| |
|
 |
| For business information, annual reports, laws, ordinances, regulations and articles. |
|
|
|
PARAMETERS
CHAPTER I
SCOPE OF THE CONVENTION
ARTICLE 1
PERSONAL SCOPE
This Convention shall apply to persons who are residents of one or both of the Contacting States.
ARTICLE 2
TAXES COVERED
(1) This Convention shall apply to taxes on income (and on
capital) imposed on behalf of a Contracting state or of its political sub-division or
local authorities, irrespective of the manner in which they are levied.
(2) These shall be regarded as taxes on income (and on capital), all taxes imposed on
total income, (on total capital), or on elements of income (or of capital) including taxes
on gains from the alienation of movable or immovable property, taxes on the total amounts
of wages or salaries paid by enterprises, as well as taxes on capital appreciation.
(3) The existing taxes to which the convention shall apply are in particular:
(a) (in State A):..........................................
(b) (in State B):..........................................
(4) The Convention shall apply also to any identical or substantially similar taxes which
are imposed after the date of signature of the Convention in addition to, or in place of
the existing taxes. At the end of each year, the competent authorities of the Contracting
States shall notify each other of changes which have been made in their respective
taxation laws.
16. Scope
The agreement affects all resident persons of the Contracting States, who have
business dealings with the other country or who have income from specified sources such as
interest, dividend, royalty, etc., from the country other than of their residence or who
receive payments from such country. The scope of the agreement relates to such vital
matters as to who particular taxpayer is entitled to agreement benefits and what taxes are
covered by it. These are the basic and fundamental requirements for the application of the
agreement.
The concept of 'person' occupies pivotal position in tax agreement whether as owner of
property or investment or business and the source of income being such investment or
business or his personal skill. ‘Person’ is entitled to the agreement benefit if
he is the recipient of income in law or in fact. If the recipient is an individual, the
taxability or the agreement entitlements depend upon his 'residence' in terms of Article 4
of the UN Model. Thus, the two expressions, viz, 'person' and 'resident' are separately
dealt with and defined in every agreement, so that the benefits of the agreement could be
confined to only those who fall within this definition in addition to their being resident
of one or the other or both the States.
The agreement applies to taxes on income imposed by each country, irrespective of the
manner in which these are levied. It specifies the 'taxes' which are normally covered
under the agreement. As for Pakistan, these are income-tax, super-tax and surcharge (if
any) levied under the Income Tax Ordinance, 1979. The agreement further designates what
'income' or 'profit' is covered by its rules and how the same is to be attributed to each
Contracting State.
The scope thus determines the person who is entitled to agreement benefits and 'tax' which
is its subject-matter.
16.1. Relation between tax object and the person receiving income and
the State - It is necessary to designate the Particular objects to which the agreement
applies for distribution of income amongst States. Income may arise from an activity such
as business or Professional activity or a property tangible or intangible. Computation of
income with reference to activity or the property has to be decided and thereafter the
right of each Contracting State to tax it. The relation between the tax object and the
person receiving it on the one hand and the State on the other has to be established
either by the presence of the activity in the State such as a fixed place or permanent
establishment, or of the situs of the real property, or by the residential status of the
person receiving it. Income attributable to the presence of the activity or of the
property in a State is taxable in that State. Distribution of income between the
Contracting States is thus mainly dependent upon the principle of attribution.
As regards procedure for the application of an agreement, there exists no choice with the
taxpayer. He cannot certainly choose whether or not agreement applies to him. However, tax
liability according to domestic law has first to be examined. Agreement being lex
specialize in relation to domestic laws, has to be applied in addition to or even beyond
them for establishing a tax liability. Agreement provisions have to be superimposed upon
those of the domestic laws and to the extent of conflict, the former
prevail.
The tax claim of each Contracting State is limited to the amount as arrived at on the
basis of attributability. A question may arise whether agreement provisions would still be
applicable if an enterprise is liable to tax only in one of the Contracting States, viz.,
it is liable to tax in its own capacity in the country of source but not so liable in the
country of residence. agreement benefit cannot be denied to a ‘person’ who is
not liable to tax in a country in which its residence or its seat is located, because it
has no income or property or because it is exempt from tax though he may be
‘resident’ there. A person if not deemed to be so in terms of domestic law
though he qualifies for that status according to an agreement cannot forfeit its claim of
agreement protection. The purpose of defining ‘residence’ in Article 4 of the
Model with reference to the criteria as laid down under the domestic law is only to
establish a physical connection and not to deny the benefit of agreement provisions.
Similarly, if an entity which qualifies to be a person within the meaning of Article 3 of
the Model is not taxable as such, it should not be treated differently. Non-taxability in
the State of residence of a person and an entity not being taken to be a person under the
domestic law are not the relevant considerations for denial of agreement benefits. A
person should be treated ‘resident’ if his physical connection with a
Contracting State so qualifies him, had he been liable to tax in the status of a resident;
Consequently, in the source State, which treats it as an independent taxable entity, the
person is entitled to agreement protection. The expressions ‘taxes’,
‘income’, ‘total income’ which are used in Article 2 require some
discussion in the context of existing Pakistani Income-tax Law, namely, Income Tax
Ordinance, 1979.
17. Tax
The components which enter into the concept of tax are well known. The first is the
character of the imposition known by its nature which prescribes the taxable event
attracting the levy, the second is a clear indication of the person on whom the levy is
imposed and who is obliged to pay tax, the third is the rate at which the tax is imposed,
and the fourth is the measure or value to which the rate is to be applied for computing
the tax liability. If these components are not clearly and definitely ascertainable it is
difficult to say that the levy exists in point of law. Any uncertainty or vagueness in the
legislative scheme defining any of these components of the levy will be fatal to its validity.
17.1 Scheme of Income-tax Ordinance is to create charge, define,
classify and quantify income - Income-tax is only one tax levied on the sum total of the
income classified and chargeable under the various heads as enumerated in section 15 of
the Ordinance, namely, ‘Salary’ interest on securities, income from house
property, profits and gains from business or profession, capital gains and income from
other sources. The only effect of section 15 is to classify profits and gains under
different heads according to the character of the source, for the purpose of providing for
each head appropriate rules for computing the amount of income. In that context,
income-tax is not a collection of distinct taxes levied separately on each head of income.
In other words, assessment to income-tax is one whole and not a group of assessments on
different heads or items of income. A tax will remain a tax of income, whatever may be the
head and by which income is measured. Viewing
section 15 together with section 9, 10 and 11 of the Ordinance it is apparent that the
scheme, in short, is that section 9 charges total income, section 11 defines its range,
section 15 classifies and sections 16 to 31 quantify it.
17.2. Imposition of tax - There are three stages of tax
liability. There is a declaration of liability, that is to say the statute determines and
indentifies persons who are liable to tax for their income. Next, there is the assessment.
Liability does not depend on assessment. That is, ex-hypothesi has already been lured. But
assessment particularises the exact sum which a person liable has to pay. Lastly, comes
the method of recovery, if the person taxed does not voluntarily pay.
The tax liability comes into existence on the last day of the income year relevant to an
assessment year. Section 9 of the Ordinance lays
down that the income-tax shall be charged for any assessment year in respect of the total
income of the income year relevant to that assessment year. There is a good of difference
between income being liable to tax and tax being assessed and charged on income. It is not possible to construe the tax chargeable as connoting the tax
determinable on the basis of the total income of the assessee as assessed under section
59(1), 59A, 60, 60A, 62, 63 or 65 of the Ordinance. Tax determinable on income may turn
out to be nil because of allowances or admissible expenses or other deductions or prior
assessed losses, if any, carried forward.
Income which is chargeable is not only the amount which in fact has arisen, accrued to or
received by the assessee but is also the amount which is deemed to be his income by virtue
of the legal fiction. The income must include every item of income which goes to make up
the total income assessable under the Ordinance. Once an amount is deemed under any
provision of the law to be the assessee's income, all necessary consequences by treating
the said amount as income for the purpose of law would necessarily
follow.
17.3. Income Tax Ordinance governs taxation of income in the
absence
of provision in agreement - In considering what taxes are attributable to the tax laws
of a particular country, one has to take into consideration all the provisions of the
statute levying tax. In other words, for determining the tax due from an assessee, one
should not merely to look to the charging section but also to the provisions providing
exemptions and allowances and deductions. Where a
double taxation agreement provides for a particular mode of computation of income, the
same should be followed irrespective of the provision in the Income Tax Ordinance. Where
there is no specific provision in the agreement, it is the basic law, i.e., the Income Tax
Ordinance, that governs the taxation of income.
18. Income
The object of the Income Tax Ordinance is to tax income, a term which it does not
define. The definition of income in section 2(24)
of the Ordinance is inclusive and not exhaustive. Such a definition may not be helpful in
deciding all questions whether a receipt in the hands of an assessee represents income
taxable under the Income Tax Ordinance. But, the decided cases have held that the word,
‘income’ should be understood according to its ordinary dictionary meaning. The
ordinary dictionary meaning of the word ‘income’ is that which comes in as the
periodical produce of one’s work, business, lands or investments (considered in
reference to its amount and commonly expressed in terms of money); annual or periodical
receipts accruing to a person or corporation (Oxford Dictionary). The word clearly implies
the idea of a receipt, actual or constructive. The policy of the Ordinance is to make the
amount taxable when it is paid or received either actually or constructively.
The word ‘income’ cannotes a periodical monetary return
coming in with some sort of regularity or expected regularity, from a definite source. The
source is not necessarily one which is expected to be continuously productive but it must
be one whose object is the production of a definite return, excluding anything in the
nature of a windfall. The income has been likened pictorially to the fruit of a tree, or
the crop of a field. Thus, every receipt which
can be described income is taxable under the Ordinance, unless expressly exempted. The source of income needs not be one which is
recognised under the law and even income derived from illegal business could be held
liable to tax. the diverse forms which income may
assume cannot exhaustively be enumerated and so in each case the decision of the question
as to whether any particular receipt is income or not must depend upon the nature of the
receipt and the true scope and effect of the relevant taxing provision. Thus, income is a monetary return expected by the assessee for the
labour and/or the skill bestowed and/or the capital invested by him coming in from a
definite source, which need not be legal source, in the sense that the failure to pay the
same need not be enforceable in a court of law; and excluding a receipt ‘in the
nature of’ a mere windfall which must mean a windfall in regard to its very nature
and not in regard to its extent or quantum.
Thus, the definition of income in section 2(24) of the Ordinance is not exhaustive. It is
inclusive and fictional, covers things which this clause declares to include, but also
such things as the word signifies according to its natural import. This clause is drafted
in a manner to bring in artificial categories to the natural connotation of
‘income’. The object of the Ordinance is to tax ‘income’, a term of
formidably wide and vague import. The word ‘income’ is to tax
‘income’, a term of formidably wide and vague import. The word
‘income’ is an expression of elastic nature. It is a more general term than
‘profits’ and ‘gains’; it means something which is in the nature of
interest or fruit, as opposed to the principal or tree. The profit of a trade or business
is the surplus by which the receipts from the trade or business exceed the expenditure
necessary for the purpose of earning those receipts. The tax is upon income, profits or
gains; it is not a tax on gross receipts. The expression ‘profits or gains’ is
not limited to business only but it used in the Ordinance with reference to other sources
of income as well. The income need not necessarily arise from any business activity,
investment or outlay as any enforceable obligation to pay. Voluntary payments in order to
be taxable in the hands of recipient as income must have an origin which a practical man
would regard as a real source of income. In United
States of America and in Australia, the expression 'income' is understood in a wide
sense so as to include even capital gains, as is done in Pakistan and to which the
agreement model refers. The Supreme Court of India in Navinchandra Mafatlal v. CIT held that capital gain is also 'income'. If an
asset is employed, say, by way of investment and produces income, the income arises or
springs from the asset; the operation which causes the income to spring from the asset is
the operation of investment. In the operation of investment, income is produced while the
asset continues to belong to the assessee, whereas in the operation of sale, gain is
produced, which is still income but in the process, the title to the asset is parted with.
Although the process involved in the two cases are different, the gain which has resulted
to the owner of the asset, in each case, is the gain which has sprung or arisen from the
asset. There is hence no room or logic for argument that the capital gain is not income
arising from this asset.
18.1. To constitute income source is necessary - To constitute
income, profits or gains, there must be a source from which the particular receipt has
arisen, and a connection must exist between the quality of the receipt and the source. If
the payment is by another person, it must be found out why that payment has been made. It
is not the motive of the person who pays that is relevant. More relevance attaches to the
nature of the receipt in the hands of the person who receives it though in trying to find
out the quality of the receipt, one may have to examine the motive out of which the
payment is made. It may also be stated as a general rule that the fact that the amount
involved is large or that it is periodic in character have no decisive bearing upon the
matter. A payment may even be described as 'pay', 'remuneration', etc., but that does not
determine its quality, though the name by which it has been called may be relevant in
determining its true nature, because this gives an indication of how the person who pays
the money and the person who receives it view it in the first instance. The periodicity of
the payment does not make the payment a recurring income because periodicity may be the
result of convenience and not necessarily the result of the establishment of a source
expected to be productive over a certain period.
18.2. Nature of receipts decided at the time it is received -
Once the amounts are received by the assessee as trading receipts, they continue to retain
that character and that character is not affected or altered merely because subsequently
the assessee chooses to bring them to its profit and loss account in the accounting year
in question. If the amount is of the nature of a trading receipt in the hands of an
assessee from the very inception, merely because the assessee chooses to place the said
amount in the suspense account or in any other account and thereafter bring it in the
profit and loss account, will not change the character of the payment received by the
assessee. The assessee cannot unilaterally change the character of the payment if the
payment was initially made towards the price of the goods supplied.
18.3. Nomenclature of receipt is not decisive - Where money is
paid under a contract of sale, the nomenclature employed, whether earnest or advance, is
not really the crux of the matter. Though the clause providing for forfeiture of amount in
the event of default by the purchaser is not by itself a conclusive circumstance, that
circumstance has to be taken into consideration along with other circumstances to
ascertain the real character of the amount paid under the contract. Where an amount is
paid on the date of the agreement there is an initial presumption that the amount is paid
as security for performance of contract. That the amount has been described as advance and
not earnest is not sufficient circumstance to rebut the presumption.
It is well-settled that the way in which entries are made by an assessee in his books of
account is not determinative of the question whether the assessee has earned any profit or
suffered any loss. The assessee may, by making entries which are not in conformity with
the proper accountancy principles, conceal profit or show loss and the entries made by him
cannot, therefore be regarded as conclusive one way or the other. What is necessary to be
considered is the true nature of the transaction and whether in fact it has resulted in
profit or loss to the assessee.
The quality and nature of receipt for income-tax purposes is fixed once for all, when it
is received. Receipts of money or deposits for adjustment in the price of goods to be
supplied or services to be rendered may be mere advance payments and, therefore, revenue
receipts and not borrowed money. They are an integral part of a commercial transaction of
sale or services and are related to the price of goods or to the charges for services
rendered. They are trade receipts and money of the assessee, and hence his revenue or
income. Receipts in the nature of deposits for making good the defaults, if any, of the
person making the deposit on the other hand, are simply loans owned by the assessee to
such person and they form part of the assessee’s trading structure and not trade
receipts. Such deposits may be made not on account of any goods supplied or services
rendered in the course of trade; but simply in consideration, say, for example, of such
person’s appointment as an agent. They have no relation to the price of goods
supplied or the charges for services rendered and are in the nature of borrowed money and,
therefore, capital and not trade receipts, and do not cease to be so by being written in
the assessee’s books in a particular manner.
In Morley (Inspector of Taxes) v. Tattersall, the
Court held that the quality and nature of a receipt for income-tax purposes is fixed
once and for all when the subject of the receipt is received. In that case Tattersall, a
firm, carried on the business of auctioneers of horses. One of the conditions of sale was:
‘No money paid, or remittance sent by post, without written order.’ Unclaimed
balances got accumulated in the course of time and remained in the firm’s hands. At
all times the firm considered itself liable to pay such balances as and when claims were
made. Under the partnership deed by which the firm was constituted part of the unclaimed
balances were transferred to the credit of the partners and provision was made for
subsequent annual transfers. The deed provided also that any payments which might be
claimed and made in respect of the balances should be borne by the partners in proportion
to their shares of profits at the date of payment. The question arose whether the
unclaimed balances transferred to the partners were trading receipts in respect of which
the assessee was assessable. Giving a negative answer to the question, Sir Wilfrid Greene
M.R., observed:
"...The money which was received was money which had not got any profit-making
quality about it; it was money which is a business sense was the client’s money and
nobody else’s. It was money for which they were liable to account to the client, and
the fact that they paid it into their own account, as they clearly did, and the fact that
it remained among their assets until paid out, do not alter that circumstance. It would
have been for income-tax purposes in my judgment, entirely improper to have brought those
receipts into the account at all for the purpose of ascertaining the balance of profits
and gains...."(p.323)
The Court also held that at the time of transferring the balances to their own accounts
the partners ‘could not imprint upon some existing asset the quality different from
what it had possessed before’. There was no existing asset at all at that time as it
was a liability. By writing down the liability item in the balance sheet, they could not
convert it into something which it never was.
In Davies (H.M. Inspector of Taxes) v. Shell Co. of China Ltd., the assessee, under an agreement with its agents, was to retain
deposits received from the agents during the period of the agency for making good the
agents’ defaults in the event of any default in payment. These amounts remained
simply as loans owing by the company to the agents and repayable on termination of the
agency. Agents’ deposits were described as part of the company’s trading
structure, not trade receipts, but anterior to the stage of trade receipts. The agent was
held to be a creditor of the company in respect of deposit, not on account of any goods
supplied or services rendered by him in the course of its trade, but simply by virtue of
the fact that he had been appointed an agent of the company with a view to trade on its
behalf, and as a condition o appointment had deposited with or in other words, lent to the
company the amount of his stipulated deposit. As loans were held to be on capital account
and not on revenue account, these were considered as part of the company’s fixed and
not its circulating capital.
18.4. Whether a receipt is capital or revenue - The principles
that can be deduced from various decisions of the Pakistani and the foreign courts for
determining whether a particular amount received by an assessee is capital or revenue in
nature are as under:
* The name given to a transaction by the parties concerned does not necessarily decide the
nature of the transaction. In such a case the question always is what is the real
character of the payment not what the parties call.
* It is the quality of the payment that is decisive of the character of the payment and
not the method of payment or its measure and makes it fall within capital or revenue.
* The fact that receipt is a periodic receipt or a single receipt is immaterial for the
purpose of determining its nature; an income receipt is not necessarily recurring; nor a
capital receipt necessarily single.
* The nature of the receipt is to be determined from a commercial point of view.
* The nature of the receipt is to be seen in the hands of the receiver and not in the
hands of the payer.
* The nature and quality of the payment is to be seen and the motive of the payer is not
material though motive may be enquired into. Whether the amount is large or is periodic in
character, they do not determine its quality.
* The fact that a certain payment is measured by estimated annual yield or profits does
not make the payment an income receipt.
* Profit motive is not decisive of the question whether a particular receipt is capital or income.
* The question whether the payer is compellable to pay has no relevance in the
determination of the character of the receipt. It may be that the payee has no legal claim
for payment and the payment is made voluntarily, yet the receipt may be of revenue character.
* A voluntary payment is a profit of employment if it accrues by virtue of the employment
notwithstanding that there may not be any legal obligation to make the payment. If,
however, the payment is in the nature of a personal gift to him, it is not regarded as a
payment for services but as a mere present.
* The voluntary payment to a lawyer by a person who is not a client but who has benefited
by the lawyer’s professional services to another is taxable.
* The fund out of which the money came is not material.
* General payments made by way of donation to a company out of benevolence or feeling of
charity would not entail income in the hands of the recipient.
* Amounts received in settlement of a right under trading contract are trading receipts.39
On the question of receipt in the nature of compensation the law is as discussed below:
18.5. Compensation on termination of agency itself vis-a-vis
compensation on termination of agreement which is not the source of income - If the
agreement itself is the source of income from which income, profits and gains spring up
and the compensation is paid to a person on account of its termination, it could be said
that the compensation relates to the extinction of the source and also the profit-making
apparatus and in that sense, a capital receipt, as happens normally on termination of
agency contracts. In that case there is no capital asset de hors the agreement. But if the
agreement is not the real source of income and the real resource is something else (for
example trading or commercial assets such as cinema hall, factory, which are leased out
under an agreement), the compensation on termination of the agreement could be a trading
receipt. The agreement is only a means to manage and exploit that asset to produce income.
If the agreements, which constitute the source and profit-making apparatus, are
terminated, the compensation received by the assessee is capital receipt provided, besides
the agreements, there are no other capital asset producing the income.
18.6 Amount paid for refraining from carrying on competitive
business - There is no imitable principle that the compensation received on
cancellation of an agency must always be regarded as capital. Compensation paid for
agreeing to refrain from carrying on competitive business in the commodities in respect of
the agency terminated or for loss of goodwill is prima facie of the nature of a capital receipt.
18.7 Compensation for surrender of industrial licence - In CIT
v. Automobile Products of India Ltd., the Bombay
High Court held that where the termination of the activity is not a necessary incident of
the business of the assessee and that the extinction and surrender of the industrial
licence and the collaboration agreement has impaired the profit-making structure of the
assessee, the amount received by it as compensation will be a capital receipt.
18.8 Amount received on termination of agreement for distribution
of films - In CIT/CEPT v. South India Pictures Ltd., the Supreme Court of India held that the amount received by the assessee,
who was carrying on business of distribution of films, from the producers on the
termination of the agreement, was not the compensation for not carrying on its business
but was a sum paid in the ordinary course of business to adjust the relation between the
assessee and the producers and that the termination of the agreement did not radically or
at all affect or alter the structure of the assessee’s business. The amount received
by the assessee was held taxable.
18.9. Forfeiture of security deposited by lessee - In CIT v.
Balaji Chitra Mandir, the assessee had leased out
a cinema hall and received certain amount from the lessee on a security under the
agreement. The lessee committed default in the payment of the weekly rent and the assessee
terminated the lease and forfeited the security. The High Court held that the amount
received by the assessee as forfeiture of the security deposit constituted a revenue
receipt on the ground that the capital asset producing income was not the lease agreement
but the cinema hall itself and that the lease agreement was only a means to manage the
cinema hall and that the payment made in the settlement of rights under a trading contract
are trading receipts.
18.10. Compensation on termination of contracts is capital receipt
except in certain cases - The law is well-settled that compensation for termination of
contracts would be capital receipt if received in return of the loss of an
income-producing or an enduring asset. It would be revenue receipt if done in the ordinary
course of business. But the Legislature have intended to treat certain receipts as taxable
which would otherwise have been of capital in nature. Under section 16(2)(c)(i), the
amount of any compensation due to or received by an assessee from his employer or former
employer at or in connection with the termination of his employment or the modification of
the terms and conditions relating thereto, is deemed to be profit in lieu of salary and is
assessable as income under the head ‘Salary’. Compensation or other payment
received by an assessee at or in connection with termination of agreement of management or
of agency or of office, or modification of the terms and conditions of such agreement is
deemed to be the assessee’s income assessable under the head ‘Income from
business or profession’ in view of section 22(a). But in a case which falls beyond
the scope of the provisions of section 16(2)(c)(i) or 22(a) the compensation, if it refers
to the impairment of income-producing asset, it would be taken as a capital receipt.
* If the compensation has been paid in respect of two distinct matters, one taking the
character of a capital receipt and the other of a revenue receipt, nothing prevents the
apportionment of income between the two matters on accounting principles or on reasonable
estimates consonant with general and equitable principles. Even if there be a difficulty
in making such apportionment, it cannot be a ground for rejecting the claim either of the
revenue or of the assessee.
The fact that the amount might be used as capital in the hands of the assessee is
irrelevant for considering it as a non-revenue receipt.
19. Total income - Meaning of
Section 2(44) of the Ordinance defines ‘total income’ to mean the total
income referred to in section 11 of the Ordinance, computed in the manner laid down in the
Ordinance. Section 9 of the Ordinance is captioned as ‘charge of income-tax’ and
it implies that income-tax shall be charged in respect of the income of the income year of
every assessee. Section 11 defines ‘scope of total income’. It states that
subject to the provision of the Ordinance, the total income of any income year of a person
who is resident includes all income from whatever source derived and is significant
inasmuch as the Ordinance seeks to tax only that kind of income which arises from the
sources mentioned in the Ordinance, namely income from ‘Salary’, income from
interest on securities, income from house property, income from capital gains, income from
business or profession and income from other sources. These heads of income are mutually
exclusive and if the receipt could not be brought under a head which is appropriate for
such receipt, it cannot be brought under the residuary head ‘Income from other
sources’. The Ordinance does not provide that the entire total income shall be
chargeable to tax. Section 9 says that the chargeability of an income to tax has to be in
accordance with, and subject to, the provisions of the Ordinance. The income has,
therefore, to be brougth under one of the heads in section 15 and can be charged to tax
only if it is so chargeable under the computing section corresponding to that head. If it
is not so chargeable, it will escape taxation even if it could be included in the total
income under section 9.
20. Total Income - Scope of
Under section 9 of the Ordinance the charge of income-tax is in respect of the total
income. Section 11 of the Ordinance provides that in the case of a person not resident in
Pakistan, the income which accrues or arises to him outside Pakistan shall not be included
in his total income, unless it is derived from a business controlled in or a profession
set up in Pakistan. Similarly, the plain language of section 11 indicates that the total
income of a non-resident includes only the income received or deemed to be received by him
in Pakistan or income accruing or arising or deemed to accrue or arise to him in Pakistan
during the relevant income year. The expression ‘subject to’ used in the opening
portion of section 11 has to exclude such income as is excluded from the scope of the
total income by reason of any other provision of the Ordinance and not that the other
provisions of the Ordinance override the provisions of section 11. If one were to give the
provisions of section 11 the other interpretation, the result would be that in the case,
for example, of a non-resident assessee having some taxable income in Pakistan, even the
income earned by his wife and minor sons who are not resident in Pakistan from a
partnership business carried on abroad and not controlled from Pakistan in which the
assessee is a partner could be liable to be included in the total income of the assessee
liable to tax in Pakistan. This interpretation would amount to straining the plain
language of section 11 to bring about an illogical and unjust result and there is no
warrant in law to do so.
21. Total income - Computation of
It may be noted that even in the Income Tax Ordinance, 1979, the word
‘computed’ has been consistently used in relation to ‘income’ in the
sense involving both inclusion and exclusion of items of income. Section 2(44) of the
Ordinance defines ‘total income’ to mean the total amount of income referred to
in section 11 of the Ordinance. Now if the provisions of the Ordinance are looked at,
which lay down the manner of computation of the total income, it would be clear that the
process of computation of the total income involved both inclusion or exclusion of various
items of income. Section 14 of the Ordinance provides that in computing the total income
of an income year of any person, any income falling under any of the clause of the Second
Schedule shall not be included in the total income, though such income which is required
to be excluded is undoubtedly income and, therefore, part of the total income according to
the plain natural connotation of that expression. But it is required to be excluded in
determining the charge of tax because ‘total income’ is defined as total amount
of income ‘computed in the manner laid down in the Ordinance.’
Thus, while referring to the definition of ‘total income’ in section 2(44), the
Legislature has used the word ‘computed’ comprehending within its scope not only
inclusion but also exclusion of certain items of income which are admitted and, without
doubt, part of income of the assessee.
22. Total income - Accessibility of
The income assessable to income tax is of two kinds:
* Received, accruing or arising in Pakistan
* Deemed to receive or accrue or arise in Pakistan
The concept of actual accrual or arising of income in Pakistan, although not dependent
upon the receipt of income in Pakistan, is quite distinct and apart from the notion of
deemed accrual or arising. The term
‘deem’ includes within the net of chargeability, income not actually accruing
but which is supposed notionally to have accrued in the circumstances as specified in
section 12 of the Ordinance. The statutory fiction created by section 12, which can in no
sense be said to accrue, at all, may be considered as so accruing. Similarly the fiction
may relate to the place, the person or be in respect of the year of taxability. The concepts involved in the fiction are the
matters relating to:-
(a) circumstances under which income could be deemed to have accrued or arisen in
Pakistan,
(b) the place of accrual,
(c) the person to whom accrued, and
(d) the year in which accrued.
22.1. Receipt of income - In deciding whether income is
‘received’, it is necessary to see if there is a receipt. ‘Receipt’ is
a commercial term with a well established meaning of having got, or been paid, income. To
constitute a receipt of anything there must be a person to receive and a person from whom
he receives, and something received by the former from the latter. A mere entry in the
books of account does not prove any receipt whatever else it may be worth. Book entries
are, however, held to be receipt when they are made to obviate the necessity of cross
remittance. If the money is not received in specie or in any form known to the commercial
world, it cannot be said to have been received. A sum of money may be received in more
ways than one, e.g, by the transfer of a coin or a negotiable instrument or other document
which represents and produces coin, and is treated as such by businessmen. Even a
settlement in account may be equivalent to a receipt of a sum of money although no money
may pass. It cannot be said that what amongst businessmen is equivalent to a receipt of a
sum of money is not a receipt within the meaning of the statute, and, as stated earlier,
to constitute a receipt of anything there must be a person to receive and a person from
whom he receives and something received by the former from the latter, and that something
may be money.
22.1-1 Constructive receipt of income is not the same thing as
actual receipt - Constructive receipt is not the same thing as actual receipt. If it
means something differing from or short of an actual receipt, a constructive receipt is
not recognised by statute, which is using the word ‘received’ alone. The statute
may be taken to have used it having regard to its ordinary acceptation.
22.1-2 Settlement of account means receipt of income - When a
person has received ‘income’ in Pakistan, whether such income is represented by
money or by adjustment in book entries or by some commodities, it becomes taxable.
Even a settlement in account may be equivalent to a receipt of a sum of money, although no
money may pass. What amongst the businessmen is
equivalent to a receipt of income is not a receipt within the meaning of section 11 of the
Ordinance, cannot be accepted as a true interpretation of the expression ‘received or
is deemed to be received in Pakistan’.
22.1-3 Income received does not mean income receivable -
Income is said to be received when it reaches the assessee and not when the right to
received the income gets vested in the assessee. There is no scope for holding that the
expression ‘received’ means ‘receivable’. Nor does the lessening of liability in Pakistan would tantamount to
the receipt of income in Pakistan.
22.1-4 Income is received when recipient gets money under his
control - The word ‘receipt’, therefore, refers to the occasion when the
recipient gets the money under his control. Once the amount is received as income, any
remittance or transmission of the amount to another place does not result in receipt at
the other place. receipt of an amount as income
by a person in foreign country would not, if transmitted or remitted to Pakistan, be
receipt of income in Pakistan, within the meaning of section 11.
22.1-5 Receipts through book entires - Receipt is not only
represented by the physical acquisition of cash or money but also when in the absence of
such acquisition, the person has been placed in a position to exercise control over it. He is deemed to have received the amount if his
account is credited with it in terms of the
agreement between the receiver and the giver or of the former’s command so also the
amount so credited is at his disposal or control. Without such control or disposal, the
credit by making book entries does not amount to receipt. The credit balance,
without’ anything more, only represents debt and a mere book entry in the
debtor’s books does not constitute payment which secures a discharge from debt.
22.1-6 Deemed receipt - What is subjected to tax is not merely
receipt of income in Pakistan but also what is deemed to have been received. an amount is
deemed to be received in Pakistan as income by virtue of any provision of the Ordinance is
to be thus subjected to tax. The statutory
receipt might be conveniently employed to cover income which is deemed to be received. The
amount cannot be deemed to be received merely by volition or sweet will of an individual.
Only when any provision of the Ordinance deems an amount to be received, though it might
not have in fact been received, the amount becomes taxable.
Income derived from whatever source if received in Pakistan or is deemed to be received in
Pakistan is taxable by virtue of section 11 of the Ordinance. It is to be seen whether
income from remittances payable in Pakistan, or from property imported in Pakistan or from
money or value arising from property not imported or from money or value received on
credit or on account of remittances, property, money or value brought or to be brought
into Pakistan, could be said to have been received in Pakistan within the meaning of the
expression ‘received or is deemed to be received in Pakistan’. There is no
difficulty in tracing the receipt of income in Pakistan if the source is situated in
Pakistan. But difficulty would arise when the source is in the foreign country. In the
case of income from foreign possession, it must be shown either the assessee has received
it in Pakistan or that he is entitled to receive it at the time it arrived in Pakistan. To
receive means to acquire cash or any other asset or a service.
Receipt of cheque is receipt of that amount of income. If a cheque is received by the bank and the bank at the
assessee’s direction gives value for it to a third party, there is no doubt that the
assessee would be entitled to the income and be charged whether he has actually received
it or not.
22.1-7 Receipt through cheque - Place of receipt - The
principles, which govern cases where payment is received by cheques, demand drafts or
other instruments, are well-settled and are as
follows:
* When payment is received by cheque, the receipt is at the time when the cheque is
delivered and not when it is encashed.
* If the cheque is sent by post, the receipt would be at the place where cheque is posted
provided the mode of sending it by post is adopted at the express or the implied request
of the addressee; in such cases the post office being the agent of the addressee.
Otherwise, the receipt would be at the place where the cheque is delivered by the post
office to the addressee.
* Having regard to business, a request to make payment by cheque may in itself imply a
request to send it by post, while a request to remit the amount would tantamount to an
express request to send it by post. Thus, the question must, therefore, always be, first
whether there is any agreement between the parties in regard to the place of payment and
secondly, if there is no such agreement, whether the cheque or hundi is sent by the debtor
through post pursuant to any request express or implied made by creditor.
Only in a case where there is no agreement between the parties
regarding the place of payment, the court has to see whether the cheque is posted by the
debtor in pursuance of the request, express or implied, made by the creditor and if there
is such an express or implied request, then the post office is an agent of the creditor
for the purpose of receiving the payment. But if it
is found that the assessee has expressly required the amount to be paid at a
particular place, the rule as laid down in CIT v. Ogale Glass Works Ltd.
would not be applicable.
22.1-8 Receipt v. accrual or arising of income - Under the
Income Tax Ordinance, income is taxable when it accrues, arises or is received or when it
is by fiction deemed to accrue, arise or is deemed to be received. ‘Accrues’,
‘arises’ and ‘is received’ are three distinct terms. So far as
receiving of income is concerned, there can be no difficulty; it conveys a clear and a
definite meaning. It means actual receipt and not the paper receipt, i.e., the recipient
must get the money under his control. Income is
said to be received when it reaches the assessee.
22.2 Accrual or arising of income - When the right to receive the
income becomes vested in he assessee, it is said to accrue or arise. The words
‘arising or accruing’ are general words descriptive of a right to receive. ‘Accruing’ is synonymous with
‘arising’ in the sense of springing as a natural growth or result. These
expressions having been used in the Ordinance, strictly speaking ‘accrues’
should not be taken as synonymous with ‘arises’ but in the distinct sense of
growing up by way of addition or increase or as an accession or advantage, while the word
‘arise’ means comes into existence or notice or presents itself. The former
connotes the idea of a growth or accumulation and the letter of the growth accumulation
with a tangible shape so as to be receivable. The
word ‘arising’ indicates something whose origin is in the country than
something brought in it. The words
‘accrue’ and ‘arise’ do not mean actual receipt of income, profit or
gains. These are used in contradistinction to the word ‘receive’ and indicate a
right to receive and represent a stage, anterior
to the point of time when the income becomes receivable and connote a character of the
income which is more or less inchoate.
22.2-1 Accrual means right to receive - A right to receive can
be said to have acquired when there is a debt owned to him by somebody. Unless and until there is created in favour of the assessee a debt due
by somebody it cannot be said that he has acquired a right to receive income or that
income has accrued to him.
‘Debt’ is a sum of money which is now payable or will become payable in future
by reason of a present obligation. In ordinary
dictionary meaning, the word ‘debt’ is applicable to a sum of money which has
been promised at a future day as to a sum now due and payable. If one wishes to
distinguish between the two, one says of the former that it is a debt owing and of the
latter that it is a debt due. In other words, debts are of two kinds: solvendum in
praesenti and solvendum in futuro. A sum of money which is certainly and in all events
payable is a debt, without regard to the fact whether it is payable now or at a future
time. A sum payable upon a contingency, however, is not a debt, or does not become debt,
until the contingency has happened.
22.2-2 Income has not resulted if there is neither accrual nor
receipt - The income can be said not to have resulted at all if there is neither
accrual nor receipt of income. An income accrues or arises when an assessee acquires a
right to receive the same. When does right to receive an amount accrues or arises, depends
upon the terms of a particular contract. If an assessee does not acquire a right to
receive an income under a contract in a particular income year, by some fiction the amount
received by him in a subsequent year in connection with the contract, though not arising
out of a right accrued to him in the earlier years and made taxable along with the income
of that year, no power is available with the assessing officer to relate back an income
that accrued or arose in a subsequent year to another earlier year on the ground that the
said income arose out of an earlier transaction. No
right to income arises during the previous year when an assessee makes unilateral
claims against the customers on account of the work done in excess of the quantity
contracted. Unless these claims are acknowledged or accepted or negotiated upon and
reached a final stage either through settlement or arbitration or otherwise, the assessee
cannot claim to recover this amount as a matter of right, when this right is conspicuous
by its absence. No income accrues until then.
22.2-3 When income accrues or arises, receipt is not relevant - The
total income of a non-resident assessee includes all income which accrues or arises in
Pakistan. The receipt of income by non-resident is not relevant, so long as it has accrued
or arisen in Pakistan. Though income of an assessee has to be computed in accordance with
the method of accounting regularly employed by him in terms of section 32 of the
Ordinance, such method of computation has limited relevance in case of a non-resident
assessee. Once income has accrued or arisen in Pakistan, it becomes taxable, irrespective
of whether the non-resident assessee has been maintaining account on cash basis in respect
of that income and he has not so far received it. To hold it otherwise would mean
defeating the charge under section 9 of the Ordinance, obliterating section 11(1)(b) and
consequently resulting in escapement of income. If
the income of a non-resident assessee is deemed to accrue at the point of receipt, it
will not be taxable at all as in that case the situs of income would be outside Pakistan.
Once income has accrued in Pakistan, its escapement from assessment on the ground that the
assessee has been employing cash system of accounting or has not been able to exercise
control over it, cannot be the intention of the legislation.
22.3 Concept of deemed accrual - Income received or deemed to be
received or accruing or arising in Pakistan in the relevant income year is taxable by
virtue of section 11(1)(a) and 11(1)(b) irrespective of assessee is resident or
non-resident. Receipt of incomed in Pakistan or its accrual does not present any
difficulty as for assessment is concerned. The difficulty may arise on account of the
deeming provision. Since income which is deemed to accrue or arise in Pakistan is also to
be subjected to tax, one must be sure about such income with certitude and exactness and
section 11 provides guidelines therefor.
The important feature of Pakistan tax laws lies in extending the charge, by following the
inclusive approach to income ‘arising or accruing’, and ‘derived from or
received in the territory’. It is in contrast to the limitation of the charges to
earnings and profits arising in and derived from the territory, i.e., the income
orginating from the territorial source of income. The territorial source limits the scope
of taxability of that income, profits or earnings which stem from a source situated within
the boundaries of the country, irrespective of the residential status of the assessee or
in disregard to the wide ranging ‘mind and management’ concept. The locality and
the location of ‘mind and management’ may not be coincidental in the
international trade or business. The situs of arising of income is determined the world
over, with few exceptions, on where the ‘mind and management’ is located.
So that the foreign companies may receive profits in a host country and distribute them to
shareholders who are by no means confined to local residents and thereby escape from tax
if the chargeability depends on the sole criterion of ‘mind and management’, the
concept of ‘business connection’ which is a common feature of tax laws of almost
all countries, takes care of escapement of income on the basis of its territorial source.
Section 12(2)(a) is a provision in this regard. The question whether a particular income,
profits or gains arises or accrues in Pakistan will have to be decided having regard to
the general principle as to where the income, profits or gains could be said to have
arisen or accrued. section 12 has no relevance to the aforesaid question as it relates to
income which is deemed to have arisen or accrued and not which has actually arisen or
accrued in Pakistan. Section 12 defines what
income is deemed to accrue or arise in Pakistan. It is only the application of this
definition that one class of income out of many as specified in section 11, can be
determined, i.e., what income has deemed to accrue or arise in Pakistan. Whatever other
considerations may arise in estimating the foreign income of a resident will not be
applicable to income deemed to accrue within Pakistan.
The scope of section 12 is limited only to the determination of the extent of income which
has deemed to have arisen or accrued in Pakistan. the criterion specified in that section
for such determination has no relevant to a case when income has been received in Pakistan
or otherwise has arisen or accrued in Pakistan. In Performing Right Society Ltd. v. CIT whereunder an agreement executed in England
between the assessee non-resident and the Government of India, former was to broadcast its
music in India, it was held that royalty payable would accrue in India irrespective of the
fact that they were paid in England and, therefore, section 9 (relevant to section 12 of
Income Tax Ordinance, 1979) would not be applicable as income had accrued in India. The
fiction created in section 12 which speaks of only deemed income, cannot, therefore, be
invoked where income is received or has arisen or accrued in Pakistan.
All income is deemed to accrue or arise in Pakistan if, inter alia, it accrues or arises
directly or indirectly through or from -
(a) any business connection in Pakistan,
(b) any property in Pakistan,
(c) any asset or source of income in Pakistan,
(d) through the transfer of a capital asset situated in Pakistan.
The concept of accrual or arising of income in respect of (b), (c) and (d) has been
discussed under respective Chapters dealing with the subject and not done here as the
accrual or arising depends upon the location of the source of income and under the UN
Model and right to tax has been given to the source country. The concept of business
connection, however, has been discussed in the following paras:
22.3-1 Deemed accrual and business connection -
Section 12(2)(a), seeks to charge the income of a non-resident with the aid of the concept
of ‘business connection’. The income accruing or arising, whether directly or
indirectly, through or from any business connection in Pakistan is deemed to accrue or
arise in Pakistan. Thus, income, profits and gains which accrues or arises, to a
non-resident outside Pakistan is sought to be brought within the net of the income-tax law
by section 12(2)(a) and not the income, profit or gain which accrues or arises within its
taxable territories. Income received, or deemed to be received, or accruing or arising in
Pakistan in the income year is taxable by virtue of section 11(1)(a) & 11(1)(b)(ii)
irrespective of the fact whether the person earning is a resident or non-resident. If the
agent of a non-resident receives the income or is entitled to receive that income, it may
be taxed in the hands of the agent by the machinery provision enacted in section 78 of the
Ordinance. Income of a non-resident not taxable otherwise becomes taxable under section
12(2)(a) if there subsists a connection between the activity in Pakistan and the business
of the non-resident and if through and from that connection income arises directly or
indirectly.
The expression ‘business connection’ means something more than a business,
though its precise connotation is vague and indefinite. It means a relation between a
business carried on by a non-resident which yields profits or gains and some activities in
the taxable territories which contribute directly or indirectly to the earning of those
profits or gains. A relation to a business connection must be real and intimate, through
or from which income must accrue or arise whether directly or indirectly to the
non-resident. It predicates an element of continuity between the business of the
non-resident and the activities in the taxable territories: a stray or isolated
transaction is normally not to be regarded as a business connection.
Business connection may take many forms. For instance:
- It may include carrying on a part of the main business or activity incidental to the
main business of the non-resident through an agent.
- It may merely be a relation between the business of the non-resident and the activity in
the taxable territory, which facilitates or assists the carrying on that business.
In respect of first above, the agent is the representative assessee of the non-resident
[section 78] and assessment can be made in respect of the income of the non-resident in
his hands, and in respect of second, the assessment is made directly on the non-resident
itself. In each case assessment could be made either in the hands of the representative
assessee or of the non-resident, but not in those of both. The revenue has two modes of
assessment available in respect of amount actually received by the non-resident; one is to
assess it in the hands of the agent in a representative capacity and the other to assess
it directly in the hands of the non-resident. These two modes are alternative to each
other. The revenue can adopt either of the one or the other but not both. This would
appear to be clear on principle both having regard to the scheme of the sections 78, 79
and 80 as also the application of the doctrine that the revenue cannot, in the words of
the Indian Supreme Court in CIT v. Murlidhar Jhawar & Pruna Ginning & Pressing
Factory seek to assess the one income twice. The
revenue, cannot, therefore, proceed against a non-resident as also against his
representative agent in Pakistan simultaneously.
* Instances of business connection - Some illustrative instances of non-resident having business connection in Pakistan, as given below
are:
- Maintenance of a brand office in Pakistan for the purchase or sale of goods or
transacting other business.
- Appointing an agent in Pakistan for the systematic and regular purchase of raw materials
or other commodities, or for sale of the non-resident’s goods or for other business
purposes.
-Erecting a factory in Pakistan where the raw produce purchased locally is worked into a
form suitable for export abroad.
-Forming a local subsidiary company to sell the products of the non-resident parent
company.
-Having a financial association between a resident and a non-resident company.
|
|
|
|
|
|
| Home | About Us | Contact | Information Resources |