figure is only 24 hours left in the remaining period. Thus, the remaining 4 hours left is the difference between the total income and the total expenses. Therefore, we define "income" as the sum of payments, income tax, social benefits and social security and other fringe benefits received by a unit of time by one person.
2. Types of income
There are several types of income that a person receives. They may also include dividend income, proceeds of trade, interest and royalties.
Dividends: Dividend incomes refer to payment of an
accumulated fractional portion or fixed percentage of ownership in a company.
In Pakistan, every five shares of a publicly listed company is allocated 10% of
its total equity as dividends. Since companies are required to pay dividends
out of funds available, most corporations distribute them in cash form. Apart
from being the primary source of fund for the development of a nation, they are
also part of overall revenue generation in terms of taxes paid by the
government. According to Accounting Standards Board, Pakistan pays only 7%
percent of its GDP in dividends as compared to over 80% in India. Besides that,
another reason for low dividend income is poor market performance in Pakistan.
Most companies do not pay dividends due to lack of confidence and preference
for debt instruments and stock options. Also because of large shareholding of
foreign shareholders, companies mostly prefer selling their stocks rather than
paying dividends, which results in lower dividend payments by the public
companies. There are certain exceptions to this rule. Some companies like
Zia-ul-Haq Investment Company Limited-ZIA-UH (ZIHAQ) pay regular dividends, but
usually keep them at an average level of 10%. Similarly, Dr. Syed Abdul Qadir
Baloch Ltd., a state-owned Pakistani company, pays higher dividend of 15% per
annum to its common shareholders. To make things simpler, if we add an extra
$100 per month, the quarterly payments will increase the cumulative dividends
paid by the company to $16000 per year. Another exception to the usual practice
of dividends is if the organization has declared it quarterly, or if management
announces a bonus, a long-term incentive or a grant of some sort of benefit.
All these factors together lead to increased shareholder value of the private
organizations.
Investment income: This type of income occurs when an investor sells or purchases a certain quantity of a security or a group of securities such as a depositary and buys back that amount after some amount of time (for instance, three months). Again this includes trading in foreign exchange transactions. As it is possible to invest in a variety of securities such as bonds or mutual funds, so it is also possible to receive dividend income from investments too. Generally speaking, investors earn interest from the returns generated from the investment and interest income from the retained earnings. When stock prices rise, people tend to buy more stocks, as there is a sense of buying higher-priced items with better expected returns. So, it becomes difficult for the public sector to maintain public spending power and for investors who want to sell their stocks. On the other hand, the cost of investing is quite high in Pakistan. Investors often find themselves having very little choice on how and where to invest. Now the question arises how can someone do in such circumstances? One way of solving such a problem is to offer them loans. Banks are aware that when you borrow from your friends, relatives and colleagues, you get less risk involved and also earn more interest income in return. But banks are hesitant to offer loans to large companies, fearing that it can affect credit growth, resulting in loss of credit worthiness. Credit growth helps the economy by generating output in terms of output to GDP ratio. Lack of enough consumer credit limits aggregate demand in production and slows economic expansion. The opposite effect can be achieved with loan growth. Credit growth leads to an increase in aggregate demand by increasing consumption levels. If consumers have the capacity for saving up to $1000 per month and cannot repay the advance quickly enough, it causes balance of payment crisis because the deficit is unable to meet public expenditure. The same case applies to export sector. If consumers have the ability to save up to $1000 per month with no option to pay up, balance of payment crisis can be avoided. Government institutions try to attract small businesses with good credit worthiness records by offering tax breaks and incentives. Moreover, many business loans are structured on concessional repayment and also tax exemptions. Businesses are encouraged to seek financing from well-established lenders. It is seen that big business owners like SABIC Bank and ITCL finance almost 30% of the country's exports.
3. Non-taxable Sources of Revenues
The value which a user gives to his/ her house, depending
on its condition, size and age. Value given to the land which is held as
property or immovable property, irrespective of its location and maintenance.
The amount that a professional worker keeps in business accounts. Other amounts, such as income from lease of premises for rental purposes, depreciation of motor vehicles, allowance from employer for retirement funds and insurance premium paid, among others are also non-taxable income.
The amount which can be deducted from income and includes the amount which falls outside the taxable bracket. Like in section 53B of Income Tax Ordinance 1986, the income from investment does not attract any tax on its basis as long as they are not related to income from service. Further, a contractor can carry forward income from building works with regard to the expiry date of completion of contract. So, in fact, the owner of the property loses nothing by not levying additional tax as long as the construction costs exceed the end of contractual period (as agreed upon in writing by the parties concerned). If it would be possible, the taxpayer is permitted to claim refundable interest incurred on the property acquired, provided that the property is still at its existing stage of use and is not undergoing replacement. There are certain conditions to claim a refundable interest under this section. Firstly, there must be an agreement between the taxpayers (in writing) specifying clearly that the transaction is a legal transaction. Secondly, there should be evidence showing the nature and extent to which the buyer had knowledge about the purchase, i.e. he/she knew that it was likely to be completed or even started soon, and the seller was aware of that. Thirdly, there should be evidence showing that the buyer paid the amount due within the stipulated time frame and did not take advantage of time by not completing the transaction sooner, otherwise, he/she is not eligible to redeem the right to redeem and the transaction is cancelled. Fourthly, the seller should have taken responsibility of the property and should have continued taking care of it on a continuous basis as a result of negotiations between the parties concerned. Fifthly, it should be evident that the buyer is responsible for the full cost of the transaction including the real estate and taxes (if applicable) were paid for the purpose specified for completing the property and the total price paid for it was fair and reasonable. Sixth, the seller must show evidence of inability to continue operating the property because of it.
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