Understanding Income Tax in Pakistan: A Concise Overview

The taxation landscape in Pakistan operates under the ambit of the Income Tax Ordinance, 2001 (ITO 2001), overseen by the Federal Government. This comprehensive framework encompasses individuals, companies, firms, associations of persons, and other legal entities. The taxation cycle aligns with a standard fiscal year from 1st July to 30th June. Pakistan adheres to a residency-oriented taxation model, meaning that entities are taxed based on their resident status and income sourced within the country. Non-residents, on the other hand, are subject to taxation solely on income derived from Pakistan, as stipulated in the ITO 2001. This prevailing system underscores the importance of determining residential status through the following criteria:

Individuals: Residing in Pakistan for a minimum of 183 days during the tax year.

Companies: Incorporated or formed in accordance with prevailing Pakistani laws.

Associations of Persons: Control and management of affairs situated wholly or partly in Pakistan during any period of the year. 

Taxable Income in Pakistan 

Resident individuals bear the responsibility of taxation on their global income, with considerations for applicable tax treaties. Conversely, non-resident individuals are subject to taxation exclusively on income sourced within Pakistan.

Classifcation of Income Streams: A Closer Look

1. Income from Salary: Income arising from employment undergoes taxation within the scope of the employee’s fiscal responsibilities.

2. Income from Property: Taxation is applied to rented properties, assessed based on the higher value between the earned rent and the fair market rent during the lease period.

3.Income from Business: Business and professional income, net of allowable deductions and allowances, contribute to the taxable income.

4.Capital Gains: Gains derived from the disposal of specified capital assets fall under this category.

5.Income from Other Sources: This head covers income that doesn’t fit into any of the aforementioned categories.

Tax Implications for Expatriates in Pakistan

The trend of expatriates engaging in employment within Pakistan is well-established. Expatriates assuming roles in Liaison and Branch Offices within Pakistan must secure a work visa before commencing their employment. Naturally, questions about tax liabilities arise for these expatriates. Notably, Pakistan’s tax laws embrace a unique residency principle. Resident individuals are exempt from foreign-source income not remitted to Pakistan, provided they meet the criteria of a “short-term resident” – a resident by employment for no more than 3 years. Furthermore, Section 44 of the ITO outlines tax exemptions for individuals receiving salaries under Aid Agreements between the Federal Government and foreign governments or international organizations. This exemption applies to non-residents or residents present due to services specified in the Aid Agreement, where salaries are disbursed from aid funds. Specific conditions apply if the Agreement involves a foreign country.

Similarly, Section 44(3) provides tax exemptions for individuals engaged as contractors, consultants, or experts on projects within Pakistan, as per bilateral or multilateral technical assistance agreements. Compliance with stipulated conditions is imperative. In summary, Pakistan’s taxation framework revolves around residency status and income sources, aiming to foster clarity and adherence in an ever-evolving fiscal landscape.

Tax Rates in Pakistan

The taxation framework in Pakistan employs a Progressive Tax System for individuals and AOPs (ranging from 0% to 35% of taxable Income). This system ensures that those with higher incomes contribute proportionally more to the nation’s tax revenue. Conversely, companies adhere to a Proportional or Flat Tax System, where a uniform tax rate applies regardless of income level. For companies, the standard tax rate is 29%, accompanied by additional obligations such as the Alternate Corporate Tax or Minimum Tax, each serving to diversify the taxation landscape.

Corporate Tax Rates

Minimum Tax in Pakistan

Under the income tax laws of Pakistan, the concept of ‘Minimum Tax’ is enforced. This entails that certain legal provisions within the Income Tax Ordinance (ITO) mandate that the tax liability of a business entity must not fall below a specified amount or percentage of turnover or net profit. The following are key provisions related to minimum tax:

 Applicable Entities and Rates

Resident companies, individuals, or AOPs with a turnover exceeding Rs 100 million in the tax year 2017 or subsequent years, and permanent establishments of non-residents are subject to a minimum tax rate of 1.25% of turnover. This provision applies even if the entity’s income is exempt from income tax or if no tax is payable due to losses, tax credits, or depreciation.

Carry Forward of Excess Minimum Tax

Any excess of minimum tax over normal tax liability can be carried forward and adjusted against subsequent years’ tax liability, up to 10 years.

Alternative Corporate Taxation

Corporate taxpayers in Pakistan have the obligation to pay the higher of the following:

• Tax liability calculated under the General Provisions computed at 29% of taxable income OR
• Minimum tax computed under section 113 at a rate of 1.25% of turnover OR

Alternative Corporate Tax: Calculated at 17% of the company’s accounting income.  

Tax Deadlines and Filing Requirements

 To ensure compliance, taxpayers are required to submit various returns and statements, including:

Annual filing of:

•   Income tax return as per section 114 read with section 115.
• Wealth Statement (for resident individuals).
• Wealth Reconciliation Statement (if applicable).
• Foreign income and assets statement for resident individuals under section 116A.

 Quarterly Filling:

• Advance tax for companies, AOPs, and individuals with taxable income exceeding 1 million.
• Withholding tax statements by withholding agents by specific dates.

Different deadlines for returns based on year-end dates.

30th September:

• Return of income by an individual or AOP.
• Return of income by a company having year end between 1st July to 31st December

31st December:

• Return of income by a company having year end between 1st January and 30th June.

Tax Administration and Dispute Resolution

 In Pakistan, taxpayers can be subject to audits by the Federal Board of Revenue (FBR). If dissatisfied with the assessment, taxpayers have an appeals process, including Commissioner Inland Revenue, Commissioner Inland Revenue (Appeals), Appellate Tribunal, High Court, and Supreme Court.

Alternative Dispute Resolution (ADR)

ADR operates alongside the conventional appellate system, offering simpler procedures. ADR applies in specific circumstances, involving tax liabilities, refunds, penalty waivers, or other relief needs. The process involves applying to the Board for a resolution committee’s appointment, submitting an initial proposition for dispute resolution, and adhering to Committee decisions. The Committee’s decision is binding on the Commissioner if the aggrieved party withdraws their appeal within 60 days. If the Committee doesn’t decide within 60 days, the dispute is resolved in court.

Avoidance of Double Taxation and Unilateral Relief

Pakistan has entered into agreements for avoidance of double taxation (DTAAs) with various countries, aimed at eliminating international juridical double taxation. These treaties provide a framework to allocate taxing rights and offer legal certainty for taxpayers. These arrangements are based on Section 107 of the ITO.

Investment Vehicle Options for Foreign Investors 

1. Liaison Office

 Foreign entities seeking to establish a presence in Pakistan often opt for a Liaison Office (LO). This office’s activities are centered around promotional endeavors for products not yet introduced to the local market, fostering technical and financial collaborations between the foreign entity and Pakistani stakeholders, and providing technical assistance. LOs facilitate joint collaboration prospects and export promotion on behalf of their parent companies. It’s important to note that revenue-generating activities are prohibited for LOs, which are required to sustain operational costs through remittances from their parent companies via standard banking channels, duly converted to the local currency. Pertinent regulations include:

•  Approval requirements sanctioned by the Board of Investment (BOI).
• Mandatory filing of prescribed returns and documents with the Registrar of Companies, in accordance with the Companies Act of 2017, subsequent to BOI authorization.
• Adherence to accounting, audit, and submission obligations to the Registrar of Companies.
• Compulsory registration with local tax authorities.

2. Branch Office

Foreign entities can establish a Branch Office (BO) to operate in Pakistan, typically for executing contracts awarded to the foreign entity. The BO’s scope is confined to the terms specified in the relevant agreements or contracts and does not extend to commercial or trading activities. Key considerations encompass:

• Repatriation of revenue and profits from BO activities (excluding banking operations) to the Head Office, contingent upon tax deductions and compliance with Foreign Exchange Regulations of the State Bank of Pakistan.
• Funding of BO expenses through transfers from abroad, following prescribed banking channels and conversion to local currency, or through contract-related income.
• Application submission to the BOI, along with necessary documentation, for BO establishment.
• Authorization for opening branches of foreign banks granted by the State Bank of Pakistan.
• Fulfillment of returns and documentation obligations, in line with the Companies Act of 2017, subsequent to BOI approval.
• Adherence to accounting, audit, and submission mandates to the Registrar of Companies.

3. Pakistan Subsidiary / Joint Ventures

Foreign entities have the option to establish wholly owned subsidiaries or joint ventures with Pakistani or foreign partners in Pakistan. This avenue aligns with Foreign Direct Investment (FDI) policies and the stipulations of the Companies Act of 2017. These ventures can take the form of private or public companies, offering diverse pathways for market engagement.

4.Permanent Establishment: Establishing Business Presence

A Permanent Establishment (PE) refers to a designated place of business through which the activities of a non-resident entity are either fully or partially carried out. This encompasses various scenarios, including:

Physical Locations: A PE comprises distinct physical spaces such as management offices, branches, factories, warehouses, and more. Certain exceptions, like liaison offices primarily engaged in non-contractual negotiations, exist.

Resource Extraction: Properties related to agriculture, pastoral activities, forestry, mining, oil/gas wells, quarries, and other natural resource extraction sites.

Construction Projects: Encompasses building sites, construction, assembly, installation projects, and supervisory roles linked to such endeavors, exceeding 90 days within a 12-month timeframe.

Service Provision: The rendering of services, including consultancies, by individuals, personnel, or entities engaged by the concerned party.

Agency Activities: A person operating on behalf of another, typically in an ongoing authority to conclude contracts, plays a significant role in contract execution, and involves ownership transfer or service provisions.

Equipment Presence: Incorporating substantial equipment, assets, or properties capable of generating income.

Complementary Functions: When a place of business is maintained by an entity or its associate, and both the original and additional business operations constitute cohesive, complementary functions.

Virtual Business Presence:  The scope of a PE extends to virtual business models conducted over the internet or electronic mediums, irrespective of physical presence.

In cases involving a Double Taxation Treaty (DTT), the PE definition within the treaty takes precedence when executed between Pakistan and the relevant origin country of the PE.