Advanced Taxation

Definitions

Agriculture Income (Section 41)

The agricultural income means income:

  1. Derived from land;
  2. Land is situated in Pakistan; and
  3. Land is used for agricultural purposes.

Thus, any income derived as rent, revenue, or from sale of any produce which is grown on a Pakistani land is agricultural income. However, it is necessary to understand that the land must be used for agricultural purposes, which means that some human labour and efforts are necessary to be employed. If a produce is grown wild or spontaneously on land without any human effort or labour, it will not be treated as agricultural income under this definition.

Illustration 1

a)Income derived from forests of spontaneous growth is not agricultural income, because no human efforts are involved.

b)If a zamindar grows trees on his own land and derives income therefrom, it is agricultural income.

If a person owns some land in a foreign country, the income derived from such land is also excluded from the scope of the above definition connected with any activity with land. Non-agricultural income does not become agricultural by reason of indirect connection with agricultural land.

Illustration 2

a)Income from supply of water for irrigation purposes is non-agricultural income. It cannot become agricultural income merely because the water is being supplied to an agricultural land.

b)Salary received as agricultural manager is non-agricultural income. It cannot become agricultural income merely because the income has an indirect connection with agricultural land.

It is immaterial whether the agricultural income is being realized in the shape of cash or kind.

Illustration 3

a)A person grows wheat in his farm and sells the crop. The cash received is agricultural income.

b)A landlord receives rent in the form of share of crop. The produce so received is also agricultural income.

Types of Agricultural Income

Agricultural income has been classified into five categories:

  1. Rent or revenue derived from agricultural land.
  2. Income derived from such land by agriculture.
  3. Income derived from such land by the performance of a process ordinarily employed by a cultivator or receiver of rent in kind to render the produce fit for market.
  4. Income derived from such land by the sale of produce by a cultivator or receiver of rent in kind.
  5. Income derived from any building required for agricultural purposes.

The last category, i.e., income from agricultural building, will be treated as agricultural income only, if:

a)Building is in the immediate vicinity of agricultural land.

b)Building is occupied by the cultivator or the recipient of agricultural income.

c)The cultivator or recipient by reasons of his connection with the land requires it as a dwelling house, store room or other out building.

Examples of Agricultural Income

Some examples of agricultural income are as follows:

  1. Rent received by lessor of agricultural land.
  2. Income received by lessee of agricultural land.
  3. Income from cultivation of tobacco, wheat, sugarcane, rubber, etc.
  4. Income from growing tea.
  5. Land revenue assigned to Jagirdar.
  6. Income from building used for agricultural purposes.
  7. Fee paid by tenant for renewal of lease.
  8. Income from any land used for carrying on any process necessary to make the agricultural produce fit for the market.
  9. Income from sale of honey or its products.
  10. Receipt of any amount for compromise of a dispute regarding agricultural land.

Examples of Non-Agricultural Income

Some examples of non-agricultural income are as follows:

  1. Income from stone quarries.
  2. Income from fisheries and ferries.
  3. Income from mining and mining royalties.
  4. Income from land used as a market.
  5. Income from a flour mill.
  6. Income from land used for storing timber.
  7. Income received from a cotton ginning factory.
  8. Profits from a contract of cutting and selling trees.
  9. Income from sale of earth for brick making.
  10. Income from markets.

Examples of Partly Agricultural and

Partly Non-Agricultural Income

  1. Income of a person who grows tea leaves on his own farms in Pakistan and then manufactures it into tea.
  2. Income of a sugar mill which grows sugarcane and manufactures sugar.
  3. Income of a cigarette company growing tobacco on its own lands and manufacturing cigarettes.

In all the above cases, growing of crops (tea plants, sugarcane and tobacco respectively) is an agricultural process fulfilling all the conditions of agricultural income. The second component of theses incomes is a manufacturing process and thus chargeable to tax under the head “Income from Business and Profession”. In determining that part which is chargeable to tax, the market value of any agricultural produce which has been raised by the person or received by him as rent in kind and which has been utilized as raw material in such business, shall be deducted and no further deduction in respect of any expenditure incurred by the person as a cultivator or receiver of rent in kind will be allowed.

Capital Asset (Section 2(10) and 37(5))

Capital asset means property of any kind held by a person. It is immaterial whether the property is connected with his business or not. However, the following are excluded from the definition:

a)Any stock in trade, consumable stores or raw materials held for the purpose of business.

Explanation

  1. The medicines available in a medical store for the purpose of sale is stock-in-trade and so excluded from the definition of ‘capital asset’.
  2. Shares possessed by a dealer of shares for the purpose of sale are his stock in trade but still these will be treated as ‘capital asset’.
  3. Spare parts owned by a manufacturing concern for use in the machinery are consumable store and are excluded from the scope of ‘capital asset’.
  4. Yarn possessed by a cotton mill is their raw material held for the purpose of business and so not a ‘capital asset’.

b)Any property with respect to which the person is entitled to a depreciation deduction or amortization deduction.

Explanation

Any asset which a taxpayer uses for the purpose of his business is entitled to depreciation. In case of intangible assets used for the business purposes entitlement of amortization is present. Such assets are not included in the definition of “capital asset”. For example, a car being used for business purpose or a trade mark purchased and being used in a business concern are not treated to be “capital assets”.

c)Any immovable property.

d)Any movable property (including wearing apparel, jewellery, or furniture) held for personal use by the person himself or any member of his family dependent upon him.

If should be noted that the definition states that property should be held by a person. It means that even if the property is held on someone else’s behalf, e.g., as a trustee, executor, liquidator, receiver, lessee, assignee, administrator, co-owner etc.,it will be treated as his capital asset.

In item (d) of the definition the three items have been given only for the purpose of illustration, which provides a guide as to what type of moveable property can be treated as property held for personal use.

Company [Section 2(12) and 80]:-

According to the Income Tax Ordinance, 2001, ‘company’ means;

  1. A company as defined in the Companies Ordinance, 1984;
  2. A body corporate formed by or under any law in force in Pakistan;
  3. A modaraba;
  4. A body incorporated by or under the law of a country outside Pakistan relating to incorporation of companies;
  5. A trust, a cooperative society or a finance society or any other society established under law;
  6. A foreign association whether incorporated or not, which the Board has declared to be a company;
  7. A provincial government;
  8. A local authority in Pakistan; or
  9. A Small Company.

Explanation

In our country, there are three popular forms of business organizations: sole proprietorship, partnership and company. The company is created by law and so has a distinct legal entity. For the purpose of tax, a company is treated to be a separate business entity apart from its shareholders. The assets possessed, or liabilities owned by a company are its own, and legally the shareholders are not responsible for any liabilities. Company pays the tax in discharge of its own liability and not on behalf of its shareholders or as their agent.

It must be noted that any foreign body, even if it is an incorporated association, can be declared as company by the Board and will be taxed as such. A foreign association can neither object to such an order not it can claim as a right that it should be declared a company. It is on the sole discretion of the Board whether or not to declare a foreign association as a company.

Dividend [Section 2(19)]

Dividend includes:

a)Any dividend by a company of accumulated profits to its shareholders, whether capitalized or not;

b)Any distribution by a company, to its shareholders of debentures, debentures stock or deposit certificate in any form whether with or without profit, to the extent to which the company possesses accumulated profits whether capitalized or not;

c)Any distribution made to the shareholders of a company on its liquidation out of accumulated profits of the company immediately before its liquidation, whether capitalized or not;

d)Any distribution by a company to its shareholders on the reduction of its capital to the extent to which the company possesses accumulated profit whether capitalized or not;

e)Any payment by a private company or trust of any sum by way of advance or loan to a shareholder or any payment by any such company or trust on behalf, or for the individual benefit, of any such shareholder to the extent to which the company or trust, in either case, possesses accumulated profits;

f)Remittance of after tax profit of a branch, of foreign company operating in Pakistan;

But does not include:

  1. A distribution made in respect of any share for full cash consideration or redemption of debentures or debenture stock, where the holder of the share or debenture is not entitled in the extent of liquidation to participate in the surplus assets;
  2. Any advance or loan made to a shareholder by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company;
  3. Any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend; and
  4. Remittance of after tax profit by a branch of petroleum exploration and production foreign company operating in Pakistan.

Explanation

Dividends are distribution to the shareholders of a company in proportion to the number of shares held by them. During a tax year a company earns profits from its business. This profit may be retained by a company in its business or may be distributed to the shareholders. The profit which is distributed to the shareholders is called dividend, and the profit which is retained by a company in its business is known as accumulated profit or retained earnings. Dividend may be distributed out of current year’s profit or out of accumulated profits. It must also be noted that dividend may be distributed by way of cash or in any other form, such as property dividend, stock dividend, script dividend, etc.

By virtue of any amendment made through Finance Act, 2008, clause (f) above way inserted. It is a legitimate attempt to curb remittance of after tax profits by a branch of foreign company as a measure of foreign exchange conversation.

Illustration 4

Sodhi Company Limited has a paid up capital of Rs. 500,000 consisting of 50,000 shares of Rs. 10 each. On 31.12.2007, company’s balance sheet shows accumulated profits of Rs. 150,000. The company has to be liquidated. The official liquidator realized Rs. 450,000 and distribution among the shareholders was made at the rate of Rs. 9 per share. Mr. Akram had 20,000 shares in the company.

Required: How much of the amount received by Mr. Akram is dividend? Why?

Solution:

Mr. Akram received a total of Rs. 180,000 (20,000 × 9). Out of this amount Rs. 3 per share will be treated as dividend. That means Rs. 60,000 (Rs. 20,000 × 3) is dividend because the company at the time of liquidation possessed Rs. 1, 50,000 as accumulated profits and every share is receiving Rs. 3[150,000/50,000] from such profits.

Industrial Undertaking [Section 2(29C)]

This definition has been added through Finance Act, 2004. An organization fulfilling the following conditions will be known as industrial “undertaking”.

  1. Organization is set up in Pakistan;
  2. It uses electrical energy or any other form of mechanical energy and employs ten or more persons; or

It does not use electrical or any other form or energy but;

a)Employs twenty or more persons;

b)Is engaged in a manufacturing process;

c)Engaged in ship building;

d)Engaged in generation, conversion, transmission or distribution of electrical energy, or the supply of hydraulic power;

e)Engaged in the working of any mine, oil well or any other source of mineral deposits.

Moreover, the Federal Board of Revenue can declare any other organization which does not fall in the orbit of above two types as “Industrial Undertaking”.

Person [Section 2(42) and 80]

Under the Income Tax Ordinance, 2001, a person includes the following;

a)An individual;

b)A company;

c)An association of persons incorporated, formed, organized or established in Pakistan or elsewhere;

d)The Federal Government, a foreign government, a political sub division of a foreign government, or public international organization.

Public Company [Section 2(47)]

Under income tax law a public company means:

a)A company in which at least fifty percent of the shares are held by the Federal Government of Provincial Government.

b)A company in which at least fifty per cent of the shares are held by a Foreign Government.

c)A foreign company owned by a Foreign Government.

d)A company whose shares were traded on a registered stock exchange in Pakistan at any time in the tax year and which remained listed on that exchange, at the end of that year; or

e)A unit trust whose units are widely available to the public and any other public trust.

Resident and Non-Resident Persons [Section 81-84]

Income Tax Ordinance, 2001, does not make any distinction on nationality or domicile basis, rather tax liability of a person is determined on the basis of the fact that whether he is a resident or non-resident person.

It must be noted that:

  1. To be a resident or non-resident as used above has nothing to do with a dwelling place of nationality, rather it is a term purely designed for tax purposes.
  2. The status of resident or non-resident is always associated with a particular income year because it may change from year to year.
  3. A person’s status is determined with reference to the period of his stay (purpose of stay is immaterial) in Pakistan in the tax year.
  4. The Federal Government is treated as resident.

For the purpose of income tax, all the persons are grouped under two categories:

a)Residents

b)Non-Residents

  1. Resident Individual

An individual will be a resident in Pakistan in any tax year if he fulfills ay one of the following two conditions:

1)He is in Pakistan for a period or periods amounting, in all, to 183 days or more.

2)He is an employee or official of the Federal Government or a Provincial Government posted abroad in the tax year.

Explanation

An individual will become a resident of Pakistan in a tax year if his stay in Pakistan in that year is 183 days or more. It is not necessary that the stay should be continuous. Moreover, as already mentioned, purpose of stay is also immaterial. It is also not necessary that the stay should be at one place only. Mere physical presence for the period is sufficient.

Fulfillment of any one of the requirements given in clause (1) or (2) is sufficient. The purpose or nature of stay, the place of stay, the frequency of visits, the circumstances of visits etc. have no bearing on the determination of residential status. In case of (2) above a visit to Pakistan is not necessary.

Illustration 5

During the tax year 2010:

  1. Mr. Akbar stayed in Pakistan in a rented house for 170 days, then went abroad and came back. Eh again stayed in a hotel at Karachi for 15 days.
  2. For the first time in his life Mr. Ajmal left Pakistan for Iraq on July 5, 2009 and came back on May 15, 2010.
  3. Mr. Anthony, a foreigner, came to Pakistan on a pleasure trip and stayed with his friend for nine months.
  4. Mr. Abdullah serves in Saudi Arabia with a private employer. During the last 4 year, his total stay in Pakistan was of 8 months. During this year he came on a long leave to stay with his family for 4 months.
  5. Mr. Asad came to Pakistan to attend a marriage ceremony. He fell ill and on medical advice had to stay in Murree for 7 months.
  6. Mr. Umar is an employee in foreign ministry. He is posted in Iraq. During the tax year 2010 he did not come to Pakistan.

Required: Determine whether these individuals are resident or non-resident for the tax year 2010.

Solution

Resident or Non-Resident / Reasons
Resident / His total stay during the tax year is more than 183 days (continuous stay not necessary).
Non-Resident / During the tax year 2010 his stay is only for (5+46) 51 days so he is a non-resident.
Resident / His total stay during the tax year is for more than 183 days (purpose and place of stay is immaterial)
Non-Resident / He does not fulfill any one condition.
Resident / He stayed in Pakistan for more than 183 days during the year.
Non-Resident / The employee of official of Federal or Provincial Government posted abroad in treated as resident.
  1. Resident Company (Section 83)

A company shall be a resident company for a tax year if it fulfills any one of the following conditions:

a)It is incorporated or formed by or under any law in Pakistan;

b)The control and management of the company is situated wholly in Pakistan at any time in the year; or

c)It is a Provincial Government or local authority in Pakistan.

Explanation:

a)In case a company is incorporated in Pakistan, it will always be a resident in Pakistan.

b)In case of other companies, they will become resident in Pakistan only if their control and management is wholly situated in Pakistan. Partial control is not sufficient for this purpose.

c)A major difference in determining the status of an association of persons and company (other than a company incorporated in Pakistan) must be noted. In case of association of persons, even if partial control is in Pakistan it will be a resident of Pakistan for that tax year. But in case of a company (other than a company incorporated in Pakistan) if partial control is in Pakistan, it will be treated as non-resident.

d)It is necessary to differentiate between the act of doing business and controlling and managing a business. It may be possible that a business is being wholly done in a foreign county but it is being fully managed and controlled from within Pakistan, and vice versa. Distinction should be made between employees, agents, attorneys or managers who are doing business and partners, board of directors, presidents, etc., who are controlling the organization. For the purpose of finding the place of control and management for tax purposes, the whereabouts of the brain behind the business should be found out.