Tax Saving Instruments in Pakistan
(Under Income Tax Ordinance, 2001)
A. Income Tax Planning: An Introduction
Income Tax is the tax that an individual pay on his income. The Income Tax Ordinance, 2001 forms the main body of the statue law on income tax in Pakistan. Under this Ordinance, total income is the aggregate of income under five heads i.e. salary, income from property, income from business, income from capital gains and income from other sources like dividend, royalty etc. While taxable income is defined under Section 9 of the Ordinance as total income reduced by total of any deductions allowed under Part IX Chapter 1. Under the Ordinance, different arrangements can be made to reduce the total income and the taxable income, by which the tax liabilities can be reduced wholly or to the maximum possible extent by remaining within the framework of taxation law.
Tax Planning involves considering different alternatives like when, whether and how to conduct business and transactions so as eliminate or reduce the tax incidents. It ensures not only the accruals of tax benefits but also ensures that the tax obligations under the Ordinance are properly discharged to avoid penal provision. Tax Planning does not amount to tax evasion. Tax evasion refers to situation where a person tries to reduce tax liabilities by non-reporting and under-reporting. It involves submitting misleading documents, suppression of facts and making false statements and such acts are punishable under the law. Tax evasion is illegal whereas tax planning is legal and in complete compliance with the law.
The present study is a descriptive type of research because it analyzes the different types of tax saving instruments given under Income Tax Ordinance, 2001. In order to narrow down the topic and to provide a qualitative research paper, this research paper provides different tax saving instrument for individual persons (not company) under the Ordinance. In order to access the perception of legal experts, interview of tax law experts were conducted.
After detailed analysis of Income Tax Ordinance 2001, we have identified the following instruments which can be used for the purposes of tax planning in Pakistan. These include deductions, tax credits, exemptions and tax concessions allowed under Income Tax Ordinance 2001, and other tax deductions allowed on gifts, inheritance, remittances, corporatization, real estate and withholding tax.
1. Deductions and Tax credits allowed under Income Tax Ordinance, 2001
The Income Tax Ordinance, 2001 gives various strategies that can be employed for an efficient tax planning. Generally it is provided as exemptions, tax concessions, deductible allowances and tax credits. The Income Tax Ordinance provide different deductions under each head of the income which can be employed to minimize the person's income under that head which eventually reduces the total income, the sum of the person's income under each of the heads of income. In addition to that the benefits of deductible allowances under Part IX Chapter 1 and tax credits under Part X Chapter 1 can also be employed to reduce the taxable income. Some of the provisions which can be employed to effectively reduce the tax liabilities are enumerated below:
A person who paid Zakat in a tax year under the Zakat and Ushr Ordinance, 1980 shall be entitled to deductible allowance under Chapter 1, Part IX of the Income Tax Ordinance, 2001. Zakat is chargeable at a rate of 2.5% with the Nisab (minimum income required to be present in order for Zakat liability to incur) being set at Rs. 39,198 for the year 2018.1 Under Section 9 of the Ordinance, the taxable income of a person shall be calculated after deduction of Zakat from the total income of the person for the tax year.2
- Workers' Welfare Fund & Workers' Participation Fund
As per Section 60 A of the Income Tax Ordinance 2001, the amount paid by a person to any Workers' Welfare Fund in compliance with the provisions of the Workers' Welfare Fund Ordinance 1971 shall be entitled to a deductible allowance3 and under Section 60 B of the Income Tax Ordinance 2001, a person shall be entitled to a deductible allowance for the amount of any Workers' Participation Fund paid by the person in a tax year in accordance with the provisions of the Companies Profit (Workers' Participation) Act' 1968.4 The purpose of Workers' Welfare Fund (WWF) was to provide facilities such as residential and other facilities to workers working in the industry. Under the Workers' Welfare Fund Ordinance 1971, all the industries which had an income of at least 100,000 were required to deposit two percent of their income in the Workers' Welfare Fund.5 The purpose of Workers' Participation Fund is to financially contribute towards residential projects for workers and also for their education and trainings. Under the Companies Profit (Workers' Participation) Act' 1968, it is mandatory for a company to create a workers' participation fund and deposit five percent of its net profits in that fund every year.6
- Deductible allowance for educational expenses
Section 60D of the Income Tax Ordinance 2001 provides for a deductible allowance for the tuition fees paid in a tax year. However, in order to benefit from this, the taxable income of the individual should be less than 1.5 million rupees.7 This is also adjustable in the tax returns of either of the parents provided they are the ones who are paying the fee.
The deductible allowance under this provision will be the lesser one of either five percent of the total tuition fee paid or twenty five percent of the individual's taxable income or multiple of sixty thousand with the number of children of the individual.8
- Charitable Donations
Tax credits are allowed to individuals in respect of any sum paid or any property given by the person in the year as charitable donation to any university in Pakistan established under federal or provincial law or to any non-profit organization under Section 61 of the Income Tax Ordinance, 2001.9 The “non-profit organization” as defined under section 2(36) includes any person established for religious, charitable or educational purposes, which is registered as a non-profit organization and which does not confer any private benefit on any other person.10
Clause 61 of Second Schedule Part-I enlists the institutions, foundations, societies, boards, trusts and funds who qualify for such donations.11 This is a necessary step as this will ensure that people don't make counterfeit charity organizations which have been set up only to facilitate people in reducing their tax liabilities. These include reputable institutions like The Citizens Foundation, Fatimid Foundation, Karachi, Shaukat Khanum Memorial Trust amongst others. However, there are certain conditions which need to be adhered to. It is required that the donations be made via a crossed cheque drawn on a bank.12 In case it is a property, its amount will be determined as per its fair market value at the time that it is given.13
The tax credits granted for charitable donations are calculated as follows:
Abbildung in dieser Leseprobe nicht enthalten
C will be taken to be the lesser one of either the amount donated or, in case of individuals, thirty percent of the taxable income of the person for the year or, in case of companies, twenty percent of its taxable income for the year.
- Investment in shares and insurance
As per Section 62 of Income Tax Ordinance, any contribution made by a resident person (not a company) is entitled to tax credit for a tax year in respect of the cost of acquiring in the year new shares or sukuks offered to the public by a public company listed on a stock exchange in Pakistan where the person is the original allottee of the shares/sukuks or the shares are acquired from the Privatization Commission of Pakistan.14 This section also allows tax credits for any life insurance premium if the person is deriving income for which he is being charged tax from salary or business.15 However, if the person surrenders his tax policy within 2 years of acquiring such insurance policy then any tax credits granted will be deemed to be wrongly allowed.16 The maximum amount eligible for tax credit has been limited to 1.5 million rupees.17
The tax credits under this section are calculated as follows:
Abbildung in dieser Leseprobe nicht enthalten
C will be taken to be the smallest amount amongst either the total cost of acquisition of shares/sukuks/premium paid or twenty percent of the taxable income of the person or 1.5 million rupees.
- Investment in health insurance
A resident person (not a company) if deriving income chargeable to tax under the head “salary” or “income from business” can save tax by investing in health insurances as per Section 62A of Income Tax Ordinance, 2001.18 In such cases, tax credits shall be given in respect of any health insurance premium or contribution paid to any insurance company. The maximum investment for which tax credit can be claimed is Rs. 150, 000 as per the latest amendment in Finance Act, 2017.19
The tax credits for investing in health insurance are calculated as follows:
Abbildung in dieser Leseprobe nicht enthalten
C will be taken to be the lesser amount of either the premium paid under this section or five percent of the person's income or Rs. 150, 000.
2. Exemptions and tax concessions under Second Schedule
The Second Schedule of Income Tax Ordinance 2001 also provides for certain tax exemptions and tax concessions which can be employed for the purposes of tax planning. Four types of exemptions and concessions provided in it are as follows:
a. Exemption from total income
b. Reduction in tax rate
c. Reduction in tax liability
d. Exemption from Specific Provisions
2 Section 9 of Income Tax Ordinance 2001
3 Section 60 A of Income Tax Ordinance 2001
4 Section 60 B of Income Tax Ordinance 2001
5 April 15, 2013, DAWN NEWSPAPER
6 Parvez Rahim April 15, 2013, DAWN NEWSPAPER
7 Section 60D (1) of Income Tax Ordinance 2001
8 Section 60D (2)(a) and 2(b) of Income Tax Ordinance 2001
9 Section 61 of Income Tax Ordinance 2001
10 Section 2(36), of Income Tax Ordinance 2001
11 Clause 61 of Second Schedule Part-I of Income Tax Ordinance 2001
12 Clause 61(4) of Second Schedule Part-I of Income Tax Ordinance 2001
13 Clause 61(3) of Second Schedule Part-I of Income Tax Ordinance 2001
14 Section 62(1)(i) of Second Schedule Part-I of Income Tax Ordinance 2001
15 Section 62(1)(ii) of Second Schedule Part-I of Income Tax Ordinance 2001
16 Finance Act, 2017
17 Amendment by Finance Act, 2015.
18 Section 62A of Second Schedule Part-I of Income Tax Ordinance 2001
19 Section 62A, subsection 2(c) of Second Schedule Part-I of Income Tax Ordinance 2001