| |
|
 |
| For business information, annual reports, laws, ordinances, regulations and articles. |
|
|
|
7. Double taxation agreements whether decide or
allocate jurisdiction
States levy taxes according to their domestic tax laws, and double taxation agreements
recognise this principle. These, however, limit the application of the domestic laws to
certain type of income to prevent it from being doubly taxed, either by excluding it or by
allowing a credit of tax paid in the other country. Jurisdiction to tax total world income
or wealth has been conferred upon the State by its own laws, though it is sought to be
limited by the tax agreements on the basis of reciprocity. In the event of occurrence of
the overlapping, the tax agreement decides which of the Contracting States should exercise
its jurisdiction to tax an income and which of the other should withdraw its claim. This,
however, does not suggest that the agreements "decide" or "allocate"
jurisdiction between the two Contracting States. Division of tax claims is their purpose
and intention, which is achieved by the States Division of tax claims is their purpose and
intention, which is achieved by the States by agreeing to waive tax claims in favour of
exemption method or to grant credit of tax already paid in the other State (credit
method). The tax agreements, therefore, put limitation on the domestic tax laws in their
application to income which has been subject-matter of tax elsewhere. These do not invest
a State with a jurisdiction to tax income which it does not have under its domestic tax
laws, or with a jurisdiction beyond what it has.
Under the Pakistani tax laws, income which is subject to charge to tax is, inter alia,
income which accrues or arises or deemed to accrue or arise in Pakistan or which accrues
or arises outside Pakistan, if the assessee is resident in Pakistan. In case of a
non-resident assessee, income which accrues or arises outside Pakistan is not taxable. The
chargeability of income depends-
(a) upon the residential status of the assessee who is treated resident of the both
countries according to their laws, in respect of that income, or
(b) the source of income, and
(c) upon the concept of income as meaning to accrue or arise anywhere in the world.
Dependence of the taxability of income upon (i) the residential status of the assessee,
and (ii) the location of the source of income results often time in double taxation. So
that the same income may not suffer tax twice, once in the country of its source and again
in the country of residence of an assessee, some relief has to be provided or measures
have to be taken to avoid occurrence of such a situation.
For avoidance of double taxation of the same taxpayer on account of the same object, a
bilateral convention between the two countries is entered into, which normally proposes in
substance that income-tax is levied, (i) in respect of a particulars source of income, by
the country in which the source is located; (ii) in respect of one’s total income, by
the country where he resides, while deduction of taxes is collected by other State under
(i) above, or (ii) in respect of income which has suffered tax in one country, it is not
subjected to tax in the other, irrespective of what the laws of the respective country
provide.
Three fundamental issues have, therefore to be decided before the tax liability is hoisted
on the person. These relate to-
(a) his residence,
(b) the source of income and,
(c) permanent establishment.
7.1. Residence- The determination of the residential status
assumes significance, as the taxability of income under the domestic laws, depends upon
it, and as also only the resident person can seek relief from double taxation. For tax
purposes, the domicilatory status of a person has practical meaning in the sense of a
residence, the physical presence in a country enabling it to apply its tax laws. Since
residence is a factual concept, the criterion for its determination may differ
substantially.
The possibility of a person having dual residential status cannot be ruled our because he
may qualify for that status in relation to one State according to some criterion and may
also qualify for similar status in relation to another some other criterion. Such a
situation may result in taxation of income in more than one country. The difficulty is
resolved by laying down. circumstances when he could be considered resident either of this
or of that State.
Tax agreements, therefore, contain a provision to avoid dual residence by listing a number
of precise criteria. The exclusion of dual residence is for pragmatic reasons. Such a
provision is valid for the purpose of relationship between both the contracting parties as
regulated by the agreement. Beyond the aims and objects of the agreement, the residential
status as determinable under the domestic laws remains unchanged. The determination of
fiscal domicile for the purpose of the concerned agreement has been discussed in detail in
the book later.
7.2. Source - ‘Source’ means not a legal concept; but
something which a practical man should regard as a real source of income. A person may have separate sources of income. All taxable income must
necessarily have a definite source. The word
'source' therefore, means something from which income arises. It relates to the physical source of a flow of money not the physical
situs of payment but rather to the property, activity or service which produces the
income. The concept of the 'source of income' was first introduced in the United States
tax system in 1916 and subsequently embodied in the 1939 US tax code. It has been the rule
in the United States since the inception of the concept of source of income to consider
the place where service is done, decisive. For instance, if service is done in the US, the
income from the service should be from the sources within the United States. Compensation
for labour for personal services performed in a country constitutes that country's source
of income. This principle applies not only to services rendered by an individual or
natural person but also to services rendered by or through the medium of a juridical
person.
There may be circumstances that the source of income is determined to be in more than one
country. Each country determines source according to its laws. The laws of two countries
may come into conflict in determining a source in either of them. Where a double tax
agreement exists between the two countries, the problems of dual source are largely
resolved, as the agreement determines the country of the source in respect of various
classes of income. Where, however, no agreement applies, the recipient may be taxed in
both countries in respect of the same income.
Under the double taxation agreement, the difficulty is resolved thus: taxes are levied (i)
in resect of a particular source of income, by the country in which the source is located;
and (ii) in respect of a person’s total income, by the country where he resides, with
deduction of taxes collected by other State under (i) above.
Thus, as a general principle, income with a Pakistani source is taxable in Pakistan. But
where the person is resident of another country and he is in receipt of income in respect
of a Pakistani source, the taxability of income in Pakistan will be determined on whether
the person is non-resident in Pakistan, or whether he is a resident of a country with
which Pakistan has a double taxation agreement. In case he is non-resident in Pakistan but
is resident of a country with which Pakistan has no double taxation agreement, the
Pakistan source income will be taxed in Pakistan at the tax rate given in the law. In case
he is a resident of a country with which Pakistan has a double taxation agreement, the
taxability of income, its extent and rate would be governed by that agreement.
7.3. Permanent establishment - Foreign company or establishment
carrying on business in a wide range of circumstances is subjected to tax under the
domestic laws of many countries. Even a casual activity which may not be an effective or
immediate source of income is not spared. Double taxation agreement restricts the
jurisdiction of the Contracting States to taxing business income only if the foreign
company or establishment carries on business through a permanent establishment. Therefore,
the expression ‘permanent establishment’ is defined extensively in all tax
agreements so as to limit the circumstances in which a company or enterprise resident in
one country is taxable on business profits in the other. In most agreements the permanent
establishment is extensively defined so as to limit the circumstances in which a foreign
enterprise is taxable on its business income in the host country. The effect of this
provision is that variety of business operations are no longer subject to double taxation.
The definition contains the following categories of permanent establishment:
* Place of management
* Branch establishment
* Office, manufacturing premises or workshop, warehouses, purchasing and selling agencies
* Place for the extraction of mineral resources
* Building projects.
8. Unilateral relief vis-a-vis bilateral relief
Income that arises or accrues in one country and then flows to another, say, business
profits, dividends, interest, royalties, and so on, is generally taxed by both countries
according to their respective laws. If the taxation o such income is not co-ordinated, a
heavier burden may be imposed on that income than on domestic income. The consequences
would be an adverse effect on the international trade and economic relations. Two
approaches have been used in achieving such co-ordination - one unilateral and the other
bilateral. While the expression ‘bilateral’ suggests an agreement between the
two countries allocating the right to tax the different categories of income and,
sometimes capital, the expression ‘unilateral’ suggests an initiative where the
home country employs measures on a unilateral basis which mitigate or prevent income that
has its source in another country for being taxed twice.
Under a unilateral system of double taxation relief, the relief has to be given to every
person resident of every country, irrespective of whether that country grants a
corresponding relief. Under double taxation agreement, additional reliefs are provided on
reciprocal or mutual basis. A relief is given in exchange of a similar relief to its
resident in the other country. Taxpayers in both the countries are treated equally, when
the problems relating to double taxation arise.
There is a possibility of the co-ordination of two differing tax systems, which possibly
does not exist under the unilateral tax relief system. The relief could be tailored to the
particular tax system of the two countries. In case there is a conflict in regard to
matters on double taxation, provision for resolving them exists in the double taxation
agreement. Close co-operation between the tax authorities of the two countries in regard
to exchange information or working together in administration to their tax laws is
promised in the double taxation agreement.
8.1. Unilateral relief - To mitigate hardship on account of
foreign source income having to suffer tax twice, once in the country of the source and
again in that of the assessee's residence, the domestic tax laws contain many measures in
the form of either exempting totally or partially foreign source income, or permitting the
taxpayers to deduct foreign income-tax in the same manner as other items of cost or
expense. The other measure relates to the grant of foreign tax credit. All these measures
are taken unilaterally without reference to a corresponding or reciprocal arrangement with
the other country.
Relief is given under the provisions of a country's own domestic tax laws in any of the
following ways:
* By exempting foreign source income and gains from domestic taxes.
* By exempting income of non-resident earned in the host country.
* By means of a credit of foreign taxes against domestic taxes on foreign source income
and gains.
* By allowing foreign taxes as a deduction in computing income and gains for domestic tax
purpose.
8.1-1 Exemption of foreign source income - One method of
unilateral relief is to exempt the foreign source income. Its essential feature is that
the investor's home country grants an exclusive right to the source country to tax it. It
is limited to certain types of income such as business profits, inter-company dividends
received by domestic companies or other persons, income from real estates, situated
abroad. Tax liability is no more or no less than what it could be according to the
domestic law of the source country.
Thus, there is tax neutrality. First, in the sense that the home country investor is
treated at par with the nationals of the source country and thus he receives the same
treatment as the domestic law extends to its nationals. Secondly, in the sense that his
income from the home country investments and foreign source country investments is not
taxed alike. Thirdly, in the sense that repatriation or non-repatriation of the profits
has no influence on the amount of taxation.
As for Pakistan, exemption of foreign source income from the domestic laws is provided
unilaterally either entirely or partially in respect of some cases. Complete exemption is
provided in respect of interest payable on the money borrowed from, or the debts owned to,
the sources outside Pakistan by the Government or a local authority or by an industrial
undertaking or the Industrial Finance Corporation or any other financial institution or a
company or by an individual [clauses (75) to (77A), Part I of the Second Schedule to the
Ordinance]. The following clauses of Second Schedule deal with the nature and extent of
exemptions or tax reliefs available to non-residents in Pakistan:
PART I, SECOND SCHEDULE
Incomes or classes of income, or persons or classes of persons,
enumerated below shall be exempt from tax, subject to the conditions and to the extent
especified hereunder:
(7B) Any income chargeable under the head "Salary" received by, or due to, any
person being an employee of the International Irrigation Management Institute (IIMI) in
Pakistan, who is neither a citizen of Pakistan nor was resident in Pakistan in any of the
four years immediately preceding the year in which he arrived in Pakistan.]
(7C) Any income chargeable under the head
"Salary" received by, or due to, any person (who is neither a citizen of
Pakistan nor was resident in Pakistan in any of the four years immediately preceding the
year in which he arrived in Pakistan) for the period ending the thirtieth day of June,
1999, from the date of his arrival in Pakistan, as remuneration for services rendered by
him during such period as an expert under a contract of service approved by the
Commissioner of Income Tax for the purposes of this clause, employed by the Agha Khan
Hospital and Medical College Foundation, Karachi:
Provided that the total number of expatriate employees enjoying exemption under this
clause shall not exceed seventeen in number.
Explanation.- For the purpose of this clause, the expression "expert"
means a professionally qualified person who possesses specialized knowledge in the fields
of medicine, surgery, including general medicine pathology, pharmacy, obstetrics,
paediatrics, nursing intensive care, central sterile supply, consulting clinic, medical
record, health/hospital administration, community health sciences and all branches of
basic health sciences, including bio-chemistry, cellular biology, anatomy, physiology,
psychiatry, microbiology, pharmacology, anesthesiology, radiology and allied fields of
health, hospital management or administration, or in other branches of higher learning in
aforesaid educational fields, teacher training and educational research and whose
employment in Pakistan, irrespective of his designation or capacity in which he is
employed to impart such specialized knowledge and experience.
(7D) Any income chargeable under the head
"Salary" received by, or due to, any person, not being a citizen of Pakistan or
a person resident in Pakistan, as remuneration for services rendered by him as a health
professional under the contract of service concluded with Shaukat Khanum Memorial Hospital
and Research Center, Lahore, and approved by the Federal Government for the purposes of
this clause.
(7E) Any income chargeable under the head
"Salary" due to, or received by a person who, not being a citizen of Pakistan,
is engaged as an expert or technical, professional, scientific advisor or consultant or
senior management staff by institutions of the Agha Khan Development Network, (Pakistan)
listed in Schedule 1 of the Accord and Protocol dated November 13, 1994 executed between
the Government of the Islamic Republic of Pakistan and Agha Khan Development Network.
(12) Any income chargeable under the head "Salary" of persons, [-- ] who are stationed in Pakistan in accordance with the terms of an
Aid Agreement entered into by the Government of Pakistan with the Government of the
country to which such persons belong or with any international agency and whose salary is
paid by such Government or agency out of funds or grants released as aid to Pakistan in
pursuance of such Agreement.
(12A) Any income of a person who, not being a
citizen of Pakistan or a person resident in Pakistan, is engaged as a contractor,
consultant or expert on a project in Pakistan financed out of grant funds in accordance
with the terms of a bilateral or multilateral technical assistance agreement entered into
by the Government of Pakistan with any foreign government, international donor agency or
bank or other aid-giving organisation and derives such income out of the funds of the
grant in pursuance of such agreement:
(13) Any salary received by a person, not being a citizen of Pakistan, by virtue of his
employment with the British Council.
(75) Any interest payable to a non-resident in respect of such private loan to be utilised
on such project in Pakistan as may be approved by the Federal Government for the purposes
of this clause, having regard to the rate of interest and the terms of re-payment of the
loan and the nature of the project on which it is to be utilised.
(75A) Any interest payable to a non-resident on a
loan in foreign exchange against export letter of credit which is used exclusively for
export of goods manufactured or processed for exports in Pakistan.
(76) An interest payable by an industrial undertaking in Pakistan -
(ii) on moneys borrowed or debts incurred by it in a foreign country in respect of the
purchase outside Pakistan of capital plant and machinery in any case where the loan or
debt is approved by the Federal Government, having regard to its terms generally and in
particular to the terms of its payment, from so much of the tax payable in respect thereof
as exceeds the tax or taxes on income paid on such interest in the foreign country from
which the loan emanated or in which the debt was incurred (hereinafter referred to as the
'said country'):
Provided that, where the amount of such tax or taxes paid in the said country exceeds the
amount of the tax payable in Pakistan, no refund of the amount paid in excess shall be
allowed:
Provided further that, where the said country exempts such interest or allows credit
against its own tax for the tax which would have been payable in Pakistan if the said
interest were liable to tax in Pakistan, no tax shall be payable in Pakistan in respect of
such interest.
(77) Any income of an agency of a foreign
Government, a foreign national (company, firm or association of persons), or any other
non-resident person approved by the Federal Government for the purposes of this clause,
from interest on moneys borrowed under a loan agreement or in respect of foreign currency
instrument approved by the Federal Government.
(77A) Any interest payable to a non-resident being
a foreign individual, company, firm or association of persons in respect of a foreign loan
as is utilized for industrial investment in Pakistan provided that the agreement for such
loan is concluded on or after the first day of February 1991, and is duly registered with
the State Bank of Pakistan.]
(77B) Any profit derived by a non-resident, being a
foreign individual, company, firm or association of persons, in respect of the Islamic
mode of financing, including istisna, morabaha, musharika [:]
(78) Any interest derived from foreign currency accounts held with the authorised banks in
Pakistan, in accordance with Foreign Currency Accounts Scheme introduced by the State Bank
of Pakistan, by citizens of Pakistan and foreign nationals residing abroad, foreign
association of persons, companies registered and operating abroad and foreign nationals
residing in Pakistan.
(78A) Any interest or profit derived from a rupee account held with a scheduled bank in
Pakistan by a citizen of Pakistan residing abroad ,
where the deposits in the said account are made exclusively from foreign exchange remitted
into the said account.
(78E) Any profit or interest derived from Pak rupees account or
certificates of deposit which have been created by conversion of a foreign currency
account or deposit held on the 28th day of May, 1998, with a bank authorised under the
Foreign Currency Accounts Scheme of State Bank of Pakistan:
Provided that nothing contained in this clause shall apply to such Pak rupee account or
certificates which are created out of foreign currency deposits which are not exempt under
.clause (78).]
(79) Any interest income received from a Pakistani bank by a foreign bank, approved by the
Federal Government for the purposes of this clause, for such period as may be determined
by the Federal Government:
Provided that-
(i) the interest income is earned on deposits comprising of remittances from abroad held
in a rupee account opened with a Pakistani bank with the prior approval of the State Bank
of Pakistan;
(ii) the Pakistani bank maintaining the said rupee account holds 20 per cent or more of
the equity capital of the said foreign bank and the management of the latter vests in the
Pakistani bank; and
(iii) the rate of interest chargeable on the said deposits does not exceed the rate of
interest chargeable on the deposits in the foreign currency accounts allowed to be opened
with banks in Pakistan by the State Bank of Pakistan.
(79C) Any income derived by a non-resident from foreign investment
in 7th issue of Pak rupee denominated WAPDA Energy Bonds issued under the WAPDA Energy
Bonds (7th Issue) Regulations, 1997.
(80) Any income derived by a non-resident (excluding local branches,
subsidiaries or offices of foreign banks, companies, associations of persons or any other
person operating in Pakistan) from Federal Government securities and redeemable capital,
as defined in the Companies Ordinance, 1984, (XLVII of 1984) listed on a registered stock
exchange, where the investments are made exclusively from foreign exchange remitted into
Pakistan through a Special Convertible Rupee Account maintained with a bank in Pakistan.
(115) Any income derived by a person from plying of any vehicle registered in the
territories of Azad Jammu and Kashmir, excluding income arising from the operation of such
vehicle in Pakistan to a person who is resident in Pakistan and non-resident in those
territories.
Income of returning expatriates:-
(130A) Any income which accrues or arises outside Pakistan to a resident (who is a citizen
of Pakistan but was not resident in any of the four years preceding the year in which he
became resident) for two years, that is to say, in respect of the income year in which he
became resident and the income year next following.
(133A) Any income of the Institutions of the Agha Khan Development
Network, (Pakistan) as contained in Schedule 1 of the Accord and Protocol, dated November
13, 1994, executed between the Government of the Islamic Republic of Pakistan and the Agha
Khan Development Network.
Income of foreign air and shipping enterprises:
(141) Any income of a foreign enterprise, for the time being approved by the Federal
Government for the purpose of this clause, from the operation of ships and aircraft in
international traffic except where such income is earned from ships and aircraft used
principally to transport passengers and goods exclusively between places in Pakistan:
Provided that exemption under this clause shall not be available to an enterprise of a
country which does not allow similar exemption to a like enterprise of Pakistan.
Explanation.-"Foreign enterprises" means an enterprise which is carried
on by a person who is not resident in Pakistan and the effective management of which is
situated outside Pakistan.
Income of North South Roundtable:
(155A) 'Any income derived by North South Roundtable.
(167C) Any amount deemed to be income of an
employee for the purposes of tax on tax [--].
(177) Payments made on or after the first day of July, 1991, for the
supply of plant, equipment and machinery to Hub Power Company Limited by a non-resident
being a foreign individual, company, firm or association of persons.
(178) Profits and gains derived by an assessee from transmission line project set up in
Pakistan on or after the 1st day of July, 1995.
The exemption under this clause shall apply to such project which is-
(a) owned and managed by a company formed for operating the said project and registered
under the Companies Ordinance, 1984 (XLVII of 1984), and having its registered office in
Pakistan;
(b) not formed by splitting up, reconstruction or reconstitution of a business already in
existence or by transfer to a new business of any machinery or plant used in a business
which was being carried on in Pakistan at any time before the commencement of the new
business; and
(c) owned by a company fifty per cent of whose shares are not held by the Federal
Government or Provincial Government or a local authority or which is not controlled by the
Federal Government or a Provincial Government or a local authority.
(179) Income from export of computer software and its related
services developed in Pakistan.
(182) Any income referred to in Section 3.4 (a) of the Facilitation
Agreement between the President of the Islamic Republic of Pakistan and the assessee
purchasing the Kot Addu Power Station from Pakistan Water and Power Development Authority
for a period of ten years from 28th June, 1996; provided, however, that the exemption
under this clause shall only be available subject to the business of the said assessee
being restricted to *owing and operating the Kot Addu power station.
PART II, SECOND SCHEDULE
(6) In the case of Daewoo Corporation, Seoul, Korea (hereinafter
referred to as the Contractor), payments received in full or in part (including a payment
by way of an advance) in pursuance of the contract agreements made with the National
Highway Authority on the thirtieth day of December, 1991, for design and construction of
Lahore-Islamabad Motorway shall be deemed Highway Authority on the thirtieth day of
December, 1991, for design and construction of Lahore-Islamabad Motorway shall be deemed
to be the income of the Contractor and charged to tax at the rate of three per cent of
such payments which shall constitute final discharge of his tax liability under this
Ordinance and the Contractor shall not be required to file the return of total income
under section 55.
(6A) Tax shall be collected at 3/4th of the
rate applicable under sub-section (5) of section 50 on the goods imported under the Afghan
Transit Trade Agreement, 1965, and subject to Notification S.R.O. 368(I)/95, dated the 2nd
May, 1995.
(10) In the case of a non-resident O&M Contractor payments, received in full or in
part including a payment by way of an advance, for the operation and maintenance of a
private sector power project and transmission line
projects approved by the Federal Government shall be deemed to be the income of the
said O&M Contractor and charged to tax at the rate of five per cent of such payments
for a period of three years beginning with the date of commencement of company's operations which shall constitute the final discharge of tax
liability by the O&M Contractor under this Ordinance in respect of the said project.
(11) In the case of a non-resident, being a company, rate of
deduction of tax under sub-section (3) of section 50 on dividends received from a company
engaged exclusively in mining operations, other than petroleum, shall be 7.5 per cent of
the gross amount of dividend.
(13) In the case of consortium of M/s. STFA Construction Company of
Turkey and M/s. JDN of Belgium (hereinafter referred to as the contractor) all payments
received in pursuance of the contract agreement No. CEN-126/93, made with the Ormara Naval
Harbour Project Board, on the fourteenth day of June, 1993, for theconstruction of a Naval
Harbour at Ormara (including off-shore and land development works), chargeable to tax in
any assessment year, shall be deemed to be the income of the contractor and charged to tax
at the rate of three per cent which shall constitute final discharge of contractor's tax
liability under this Ordinance.
PART IV, SECOND SCHEDULE
(9A) The
provisions of section 80C shall not apply in respect of a non-resident person [-- ] unless he opts for the presumptive tax
regime:
Provided that a declaration of final and irrevocable option is furnished in writing
alongwith the return of total income under section 55.
(10A) The provisions of sub-section (5) of section 50 shall not
apply to goods or classes of goods imported by contractors and sub-contractors engaged in
the execution of power project under the agreement between the Islamic Republic of
Pakistan and Hub Power Company Limited.
(12) The provisions of clause (30) of
section 2 in so far as these relate to the application of rate of tax under sub-paragraph
(3) of Paragraph A of Part IV of the First Schedule shall not apply to an individual
being-
(i) a Government servant staying abroad on official assignment or with the permission of
the Federal Government or Provincial Government; and
(ii) a Pakistani student, teacher or scholar staying abroad for studies or research [--]
(iii) a Pakistani national who is not
resident in Pakistan in any year and not earning any income abroad.
(17) The provisions of sub-section (5) of section 50 shall not
apply to goods or classes of goods imported by contractors and sub-contractors engaged in
the execution of power project under the agreement between the Islamic Republic of
Pakistan and Hub Power Company Limited.
8.1-2 Foreign tax credit system - Under the foreign tax credit
system, foreign income of residents is subject to Pakistan Tax. However, up to the amount
not exceeding the Pakistan Tax payable thereon, the foreign tax paid will be credited
against the total tax liability in Pakistan arising from the receipt of foreign income.
Thus, a Pakistani resident pays tax on foreign income as if it were received or it had
accrued in Pakistan. The effect of such credit is to impose ‘tax neutrality’
prompting a decision on the part of a Pakistani resident in regard to location of the
source of income to a country where the tax rate is low. In treating foreign and domestic
taxes alike, the countries observe strict neutrality as regards foreign and domestic
investment. Such treatment neither encourages nor discriminates against the foreign
investment.
The common features of a foreign tax credit system is that the creditable foreign taxes
cannot exceed the ‘home’ or ‘residence’ country’s tax on the
foreign income. Failing such a foreign tax credit limit, the excess’ credit arising
could be offset against tax on domestic income, reducing the home country’s revenue
collections. In setting a foreign tax credit limit, two options are available, namely, a
country-by-country or a worldwide limit. In the case of the former foreign tax credit
limit is calculated separately for each country and excess credits from high tax countries
cannot be used to offset low taxes in other countries. In the case of latter, an averaging
of high and low taxes is taken, providing enough scope to the taxpayer for planning taxes
with a view to reducing their incidence to the minimum.
There is another mode of following the foreign tax credit system. The countries which
follow this system allow a ‘deemed paid’ foreign tax credit for profits taxes
paid by foreign subsidiaries of domestic corporations, to the extent that such profits are
distributable in the form of dividends. Such a practice is like a scheme popularly known
as ‘imputation system’. An imputation system of company taxation imputes to
shareholders tax that has already been paid by their company or corporate profits. The
‘imputation system’ is of recent origin and tends to eliminate the double
taxation of the company profits which the classical system imposes. A shareholder receives
a tax rebate for the tax paid on the company’s income. Tax payments are passed on to
the shareholders in the form of franked dividends, with the amount of dividend carrying a
full tax rebate having termed the franked amount of dividend.
But the foreign tax credit system and imputation system of company tax have important
interaction. The most significant relationship is that the foreign tax credits to which a
domestic company is entitled to cannot passed on to the shareholders. The imputation
system is effective or operative up to one stage alone and cannot be extended to a second
degree of recipients. The domestic company is the beneficiary of the imputation system in
respect of the income received by it as dividend from its foreign subsidiary.
Its shareholders cannot be entitled to have the benefit of credit for the foreign tax paid
by the foreign company. They only receive a tax rebate for the actual domestic tax paid
computed after making allowance of the foreign tax credit received by that company.
However, if an individual has been shareholder in the foreign company, and not through the
domestic company, he would have received the foreign tax credit. To that extent
discrimination exists in his favour vis-a-vis an individual who is recipient of a profit
of the foreign company through the domestic company.
Thus, the essential feature of foreign tax credit is that the country allowing deduction
for it treats it as if it were paid to itself, within certain statutory limitations of its
domestic laws. Its main defect, however, is that any tax benefit given by the source
country in order to attract foreign investment either on account of low rate of tax or of
special tax concessions, accrues to the country of investor rather than to himself for
whom the benefit is designed. The revenue is shifted from the source to the residence
country. This defect is somewhat mended through the doctrine of 'tax sparing' which is
discussed in detail in this book in the coming chapters.
Further, unilateral measures to eliminate excessive tax burden are insufficient and
inadequate. Satisfactory accommodation of the conflicting tax claims could be agreed upon
bilaterally, which otherwise could not have been possible. The provisions under the
domestic laws for unilateral tax relief are inflexible, conflicting tax claims cannot be
reconciled under them. Bilateral tax treaty permits a degree of mutual adjustment and
accommodation.
8.1-3 Section 164 and unilateral relief - Income Tax
Ordinance, 1979 seeks to reduce the impact of double taxation by allowing foreign taxes to
be credited against the amount of tax as is chargeable in Pakistan on the same income
[section 164 read with Seventh Schedule]. This is done unilaterally. The credit allowable
is worked out as follows, but it will never exceed the amount of Pakistani Tax which
becomes due and payable:
* Where the foreign tax equals the Pakistani tax rate, only the foreign tax will be
payable.
* Where the foreign tax exceeds the Pakistani tax, no tax will be payable in Pakistan.
* Where the foreign tax paid is less than the Pakistani tax, there is a liability on the
balance up to the Pakistani tax rate.
The benefit of such adjustment is given only in case the person is resident in Pakistan
during the relevant year.
In order that an assessee is entitled to claim deduction on the double taxed income, the
following requirements have to be satisfied:
* The assessee must have been resident in Pakistan in the relevant income year.
* Income must have accrued or arisen to him during that income year outside Pakistan.
* In respect of that income which has accrued or arisen outside Pakistan, he must have
paid by way of deduction or otherwise tax under the law in force in the country in
question.
If the above conditions are satisfied, the assessee is entitled to deduction from the tax
payable by him in Pakistan of a sum calculated on such doubly taxed income at the
Pakistani rate of tax or at rate of tax of the said country, whichever is lower.
9. "Such doubly taxed income" - Meaning of
The entitlement of an assessee to deduction extends to ‘such doubly taxed
income’. Therefore, this expression requires detailed discussion. The expression
‘such’ must not only refer to the category of income included in the gross total
income but also to the quantum of income so included.
The category of income included in the total income should be that which has already
suffered tax in the foreign country. Thus, the expression ‘such’ refers to the
income which accrues or arises outside Pakistan during the income year, and the expression
‘doubly taxed income’, in its plain grammatical meaning refers to foreign
income-tax under the Pakistani law. The word
‘such doubly taxed income can have reference to the tax which the foreign income
bears once again the burden of Pakistani income-tax by its being included in the total
income chargeable under section 9.
The main requirement, therefore, is that the income must have been taxed outside Pakistan
and the same income must have been taxed under the Income-tax Law in Pakistan. If any
portion of the foreign income is not subjected to tax in Pakistan, then the assessee would
not be entitled to claim deduction on that part of the income which is not so subjected to
tax. The criteria are not only that the foreign income be included in the total income in
the assessment made under the Income Tax Ordinance, 1979, but that it should also be
subjected to tax in this country. The real test, therefore, is whether the income in
respect of which tax deduction is claimed by the assessee is subjected to tax under the
Income Tax Ordinance. If any slice of foreign income is not subjected to tax in the
assessment made in Pakistan, it is not possible to treat such foreign income as subjected
to tax in Pakistan, it is not possible to treat such foreign income as subjected to tax in
Pakistan, it is not possible to treat such foreign income as subjected to tax in Pakistan
and also as forming part of doubly taxed income for the purpose of section 164.
In CIT v. C.S. Murthy, a question arose before the
Andhra Pradesh High Court, whether the assessee was entitled to relief, under section 91
of the Indian Act (parallel to section 164 of Pakistani Income Tax Ordinance, 1979) of the
entire tax deducted at source by the foreign Government, or only of that amount which is
referable to the income subjected to tax in India. The facts of this case were:
The assessee, who was employed as a dental surgeon in India, went on deputation to Iran.
He received a salary of Rs. 64,470 from the Government of Iran, wherefrom tax of Rs. 5,974
was deducted. This amount was also to be included in the total income of the assessee in
India by virtue of section 5(1)(c) of the Act (parallel to section 12(1) of Income Tax
Ordinance, 1979) the assessee was entitled to deduction of 50 per cent of such income
under section 80RRR. The Income-tax Officer allowed deduction of Rs. 32,235. In respect of
the double taxed income, he held that although the assessee received the remuneration of
Rs. 64,470 from the foreign employer, the amount that was doubly taxed under the Act was
only one-half as the balance half was allowed as deduction under section 80RRR and hence
the assessee was entitled to relief under section 91 only on Rs. 32,235. The tax at the
rate applicable in Iran on the sum of Rs. 32,235 was ascertained at Rs. 2,986 and as that
tax was less than the Indian rate of tax, the said amount of Rs. 2,986 was allowed
deduction from out of the tax payable by the assessee. The High Court, while upholding the
view taken by the Income-tax Officer, held that the relief by way of deduction of tax
under section 91 should be confined to the amount doubly taxed in accordance with the
provisions of the Act and not to the full amount received by the assessee from the foreign
employer. [This case has significant relevance for Pakistani Income Tax Law as provisions
of unilateral relief are similar in both the enactments.]
10. Foreign collaboration policy in Pakistan
Foreign investment plays an important role in the growth and development of any
economy. The pace of industrial development, specifically in the developing countries,
depends largely on investment from foreign companies as well as in transfer of
technological know-how. The investment may consist in providing technology, technical
know-how, services in banking, advertising, transportation, insurance, communication, data
processing, construction, engineering, entertainment, tourism, management and capital. In
addition to transferring financial resources, direct foreign investment makes available to
the local partners management skills and technical know-how. The presence of foreign
enterprises with superior administration/managemental techniques and technologies tends to
stimulate innovation and adaptation and improve management efficiency in local companies.
The direct foreign investment has far-reaching effect on the balance of payment in two
ways (a) capital inflow and outflow, directly assisted foreign investment and trade
related activities by the foreign companies and (b) direct foreign investment has,
therefore, been an important source of technology and valuable foreign exchange. This
effects the economic and industrial development of Pakistan in the following manner:-
(a) They bring in foreign capital.
(b) They bring technology and knowledge of which are often lacking in our industrial
environment.
(c) They employ our unemployed or underemployed.
(d) They reinvest their surplus.
(e) They provide the much needed competitive edge.
It is a well-know fact that foreign investment not only brings in foreign capital but also
technology. Technology is now recognized as an increasingly indispensable factor in
development. For developing countries like Pakistan, import of technology is inevitable
because of impossibilities and incapacity to develop it themselves.
The impossibilities reside in the lack of funds, resources and the infrastructure. The
cost of technology generation, including construction of pilot plant, are prohibited. For
example it has been estimated that it costs US $ 80 million to develop the technology for
transistor, and US $ 13.3 million for float glass. The interval between invention and
commercialization is also lengthy. For example, 13 years for photocopying process, 22
years for television and 11 years for nylon. The developed countries neither have the
expertise, skill, resources and funds to undertake research for development of
technologies nor the patience to wait for long before the research culminates into
commercialization. Therefore, dependence on foreign technology as a means for their
industrialization and for enabling themselves in future to develop and generate local
technology is inevitable.
10.1. Technology, meaning of - With the rapid pace of
development in developing countries, the need of transfer of advance technology or
appropriate technology has become a prerequisite for maintaining the level of development
and for ensuring that they do not suffer from either stagnation or retardation. Technology
is a complex subject. According to UNIDO Guidelines Paper, it denotes "some
knowledge, expertise and skills necessary for manufacturing a product or products and for
establishing an enterprise for its purposes". Technology not only refers to raising
or producing goods but also a mean of fulfilling needs and deriving satisfaction. The
technology of consumption has a profound impact on the structural pace of the economy
influencing the goods and services to be produced. In a proper sense, technology is viewed
as a systematic or practical knowledge, expertise to skill used for: (i) mainly of
products or application of process, (ii) commercial or management purposes in industry,
(iii) the achievement of any desired result be it in industrial or social areas of life.
Technology serves as the following:-
1. An instrument for industrial resources into commercial products.
2. As a tool for conditioning environment.
3. As a resource of channelizing wealth.
4. As a medium for bringing socio-economic changes.
5. As a determinant factor in development.
6. As a trade product.
Developed countries continue to dominate the field of science and technology to the extent
of about 95% of research and development being executed by them, while the developing
countries which represent 75 per cent of the global population have only 5% of the
world’s research and development capacity as noted in US Conference on Science and
Technology for Development in the preamble for the "Programme of Action adopted in
Vienna in 1979". There has been a realization in the developing countries for the
need of advanced technology to encourage intra-regional investment. With the transfer of
technology, there is exchange of information, consultancy service and specialised
training. For the development of economy the developing countries need three types of
technology-based projects:-
(a) Import sector projects based on acquiring technologies and aimed at rapid
socio-economic development.
(b) Projects based on indigenous technology which attempt to bring harmony in surroundings
and improving the real economy.
(c) Export sector projects for the export of production of high potential and high
technology projects.
The developing countries do have technology policies spelt out in varying degrees of
detail reflecting the ideologies, prospectives and objects of the national development.
10.2. Technology policy of Pakistan - In Pakistan, the
technology policy is laid down in considerable detail indicating clearly the quantum and
quality of latitude available to the contracting parties.
The objectives of technology policy are development of indigenous technology and efficient
absorption and adaptation of imported technology appropriate to national priorities and
resources. In present day's world, Governments, policy towards import of technology is
selective and based on national priorities. Import of technology is permitted in
sophisticated and high priority areas, in export-oriented or import substitution
manufacturing or for enabling indigenous industry to update existing technology to meet
competition effectively to adjust the changing consumer preference, and become competitive
in export market. This policy stems basically from the fact that requirements in the
industrial field today are vastly different from what they used to be earlier. Pakistan
has been keen to reduce dependence on external resources and to become self-reliant
through proper utilisation of various resources - industrial, human and technical - as
speedily as possible. Government's policy endeavours to channelise technology imports into
areas which will reinforce our own efforts to accelerate the country's economic growth. It
is recognised by the Pakistan Government that with consistent technological advancement,
the need to update our production technology would arise in almost all industries over a
period of time.
Although Pakistani economy is heading towards deregulation, Pakistan's policy has been
restrictive and selective. The basic policy. is that foreign investment is welcomed only
if it is accompanied by technology transfer or if the production is primarily for export.
Additional features are saving of foreign exchange through import substitution and import
of energy saving technology.
Import of technology is made in Pakistan, amongst others, where -
(a) there is a technological gap in any industrial sector;
(b) the indigenous technology is closely held;
(c) existing technology requires updating;
(d) it is associated with substantial export.
Pakistan offers a host of incentives in the' form of tax-free industrial zones,
accelerated depreciation, carry forward of losses, total tax holidays if the enterprise is
export-oriented or is established in free trade zone, tax holidays if it is established in
backward areas and/or is engaged in manufacturing or processing of goods or articles and
many others. The Income Tax Ordinance, 1979 contains provisions exempting foreign income
or offering a credit against foreign tax levied on the world Income.
Other important measures available under the Income-tax Ordinance are:
* Taxes on income or profits paid in the other country are eligible for credit against
Pakistani income-tax payable. The credit being limited to the amount of taxes otherwise
payable on such income.
* Pakistan has double taxation agreements in force with several countries. These
agreements not only provide for specific mechanisms to avoid double taxation, normally by
way of credit, but also reduce, and put a ceiling on the rate of withholding tax that may
be imposed on dividends, interest or royalties paid by the resident of one country to the
resident of the another.
10.3. Role of double taxation agreements - Tax agreements play
a very significant role in the flow of capital and technology from the developed to the
developing countries. The aim is to provide for the tax claims of two Governments both
legitimately interest in taxing a particular source of income either by resigning to one
of the two whole claim or else by prescribing the basis on which the tax claim is to be
shared between them. The language employed in the agreement is what may be called
international tax language. Tax agreement together with unilateral tax relief provisions
constitutes a part of international tax understanding and help in the development of
international tax laws.
|
|
|
|
|
|
| Home | About Us | Contact | Information Resources |