Business Taxation (Pakistan

)

PART 2

WEDNESDAY 8 DECEMBER 2004

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A BOTH questions are compulsory and MUST be answered

Section B THREE questions ONLY to be answered

Tax rates and allowances are on pages 2-3

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

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The following tax rates and information are to be used in answering the questions:

A. Tax rates for individuals and associations of persons

Taxable income Rate of tax

Up to Rs. 80,000 0%

Rs. 80,001 - Rs. 150,000 7·5% of the amount exceeding Rs. 80,000

Rs. 150,001 - Rs. 300,000 Rs. 5,250 plus 12·5% of the amount exceeding Rs. 150,000.

Rs. 300,001 - Rs. 400,000 Rs. 24,000 plus 20% of the amount exceeding Rs. 300,000.

Rs. 400,001 - Rs. 700,000 Rs. 44,000 plus 25% of the amount exceeding Rs. 400,000.

Rs. 700,001 and above Rs. 119,000 plus 35% of the amount exceeding Rs. 700,000.

B. Reduction in tax liability of salaried individuals where salary income exceeds 50% of taxable income

Income slab Reduction in tax liability

Up to Rs. 60,000 0%

Rs. 60,001 - Rs. 80,000 70%

Rs. 80,001 - Rs. 100,000 60%

Rs. 100,001 - Rs. 150,000 50%

Rs. 150,001 - Rs. 200,000 40%

Rs. 200,001 - Rs. 300,000 30%

Rs. 300,001 - Rs. 500,000 20%

Rs. 500,001 - Rs. 1,000,000 10%

Rs. 1,000,001 and above 5%

C. Tax rates for companies
Tax Year Banking Public company other Private company other
company than a banking company than a banking company
2003 47% 35% 43%
2004 44% 35% 41%
2005 41% 35% 39%
2006 38% 35% 37%
2007 35% 35% 35% D. Tax rates on dividends received from companies Received by a public company or an insurance company In any other case

5% of the gross dividend 10% of the gross dividend

E. Tax rates on certain payments to non-residents Fees for technical services (FTS)

Other than for royalty or FTS

15% of the gross amount 30% of the gross amount

F. Rates of advance collection or deduction of tax at source Profit on bank deposits

Yield on certificates under the National Savings Scheme or Post Office Saving Account

Sale of goods

Prizes and winnings

Contracts up to the value of RS.30 million

10% of the profit pa id

10% of the yield paid

3·5% of the gross amount payable 10% of the gross amount paid

5% of the amount of the payment

2

G. Capital allowances Depreciation

Factory buildings

Residential quarters for labour Other buildings

Plant and machinery (not otherwise specified) Motor vehicles (all types)

10% 10% 5% 10% 20%

of the tax written down value

Initial allowance

50% of cost

H. Value of free unfurnished accommodation where salary is Rs. 600,000 or more

Land area Value for areas within municipal limits

Up to 250 sq. yards Rs. 40,000

251 to 500 sq. yards Rs. 106,000

501 to 1000 sq. yards Rs. 199,000

1001 to 2000 sq. yards Rs. 370,000

2001 sq. yards and over Rs. 462,000

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[P.T.O.

Section A - BOTH questions are compulsory and MUST be attempted

1 ABC Limited is a public company incorporated under the Companies Ordinance, 1984 whose shares were traded on the Karachi stock exchange from 1 July 2002 until 29 June 2003 on which date the company was delisted on the exchange. The control and management of the affairs of the company was situated partly outside Pakistan during the year ended 30 June 2003.

ABC Limited is engaged in the manufacture of engineering goods and the summarised income statement for the accounting year ended 30 June 2003 is as follows:

Note

Sales

Cost of sales

(2)

Rupees in thousands 718,000 575,000

Gross profit Administration expenses

Selling and distribution expenses

143,000

(3) (4)

48,500 29,200

77,700

65,300

Financial charges Provision for bad debts

(5) (7)

35,000 850

35,850

Other income

(6)

29,450 4,200

Provision for taxation

33,650 12,000

Net profit

21,650

The following additional information is provided:

(1) All amounts are stated in thousands of Rupees ('000 Rupees) (2) Cost of sales include:

Freight expenses paid in cash and not by crossed bank cheques or crossed bank drafts 6,000

(3) Administration expenses include:

Accounting depreciation. 20,500

Contributions to an unrecognised provident fund; effective arrangements have been

made by the company to ensure that tax would be deducted from any payment made

by the fund. 3,900

Payment to a software company for developing special accounting software. The

software has been used by ABC Limited since 1 March 2003 and its normal useful working life is unascertainable.

Donations to the Board of Education (Federal Government) paid by a crossed bank cheque.

6,300 700

(4) Selling and distribution expenses include:

Expenditure on the provision of perquisites and allowances to a sales executive in excess of 50% of his salary.

Salary to a part time sales representative paid in cash.

(5) Financial charges include:

Profit on a debt paid to a non-resident on a foreign currency loan on which no tax was

deducted. 750

5,600 800

4

(6) Other income includes:

Accounting profit on the sale of a car.

Dividend from a public company as defined for tax purposes (gross amount of dividend). Recoveries against bad debts written off but not allowed as a deduction in prior years.

(7) The provision for bad debts comprises:

Balance on 1 July 2002

Provision made during the year (5% of debtors)

Trading debts written off Loan to employee written off

(8) Creditors include rent payable which was allowed as a deduction against the income for the year ended 30 June 2002.

(9) The tax written down values on 1 July 2002 were:

Factory buildings Office buildings Plant and machinery Motor vehicles

600 200 300

1,750 850

2,600 (1,200) (100)

1,300

500

25,000 30,000 225,000 10,000

(i) The construction of residential quarters for factory workers was completed in December 2002 at a cost of Rs.12,000 and the workers occupied the quarters on 15 January 2003.

(ii) The chief executive's car (tax written down value RS.150) was disposed of for RS.800 in October 2002. On 17 October 2002, the company purchased a new car for Rs.1 ,200.

(iii) New plant was imported from the UK for Rs.150,000. Installation of the plant

was completed on 30 June 2003 at a cost of Rs.5,000 which was included in cost of sales. The plant was commissioned for use on 1 July 2003.

(10) Unadjusted business loss:

This business loss was determined in the assessment year 2002-2003 (income year ended on 30 June 2002).

(11)Tax deducted at source:

The tax was deducted by the customers of ABC Limited from payments made to ABC Limited for the sale of its own manufactured goods. ABC Limited has not opted to be

assessed on the final tax basis on income arising from the sale of goods.

Required

(a) State, with reasons, whether you consider ABC Limited to be a resident or a non-resident company.

(2 marks)

30,000

20,000

(b) Briefly state, with reasons, whether or not you consider ABC Limited to be a public company for tax purposes. (2 marks)

(c) Compute the taxable income of ABC Limited for the relevant tax year giving clear explanations for the

inclusion or exclusion of each of the items listed above. (23 marks)

(d) Calculate the tax liability of ABC Limited for the relevant tax year.

5

(3 marks) (30 marks)

[P.T.O.

2 The following information has been made available to you by Mr Irfan Zaidi, for his accounting year ended 30 June 2003.

(1) Irfan is a Pakistani national and was resident in Pakistan for tax purposes until 30 December 2001 when he left for Saudi Arabia. He was appointed to work at the Pakistan Embassy from 15 January 2002 on a salary of Rs.300,000 per month which was paid to him in Saudi Arabia by the Federal Government of Pakistan. He resigned his post on 31 December 2002 and returned to Pakistan on the same day. There is no tax payable in Saudi Arabia on salary income.

(2) In January 2003, Irfan as a self-employed individual entered into a one time contract with Builders Ltd to provide temporary workers during the month of January. Irfan received Rs.475,000 (after deduction of tax at the applicable rate) from the company. He informs you that he incurred costs of Rs.350,000.

(3) Since 1 February 2003 Irfan has been employed in Karachi as the company secretary of XYZ Limited. His terms of employment provide for the following:

Basic salary of Rs.500,000 per month and monthly cash allowances of Rs.60,000 and Rs.10,000 for utilities and entertainment respectively.

Medical allowance of Rs.15,000 per month. The terms of employment do not provide for free medical treatment or hospitalisation or any reimbursement of such expenses.

Payment of Rs.15,000 per month for the school fees of Irfan's children to be paid in the first week of each month to the Karachi Grammar School.

Rent free accommodation in the company's fully furnished house on a land area of 1000 square yards. The house is located within the municipal limits of Karachi.

Two company maintained motor cars. A new car was leased on 1 February 2003 from an approved leasing company for Irfan's private and business use and another car was purchased by the company for Rs.1 ,300,000 which was exclusively for his business use. The fair market value of the leased vehicle at the commencement of the lease period was Rs.3,000,000.

Annual payment of Rs.500,000 to an approved pension fund to provide for Irfan's retirement. (4) Other information

(i) Tax deducted at source from his salary income by XYZ Ltd was Rs.750,000.

(ii) Prior to accepting the position as company secretary, XYZ Limited paid Irfan Rs.1 ,000,000 in Saudi Arabia as consideration for his agreement to enter into an employment contract with the company. XYZ Limited at the same time paid Rs.200,000 to PQR Bank in Saudi Arabia in discharge of a loan taken out by Irfan from the bank.

(iii) On a business trip to the USA in March 2003 Irfan incurred expenses of Rs.350,000 which were reimbursed to him by XYZ Limited.

(iv) The salary of all XYZ Ltd's staff including allowances as a company policy is always disbursed on the first day of the following month.

(v) While in Saudi Arabia, Irfan purchased a house property in Karachi for Rs.15,000,000. He rented out the house to an individual on 1 July 2002 at a monthly rent of Rs.150,000. He also collected from the tenant a refundable deposit of Rs.300,000 which is not adjustable against the rent. Irfan has incurred the following expenditure in respect of this house.

Repairs

Property tax paid to Karachi Municipal Corporation Ground rent

Legal expenses for defending the title to the house

Profit paid to a bank on money borrowed to acquire the property

Rupees 70,000 25,000

2,000 20,000 10,000

Irfan also informs you that the tenant has not paid the rent for the months of May and June 2003. The tenant has neither vacated the house, nor has Irfan taken any steps to compel the tenant to vacate the house. Irfan wants to claim the unpaid rent as a deduction. He also wants to claim a deduction of 6% of the rent as collection charges for the rent.

6

(vi) The following amounts were also received by Irfan in the year ended 30 June 2003 after deduction of tax at source

Rs.135,000 as dividends from a private company incorporated in Pakistan.

Rs.180,000 profit on debt on a fixed deposit account maintained with a banking company. Rs.90,000 as a prize on a winning prize bond

(vii) Zakat paid was Rs.250,000.

Required

(a) State, giving a brief explanation, the residential status of Irfan in the tax year relevant to the income year

ended 30 June 2003. (2 marks)

(b) Compute Irfan's taxable income for the tax year relevant to the income year ended 30 June 2003 giving explanations for the treatment given to all of the aforesaid items in the computation of income. (19 marks)

(c) Calculate the tax payable by Irfan for the relevant tax year.

(4 marks) (25 marks)

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[P.T.O.

Section B - THREE questions ONLY to be answered

3 (a) Mr Ali is a registered person for sales tax purposes and he makes both taxable and exempt supplies. The following

transactions took place in the month of May 2004:

Purchased raw materials aggregating to Rs.l ,150,000 inclusive of sales tax of Rs.150,000, to be used for making both taxable and exempt supplies.

Taxable supplies during the month were Rs.700,000 and exempt supplies were Rs.800,000.

Required:

(i) Calculate the input tax that can be claimed for the month of May 2004.

(4 marks)

(ii) State the due date for furnishing the sales tax return for the month of May 2004 and with whom the

sales tax return would be filed. (3 marks)

(b) List any EIGHT types of services chargeable to sales tax.

(4 marks)

(c) State the particulars to be included on a sales tax invoice.

(4 marks) (15 marks)

4 Mr Idrees, a tax resident, makes the following information available to you relating to his accounting year ended 30 June 2003.

(1) He retired from his employment with Prime Foods (Pakistan) Limited on 30 June 2000 and since then he has been self-employed as a management consultant. His income from self-employment adjusted for tax purposes for the year ended 30 June 2003 is Rs.850,000.

(2) During his employment with Prime Foods he had participated in an employee share scheme of Prime Foods pic

(an associated company), the details of which are as follows:

He was granted the right to purchase 500 shares of Prime Foods pic at the exercise price of £10 per share. This amount was inclusive of a consideration of £1 for the right to acquire the shares. Idrees accepted the right offered and made payment of £500.

On 1 July 2002 he disposed of the right relating to 200 shares for Rs.40,000. On the same day he exercised the right to acquire the balance of 300 shares and made a payment of £9 per share having already paid £1 at the time of acquiring the right. The market price of one share on that date was £15.

On 30 June 2003 he disposed of his entire holding of 300 shares in Prime Foods pic for Rs.600,000.

(3) He sold jewellery on 31 May 2003 for Rs.12,000,000 which was purchased by him two years earlier for Rs.9,000,000. The jewellery was held for the personal use of his wife. Out of the sale proceeds, he purchased a rare manuscript for Rs.I0,000,000 and old coins for Rs.2,000,000. On 30 June 2003, he disposed of the manuscript for Rs.15,000,000 and of the coins for Rs.l ,000,000.

(4) He sold a residential house for Rs.7,000,000. The house had been inherited from his father in 1930 when the market value of the house was Rs.l ,000,000.

(5) Disposal of shares

Gain of Rs.75,000 on the sale of shares in a private company. The sale was made more than two years after the acquisition of the shares.

Gain of Rs.750,000 on the sale of shares in PQR Ltd, a company in which 50% of the shares are held by the Federal Government. The sale was within one year of the acquisition of the shares.

(6) Rs.6,000 Zakat was paid by Idrees.

8

(7) Unadjusted losses brought forward:

Business loss of Rs.1,000,000 sustained in the immediate preceding year which includes a loss of Rs.100,000 from speculation business and unabsorbed depreciation of Rs.600,000.

Capital loss of Rs.50,000 sustained under the income head of 'Capital gains' in the year ended 30 June 1997.

(8) The rate of exchange is to be taken as £1 = Rs.100. Required:

Compute the taxable income of Idrees for the tax year 2003, giving clear explanations for the inclusion or exclusion of each of the items listed above.

(15 marks)

5 (a) There are provisions in the Income Tax Ordinance 2001 relating to persons who are to be treated as 'associates' for tax purposes.

Required:

(i) State when two persons can generally be treated to be associates for tax purposes.

(2 marks)

(ii) Briefly state the powers of the Commissioner in the case of a transaction between associates not

considered to be an arm's length transaction. (2 marks)

(b) The Central Board of Revenue (CBR) issues circulars from time to time.

Required

(i) Explain the purpose for the issuance of circulars by the CBR. (ii) State whether or not such circulars are binding on:

the Regional Commissioner of Income Tax; the Commissioner of Income Tax;

the Commissioner of Income Tax (Appeals); and the taxpayer

(2 marks)

(2 marks)

(c) Under s.34, in the tax year 2003, a person accounting for income chargeable to tax under the head 'Income from business' on an accrual basis:

shall derive income when it is due to the person; and shall incur expenditure when it is payable by the person.

Required;

(i) Explain when an amount becomes due to a person under the accrual basis accounting.

(2 marks)

(ii) Explain when an amount becomes payable by a person under the accrual basis accounting.

(5 marks) (15 marks)

9

[P.T.O.

6 The Finance Director of Popat Electric (Private) Limited (PEPL) furnished you with the following information on 28 September 2003:

PEPL is a company incorporated in Pakistan under the Companies Ordinance 1984 engaged in the manufacture of circuit breakers.

PEPL closes its accounts on 30 June of each year. PEPLS only customer is the Federal Government.

The budgeted figures for the turnover and the taxable income (i.e. adjusted for tax purposes of PEPL) are as follows:

Tax year Turnover Taxable income
Rs. Rs.
2004 10,000,000 1,500,000
2005 12,000,000 1,920,000
2006 14,000,000 2,380,000 In the tax year 2007, PEPL plans to expand its business which would entail the purchase of new plant and machinery. The cost of the new plant is estimated to be Rs.l 0 million. The plant is expected to be commissioned for use in July 2006.

For the tax year 2007, the company's turnover is estimated to be Rs.16 million and the profit to be 18% of the turnover. The estimated profit has been adjusted for tax purposes except that no adjustments have been made for any initial allowance and depreciation allowable on the new plant.

The Finance Director wants you to:

(i) explain the tax provisions under which the tax deducted from the payments made for the sale of goods is the final tax on the income arising from the said sale;

(ii) state, with reasons, whether PEPL is eligible to be assessed on the final tax basis on the income from the sale of circuit breakers, and if so the steps to be taken by PEPL to ensure that the assessment for the tax year 2004 is made on the final tax basis; and

(iii) advise on the basis of the information furnished, whether or not it would be beneficial from a tax viewpoint for PEPL to opt for assessment on the final tax basis for the tax years 2004, 2005, 2006 and 2007.

Required;

Provide the information and advice requested by the Finance Director of PEPL relating to the three issues stated above. Your answer to item (iii) should be supported by relevant calculations and explanations.

Marks will be allocated to the three items as (i) 3 marks; (ii) 3 marks; and (iii) 9 marks.

(15 marks)

10

7 (a) A fee for technical services has been defined in the Income Tax Ordinance 2001 to mean any consideration for the rendering of any managerial, technical or consultancy services including the services of technical or other personnel but excluding consideration for services rendered in relation to a construction, assembly or like project undertaken by the recipient or consideration which is the income of the recipient chargeable as salary income.

Usman Pakistan Limited (UPU a company incorporated in Pakistan is engaged in the business of manufacture and marketing of fertilizers. Under an agreement, Urea Ltd, a company incorporated in Australia regularly sends UPL reports on the latest technical developments in the field of manufacture of fertilizers. This information is transmitted by Urea Ltd to UPL by electronic mail and is utilised by UPL for its business in Pakistan. The consideration under the agreement is received by Urea Ltd in Australia. Urea Ltd neither has any presence in Pakistan, nor have any of its employees ever visited Pakistan.

There is no Tax Treaty between Australia and Pakistan for the avoidance of double taxation. Required

(i) State, with reasons, whether the income received by Urea Ltd as consideration from UPL is Pakistan-

source income or foreign-source income. (2 marks)

(ii) State the obligations of UPL to withhold tax on making payments to Urea Ltd Australia.

(1 mark)

(iii) Explain how your answers to (i) and (ii) above would change if the reports and information received from Urea Ltd were used by UPL for its business outside Pakistan. Your answer should include a brief outline of any additional actions that UPL, Urea and/or the Commissioner should take in this case. (3 marks)

(b) Mr Tausif and Mr Nadir entered into a partnership agreement on 1 July 2002 to carryon business as management consultants under the name of Tausif Associates. The profit of Tausif Associates for the year ended 30 June 2003 as adjusted for tax purposes is Rs.500,000. Each partner is entitled to one-half of the profit of the firm.

On 31 May 2003 Tausif received Rs.1 ,800,000 as consideration for vacating possession of his residential flat. He had paid Rs.600,000 to acquire possession of the flat three years previously, which amount was not allowed to him as a deduction against his income. On 30 June 2003, he received Rs.9,000 as profit on debt on Defence Saving Certificates (National Savings Scheme) on which tax had been deducted at source. Mr Tausif paid Rs.1,000 as Zakat on 23 May 2003.

On 1 March 2003 Nadir received Rs.1 ,000,000 from his past employer as consideration for agreeing not to enter into employment with any other firm of management consultants for a period of two years.

Required

(i) State the income to be disclosed by Tausif Associates in its return of income for the relevant tax year,

and calculate the tax payable by Tausif Associates. (1 mark)

(ii) Compute the taxable income of Tausif for the relevant tax year stating reasons for the treatment given

to each of the amounts received, and calculate the tax payable by Tausif. (5 marks)

(iii) Compute the taxable income of Nadir for the relevant tax year stating reasons for the treatment given to

each of the amounts received, and calculate the tax payable by Nadir. (3 marks)

(15 marks)

End of Question Paper

11

Answers

Part 2 Examination - Paper 2.3 (PKN) Business Taxation (Pakistan)

December 2004 Answers and Marking Scheme

Marks

1 (a) ABC Ltd is a resident company since it is a company incorporated in Pakistan under the Companies

Ordinance, 1984. The test of the place of control and management of its affairs does not apply to companies

incorporated or formed by or under any law in force in Pakistan. 2

(b) A company whose shares are traded on a registered stock exchange in Pakistan at any time in the tax year and which remains listed on that stock exchange at the end of the tax year is a public company for tax purposes. Though the shares of ABC Ltd were traded on the Karachi stock exchange during the tax year 2003, ABC Ltd does not meet the test of being a public company for tax purposes since its shares were not listed on the

Karachi stock exchange on 30 June 2003. ABC Ltd is therefore not a public company for tax purposes. 2

(c) ABC Limited
Income year ended 30 June 2003
Tax year 2003
Computation of taxable income Rs. in
thousands
Accounting profit before taxation 33,650
Add: Accounting depreciation 20,500 0·5
Accounting software (Note 1) 6,300 1
Donation to an approved institution (Note 2) 700 1
Excess cost of perquisites (Note 3) 5,600 0·5
Salary to part time sales representative (Note 4) 800 1
Profit on debt on foreign currency loan (Note 5) 750 1
Tax gain on sale of motor car (Note 6) 650 0·5
Provision for bad debts (Note 8) 850 0·5
Installation cost of plant (Note 10) 5,000 1
41,150
74,800
Less: Recoveries against bad debts (Note 7) 300 1
Bad debts written off (Note 9) 1,200 1
Amortisation of accounting software (Note 1) 211 2
Accounting profit on sale of car (Note 6) 600 0·5
Initial allowance (Note 11) 6,000 1
Tax depreciation (Note 12) 28,920 4
37,231
37,569
Less: Dividend income for separate consideration 200 1
37,369
Less: Unadjusted business loss brought forward from
assessment year 2002-2003 (income year ended
30 June 2002) 30,000 0·5
Business income being the taxable income 7,369 The notes should be considered in allocating the marks against each item. Specific marks are to be given

for the five notes (1) to (5) for 'Items not included in the computation of income'. (1 mark for each note) 5

23

(d) Tax I iabil ity

On taxable income of Rs.7,369 at 43% Tax credit on donation of RS.700 (Note 13)

Balance tax refundable

3,169 (301)

2,868 (20,000)

17,132

0·5 1

Tax deducted at source (Note 14)

1

Dividend income - RS.200

Tax deducted at source is the final tax

20

0·5 3 30

15

Marks

Note (1) Acquisition of the software is an 'intangible'. As the normal useful life of the software is unascertainable, the expenditure is amortised over 10 years proportionate to 122 days (1 March to 30 June 2003) the software is used in the business (Rs.6,300 x 1/10 x 122/365 = RS.21l).

Note (2) Donation to the Board of Education is not a deductible expenditure. A tax credit is allowable on the amount paid.

Note (3) Expenditure on perquisites and allowances in excess of 50% of the salary of an employee (excluding the value of perquisites and allowances) is not allowed as a deduction.

Note (4) The expenditure on payment of salary exceeding RS.5 a month is not deductible since the amount was not paid by a crossed bank cheque or a direct transfer to the employee's bank account.

Note (5) The expenditure is not deductible since tax was not deducted at source from the payment of profit on debt to the non-resident.

Note (6) The accounting profit on the sale of the motor car is not income chargeable to tax. The gain on sale of the motor car chargeable to tax is RS.650 (sale consideration RS.800 less tax written down value RS.150).

Note (7) The amount received against debts previously written off is not taxable since the amount when written off was not allowed as a deduction.

Note (8) Since the provision made for bad debts is not for specific debts, it is not a deductible charge.

Note (9) Rs.1 ,200 written off as bad debts is a deductible charge on the assumption that the amount written off has been previously included in the company's income from business chargeable to tax and

the company has reasonable grounds to believe that the debts are irrecoverable.

Note (10) The amount spent on the installation of the plant is a capital expenditure to be added to the cost of the plant.

Note (11) Initial allowance

Residential quarters for factory workers

Rs. 12,000

Initial allowance at 50%

6,000

Note (12) Depreciation

Plant and Residential Factory Other Motor
machinery labour building building vehicle
quarters
Rates of depreciation 10% 10% 10% 5% 20%
Rs. Rs. Rs. Rs. Rs.
Written down value 225,000 25,000 30,000 10,000
Less: Disposal (150)
225,000 25,000 30,000 9,850
Depreciation 22,500 2,500 1,500 1,970
Additions 12,000 1,000
Initial allowance (6,000)
Written down value 6,000 1,000
Depreciation for six months 300
Depreciation for nine months 150 Total depreciation

Rs.

28,470

300 150

28,920

The cost of the new car (Rs.1 ,200) has been restricted to Rs.1 ,000 for claiming depreciation.

Note (13) Tax credit is allowed at the average rate of tax on the amount of the donation paid or 15% of the taxable income whichever is lower; RS.700 paid as donation is lower than 15% of taxable income. Tax credit allowable is 3169/7369 x 700 = RS.301 (tax on taxable income before tax credit/taxable income x amount of the donation)

Note (14) The tax deducted on payments received for the sale of goods is taken as a tax credit since ABC Ltd has not opted to be taxed on the final tax basis.

16

Marks

Items not included in the computation of income: (1) Cost of sales

Freight expenses paid in cash.

Any expenditure under a single head of account aggregating in excess of RS.50 paid other than by a crossed bank cheque or a crossed bank draft is not deductible. One of the exceptions to this rule is expenditure on account of freight. Therefore, freight paid in cash is an allowable deduction.

(2) Admin istration expenses

Contribution to the unrecognised provident fund.

The amount contributed to the fund is deductible since arrangements have been made by ABC Ltd to ensure that tax would be deducted from all payments made from the fund to the employees.

(3) Provision for bad debts

Loan to an employee written off against the provision is not deductible since it is not the business of ABC Ltd to lend money.

(4) No depreciation can be claimed on the new plant since the plant was not commissioned for use in the tax year 2003.

(5) Creditors. Unpaid rent.

No adjustment is required in this year. The expenditure for rent was allowed as a deduction in the accounting year ended 30 June 2002. Any amount remaining unpaid on 30 June 2005 would be treated as taxable income in the tax year 2006.

2 (a) Irfan would be resident for tax purposes in the tax year 2003. He has been present in Pakistan for 182 days

after his return to Pakistan on 31 December 2002. Furthermore, as an employee of the Federal Government

posted abroad in the tax year 2003 he is treated as a resident. 2

(b) Mr Irfan Zaidi

Income year ended 30 June 2003 Tax year 2003

Computation of taxable income

SALARY INCOME

From the Federal Government

Service in Saudi Arabia (Rs.300,000 x 6) From XYZ Ltd

Consideration received for agreeing to enter into the contract for employment (Note 1)

Payment to PQR Bank by XYZ Ltd against loan taken by Irfan (Note 2)

Basic salary for four months (Note 3)

Utility allowance for four months (Rs.240,000 less

10% of basic salary exempt)

Medical allowance - exempt (Note 4) Entertainment allowance for four months School fees for five months (Note 5)

Rent free furnished accommodation (Note 6) Benefit of company maintained car (Note 7)

Rupees
1,800,000 0·5
1,000,000 1
200,000 1
2,000,000 0·5
40,000 0.5
0.5
40,000 0·5
75,000 0.5
95,354 1
62,500 1
5,312,854 17

Marks

Rupees

INCOME FROM PROPERTY Rent chargeable to tax

Rent for 12 months (Rs.150,000 x 12) Non-adjustable deposit (Note 8)

1,800,000 30,000

0·5 1,5

1,830,000

Deductions Repairs (Note 9) Property tax Ground rent Legal expenses Profit on debt

366,000 25,000 2,000 20,000 10,000

1 0·5 0·5 0·5 0·5

423,000

1,407,000

INCOME FROM OTHER SOURCES

Profit on debt (tax deducted at source Rs.20,000)

200,000

0·5

Total income Zakat paid

6,919,854 250,000

0·5

Taxable income 6,669,854

The notes should be considered in allocating the marks against each item

Specific marks are to be given for the six notes (1) to (6) for 'Items not included in the

computation of income' (1 mark for each note). 6

19

(e) COM PUTATION OF TAX LlABI LlTY

Tax on Rs.700,000

Tax on balance Rs.5,969,854 at 35%

Reduction in tax liability on Rs.2,208,449 at 5%

119,000
2,089,449
2,208,449 0·5
(110,422) 0·5
2,098,027
750,000
20,000
(770,000) 1
1,328,027 Deducted at source

On salary income by XYZ Ltd On profit on debt

Balance tax payable

TAX DEDUCTED AT SOURCE CONSIDERED AS FINAL TAX

Gross Tax deducted

Labour contract Dividends

Prize on prize bonds

receipts 500,000 150,000 100,000

is the final tax 25,000 15,000 10,000

1 0·5 0·5

4

25

18

Marks

Note (1) Rs.1 ,000,000 received as consideration for I rfan's agreement to enter into the employment relationship is salary income despite the fact that it was received in Saudi Arabia prior to commencement of employment.

Note (2) The payment to PQR Bank by XYZ Limited against money owing by Irfan to the bank is a benefit of employment taxable as salary income.

Note (3) Salary is taxable on a receipt basis. As the company's policy is to pay salaries of the month on the first day of the following month, the salary and allowances for June 2003 are paid in July 2003. Salary and allowances for four months (February to May 2003) are taxable in the tax year 2003.

Note (4) Medical allowance is exempt up to 10% of basic salary since the terms of employment do not provide for free medical treatment or reimbursement of medical expenses.

Note (5) Payment of school fees for five months is a benefit taxable as salary income. The benefit is calculated for five months since, the fees for the month are paid in the first week of the said month.

Note (6) The annual value of rent free housing is Rs.199,000 (house on 1000 sq. yards within municipal limits) plus 15% of Rs.199,000 (Rs.29,850) for the furnished accommodation. Amount chargeable to tax for five months (February to June) is Rs.95,354 (Rs.228,850 x 5/12).

Note (7) Fair market value of the leased car at the commencement of the lease period is Rs.3,000,000. As the car is partly for private use Rs.150,000 being 5% of Rs.3,000,000 is the annual benefit. Amount chargeable to tax for five months (February to June) is Rs.62,500 (Rs.150,000 x 5/12).

Note (8) A non-adjustable deposit received from a tenant is taxable in 10 tax years in equal proportion including the year in which the deposit is received.

Note (9) One-fifth of the rent chargeable to tax is a deductible charge irrespective of the amount spent (l/5 x 1,830,000).

Items not included in the computation of income

(1) There is no taxable benefit for the use of the second car since the car is used by Irfan wholly for the business of the company.

(2) Until such time as Irfan is entitled to pension benefits, he has no right to any part of the contributions made by XYZ Limited to the pension fund and therefore the annual payment made to the pension fund is not Irfan's income.

(3) Reimbursement of expenses incurred by Irfan on a business trip is not a benefit of employment.

(4) No deduction is allowable for unrealised rent since no steps have been taken to compel the tenant to vacate the house.

(5) Collection charges up to a maximum of 6% of rent is allowable provided the expenditure is incurred. No deduction is allowable since Irfan has not incurred any expenditure for collecting the rent.

(6) The income from dividends, prize on prize bonds and the labour contract are not chargeable to tax under any head of income and are therefore not included in the computation of taxable income. The deduction of tax on the gross amount received is the final tax on such income.

The expenditure of Rs.350,000 incurred in the execution of the labour contract is not deductible. No deduction is allowed for any expenditure incurred where the deduction of tax is the final tax.

19

Marks

3 (a) (i) The input tax claim is to be calculated according to the formula given below by the Apportionment of I nput Tax Rules, 1996 as follows:

Taxable supplies/(Taxable supplies + Exempt supplies) x Input tax 700,000/(700,000 + 800,000) x 150,000 = RS.70 000

Mr Ali can claim the input tax of Rs.70,000 during the tax period of May 2004.

(ii) Under the provisions of s.2(9) of the Sales Tax Act 1990 the sales tax return for the month of May 2004 would be due to be filed on 15 June 2004.

4

1·5

Under the provisions of s.26(1) of the Sales Tax Act 1990 monthly sales tax returns are to be filed

with the designated bank specified by the Central Board of Revenue. 1·5

(b) The following services are chargeable to sales tax:

(1) Services provided or rendered by Hotels

Marriage halls and lawns Clubs

Caterers

Laundries

Dry cleaners

(2) Services provided or rendered by persons authorised to transact business on behalf of others Custom agents

Sh ip chandlers

Stevedores

(3) Courier services

(4) Services provided or rendered for personal care by Beauty parlours

Bea uty cI in ics

Slimming clinics

(5) Advertisement on T.v. and Radio Any 8 items at a 1/2 mark each

4

(e) Under the provisions of s.23 of the Sales Tax Act, 1990 the following are the particulars to be included on a sales tax invoice:

(1) Serially numbered invoice (2) Date of issue of invoice

(3) Name, address and registration number of the supplier (4) Name, address and registration number of the recipient (5) Description and quantity of goods

(6) Value exclusive of tax

(7) Amount of sales tax

(8) Value inclusive of tax

1/2 mark per item

4

15

20

4 Mr Idrees

I ncome year ended 30 June 2003 Tax year 2003

Computation of taxable income I ncome from business Consulting income

Set off of brought forward loss (Note 1)

850,000 (850,000)

Salary

Employee share scheme

sale of rights (Note 2(i))

benefit on acquisition of shares (Note 2(ii))

20,000 150,000

Capital gains

Gain on sale of shares acquired under employee share scheme (Note 3)

Gain on sale of jewellery (Note 4) Gain on sale of manuscript (Note 5) Gain on sale of shares (Note 6)

150,000 2,250,000 5,000,000 56,250

Set off of brought forward capital loss (Note 7)

7,456,250 (50,000)

Total income Zakat paid

Taxable income

Rupees

170,000

7,406,250

7,576,250 (6,000)

7,570,250

The notes should be considered in allocating the marks against each item. Specific marks are to be given for the three notes (1) to (3) for 'Items not included in the computation of income. (1 mark for each note)

Note (1) Losses brought forward

Rs.1,000,000 includes a speculation loss of Rs.100,000 which can only be set off against speculation gains. The balance of Rs.900,000 represents a business loss of Rs.300,000 and unabsorbed depreciation of Rs.600,000. Since a business loss can be carried forward for six years only, it should be set off first before unabsorbed depreciation.

Business Unabsorbed Speculation

Total Loss Loss Depreciation Loss

Rs. Rs. Rs. Rs.

1,000,000 300,000 600,000 100,000

Loss set-off 850,000 300,000 550,000

Loss carried forward

150,000

50,000

100,000

Note (2) Employee share scheme

(i) Idrees agreed to accept the offer of the right to purchase 500 shares in Prime Foods pic by paying £1 per share. The sale of the right for 200 shares for Rs.40,000 resulted in a gain of Rs.20,000 [Rs.40,000 - Rs.20,000 (£200 = Rs.20,000)l. This gain is not taxable as capital gains but as salary income.

(ii) 300 shares of Prime Foods pic were acquired at the exercise price of £10 per share. The fair market value at the date of issue of the shares was £15 per share. The difference of £5 is the taxable benefit. £5 x 300 = £ 1,500 (Rs.150 ,000).

21

Marks

0·5 2

1 1

3 1 1 1

1

0·5

3

15

Marks

Note (3) Gain on disposal of shares acquired under employee share scheme.

Consideration on disposal of 300 shares Cost of 300 shares

£10 per share paid on acquisition including £1 paid for the right - £10 x 300 = £3,000 Amount chargeable to tax as salary income on acqu isition of shares (Note 2)

Rupees 600,000

300,000

150,000

450,000

Gain on disposal

150,000

The entire gain is taxable since the shares were not held for more than one year.

Note (4) Jewellery even if held for personal use is included in the definition of a capital asset and the gain on its disposal is taxable as capital gains. As the jewellery was held for more than one year, only 75%

of the gain of Rs.3,000,000 is chargeable to tax.

Note (5) The entire gain of Rs.5,000,000 on disposal of the rare manuscript is chargeable to tax since the manuscript was not held for more than one year.

Note (6) As the shares of the private company were held for more than one year, 75% of the gain of Rs.75,000 is chargeable to tax.

Note (7) A capital loss cannot be carried forward for more than six years immediately succeeding the tax year in which the loss was incurred. The loss was incurred in the year ended 30 June 1997.

The limit of six years expires on 30 June 2003 and therefore the capital loss can be set off against capital gains in the tax year 2003.

Items not included in the computation of income:

(1) The loss of Rs.l,OOO,OOO on disposal of the old coins is not recognised as a capital loss for tax purposes. (2) Immovable property is not a 'capital asset' for capital gains purposes. The gain on the house is not

chargeable to tax.

(3) The gain of Rs.750,000 on the sale of shares in PQR Ltd is exempt from tax as PQR Ltd is a public company. PQR Ltd is a public company because not less than 50% of its shares are held by the Federal Government.

5 (a) (i) Two persons can be treated as associates where the relationship between them is such that:

one person may reasonably be expected to act according to the wishes of the other person; or both persons may reasonably be expected to act according to the wishes of a third person.

(ii) Where the Commissioner is of the view that any transaction between persons who are treated as associates for tax purposes is not on an arm's length basis, he has been empowered to distribute, apportion or allocate income, deductions or tax credits between the persons, so as to arrive at the income wh ich would have been earned by the persons in an arm's length transaction.

2

2

(b) (i) The Central Board of Revenue issues circulars to set out the Board's interpretation of the provisions of the Income Tax Ordinance so that there is consistency in the administration of the Ordinance and

also to provide guidance to the officers of the CBR and to taxpayers. 2

(ii) CBR circulars are binding on

the Regional Commissioner of Income Tax the Commissioner of Income Tax

0·5 0·5

CBR circulars are not binding on

the Commissioner of Income Tax (Appeals) taxpayers.

0·5 0·5

22

Marks

(e) (i) An amount becomes due to a person under the accrual basis accounting at the time the person becomes entitled to receive the amount despite the fact that the receipt of the amount may be postponed or that the amount is payable in instalments.

2

(ii) An amount becomes payable by a person under the accrual basis accounting when:

(1) all events that determine the liability to pay have occurred; 1

(2) the amount can be ascertained with reasonable accuracy; and 1

(3) economic performance occurs 1

Economic performance occurs:

in the case of the acquisition of services or assets, at the time the services or assets are provided; 0·5

in the case of the use of assets, at the time the assets are used; and 0·5

in any other case, at the time payment is made in full satisfaction of the liability. 0·5

In other words in addition to the conditions listed in items (1) and (2) above, the occurrence of economic

performance is mandatory. 0·5

15

6 (1) The provisions of the tax law relating to assessment on the final tax basis applicable to income arising from

the sale of goods are that:

A prescribed person making a payment to a resident person for the sale of goods is requ ired to deduct tax under the provisions of s.153(1) of the Income Tax Ordinance 2001 at the rate of 3·5% from the gross

amount of the payment. A prescribed person includes the Federal Government and a company. 1·5

The tax so deducted would be the final tax of the resident person if

the resident person is the manufacturer of the goods sold; and

the resident person specifically opts to be assessed on the final tax basis by furnishing to the Commissioner a declaration in writing of the option to be assessed on the final tax basis within three months of the commencement of the relevant tax year. The declaration is irrevocable and remains in

force for three years. 1·5

(2) Eligibility of PEPL to be assessed on a final tax basis.

PEPL is eligible to be assessed on a final tax basis on the income from the sale of the circuit breakers since:

PEPL being a company incorporated under the Companies Ordinance 1984, is a resident person; all the circuit breakers sold to the Federal Government have been manufactured by PEPL; and

the Federal Government being a prescribed person, will deduct tax at 3·5% from the gross amount paid

to PEPL for the sale of the circuit breakers. 1·5

If PEPL wants to be taxed on the final tax basis for the tax year 2004, PEPL is required to furnish to the Commissioner a declaration in writing of the option to be assessed on a final tax basis within three

months of the commencement of the tax year. For tax year 2004, the last date for furnishing the declaration is 30 September 2003, as PEPL's tax year commences on 1 July 2003. The declaration being irrevocable

would remain in force for three years, in other words for the tax years 2004, 2005 and 2006. 1·5

23

Marks

(3) Basis of taxation recommended for PEPL

To determine whether it would be beneficial for PEPL to be assessed on the final tax basis or the regular basis of assessment on its taxable income, the budgeted figures for the relevant tax years have been analyzed as under:

Tax year Turnover Tax Taxable Rate of tax
deducted income
Rs. Rs. Rs.
2004 10,000,000 350,000 1,500,000 41 %
2005 12,000,000 420,000 1,920,000 39%
2006 14,000,000 490,000 2,380,000 37%
1,260,000 Tax liability

Rs.

615,000 0·5

748,800 0·5

880,600 0·5

2,244,400

Tax liability on basis of taxable income

Tax liability if the tax deducted is the final tax

Rs. 2,244,400 1,260,000

984,400 0·5

In the tax year 2007, due to the investment of Rs.10,000,000 in the purchase of new plant and machinery, PEPL would be entitled to claim initial allowance and depreciation in computing the taxable income.

Loss to be carried forward

Rupees
10,000,000
5,000,000 0·5
500,000 0·5
560,000 0·5
2,880,000
(5,500,000)
2,620,000 0·5 Cost of new plant

Initial allowance at 50%

Depreciation at 10% on written down value of Rs.5,000,000 (Rs.10,000,000 less Rs.5,000,000)

Tax deducted at source at 3·5% on turnover of Rs.16,000,000

Computation of taxable income

Taxable profit prior to initial allowance and depreciation (18% of Rs.16,000,000) Initial allowance and depreciation (5,000,000 + 500,000)

The Finance Director should be advised as under:

(i) For the tax years 2004, 2005 and 2006 it would be beneficial for PEPL to be assessed on the final tax basis

as against being assessed on the taxable profits as this would result in a saving in tax of Rs.984,400. 1

(ii) Therefore PEPL should before 30 September 2003 submit to the Commissioner in writing, a declaration of the

option to be assessed on the final tax basis for the tax year 2004. As the option is not revocable for three years,

the tax years 2005 and 2006 would also be assessed on the final tax basis. 1

(iii) For the tax years 2004, 2005 and 2006, PEPL should not file a regular return of income on the taxable income basis but submit a statement prescribed under the law detailing the gross amount of the sale proceeds and the

tax deducted therefrom. 1

(iv) For the tax year 2007 PEPL should not file the declaration of option to be assessed on the final tax basis. PEPL

should submit a return of income on the taxable income basis:

declaring a loss of Rs.2,620,000 which would represent unabsorbed initial allowance; and

claiming a refund of Rs.560,000 being the tax deducted at source from the payment received for the sale

of goods. 1·5

Besides the saving in tax in the tax year 2007 the unabsorbed initial allowance of Rs.2,620,000 can be carried

forward until it is completely set-off against the future profits of PEPL. 0·5

15

24

Marks

7 (a) (i) The amount received by Urea Ltd Australia is consideration for fees for technical services (FTS) and is Pakistan-source income since it is paid by Usman Pakistan Limited (UPl), a resident company and the technical reports and information obtained from Urea Ltd are not utilized by UPL for any

business carried out by them outside Pakistan. 2

(ii) As the income of Urea Ltd Australia is Pakistan - source income, UPL has to withhold tax at the rate

of 15% of the gross payments made to Urea Ltd. 1

(iii) If the reports and information received from Urea Ltd are used by UPL for their business outside Pakistan, then the consideration receivable by Urea Ltd would be foreign-source income. As Urea

Ltd is a non-resident company, the foreign-source income is not chargeable to Pakistan tax and no tax is to be withheld by U PL.

However, U PL, before making payment to Urea Ltd has to furn ish a notice in writing to the Commissioner stating the name and address of Urea Ltd, the amount payable and the nature of

the payment. The Commissioner has to pass an order either accepting the contention of UPL or direct UPL to deduct tax under s.152 of the Income Tax Ordinance at the standard rate of 30% of the

gross payment. On an application to be made by Urea Ltd, the Commissioner may issue a certificate exempting the amount from tax or requiring deduction of tax at a rate lower than 30%. UPL would then

have to comply with the directions given in the certificate for withholding purposes. 2

1

(b) (i) Tausif Associates is an 'association of persons' (AOP) for tax purposes.

Rupees

Tausif Associates

Income year ended 30 June 2003 Tax year 2003

Computation of taxable income Income from business

500,000

Taxable income

500,000

0·5

Tax payable

On Rs.400,000

On balance of Rs.100,000 at 25%

44,000 25,000

69,000 0·5

(ii) Mr Tausif

Income year ended 30 June 2003 Tax year 2003

Computation of taxable income

Rupees

Income from business

Share of income from Tausif Associates Rs.250,000 - exempt from tax - Note 1 Income from other sources

Consideration for vacating possession of the flat (Note 2) Profit on debt (tax deducted at source Rs,l ,000)

0·5

120,000 10,000

1·5 0·5

Total income Zakat paid

130,000 (1,000)

0·5

Taxable income

129,000

Tax liability (Note 3(i)) Tax deducted at source

13,547 1,000

1·5 0·5

Tax payable

12,547

25

Marks

(iii) Mr Nadir

Income year ended 30 June 2003 Tax year 2003

Computation of taxable income Salary

Consideration received from ex-employer for agreeing to a restrictive covenant I ncome from business

Share of income from Tausif Associates Rs.250,000 - exempt from tax (Note 1)

1,000,000

1

0·5

1,000,000

Tax payable (Note 3(ii))

249,200

1·5 15

Note (1) If tax is paid by an AOP, the share of profit received by a member out of the income of the AOP is exempt from tax.

Note (2) Consideration received for vacating h is flat Amount paid to acquire possession of the flat

Rupees 1,800,000 (600,000)

Income

1,200,000

The income of Rs.1 ,200,000 is taxable in 10 years in equal proportion including the year in which the consideration is received. Rs.120,000 (1/10 of Rs.1,200,000) is taxable in the tax year 2003.

Note (3) The share of profit from the AOP received by Tausif and Nadir is exempt from tax and does not form part of their taxable income. However, for the purpose of determining the rate of

tax that would be applicable to the taxable income of each individual (other than the share of profit from the AOP), the respective share of profit from the AOP is included in each of the individual's taxable income as if the share of profit was chargeable to tax.

(i) Tausif Rupees
Taxable income (C) 129,000
Income if share of profit from AOP was not exempt
from tax (129,000 + 250,000) (8) 379,000
Tax on Rs.379,000
On Rs.300,000 24,000
On Rs. 79 ,000 at 20% 15,800
(A) 39,800
Tax liability
(AlB) xC
39,800/379,000 x 129,000 = 13,547
(ij) Nadir
Taxable income (C) 1,000,000
Income if share of profit from AOP was not exempt from tax
(1,000,000 + 250,000) (8) 1,250,000
Taxon Rs.1,250,000
On Rs.700,000 119,000
On Rs.550,000 at 35 % 192,500
(A) 311,500
Tax payable
(AlB) xC
311,500/1,250,000 x 1,000,000 = 249,200 26

Business Taxation (Pakistan)

PART 2

WEDNESDAY 8 JUNE 2005

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A BOTH questions are compulsory and MUST be answered

Section B THREE questions ONLY to be answered

Tax rates and allowances are on pages 2-3

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

z ~ 0....

N

\,

Q) 0.. CO

0....

The following tax rates and information are to be used in answering the questions:

A. Tax rates for individuals and associations of persons for the tax year 2004

Taxable income Rate of tax

Up to Rs. 80,000 0%

Rs. 80,001 - Rs. 150,000 7·5% of the amount exceeding Rs. 80,000

Rs. 150,001 - Rs. 300,000 Rs. 5,250 plus 12·5% of the amount exceeding Rs. 150,000.

Rs. 300,001 - Rs. 400,000 Rs. 24,000 plus 20% of the amount exceeding Rs. 300,000.

Rs. 400,001 - Rs. 700,000 Rs. 44,000 plus 25% of the amount exceeding Rs. 400,000.

Rs. 700,001 and above Rs. 119,000 plus 35% of the amount exceeding Rs. 700,000.

B. Tax rates for individuals and associations of persons for the tax year 2005

Taxable income Rate of tax

Up to Rs. 100,000 0%

Rs. 100,001 - Rs. 150,000 7·5% of the amount exceeding Rs. 100,000

Rs. 150,001 - Rs. 300,000 Rs. 3,750 plus 12·5% of the amount exceeding Rs. 150,000.

Rs. 300,001 - Rs. 400,000 Rs. 22,500 plus 20% of the amount exceeding Rs. 300,000.

Rs. 400,001 - Rs. 700,000 Rs. 42,500 plus 25% of the amount exceeding Rs. 400,000.

Rs. 700,001 and above Rs. 117,500 plus 35% of the amount exceeding Rs. 700,000.

C. Reduction in tax liability of salaried individuals where salary income exceeds 50% of taxable income

Income slab Reduction in tax liability

Up to Rs. 60,000 0%

Rs. 60,001 - Rs. 80,000 70%

Rs. 80,001 - Rs. 100,000 60%

Rs. 100,001 - Rs. 150,000 50%

Rs. 150,001 - Rs. 200,000 40%

Rs. 200,001 - Rs. 300,000 30%

Rs. 300,001 - Rs. 500,000 20%

Rs. 500,001 - Rs. 1,000,000 10%

Rs. 1,000,001 and above

5%

D. Tax rates for companies

Tax Year Banking

company

2004 44%

Public company other than a banking company 35%

Private company other than a banking company 41%

E. Tax rates on dividends received from companies Received by a public company or an insurance company In any other case

5% of the gross dividend 10% of the gross dividend

F. Rates of advance collection or deduction of tax at source Import of goods

6% of the value of the goods determined for custom purposes

Yield on certificates under the National Savings Scheme or Post Office Savings Account

10% of the yield paid

G. Capital allowances Depreciation

Factory buildings

Other buildings Furniture and fittings

Plant and machinery (not otherwise specified) Motor vehicles (all types)

10%

5% 10% 10% 20%

of the tax written down value

Initial allowance

50% of cost

2

H. Value of free unfurnished accommodation where salary is Rs. 600,000 or more

Land area Value for areas outside municipal limits

Up to 250 sq. yards Rs. 27,000

251 to 500 sq. yards Rs. 66,000

501 to 1000 sq. yards Rs. 106,000

1001 to 2000 sq. yards Rs. 198,000

2001 sq. yards and over Rs. 264,000

I. Benchmark rate

For determing the value of the perquisite on loans given to employees, the benchmark rate is:

For the tax year 2003:

A rate of 5% per annum

For subsequent tax years:

The rate for each successive year to be 1 % more than the immediately preceding tax year's rate but not exceeding the rate if any which the Federal Gevernment may specify for any tax year.

3

[P.T.O.

Section A - BOTH questions are compulsory and MUST be attempted

1 PQR Ltd, an industrial undertaking engaged in the manufacturing of pesticides, requires you to prepare its income tax return for the accounting year ended 30 June 2004.

The following information has been made available to you:

(1) All amounts are stated in thousands of Rupees ('000 Rupees)

(2) PQR Ltd is a public company under the Companies Ordinance 1984. The company applied for listing on the Karachi stock exchange on 1 December 2003 and the shares of the company commenced trading on that exchange on 1 June 2004. The company remained listed on that exchange until 31 December 2004 on which date the company was delisted on the exchange

(3) The accounting profit for the year ended 30 June 2004, after providing Rs.3,500 for taxation, is Rs.1O,500 (4) Cost of sales include:

Excise duty paid in cash

Demurrage paid to the Karachi Port Trust for the late lifting of imported raw materials Tax collected by the Collector of Customs on the value of raw materials imported by the company for its own use

Amount paid to the Collector of Customs for an erroneous declaration in a bill of entry Expenditure of Rs.9,600 was incurred for in-house development and creation of a new

process for the faster formulation of pesticides. The process has been used by PQR Ltd

since 1 May 2004. On the basis of the production manager's report that the process

would be obsolete in three years, the expenditure is being written off equally in three years (113 of Rs.9,600)

Depreciation charged in the accounts

(5) Administration expenses include:

Legal expenses incurred in defending the title to the company's building

Legal costs incurred in defending a director of the company for a traffic accident Purchases of items of furniture costing less than RS.100 each charged off in the accounts,

in accordance with the consistent accounting policy of the company. Purchases of such items in July 2003 amounted to

Amortisation of preliminary expenses incurred on incorporation of the company in 1996. 10% of the expenditure is being written off each year

(6) Selling and distribution expenses include:

A 1600cc motor car was purchased and given to Mr Baig, a dealer, for achieving the highest sales of 'Chandi' pesticides for the six months ended 31 December 2003. No tax was collected

by PQR Ltd from Baig, since the sales director of PQR Ltd and Baig were of the view that the law envisaged collection of tax only on cash prizes

(7) Financial charges include:

Profit on a debt paid to Rich Bank, Bahamas on a US Dollar loan. The loan was used by PQR

Ltd for its business in Pakistan. No tax was deducted at source from the payment of the profit

on the contention that the profit was not chargeable to tax in Pakistan since Rich Bank has no permanent establishment in Pakistan and the profit on the debt has been received by Rich Bank in the Bahamas where no income tax is payable

(8) Other income includes:

Recoveries against bad debts written off in prior years which were allowed as a deduction 250

Dividend received (gross amount) from PQR's wholly owned subsidiary company, which is a

private company 200

Dividend received (gross amount) from a public company 100

700 300

8,000 90

3,200 1,125

165 60

750

650

1,600

9,800

(9) Creditors include excise duty which was allowed as a deductible charge in the income year

ended 30 June 2000 900

4

(10) Fixed assets

(i) In the tax year 2003, a second hand mixing machine which had not previously been used in Pakistan was imported from the UK for Rs.2,500. Due to some major renovations required before the machine could be used in the business, the machine could not be commissioned for use in the tax year 2003. In July 2003, the necessary renovations costing RS.576 were completed and the machine was commissioned for use in the month of July 2003. The renovation cost of RS.576 has been included in the 'Cost of sales'.

(ii) The tax written down values of the fixed assets on 1 July 2003 were:

Factory buildings Office buildings

Plant and machinery Motor vehicles Furniture

(iii) One of the office buildings (cost Rs.5,000 and tax written down value Rs.3,200) was sold on 30 June 2004 for Rs.6,000. The accounting profit of RS.745 on the sale of the building has been included in 'Other income'.

(iv) A new motor vehicle was purchased on 1 July 2003 for Rs.1 ,500

(11) Unadjusted business loss brought forward:

This loss was determined for tax purposes in the accounting year ended 30 June 1997 which includes unabsorbed depreciation of Rs.1 ,500

(12)Tax paid or deducted at source

Tax of Rs.465 was deducted by the customers from payments made to PQR Ltd for the sale of its own manufactured goods. PQR Ltd has furnished a declaration to be assessed on a final tax basis to the Commissioner of I ncome Tax on 30 October 2003.

2,500 8,200 9,500

400 250

2,750

Rs.8,000 was paid as advance tax for the tax year 2004.

Required:

(a) Briefly state with reasons whether or not you consider PQR Ltd to be a public company for the tax year 2004. (2 marks)

(b) Compute the taxable income of PQR Ltd for the relevant tax year giving clear explanations for the inclusion

or exclusion in the computation of income of each of the items listed above. (25 marks)

(c) Calculate the tax payable by/refundable to PQR Ltd for the relevant tax year.

5

(3 marks) (30 marks)

[P.T.O.

2 Mr Iqbal is a citizen of Canada and since 1999 he has been working in the United Kingdom as a chemist employed by Chemicals pic (CPLC). He retired from CPLC on 1 October 2003 having accepted CPLC's offer to work as the chief chemist of Pakistan Chemical Ltd (PKC), an associate company of CPLC from 1 January 2004. The directors of CPLC in appreciation of Iqbal's agreement to serve PKC, voluntarily informed him that PKC would pay him Rs.500,000 on his joining the Pakistan company.

Iqbal has approached you to prepare his return of income for the tax year 2004. The following information has been made available to you for the accounting year ended 30 June 2004.

(1) After returning to Pakistan on 3 October 2003, Iqbal imported a consignment of pharmaceuticals in finished form from the United Kingdom. The value of the imported goods as determined for custom purposes was Rs.5,488,500. The landed cost of the consignment including duties and clearing charges was Rs.5,885,000. The entire consignment was sold for Rs.6,500,000 in December 2003. Rs.60,780 storage charges were incurred in addition to the landed cost.

(2) His taxable income for the period from 1 July 2003 to 31 October 2003 from CPLC was £12,000 on which tax of £ 2,000 had been withheld by CPLC and paid to the UK revenue authorities.

(3) Iqbal received the Rs.500,000 as previously promised by the directors' of CPLC from PKC on joining the company on 1 January 2004. As the payment was dependent upon the goodwill of CPLC, neither the employment agreement with CPLC nor PKC provided for this payment.

(4) In accordance with the terms of his employment with PKC the following remuneration and benefits were received

by Iqbal:

A basic monthly salary of Rs.300,000

A monthly cash allowance of Rs.30,000 each for cost of living and entertainment respectively A one time payment of Rs.308,000 as relocation allowance

Rs.375,000 for a return business class airfare to Toronto for Mrs. Iqbal

A fully maintained 2000cc motor car for his business and private use which was purchased by the company for RsA,750,000. A deduction of Rs.3,000 a month is being made from his salary for this benefit.

Rent free housing in the company's bungalow on a land area of 1,000 square yards outside the limits of the Karachi Municipal Corporation. Electricity is provided by the company's own generator. The number of units consumed, if purchased from the Karachi Electric Supply Corporation would have cost Rs.210,000. Services of a gardener which costs PKC Rs.8,000 a month.

Reimbursement of all medical and hospitalisation expenses which cost the company Rs.257,000.

(5) On 1 January 2004, Iqbal took a loan of Rs.300,000 from PKC repayable in six yearly installments. No profit was payable on the loan. On 30 June 2004, 50% of the loan was waived by PKC.

(6) Iqbal had elected to participate in the CPLC employee share scheme (Scheme) and had been granted the right to purchase 1,000 shares of CPLC at the exercise price £15 for one share. On 1 February 2004, he exercised his right to purchase 500 shares and remitted £7,500 to the custodian of the Scheme. The rights for the remaining 500 shares were disposed of for Rs.50,000. The market price of one share of CPLC on the date of issue of the rights was £22 and on the date when Iqbal exercised his right to purchase the shares it was £23.

(7) Iqbal is the owner of a piece of land. He has allowed B the right to use the land for an annual rent of Rs.I00,000.

On 1 July 2003 he collected two years rent in advance and a refundable deposit of Rs.l 00,000 which is not adjustable against the rent payable. Iqbal is of the view that the deposit of Rs.lOO,OOO is taxable over a period of 10 years.

(8) The following amounts were also received by Iqbal in the year ended 30 June 2004 after deduction of tax.

Rs. 7 ,500 dividend from a private company

Rs.270,000 profit on saving certificates issued by the National Savings Centre.

(9) Zakat paid by Iqbal was Rs.75,000

(10)Tax deducted at source by PKC on salary income was Rs.l ,467,800 (11 )The rate of excha nge is to be ta ken as £ 1 = Rs.l 00

6

Required:

(a) Compute the total income and taxable income of Iqbal for the tax year relevant to his accounting year ended 30 June 2004 giving reasons/explanations for the inclusion or exclusion in the computation of income for each of the items listed above. (20 marks)

(b) Calculate the tax payable by/refundable to Iqbal for the relevant tax year.

(5 marks) (25 marks)

7

[P.T.O.

Section B - THREE questions ONLY to be answered

3 (a) Certain persons engaged in making taxable supplies in Pakistan are required to be registered under the Sales Tax

Act 1990 (the Act).

Required:

State when each of the following is required to register under the Act. (i) a manufacturer; and

(ii) a retailer.

(3 marks)

(b) The Collector of Sales Tax, in certain cases can blacklist or suspend the registration of a person under the Sales Tax Act. 1990.

Required:

List the cases when the Collector of Sales Tax can blacklist or suspend the registration of a person.

(3 marks)

(c) Under s.8 of the Sales Tax Act 1990 the Federal Government, by a notification in the Official Gazette, has specified certain goods, acquired otherwise than as stock-in-trade, on which input tax shall not be claimed.

Required:

List any four goods which have been so notified by the Federal Government in respect of which input tax shall not be claimed. (4 marks)

(d) State the basis for calculating the compensation payable to a claimant on a refund of sales tax, when the

refund is not made within the specified time. (1 mark)

(e) On certain payments made, a buyer being a registered person is not entitled to claim input tax credit, if the payment is made otherwise than in the manner prescribed in the Sales Tax Act 1990.

Required:

Explain with reasons whether a buyer being a registered person, would be entitled to claim input tax on the following payments made:

(i) Rs.95,000 paid by cash for payment of utility bills.

(ii) Rs.17,000 paid by cash for purchase of aluminum foils used for packing material.

(iii) Rs.75,000 paid for the purchase of spare parts through a crossed bank draft drawn on the personal bank account of the buyer.

(iv) Payment of Rs.150,000 made, for new materials purchased on credit, after one hundred and eighty days of the issuance of the tax invoice through a crossed bank draft drawn on the business bank account of the buyer. (4 marks)

(15 marks)

8

4 Mr Saleem, a member of the Karachi Stock Exchange (Guarantee) Limited, is the sole proprietor of Saleem Sons, Stocks, Shares and Finance Brokers. The following information has been made available to you by Saleem for his accounting year ended 30 June 2004.

(1) Transactions in the accounts of Saleem Sons

(i) Brokerage income of Rs.785,000 on transactions effected on behalf of clients (ii) Disposal of shares held as stock-in-trade

Gain of Rs.60,000 on the sale of shares in ABC Ltd a public company under the Companies Ordinance 1984. ABC Ltd is not listed on any stock exchange in Pakistan. The sale was within one year of the acquisition of the shares.

Loss of Rs.75,000 on the sale of shares in XYZ Ltd a company which is listed on the Karachi Stock Exchange.

Loss of Rs.55,000 on the sale of shares in Highland (Private) Ltd

Gain of Rs.45,000 on the sale of shares in Gogo Limited, a company in which 50% of the shares are held by the Govemment of Sindh. The sale was made more than one year after the acquisition of the shares.

(2) Prior to his self-employment as a broker, Saleem, as the investment manager of Securities Pakistan Limited, a subsidiary of Securities pic, had participated in an employee share scheme of Securities pic. The details of the transactions relating to the employee share scheme are as follows:

On 1 January 2003 (tax year 2003), Saleem had exercised his right to acquire 1,000 shares in Securities pic by making payment of £5 per share. The market price of one share on that date was £15.

On 30 June 2004 he disposed of his entire holding of 1,000 shares in Securities pic for Rs.2,000,000.

(3) On the death of Saleem's father on 1 June 1980, he had inherited the following assets: an Italian sculpture;

two rare postage stamps - one of India and the other of China; and 50,000 shares in Bingo (Private) Ltd.

An expert valuer had then valued the sculpture at Rs.700,000 and the two postage stamps at Rs.25,000 each. The break up value of the shares in Bingo (Private) Ltd on 1 June 1980 was Rs.l 0 for each share.

(4) On 1 September 2003 Saleem transferred the 50,000 shares in Bingo (Private) Ltd to his wife under an agreement to I ive apart. The fair market value of one share on the date of the transfer was Rs.15.

(5) On 1 June 2004 Saleem sold the Italian sculpture for Rs.l,OOO,OOO, the Indian postage stamp for Rs.45,000 and the Chinese stamp for Rs.20,000.

(6) In July 2003 Saleem had purchased a motor car for Rs.l ,300,000 for the personal use of his wife, He sold the car in August 2003 for Rs.l ,400,000.

(7) Unadjusted losses brought forward

A business loss of Rs.750,000 in Saleem Sons incurred in the tax year 2003. This loss includes a net loss of Rs.50,000 suffered in the money market on forward contracts for the purchase and sale of US Dollars. All the contracts were settled by Saleem Sons other than by actual delivery or transfer of US Dollars.

A loss of Rs.l ,039,725 sustained under the income head 'Capital gains' which is made up as follows:

Accounting year ended 30 June 2003

30 June 1998

30 June 1997

Rupees 47,500 637,225 355,000

1,039,725

(8) Zakat paid was Rs.I0,000.

(9) The rate of exchange is to be taken as £1 = RS.I00 Required:

Compute the taxable income of Saleem for the tax year relevant to the accounting year ended 30 June 2004 giving clear explanations for the inclusion or exclusion of each of the items listed above in the computation of income.

(15 marks)

9

[P.T.O.

5 (a) On 15 July 2004 Mr Alibaba furnished you with the following information:

Since 1 July 2004, he has been carrying on the business of selling ice-cream to the general public for the purpose of consumption.

The first accounting year for his business will end on 30 June 2005

The gross receipts from the sale of ice-cream for the year ending on 30 June 2005 is estimated to be between Rs.2,775,000 and Rs.3,000,000.

He has been informed by his accountant that recently a new s.1l3A has been inserted in the Income Tax Ordinance 2001 whereby a retailer has the option to pay income tax at the rate of 0·75% of the total turnover for a tax year, which payment is treated as the final tax on the income arising from the said turnover. He wants you to:

(i) state who is considered to be a retailer for the purpose of s.113A;

(ii) state the conditions to be fulfilled by a retailer in order to be eligible to be assessed on the fixed tax basis; (iii) explain the term 'turnover' as would be applicable to his business; and

(iv) state, with reasons, whether he would be eligible to pay income tax at the rate of 0·75% of his turnover

which would be treated as the final tax for the tax year 2005.

Required:

Provide the information requested by Alibaba on the four issues listed above. (8 marks)

Marks to be allocated to the four items as (i) 1 mark, (ii) 3 marks, (iii) 2 marks and (iv) 2 marks.

(b) Mr X is a salaried employee and a taxpayer on record with the Income Tax Department since 1990. In 1994, he purchased a house in Clifton for Rs.3,000,000 out of his earnings as a part-time property broker which earnings had not been included by him in any of the tax returns furnished to the tax department.

For the tax year 2004, he had furnished to the Commissioner the Employer's Certificate in lieu of a return of income and the statement of assets and liabilities (wealth statement) as at 30 June 2004. The return and the wealth statement furnished were on the prescribed form and complete in all respects. No amended assessment order has been framed by the Commissioner for that tax year.

On 5 January 2005, the Commissioner was informed by his Regional Commissioner that a house property belonging to Mr X had been impounded by the Property Tax Department of the Government of Sindh for nonpayment of water and property taxes for the last ten years.

Required

Explain the steps that the Commissioner can take under the Income Tax Ordinance 2001 to safeguard the interest of revenue. (7 marks)

(15 marks)

10

6 For the purpose of this question you should assume that today's date is 15 June 2004.

Aban Akbar has the choice of two offers of employment. Whichever of the two jobs she accepts she will commence employment on 1 July 2004.

ABC Limited

Under the offer of employment from ABC Ltd, Aban would receive an annual salary of Rs.l ,000,000 which would be structured as under:

Basic salary

House rent allowance Cost of living allowance Conveyance allowance Entertainment allowance

Rupees 600,000 200,000

75,000 75,000 50,000

1,000,000

Aban requested permission from ABC Limited to restructure the salary to make it more tax efficient. Her request is not acceded to for the reason that the company has a uniform policy for the salary structure of its employees.

PQR Limited

Under the offer of employment from PQR Ltd, Aban will receive a gross annual salary of Rs.l ,000,000. Aban's request to restructuring her salary to make it more tax efficient has been accepted by the company. She is however informed that the company does not provide for free medical treatment or hospitalisation or for the reimbursement of such charges.

Required

(a) Calculate Aban's salary income after deduction of tax for the year ended 30 June 2005 if she accepts the

offer of ABC Limited. (5 marks)

(b) Advise Aban as to how she can structure the offer of Rs.l ,000,000 from PQR Limited so as to give her the

maximum benefit. Your answer should be supported by explanations for the suggestions made. (8 marks)

(c) Calculate Aban's salary income after deduction of tax for the year ended 30 June 2005, if she accepts the

offer of PQR Limited on the basis of the salary structure suggested by you in (b). (2 marks)

(15 marks)

11

[P.T.O.

7 (a) Captains Courageous Company (CCC), a company registered in the British Virgin Islands, is in the business of operating ships which are owned by it. CCC's operations in Pakistan are limited to the carriage of goods from Pakistan to destinations outside Pakistan and the carriage of goods imported into Pakistan embarked outside Pakistan.

You are informed by CCC's local shipping agent that CCC is of the view that the company's income from its Pakistan operations is not taxable in Pakistan as its world income is exempt from tax in the British Virgin Islands. However on his making inquiries of the tax department he was informed that CCC would be taxable in Pakistan on the aforesaid operations.

The agent wants you to prepare a comprehensive note explaining:

(i) The tax provisions under which CCC's income would be chargeable to tax in Pakistan, the basis of computing the amount chargeable to tax and the tax payable thereon.

(ii) Whether the above basis of computing income and the tax payable would change if some of the ships used for the carriage of goods are chartered by CCC.

(iii) The requirements to be completed by the master of a ship for income tax purposes before the ship is allowed to leave a Pakistan port.

(iv) The procedure for obtaining a port clearance certificate allowing a ship to depart from a Pakistan port, when

the master of the ship is unable to complete the requirements referred to in item (iii) above.

The rate of tax on the shipping income of a non-resident person is 8%. Required

Prepare the note required by the local shipping agent. (11 marks)

Marks will be allocated to the four items as (i) 6 marks; (ii) 1 mark; (iii) 3 marks and (iv) 1 mark.

(b) Under the provisions of s.122A of the Income Tax Ordinance, 2001 the Commissioner can call for the records of any proceedings in which an order has been passed by certain taxation officers. After making such inquiries as is necessary, the Commissioner may then make such revision to the order as he deems fit.

Required

(i) State whether or not the Commissioner can revise the following orders: - an order passed by the Commissioner (Appeals);

- an assessment order framed under the repealed Income Tax Ordinance 1979; and

- an assessment order reducing the amount of a refund determined in an assessment order.

(2 marks)

(ii) List the orders that cannot be revised by the Commissioner under the provisions of s.122A. (2 marks) (15 marks)

End of Question Paper

12

Answers

Part 2 Examination - Paper 2.3(PKN) Business Taxation (Pakistan)

June 2005 Answers and Marking scheme

Marks

1 (a) A company may be a public company under the Companies Ordinance 1984 but may not be a public

company for tax purposes. A company whose shares were traded on a registered stock exchange in Pakistan

at any time in the relevant tax year and which remained listed on that exchange at the end of that tax year is a publ ic company for tax purposes.

The shares of PQR Ltd commenced trading on the Karachi stock exchange on 1 June 2004 and the company was delisted on that exchange on 31 December 2004. PQR Ltd is a public company for tax purposes in the

tax year 2004 since its shares were traded on a registered stock exchange in Pakistan during the tax year 2004

and PQR Ltd was listed on that stock exchange on 30 June 2004 (the end of the tax year 2004). 2

(b)

PQR Ltd

Accounting year ended 30 June 2004 Tax year 2004

Computation of taxable income Accounting profit

Add: Provision for taxation (Note 1)

Tax collected by the Collector of Customs (Note 2) Penalty paid to the Collector of Customs (Note 3) Amortisation of the cost of new process (Note 4) Accounting depreciation

Legal costs (Note 5)

Purchase of furniture (Note 6)

Amortisation of preliminary expenses (Note 7) Prize for sales promotion (Note 8)

Profit on debt (Note 9)

Unpaid excise duty (Note 10)

Tax profit on sale of building (Note 11) Renovation cost of mixing machine (Note 12)

Rs. in thousands 10,500

3,500 8,000 90 3,200 1,125 60

750 650 1,600 9,800 900

1,800 576

0·5 1 1 0·5 0·5

1 0·5 0·5 1·5 1·5 1·5 1·5 0·5

32,051

42,551

Less: Accounting profit on sale of a building (Note 11) Amortisation of intangible (Note 4)

Initial allowance (Note 13)

Depreciation (Note 14)

745 533 1,538 1,984

0·5 1·5 1 4

4,800

Less: Dividend income for separate consideration

37,751 300

1

Less: Unadjusted business loss being unabsorbed depreciation (Note 16)

37,451 1,500

1

Business income being taxable income

35,951

The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income

(I mark for each item) as follows: 4

15

Marks

Items not included in the computation of income

(1) Any expenditure under a single head of account in excess of RS.50 paid other than by a crossed bank cheque or a crossed bank draft is not deductible. One of the exceptions to this rule is payment of duties. Therefore the excise duty paid in cash is deductible.

(2) Demurrage paid for the late lifting of goods is an expenditure in the normal course of carrying on the business. It is not in the nature of a fine or penalty for violation of any law, rule or regulation. It is therefore an allowable deduction.

(3) Legal expenses incurred by PQR Ltd in defending the title to its assets is a deductible expense as it is in the normal course of carrying on its business. The expenditure has neither added to the value of the assets nor created a new asset.

(4) PQR Ltd has received RS.250 against debts which were previously allowed as a deductible charge, therefore, the loss to that extent has been recouped. Where any expenditure or loss allowed as a deduction in a tax year against income chargeable to tax under a head of income, is received in cash or kind (recouped in a subsequent year), then the amount received is to be included in the income chargeable to tax under the same head of income for the tax year in which it is received. RS.250 is therefore chargeable to tax as

income from business in the tax year 2004.

27

(e) Tax liability

On business income of Rs.35,951 at 35%

Taxes paid, deducted at source or collected (Note 17)

Rs. in thousands 12,583 (16,465)

0·5 2

Balance tax refundable

3,882

Dividend income - RS.300

Tax deducted at source is the final tax (Note 15)

15

0·5

3

30

Note (1) A provision made in the accounts for taxation is not deductible. Any tax paid or payable that is leviable on the profits of the business is not a deductible charge.

Note (2) Tax collected by the Collector of Customs is not deductible. PQR Ltd is an industrial undertaking and the tax collected at the customs stage on the import of raw materials for PQR'S own use is not the final tax on the income arising from the imports but is available to PQR Ltd as a tax credit (Note 17).

Note (3) The amount paid to the Collector of Customs for the erroneous declaration made in a bill of entry is in the nature of a fine or penalty paid for violation of the customs law and is therefore not deductible.

Note (4) The expenditure on the development of a new formulation process is an 'intangible'. As the normal useful life of the new process is three years, the expenditure for tax purposes is to be amortised over three years proportionate to the number of days the intangible is used in the tax year for the purposes of business. As the intangible has been used for 61 days in the tax year 2004, the amount deductible is worked out as under:

Cost of intangible

Rs.9,600

Normal useful life

3 years

Amortisation deduction for one whole year

Rs.3,200

For 61 days in a year of 366 days (leap year) 3,200 x 61/366

RS.533

Rs.3,200 charged in the accounts for amortisation is not a deductible charge.

Note (5) Legal costs incurred in defending a director for a traffic offence is not an expenditure for the purposes of business and is therefore not deductible.

Note (6) Purchase of furniture is a capital expenditure. The expenditure is not a deductible charge despite it being the consistent accounting policy of the company to charge off such expenditure. For tax purposes it is treated as a depreciable asset (Note 14).

16

Note (7) Preliminary expenditure is capital in nature and amortisation of this expenditure is not a deductible charge. (It does not fall within the definition of an intangible to enable it to be amortised for tax purposes).

Note (8) The law specifically provides that where a prize is not in cash, the person giving the prize has to collect tax on the fair market value of the prize. Rs.l,600 is not deductible since tax was not collected by PQR Ltd from Mr Baig.

Note (9) The profit on the debt received by Rich Bank is chargeable to tax in Pakistan. It is a Pakistan-source income of Rich Bank since the amount has been paid by a resident (PQR Ltd) and the debt has not been used for any business carried out by PQR Ltd outside Pakistan. The profit on the debt paid by PQR Ltd is not deductible since tax was not deducted at source from the payment made to Rich Bank.

Note (10) The unpaid expenditure of RS.900 for excise duty was allowed as a deduction in the accounting year ended 30 June 2000. As the amount has remained unpaid for three years from the end of the year in which the deduction was allowed (30 June 2001,2002,2003) the amount is chargeable to tax in the tax year 2004 (the first year following the end of the said three years).

Note (11) In the case of the disposal of any immovable property, where the consideration received on disposal exceeds the cost of the property, the sale consideration received is to be treated as the cost of the property.

As the sale consideration (Rs.6,000) on disposal of the building is more than that its cost (Rs.5,000), Rs.6,000 is to be treated as the cost of building for working out the tax profit or loss on sale of the building.

Depreciation allowed on the building in prior years is Rs.l ,800 (actual cost Rs.5,000 less written down value Rs.3,200). Tax profit on disposal of building Sale consideration Less: Tax written down value

Deemed cost Depreciation allowed

Tax profit on sale of building

Rs. 6,000

6,000 (1,800)

4,200 1,800

Note (12) Expenditure on renovations necessary at the time of purchase of an asset to render the asset capable of being used in the business is capital in nature and adds to the cost of the asset. RS.576 is not deductible and has to be added to the cost of the mach ine.

Note (13) Initial allowance

Cost of mixing machine

Add: Cost of renovation (Note 12)

Rs.
2,500
576
3,076
1,538
Office Motor
building vehicle
5% 20%
Rs. Rs.
8,200 400
(3,200)
5,000 400
250 80
1,000
1,000
200 Initial allowance at 50%

(Note 14) Depreciation

Rate of depreciation

Plant and machinery 10% Rs. 9,500

Factory building 10% Rs. 2,500

Written down value Disposal

9,500 2,500
Depreciation 950 250
Additions 3,076
Initial allowance (1,538)
Written down value 1,538
Depreciation for 12 months 154 Furniture Total

depreciation

10%

Rs. Rs.

250

250

25 1,555

750

750

75 429

1,984

The cost of the new car (Rs.l ,500) has been restricted to Rs.l ,000 for the purposes of claiming depreciation.

Note (15) All dividends received by a public company suffer deduction of tax at 5% of the gross amount of dividend. The tax so deducted is the final tax on such dividend income.

17

Note (16) The unadjusted business loss of Rs.2,750 determined in the accounting year ended 30 June 1997 is made up

as under: Rs.

Business loss (excluding unabsorbed depreciation) 1,250

Unabsorbed depreciation 1,500

2,750

The business loss of Rs.1 ,250 cannot be set off against the income for tax year 2004 as the right to carry forward the loss had lapsed on 30 June 2003. A business loss cannot be carried forward for more than six years immediately succeeding the tax year in which it was determined. Unabsorbed depreciation can be carried forward until it is completely set off. The entire amount of Rs.1 ,500 is set off against the profits for the tax year 2004.

Note (17) Taxes paid, deducted at source or collected

Advance tax paid

Tax deducted at source on sale of manufactured goods (Note 17A) Tax collected at import stage by the Collector of Customs

Rs. 8,000 465 8,000

16,465

Note (17 A) PQR Ltd as a manufacturer has the option to be taxed on a final tax basis on the income from its own manufactured goods. To avail the option PQR Ltd was required to furnish a declaration in writing to the Commissioner to be assessed on the final tax basis within three months of the commencement of the tax year (i.e., by 30 September 2003). PQR Ltd cannot be assessed on the final tax basis since the declaration was submitted after 30 September 2003. Therefore the tax deducted has been allowed as a tax credit.

2 (a) Mr Iqbal
Accounting year ended 30 June 2004
Tax year 2004
Computation of income Rupees
SALARY INCOME
From Chemicals pic - £12,000 exempt from tax (Note 1) 0 1·5
From Chemicals Pakistan Ltd
Voluntary / non-contractual payment (Note 2) 500,000 1
Basic salary - six months 1,800,000 0·5
Cost of I iving allowance (Note 3) 180,000 0·5
Entertainment allowance (Note 3) 180,000 0·5
Relocation allowance (Note 3) 308,000 0·5
Air fare for wife (Note 4) 375,000 1
Benefit of company maintained car (Note 5) 100,750 1
Rent free accommodation (Note 6) 53,000 0·5
Value of electricity (Note 7) 30,000 1·5
Gardener's salary (Note 8) 48,000 0·5
Benefit of concessional loan (Note 9) 9,000 1·5
Reimbursement of medical and hospital charges exempt from
tax (Note 10) 0 1
Waiver of loan (Note 11) 150,000 1
Employee share scheme
Sale of rights [Note 12 (i)l 50,000 1
Benefit of acquisition of shares [Note 12(ii)l 400,000 1·5
4,183,750
INCOME FROM PROPERTY
Consideration for the use of land (Note 13) 100,000 1
INCOME FROM OTHER SOURCES
Profit on debt (tax deducted at source RS.30 ,000) 300,000 0·5
Total income 4,583,750
Zakat paid (75,000) 0·5
Taxable income 4,508,750 18

Marks

The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income

(I mark for each item) as follows: 3

Items not included in the computation of income

(1) There is no taxable event on the grant of the right to purchase 1,000 shares in CPLC at the exercise price of £ 15 for one share. Therefore the market price of the share on the date of issue of the rights is irrelevant.

(2) The refundable deposit of Rs.I00,000 which is not adjustable against the rent payable for the land is not income exigble to tax. However a similar deposit (refundable but not adjustable against rent payable) received from a tenant by the owner of a building is taxable in 10 years in equal proportion including the year in which the deposit is received.

(3) The storage charges of Rs.60,780 incurred on the import of pharmaceuticals is not deductible because when tax is imposed on a final tax basis, no deduction is allowable for any expenditure incurred.

20

(b) COMPUTATION OF TAX LIABILITY Tax on Rs.700,000

Tax on balance of Rs.3,808,750 at 35%

Rupees 119,000 1,333,063

Reduction in tax liability on Rs.l,452,063 at 5% (Note 14)

1,452,063 72,603

0·5 1

1,379,460

Tax deducted at source On salary income by PKC On profit on debt

1,467,800 30,000

(1,497,800)

1

Balance tax refundable

118,340

TAX DEDUCTED / COLLECTED AS FINAL TAX Import of pharmaceuticals (Note 15) Dividends - gross receipts Rs.8,333

Final tax 329,310 833

2 0·5

5

25

Note (1) Iqbal was resident for Pakistan tax purposes in the tax year 2004 on the basis of the number of days he was present in Pakistan in the tax year. £12,000 is foreign-source salary income of Iqbal because the employment was not exercised in Pakistan. Such income of a resident individual is exempt from Pakistan tax, if foreign income tax has been paid on the income or if tax has been withheld by the foreign employer and paid to the revenue authorities of the foreign country. The above conditions having been fulfilled, £12,000 is exempt from Pakistan tax.

Note (2) The payment of Rs.500,000 is chargeable to tax as it is a profit of employment. All voluntary payments even those depending upon the goodwill of a past, future or present employer for services rendered or to be rendered are taxable even if the recipient would have no right of action in case of non-payment.

Note (3) Where salary income including value of perquisites and benefits in a tax year is Rs.600,000 or more all cash allowances (except house rent allowance up to 45% of basic salary subject to a maximum of Rs.270,000) are chargeable to tax. As Iqbal's salary in the tax year 2004 is more than Rs.599,999, the cash allowances (for six months) for cost of living, entertainment and relocation are chargeable to tax as salary income.

Note (4) The benefit of free passage for travel is chargeable to tax in its entirely as Iqbal's salary exceeds Rs.599,999 in the tax year 2004.

Note (5) As the car is for private and business use, Rs.237,500 being 5% of the cost of the car is the annual benefit. The amount chargeable to tax for six months is Rs.118,750 which is to be reduced by the monthly payment of Rs.3,000 made by Iqbal to the company (Rs.118,750 - Rs.18,000 = Rs.I00,750).

Note (6) The annual value of rent free housing on a land area of 1,000 sq. yards outside municipal limits is Rs.I06,000.

The amount chargeable to tax for six months is Rs.53,000.

19

Note (7) Rs.210,000 would have been the cost of electricity if the units consumed were purchased from the Karachi Electric Supply Corporation. The value of electricity provided free of charge to an employee is exempt from tax up to 10% of basic salary. Therefore the benefit chargeable to tax is Rs.30,000 [Rs.210,000 less Rs.180,000 (10% of basic salaryil.

Note (8) The services of a gardener provided to Iqbal is a perquisite chargeable to tax. Salary paid for six months Rs.48,000 is a perquisite chargeable to tax.

Note (9) As no profit is payable on the loan of Rs.300,000, the amount chargeable to tax is Rs.9,000 being the amount computed at the benchmark rate of 6% per annum on Rs.300,000 for six months (6% of 300,000 x 6/12).

Note (10) Reimbursement of medical and hospitalisation charges is exempt from tax as the reimbursement of such charges is in accordance with the terms of employment. It is assumed that the National Tax Numbers of the hospitals or clinics have been furnished by Iqbal and the employer has certified and attested the medical and hospitalisation charges.

Note (11) The waiver of an obligation of an employee to repay an amount owing by the employee to the employer, is chargeable to tax in the tax year, the amount is waived. Therefore the waiver of Rs.150,000 out of the loan advanced by PKC is a taxable perqu isite and is chargeable to tax.

Note (12) Employee share scheme of Chemicals pic (CPLC)

(i) As no payment was made for the right to purchase the shares, the entire amount of Rs.50,000 received for the sale of 500 rights is chargeable to tax. The gain is taxable as salary income and not as 'capital gains'.

(ii) 500 shares of CPLC were acquired at the exercise price of £15 per share. The market price on the date Iqbal exercised his right to purchase the shares was £23. The difference of £8 per share is the taxable benefit [£8 x 500 = £4,000 (Rs.400,000)J.

The above benefit is received not from PKC (Iqbal's employer) but from CPLC an associate company of PKC. An amount or perquisite received by an employee is treated as a receipt from employment even if it is paid or provided inter alia by an associate of the employer.

Note (13) Rent received or receivable for a tax year for the use of land is chargeable to tax in that tax year. Out of the Rs.200,000 received in advance, Rs.100,000 is for the tax year 2004 which is chargeable to tax in the tax year 2004.

Note (14) As the salary income of Iqbal exceeds 50% of his taxable income he is entitled to a reduction in his tax liability at the rates given in Clause (1)(1) of Part III of the Second Schedule. On income slab exceeding Rs.1,000,000 the reduction in tax liability is 5%.

Note (15) As the goods imported were finished goods, the tax of Rs.329,310 (6% of Rs.5,488,500 - value of the goods imported as determined for custom purposes) collected under S.148 by the Collector of Customs is the final tax on the amount of income/loss arising from the imports.

Marks

3 (a) (i) A manufacturer whose annual turnover from taxable supplies, made in any period during the last twelve

months exceeds five million rupees, is required to be registered under the Sales Tax Act 1990. 1·5

(ii) A retailer whose value of supplies, in any period during the last twelve months ending any period exceeds

five million rupees, is required to be registered under the Sales Tax 1990 1·5

(b) The Collector of Sales Tax may blackl ist or suspend the registration of a person if such person is found to:

(i) have issued fake invoices; 1

(ii) evaded tax; or 1

(iii) committed a tax fraud. 1

(e) The following goods acquired otherwise than as 'stock in trade' have been notified by the Federal Government in respect of which input tax shall not be claimed:

(i) vehicles falling within Chapter 87 of the First Schedule to the Customs Act 1969;

(ii) foods;

(iii) beverages; (iv) garments; (v) fabrics;

(vi) consumption on entertainment; and

(vii) gifts and give-aways. 4

(d) Where a refund due is not made within the specified time the claimant shall be paid, in addition to the refund due to him, a further sum equal to 6% per annum of the amount of the refund due from the date following the

expiry of the specified time to the date preceding the date of payment of the refund. 1

20

(e) (i) Utility bills paid by cash are admissible for claiming input tax.

(ii) The payment of Rs.17,000 made by cash for the purchase of aluminum foils is admissible for claiming input tax as the payment is for a transaction of purchase not exceeding Rs.50,000

(iii) The payment of Rs.75,000 made through a crossed bank draft from the personal bank account is not admissible for claming input tax as the payment has not been transferred through a 'business bank account'. A 'business bank account' has been defined to mean a bank account utilised by the registered person for business transactions, declared to the Collector in whose jurisdiction such person is registered.

(iv) The payment transferred through a crossed bank draft from the 'business bank account' (as defined in item (iii) above) of the buyer is inadmissible for claiming input tax since the payment was made after one hundred and eighty days of the issuance of the tax invoice.

Marks 1

1

1

1

15

4

Mr Saleem

Accounting year ended 30 June 2004 Tax year 2004

Computation of taxable income I ncome from business Brokerage income

Set off of brought forward loss (Note 1)

Rupees

785,000 700,000

0·5 1

85,000

Capital gains

Gain on disposal of shares held by Saleem Sons (Note 2) Gain on disposal of shares acquired under employee share

scheme (Note 3)

Gain on sale of sculpture (Note 4)

Gain on sale of one postage stamp (Note 5)

5,000

1·5

375,000 225,000 15,000

3 1·5 1·5

Set off of brought forward capital loss (Note 6)

620,000 620,000

o

1·5

Total income Zakat paid

85,000 (10,000)

0·5

Taxable income

75,000

The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income (I mark for each

item) as follows: 4

Items not included in the computation of income

(1) A loss on the disposal of a capital asset is not deductible where a gain on the disposal of such an asset is exempt from tax. XYZ Ltd is a company listed on the Karachi stock exchange and any profit on disposal of its shares

is exempt from tax. Therefore the loss of Rs.75,000 is not deductible.

(2) A transfer of an asset is treated as a disposal when the transferor parts with the ownership of the asset. 50,000 shares in Bingo (Private) Ltd were inherited by Saleem on 1 June 1980 when the break up value of one share was Rs.10. Rs.500,000 (50,000 shares x RS.10) is treated to be the cost of the asset.

On the date of transfer of the shares to Mrs. Saleem, the FMVof one share was Rs.15. Ordinarily the difference of Rs.250,000 (50,000 shares x Rs.5) would be chargeable to tax as capital gains. However due to the non-recognition rules [s.79(a)] no gain is taken to have arisen because the disposal of the shares was under

an agreement between the spouses to live apart.

(3) A postage stamp is a capital asset and any gain on its disposal is chargeable to tax; however any loss on the disposal of postage stamps is not recognised as a capital loss.

(4) A motor car held for personal use by a person or any dependent family member is excluded from the definition of a capital asset. As capital gains can only arise on disposal of a capital asset, the gain of Rs.100,000 on the disposal of the car is not chargeable to tax since the car was in the personal use of Saleem's wife and the car was sold in August 2003 prior to Saleem's separation from his wife.

15

21

Marks

Note (1) Business loss brought forward

The loss of Rs.50,000, suffered in the money market, is a loss from speculation business which business is deemed to be distinct and separate from any other business. This speculation loss determined in the tax year 2003 cannot be set off against the brokerage income of Saleem Sons. The loss is to be carried forward and set off only against the profits of speculation business in subsequent years up to the tax year 2009 (six years immediately succeeding the tax year 2003). The balance of loss of Rs.700,000 (Rs.750,000 less Rs.50,000) is set off against the brokerage income.

Note (2) Disposal of shares by Saleem Sons

Rupees

Stock-in-trade is excluded from the definition of a 'capital asset'. Therefore, any

gain or loss on the sale of stock-in-trade is chargeable to tax as 'income from business'. There is one exception. Where stocks and shares are held as stock-in-trade, the gain

or loss on the disposal of such stocks and shares are chargeable to tax under the head of 'capital gains'.

ABC Ltd, though a public company under the Companies Ordinance 1984 is not a public company for tax purposes. It is not listed on any stock exchange in Pakistan. The gain on disposal of the shares is therefore not exempt from tax. The entire gain is taxable

since the shares were not held for more than one year 60,000

Loss on sale of shares in Highland (Private) Ltd (55,000)

Gogo Limited is a public company under the Income Tax Ordinance 2001 because not less than 50% of its shares are held by a Provincial Government. The gain on disposal of the

shares is exempt from tax 0

Gain on disposal 5,000

Note (3) Gain on disposal of shares acquired under employee share scheme

Consideration on disposal of 1,000 shares on 30 June 2004 Cost of 1,000 shares

£5 paid on acquisition of the shares in Securities pic on

1 January 2003 (Tax year 2003) - £ 5 x 1,000 = £ 5,000 Amount charged to tax as salary income in the tax year 2003 (Note 3A)

Rupees 2,000,000

500,000

1,000,000

1,500,000

Gain on disposal

500,000

As the shares were held for more than one year, Rs.375,000 being 75% of Rs.500,000 is chargeable as income from capital gain.

Note (3A) 1,000 shares of Securities pic were acquired by Saleem on 1 January 2003 (tax year 2003) at the exercise price of £5 per share. The fair market value of the shares on 1 January 2003 was £15. The difference of £10 per share is the taxable benefit, £10 x 1,000 = £10,000 (Rs.l,OOO,OOO). Rs.l,OOO,OOO would have been charged to tax as salary income of Saleem in the tax year 2003.

Note (4) Gain on sale of sculpture

The sculpture, a capital asset, was inherited by Saleem on 1 June 1980. For assets becoming the property of a person by inheritance, the fair market value (FMV) of the asset on the date the asset become the property of the person is treated as the cost of the asset. The asset was transferred to Saleem on 1 June 1980. The asset was then valued by an expert at Rs. 700 ,000. The valuation by the expert at Rs. 700 ,000 is the FMV of the asset and is treated as the cost of the asset.

Sale consideration

Cost being the FMV of the sculpture on the date it was acquired by inheritance

Rupees 1,000,000 (700,000)

Gain on sale

300,000

75% of RS.300,000 is chargeable as income from capital gains, as the sculpture was held for more than one year

225,000

22

Rupees

Note (5) Gain on sale of one postage stamp

Sale proceeds of the Indian postage stamp

Cost being the FMV of the stamp on the date it was acquired by inheritance

45,000 25,000

Gain on sale

20,000

75% of RS.20,000 is chargeable as income from capital gains, as the postage stamp was held for more than one year

15,000

Note (6) Capital loss brought forward

A loss incurred under the income head of capital gains can only be set off against profits under the head of capital gains. The brought forward loss of Rs.355,000 determined in the accounting year ended 30 June 1997 had lapsed on 30 June 2003 (tax year 2003) because a capital loss cannot be carried forward to more than six years immediately succeeding the tax year in which the loss was incurred.

As a capital loss can be carried forward for six years only, the loss of the year ended 30 June 1998 should be set off before the capital loss of the tax year 2003.

Loss brought forward

Set off against capital gains of Rs.620,000

Rupees 637,225 620,000

Unabsorbed loss

17,225

The unabsorbed capital loss of Rs.17,225 cannot be carried forward to the tax year 2005 as the period of six years expired on 30 June 2004.

The loss of Rs.47,500 determined in the tax year 2003 is to be carried forward to the tax year 2005.

5 (a) The information required by Alibaba is as under

(i) A 'retailer' for the purpose of s.113A means a person selling goods to the general public for the purpose

of consumption. 1

(ii) A retailer to be eligible to be assessed on the fixed tax basis in a tax year must: be an individual or an association of persons;

have a turnover of not more than Rs.5,000,000 in a tax year;

opt for payment of tax at the rate of 0.75% on his turnover for the tax year; and

furnish a statement, in the prescribed form, showing the turnover for the tax year and the tax paid

thereon. 3

(iii) Turnover for the purpose of Alibaba's business would mean the gross receipts derived from the sale

of ice-cream exclusive of sales tax and central excise duty or any trade discounts shown on his invoices

or bills. 2

(iii) Alibaba would be eligible to pay income tax at 0.75% of his turnover for the tax year 2005, which would

be treated as the final tax, since:

he is an individual; 0·5

the ice-cream sold is to the general public for the purpose of consumption; and 0·5

his turnover for the tax year 2005 would not exceed Rs.5,000,000. 1

23

Marks

(b) The Commissioner should check the tax records of Mr X to ascertain whether or not the house property has been disclosed by Mr X in the statement of assets and liabilities (wealth statement) furnished by him.

As the income of Rs.3,000,000 out of which the house was purchased, has not been shown in any of the returns of income furnished by Mr X, it is unlikely that the house property would have been declared in his wealth statements. The Commissioner would then have reasonable grounds to contend that the impounded house is a 'concealed asset'. A 'concealed asset' means any property or asset which in the opinion of the

Commissioner has been acquired out of income which was chargeable to tax but which has not been taxed. 3

As the tax return furnished to the Commissioner by Mr X for the tax year 2004 was complete in all respects,

the assessment is treated as having been made. To safeguard the interest of revenue, the Commissioner

may issue a provisional assessment order to Mr X for the tax year 2004 (which is the last completed

assessment) and include therein the amount representing the value of the concealed asset and recover the

tax due from Mr X. The Commissioner is then required to finalise the provisional assessment as soon as

practicable. 4

15

6 (a) Offer of employment from ABC Limited. Tax year 2005
Rupees
Salary income after deduction of tax
Basic salary 600,000 0·5
House rent allowance (exempt from tax - Note 1) 0 1
Cost of I iving allowance 75,000 0·5
Conveyance allowance 75,000 0·5
Entertainment allowance 50,000 0·5
800,000
Income tax
On Rs.700,000 117,500
On Rs.100,000 at 35% 35,000
152,500 0·5
Reduction in tax I iabil ity on Rs.152,500 at 10% (Note 2) (15,250) 1
137,250
Gross salary 1,000,000
Tax deduction at source (137,250)
Salary income after deduction of tax 862,750 0·5
(b) Offer of employment from PQR Limited. Tax year 2005
(i) Aban should be advised to structure the annual salary of Rs.1,000,000 as under:
Rupees
Basic salary 608,334
House rent allowance 270,000
Util ity allowance 60,833
Medical allowance 60,833
1,000,000 24

Marks

(ii) The annual salary has been structured to include the maximum amount of cash allowances which are

exempt from tax. 1

House rent allowance. A cash allowance up to 45% of basic salary subject to a maximum of

Rs.270,000 is exempt from tax where the salary income (including the value of perquisites and

benefits) exceeds Rs.599,999. 45% of Rs.608,334 is Rs.273,750. Therefore the allocation for

house rent allowance is limited to Rs.270,000. 2

Utility allowance. A cash allowance up to 10% of basic salary is exempt from tax (10% of Rs.608,334). 1·5

Medical allowance. Free medical treatment or hospitalisation or reimbursement of such charges are not

provided under the terms of employment. Therefore a cash allowance up to 10% of basic salary is

exempt from tax (10% of Rs.608,334). 1·5

(iii) Basic salary

Out of the gross salary of Rs.1,000,000, Rs.270,000 has been allocated to house rent allowance. The balance of Rs.730,000 (Rs.1,000,000 less Rs.270,000) is allocated between basic salary and 10% of basic salary each for utility allowance and medical allowance (20% of basic salary for

utility and medical allowance). The basic salary on the above basis is Rs.608,334 (Rs.730,000 x 100/120 = Rs.608,334).

(e) Salary income after deduction of tax

Basic salary

House rent allowance (exempt from tax - Note 1) Utility allowance (exempt from tax)

Medical allowance (exempt from tax)

Rupees

608,334 o o o

Taxable income

608,334

Income tax

On Rs.400,000

On Rs.208,334 at 25%

42,500 52,083

Reduction in tax liability of Rs.94,583 at 10% (Note 2)

94,583 (9,458)

85,125

Gross salary

Tax deduction at source

1,000,000 (85,125)

Salary income after deduction of tax

914,875

Note (1) As the salary income (including the value of perquisites and allowances) chargeable to tax

is in excess of Rs.599,999, an allowance for house rent received in cash is exempt from tax up to 45% of basic salary subject to a maximum of Rs.270,000.

Note (2) On an income slab between Rs.500,000 to Rs.1,000,000, the tax liability is to be reduced by 10%.

25

2

0·5

0·5 0·5

0·5

15

Marks

7 (a) (i) The Income Tax Ordinance, 2001 (s.7) provides for the separate taxation of certain classes of income, one of which is the income of a non-resident person carrying on the business of operating ships as the owner or charterer thereof. The income of the non-resident person is not computed on the net-income basis. Tax is imposed on the gross amount received or receivable for the carriage of passengers, livestock,

mail or goods depending upon whether the shipment is from a port in Pakistan or a port outside Pakistan. 2

CCC would be chargeable to tax in Pakistan despite its tax exempt status in the British Virgin Islands.

CCC would be a non-resident company for Pakistan tax purposes and the amount chargeable to tax is

to be computed as under:

For goods embarked from a port in Pakistan, the amount chargeable to tax is the gross amount received or receivable by CCC for the carriage irrespective of whether the amount is received in Pakistan or outside Pakistan.

For goods embarked from a port outside Pakistan, the gross amounts received or receivable by CCC for

the carriage is chargeable to tax only if the amount is received or receivable in Pakistan. 2

Tax at the rate of 8% is imposed on the aforesaid gross amount received or receivable (Amount). The tax imposed is the final tax on the Amount and:

the Amount is not chargeable to tax under any head of income of CCC;

no deduction is allowable for any expenditure incurred by CCC in deriving the Amount;

the Amount is not to be reduced by any deductible allowances or the set-off of any loss; and

the tax payable is not to be reduced by any tax credit allowable to CCC.

2

(ii) The above basis of computing income and tax payable would not change if the sh ips used for the carriage were chartered by CCC.

(iii) Before the departure of a ship from a port in Pakistan, the master of the ship has to furnish to the Commissioner a return showing the gross amounts specified in item (i) above. He has also to furnish

any particulars, accounts or documents which may be required by the Commissioner. The Commissioner, after being satisfied that the return furnished is complete in all respects, would determine the amount

of tax due and notify the master in writing of the amount of tax to be paid. The master or the shipping agent on behalf of the master has to discharge the tax liability before the departure of the ship. In practice tax is calculated by the master of the ship and paid at the time of furnishing the return. The Collector of Customs would issue the port clearance certificate allowing the ship to leave the port when

he is satisfied that the tax due has been paid. 3

1

(iv) When the master of the ship is unable to furnish the above return to the Commissioner before the departure of the ship from a Pakistan port, the Commissioner has been empowered to allow the return

to be furnished within thirty days of the departure of the ship provided arrangements have been made by the owners or charterers of the ship that the tax would be paid. The Collector of Customs would issue the port clearance certificate when he is satisfied that arrangements for the payment of the tax due have been

made to the satisfaction of the Commissioner. 1

(b) (i) An order of the Commissioner (Appeals) cannot be revised by the Commissioner under S.122A. 0·5 The Commissioner can revise an assessment order passed under the repealed Income Tax Ordinance 1979. 0·5 A revised order cannot be passed which is prejudicial to the taxpayer. An order seeking to reduce a

determined refund is prejudicial to the taxpayer and so such an order cannot be passed under S.122A. 1

(ii) An order cannot be revised by the Commissioner if:

it is an order against which an appeal can be made with the Commissioner (Appeals) or the Appellate Tribunal and the time within which such an appeal can be made has not expired; or

1

the order is pending an appeal before the Commissioner (Appeals) or the Appellate Tribunal.

1

15

26

Business Taxation (Pakistan)

PART 2

WEDNESDAY 7 DECEMBER 2005

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A BOTH questions are compulsory and MUST be answered

Section B THREE questions ONLY to be answered

Tax rates and allowances are on page 3

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

z ~ 0....

N

\,

Q) 0.. CO

0....

This is a blank page.

The question paper begins on Page 3.

2

The following tax rates and information are to be used in answering the questions:

A. Tax rates for individuals and associations of persons for the tax year 2004

Taxable income Rate of tax

Up to Rs. 80,000 0%

Rs. 80,001 - Rs. 150,000 7·5% of the amount exceeding Rs. 80,000

Rs. 150,001 - Rs. 300,000 Rs. 5,250 plus 12·5% of the amount exceeding Rs. 150,000.

Rs. 300,001 - Rs. 400,000 Rs. 24,000 plus 20% of the amount exceeding Rs. 300,000.

Rs. 400,001 - Rs. 700,000 Rs. 44,000 plus 25% of the amount exceeding Rs. 400,000.

Rs. 700,001 and above Rs. 119,000 plus 35% of the amount exceeding Rs. 700,000.

B. Reduction in tax liability of salaried individuals where salary income exceeds 50% of taxable income

Income slab Reduction in tax liability

Up to Rs. 60,000 0%

Rs. 60,001 - Rs. 80,000 70%

Rs. 80,001 - Rs. 100,000 60%

Rs. 100,001 - Rs. 150,000 50%

Rs. 150,001 - Rs. 200,000 40%

Rs. 200,001 - Rs. 300,000 30%

Rs. 300,001 - Rs. 500,000 20%

Rs. 500,001 - Rs. 1,000,000 10%

Rs. 1,000,001 and above 5%

C. Tax rates for companies

Tax Year Banking

company

2004 44%

Public company other than a banking company 35%

D. Rates of advance collection or deduction of tax Commission or brokerage

Import of goods

Private company other than a banking company 41%

10% of gross payment

6% of value of goods determined for customs purposes

E. Tax rates on dividends received from companies Received by a public company or an insurance company In any other case

5% of the gross dividend 10% of the gross dividend

F. Capital allowances Depreciation

Factory buildings Other buildings Fumiture and fittings

Plant and machinery (not otherwise specified) Motor vehicles (all types)

Aircraft, aero-engines and aerial photographic apparatus

10%

5% 10% 10% 20% 30%

of the tax written down value

Initial allowance

50% of cost

3

[P.T.O.

Section A - BOTH questions are compulsory and MUST be attempted

1 The provincial government of Sind holding 50 per cent of the shares in XYZ Ltd, a public company under the Companies Ordinance 1984, is engaged in the manufacture of cellular phones. XYZ Ltd is not listed on any stock exchange in Pakistan.

The finance director of the company requires you to prepare the income tax return of the company for the tax year relevant to the accounting year ended 31 December 2003. The following information is furnished to you.

(1) The accounting profit for the year ended 31 December 2003 after providing Rs.105,000 for taxation is Rs.478,000.

(2) Deductions charged in the accounts include:

(i) Anticipated loss on a forward contract for the purchase of raw material 'X' on 1 January 2004.

(ii) Contribution to the staff retirement gratuity fund. The fund is not approved by the Commissioner and no arrangements are in place to ensure deduction of tax from payments to the employees out of the fund.

(iii) Advance to an associated company written off as a bad debt. (iv) Payment in cash of salary to a temporary worker.

(v) Payment in cash to Pakistan International Airways for the sales manager's return airfare to London. The trip to London was for business purposes.

(vi) Payment to a non-resident company for technical advice on the manufacture of cellular phones in Pakistan. No tax was deducted on the contention that the non-resident is not chargeable to tax since the advice was rendered from outside Pakistan bye-mail and the non-resident has no permanent establishment in Pakistan.

(vii) Tax collected by the Collector of Customs on the value of plant imported by the company for its own use.

(viii) Major renovations to one item of plant, which resulted in substantially increasing the production capacity of the plant. The renovations were completed in

January 2003.

(ix) Payment to Zumzum Hotel for holding the annual eid-milan party for the

employees and their families.

(x) Depreciation

(xi) Legal costs on the issue of additional share capital.

(xii) Compensation paid to a customer for failure to deliver goods within the time stipulated in the contract for the supply of cellular phones.

(3) Income shown in the accounts includes:

(i) The face value of bonus shares received from a listed company in Pakistan

whose shares are held as an investment by XYZ Ltd.

(ii) Gain on revaluation of the plant.

(iii) Accounting profit on the sale of a motor car.

(iv) Dividend received (gross amount) from a private company.

(v) Share of profits received from Bigli Associates, an association of persons (AOP) in which XYZ Ltd is a member.

The taxable income of the AOP was Rs.2,000,000 and the tax assessed on the AOP was Rs.574,000

4

Rupees

200,000

300,000 300,000 4,800

120,000

250,000

100,000

900,000

215,000 590,000 700,000

1,000,000

569,000 1,100,000 100,200 90,000

800,000

(4) Fixed assets

(i) New machine was purchased on 25 January 2003 for Rs.800,000.

(ii) The tax written down values of the fixed assets on 1 January 2003 were:

Plant and machinery Factory buildings Office buildings Motor vehicles Furniture

1,700,000 1,800,000 400,000 1,010,000 100,000

(iii) The old plant and machinery was revalued on the basis of an expert valuer's report. The accounting written down value of the plant and machinery was enhanced from Rs.1,000,000 to Rs.2,l 00,000.

(iv) A motor car purchased in January 2002 for Rs.1 ,200,000 (tax written

down value Rs.800,000) was disposed of for Rs.900,000 in November 2003. For the purposes of claiming tax depreciation the cost had been restricted to Rs.1,000,000. On 1 January 2003, a new car was purchased for Rs.2,500,000.

Required:

(a) Briefly explain how the tax year in which the above income is assessed will be determined.

(1 mark)

(b) Briefly state with reasons whether or not XYZ Ltd will be a public company for tax purposes.

(1 mark)

(c) Compute the taxable income of XYZ Ltd for the relevant tax year giving clear reasons/explanations for the inclusion or exclusion in the computation of each of the items listed above. The reasons/explanations for the items not included in the computation of income should be shown separately. (22 marks)

(d) Calculate the tax payable by/refundable to XYZ Ltd for the relevant year.

(3 marks)

(27 marks)

5

[P.T.O.

2 Mary and Jane entered into a partnership on 1 July 2003 to carryon business as hairdressers under the name of Bal-Kaa-Toe sharing profits and losses equally. Jane, due to reasons of health, retired from the firm on 30 September 2003 and the firm ceased doing business on that date. Bal-Kaa-Toe is an AOP for tax purposes. The AOP has paid income tax on its taxable income for the three months ended 30 September 2003. Rs.150,000 was received by Mary as her share of the income of the AOP.

Mary took up temporary employment on 1 October 2003 for three months with Charli - a hairdressing establishment on a monthly salary of Rs.100,000. The terms of employment specifically stated that if Mary should leave the employment before the end of the three months period, she would pay Charli Rs.1 00,000 as compensation for breach of the terms of employment.

Before the end of October 2003, Mary was offered a permanent employment as the senior hairdresser with Styles (Pakistan) Ltd (Styles PK), an associated company of Styles pic. As an inducement, Styles PK agreed to reimburse Mary the Rs.100,000 she would have to pay Charli, provided Mary agreed to join the company from 1 November 2003. On Mary's agreement to the proposal, she received Rs.100,000 from Styles PK on 15 October 2003.

Mary resigned from Charli on 31 October 2003 and commenced employment with Styles PK on 1 November 2003. Charli did not pay Mary her salary for October 2003 but as instructed by Mary applied the Rs.100,000 against the compensation payable by her under the terms of employment.

The terms of employment with Styles PK, provided for the following remuneration and benefits:

(i) A basic monthly salary of Rs.lOO,OOO and a monthly cash allowance of Rs.20,000 for utilities and Rs.10,000 for entertainment.

(ii) A house rent allowance of Rs.50,000 per month.

(iii) A special monthly allowance of Rs.5,000 to be paid with the basic salary to meet entertainment expenses wholly and necessarily to be incurred in the performance of Mary's duties as a senior hairdresser.

(iv) One return air passage to India for Mary and her spouse once in two years. Mary availed of this benefit in June 2004. The cost to the company was Rs.50,000.

Other information

(1) As a company policy:

(i) the aggregate amount of the basic salary, the special allowance and the house rent allowance is deposited into the employee's bank account on the last friday of each month; and

(ii) the allowances for entertainment and utilities are to be collected by each employee from the cashier on the last working day of each month.

(2) The cash for the utility and entertainment allowances for the month of June 2004 was collected by Mary from the cashier on 5 July 2004.

(3) Mary was entitled to participate in the Styles pic employee share scheme (Scheme). Under the Scheme a participant has the free right to transfer the shares acquired under the Scheme only after a minimum holding period of two years unless permission was granted by the custodian of the Scheme for the transfer of the shares before the expiry of the holding period.

Mary was granted the right to purchase 1,000 shares at the exercise price of £10 for one share. On 1 January 2004, she exercised her right to purchase 700 shares and remitted £7,000 to the custodian of the Scheme. The market price of one share on 1 January 2004 was £13. The 700 shares purchased by Mary were in her possession on 30 June 2004.

(4) Mary has a house, which she had let out to Mr X on 1 July 2002 at a monthly rental of Rs.27,500, which included Rs.2,500 for the services of a gardener. For tax purposes, Mary accounts for the income from the house on accrual basis.

Due to a dispute with Mary on certain house maintenance matters, X had not paid Rs.75,000 out of the rent payable for October, November and December 2002. The Rs.2,500 per month for the services of the gardener was paid in full. On receiving a legal notice from Mary requiring X either to pay the Rs.75,000 or to vacate the house, X vacated the house on 30 June 2004.

6

Mary incurred the following expenditure in respect of the house:

Repairs

Profit paid to a bank on a loan utilised for renovating the house Legal expenses for preparing a new tenancy agreement

Rupees 35,000 8,000 5,000

(5) Mary received Rs.18,000 (after deduction of tax) from the Tourism Department of the Government of Sind as a commission on the sale of tickets for a whole day excursion to Moenjodaro. Mary paid Rs.5,000 to the girls working with her who had helped in selling the tickets.

(6) Tax deducted at source by Styles PK was Rs.375,000.

(7) The rate of exchange is to be taken as £ 1 = Rs.IOO

Mary approaches you to prepare her return of income for the year ended 30 June 2004. In addition to the above information, she informs you that:

on an average she receives about RsA,500 a month as gratuities from the clients of Styles PK which in her view is not taxable income, since the receipts are not from her employer but are casual and non-recurring receipts depending upon the goodwill of the clients of Styles PK; and

the Rs.IOO,OOO paid to Charli as compensation should be claimed as a deductible charge.

Required:

(a) Compute the taxable income of Mary under the relevant heads of income for the tax year 2004 giving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of the items listed above. The reasons/explanations for the items not included in the computation of income should be shown separately. (23 marks)

(b) Calculate the tax payable by Mary for the tax year 2004.

(5 marks)

(28 marks)

7

[P.T.O.

Section B - THREE questions ONLY to be answered

3 (a) You should assume that

(i) today's date is 1 January 2005; and

(ii) all the amounts given are exclusive of sales tax.

Zee Cola Ltd, a beverage firm, is a registered person for sales tax purposes and is the sole manufacturer of the beverage 'Zeecola'. Zee Cola Ltd started its business operations on 1 December 2004 and the following transactions took place in December 2004:

(1) 25,000 bottles of Zeecola valued at Rs.250,000 were distributed as free samples to the dealers at the time of launching the beverage;

(2) 100,000 bottles of Zeecola were exported to Afghanistan valued at Rs.l ,000,000;

(3) Rs.15,000,000 was received as an advance from a dealer for 1,500,000 bottles to be supplied in January 2005; and

(4) Rs.20,000,000 is payable to ZC Inc for the basic ingredient purchased against their invoice dated 15 December 2004. As agreed with ZC Inc, the invoice for Rs.20,000,000 will be due for payment on 31 March 2005.

Required:

Compute the sales tax liability (if any) to be paid along with the sales tax return for the month of December 2004. (7 marks)

(b) Briefly state the difference between zero rating supplies and exempt supplies.

(4 marks)

(c) State the responsibility of a person who has collected sales tax in excess of the tax actually payable under a

misapprehension of the law. (2 marks)

(d) State the time of payment of sales tax charged on: (i) Import of goods

(ii) Taxable supplies.

(1 mark) (1 mark)

(15 marks)

8

This is a blank page.

Question 4 begins on Page 10.

9

[P.T.O.

4 Mr Mohsin, having reached the age of 70 years, disposed of the following assets on 31 March 2004: (i) Shares in M (Private) Ltd.

(ii) The right to purchase shares under an employee share scheme. (iii) Movable assets held for personal use.

(iv) Ancestral agricultural land.

(v) Shares in two companies, both listed on the Karachi stock exchange.

The details of the transactions relating to the disposal of the assets by Mohsin are as under: (1) Shares in M (Private) Ltd.

(i) Mohsin, as the founder member of M (Private) Ltd, was allotted 8,000 shares at the face value of Rs.lO per share.

(ii) 1,000 shares were sold for Rs.20,000.

(iii) 2,000 shares were gifted to his son Abu, who is a citizen of Pakistan and has been in Pakistan since 1 July 2003.

(iv) 2,000 shares were gifted to his son Babu, who is a citizen of Pakistan and has been living in the USA since 1 December 2003.

(v) 3,000 shares were transferred to his wife Seema under an agreement to live apart. Seema is a citizen of Pakistan and has been living in the USA since 29 December 2003.

(2) The right to purchase shares under an employee share scheme.

(i) At the time of Mohsin's employment in Eatmore (Pakistan) Ltd, an associated company of Eatmore pic, he was granted the right to purchase 500 shares in Eatmore pic at the exercise price of £15 per share, which was inclusive of £2 per share for the right to acquire the shares,

(ii) On 1 April 2003, Mohsin made payment of £1,000 (when the exchange rate was £1 equals to RS.90) and acquired the right to purchase 500 shares at the exercise price of £15 per share. The right to purchase the shares could be exercised at any time after 31 December 2006.

(iii) The right to purchase the 500 shares was sold by Mohsin for Rs.200,000. On 31 March 2004, the market price of one share was £20 and the exchange rate was £1 equals to Rs.lOO.

(3) Movable assets held for personal use.

(i) Motor car

The car which had been acquired in January 2004 for Rs.l ,200,000 was sold for Rs.l ,250,000.

(ii) Paintings

A painting which had been acquired on 1 January 2004 for Rs.I00,000 was sold for Rs.500,000. His father's collection of paintings which he had inherited in 1974 was sold for Rs.l,OOO,OOO. In 1974 the paintings had been valued by an expert at Rs.2,000,000.

(iii) Manuscript

A manuscript which had been acquired for Rs.l 00,000 was alleged to be an original document of the East India Company. The manuscript turned out to be a reproduction and was sold for Rs.l ,000.

(4) Ancestral agricultural land

The agricultural land, which Mohsin had inherited in 1974, was sold for Rs.I0,000,000. In 1974, the market value of the land was Rs.700,000.

(5) Shares in two companies both listed on the Karachi stock exchange (i) Loss of Rs.I00,000 on the sale of shares in ABC Ltd.

(ii) Gain of Rs.150,000 on the sale of shares in XYZ Ltd.

10

Other information

(1) The accounting year of Mohsin ends on 30 June.

(2) Income of Rs.90,000 (adjusted for tax purposes) arose for the year ended 30 June 2004 from Mohsin's self employed business as a landscape designer for residential gardens.

(3) Unadjusted losses brought forward:

(i) Business loss of Rs.140,000 sustained in the preceding tax year in his business as a dealer in antiques.

Due to a temporary slump in the antiques market there was no activity in this line of business in the tax year 2004, but the business had not been discontinued.

(ii) Capital loss of Rs.730,000 determined in the accounting year ended 30 June 1997.

Required:

Compute Mohsin's taxable income tabulated under the appropriate heads of income for the tax year 2004 giving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of the items listed above. The reasons/explanations for the items not included in the computation of income should be listed separately.

(15 marks)

11

[P.T.O.

5 Mr Tahir is self-employed doing business in Lahore under the name of Tahir Pharma. Tahir Pharma is engaged in the business of:

(1) import and sale of raw materials used in the manufacture of pharmaceuticals; (2) sale of herbs purchased from the local market; and

(3) acting as an indenting commission agent to a Japanese corporation.

The following transactions appear in the books of Tahir Pharma for the year ending 30 June 2004. Payments made by Tahir Pharma

(i) For a new building being constructed

(a) An advance payment of Rs.500,000 to Builders Ltd, a company incorporated in Pakistan, for a contract for the supply of labour.

(b) Rs.50,000 for architect fees to Mr Baber, who is a resident for Pakistan tax purposes.

(ii) A remittance of US$ 100,000 to ABC Ltd (an enterprise of a country which does not have a tax treaty with Pakistan) for the right to use a secret process only in Pakistan for the formulation of a herbal cough syrup. The process is not to be used by Tahir Pharma for any business outside Pakistan. Tahir Pharma plans to commence the manufacture of the cough syrup in Pakistan in the tax year 2005. ABC Ltd has no permanent establishment in Pakistan and the control and management of its affairs is situated wholly outside Pakistan.

(iii) A remittance of US$ 75,000 to XYZ Hospital Inc (XYZ) for the payment of the charges for Mr Tahir's medical treatment at a hospital in Houston. XYZ is a company incorporated in the USA and is a non-resident company for Pakistan tax purposes. The remittance is in accordance with the regulations of the State Bank of Pakistan.

Receipts by Tahir Pharma

(i) Rent of Rs.1 ,200,000 for the year ended 30 June 2004 received from a Russian diplomatic mission in Pakistan, in respect of a house property belonging to Mr Tahir. The rent was paid in advance on 1 July 2003.

(ii) Proceeds received from the Federal Government of Pakistan for the sale of herbs to a government laboratory. (iii) Realisation of foreign exchange proceeds from an authorised foreign exchange dealer:

(a) on account of the export of herbs to Japan.

(b) on account of indenting commission received from the Japanese corporation.

Tax collected from Tahir Pharma

Tax at the rate of 6 per cent on the 'value of goods' (raw materials) imported by Tahir Pharma has been collected by the Collector of Customs under s.148 of the Income Tax Ordinance, 2001.

12

Required:

(a) For each of the payments made by Tahir Pharma, briefly explain the nature of the payment in the context of

the tax, if any, to be withheld by Tahir Pharma. (5 marks)

(b) For each of the amounts received by Tahir Pharma:

(i) briefly explain the nature of the receipt in the context of the withholding tax (if any) suffered by Tahir Pharrna: and

(ii) if the tax has been deducted in accordance with the law, identify the transactions where such deductions

would be the final tax of Tahir Pharma arising from the relevant receipt. (5 marks)

(c) For the tax collected from Tahir Pharma:

(i) briefly explain what is meant by the 'value of goods' which determines the amount on which tax is collected:

(ii) state whether the tax collected by the Collector of Customs at the import stage on the value of raw materials imported is the final tax of Tahir Pharma arising from the imports: and

(iii) state if your answer to item (ii) would be different, and if so how, if Tahir Pharma, was an 'industrial undertaking' for the purposes of s.148 and the raw materials imported were for its own use.

(5 marks)

(15 marks)

13

[P.T.O.

6 (a) ABC Ltd, a company listed on the Lahore stock exchange, is engaged in the manufacture of cane sugar. ABC Ltd sold its crushing plant to DEF Ltd on 31 October 2002 for Rs.I0,000,000.

Other information:

(1) The accounting year of ABC Ltd and DEF Ltd both end on 30 September 2003.

(2) The tax written down value of the crushing plant of ABC Ltd on 1 October 2002 was Rs.5,000,000.

(3) On 1 October 2002, ABC Ltd had engaged an expert valuer to determine the current values of its entire plant and machinery. In the valuer's report issued on 15 October 2002 the crushing plant was valued at Rs.15,000,000.

Required:

(i) Explain the tax implications for each of the parties (ABC Ltd and DEF Ltd) to the transaction of the

disposal of the crushing plant. (4 marks)

(ii) Calculate the profit chargeable/loss deductible on the disposal of the crushing plant for the purposes of

computing the taxable income of ABC Ltd for the relevant tax year. (2 marks)

(iii) Calculate the depreciation allowable on the crushing plant for the purposes of computing the taxable

income of DEF Ltd for the relevant tax year. (1 mark)

(b) ABC Garments Inc (ABC), a US Corporation, has established a liaison office in Karachi (LOABC). LOABC does not conduct any business in Pakistan or engage in any income generating activity. The expenditure of LOABC is borne by ABC.

The activity of LOABC in Pakistan is limited to acting as an effective conjunction and a link between ABC and the textile trade in Pakistan, the dissemination of relevant information relating to the textile trade and generally keeping ABC informed of the textile business in Pakistan.

Required:

(i) State, giving reasons, whether LOABC will be considered to have a permanent establishment in

Pakistan. (1 mark)

(ii) Explain whether or not your conclusion to (i) above would differ if LOABC, in addition to its liaison activities, also engages in the negotiation of contracts of purchase of Pakistani denim cloth. (2 marks)

(iii) Explain whether or not your conclusions to (i) and (ii) above would differ if LOABC, in addition to its liaison activities and the negotiation of contracts of purchase of denim cloth, used its office premises as a permanent sales exhibition for the manufactured garments of ABC. (2 marks)

(c) Mr Q is a partner in the firm of PQR. On 1 June 2004 Mr Q purchased a new car (Honda Civic) for Rs.l ,800,000 for his personal use. The Honda Civic was shown as an asset in Mr Q's statement of wealth as at 30 June 2004.

On 1 July 2004, it was mutually agreed between Mr Q and the partners of PQR that the Honda Civic would be used solely for the business use of the firm.

Required:

Briefly explain how the above transaction would be treated for the tax purposes of PQR.

(3 marks)

(15 marks)

14

7 Gas Supply Pakistan Ltd (GPL) is in the business of distribution of natural gas. Since the year 2002, GPL has been involved in the expansion of its distribution network to the rural areas outside the municipal limits of Quetta. This expansion activity is hereinafter referred to as 'the Project'. The Project includes the laying of new pipelines, pumping machinery, safety equipment and other ancillary plant. GPL closes its accounts on 30 June of each year.

On 1 January 2002, GPL took a loan of US$ 1,000,000 from ABC Bank, Dubai, which was utilised for purchasing the plant for the Project. The loan is repayable in 10 equal instalment in US Dollars. The rate of exchange on 1 January 2002 was US$ 1 equal to RS.58 and the loan liability was recorded in the books of account of GPL at Rs.58,000,000.

Other information:

(1) The Project was completed in June 2003, but was only commissioned for use on 31 July 2003. The total amount spent by GPL on the plant was Rs.200,000,000.

(2) On 1 July 2003, the Government of Pakistan (GOP) voluntarily paid GPL Rs.lO,OOO,OOO as a subsidy in respect of the plant installed in the Project. GPL treated the Rs.1 0,000,000 as a capital reserve.

(3) The first instalment of US$ 100,000 towards repayment of the US Dollar loan was paid to ABC Bank on 30 June 2004. The rupee equivalent of US$ 100,000 at the then rate of exchange was Rs.6,000,000 (US$ 1 = RS.60). The difference in exchange of Rs.200,000 was written off to revenue as a loss on currency exchange.

Assume today's date is 1 December 2004. The Chief Financial Officer (CFO) of GPL is preparing the income tax return of the company for the tax year 2004. In respect of the aforesaid transactions relating to the Project, he proposes to:

(i) claim the loss on currency exchange of Rs.200,000 as a deductible charge on the ground that the loss is not the result of a mere translation difference, but arose on the remittance of US$ 100,000 and is therefore a determined loss incurred on revenue account; (4 marks)

(ii) claim the subsidy of Rs.10,000,000 received from the GOP as income exempt from tax; and

(6 marks)

(iii) claim initial allowance of Rs.100,000,000 being 50% of Rs.200,000,000 (cost of the plant) and depreciation of Rs.10,000,000 being 10% of Rs.100,000,000 (cost Rs.200,000,000 less initial allowance Rs.100,000,000). (5 marks)

Required:

Explain with reasons whether or not you agree with each of the above three contentions of the CFO for the purpose of preparing the return of income for the tax year 2004. If you are not in agreement with any of the contentions of the CFO, advise the CFO of the treatment to be adopted for the purposes of the return of income for the tax year 2004.

Note: The allocation of marks is shown against each of the three proposals raised by the CFO.

(15 marks)

End of Question Paper

15

Answers

Part 2 Examination - Paper 2.3(PKN) Business Taxation (Pakistan)

December 2005 Answers and Marking Scheme

Marks

1 (a) The normal tax year is a period of twelve months ending on 30 June and denoted by the calendar year in

which the date falls. As the accounting period of XYZ Ltd ends on 31 December 2003, it is a special tax year and the tax year is denoted by the calendar year relevant to the normal tax year in which the closing

date of the special tax year falls i.e. 2004. 1

(b) A company in which not less than 50 per cent of the shares are held by the Federal Government or a Provincial Government is a public company for tax purposes. Since the provincial government of Sind holds 50 per cent of the shares in XYZ Ltd, XYZ Ltd is a public company for tax purposes.

(c)

1

XYZ Ltd

Accounting year ended 31 December 2003 Tax year 2004

Computation of taxable income Accounting profit

Add: Provision for taxation (Note 1)

Anticipated loss on forward contract (Note 2) Contribution to unapproved gratuity fund (Note 3) Advance to an associated company written off (Note 4) Payment to a non-resident for techn ical advice (Note 5) Tax collected by the Collector of Customs (Note 6)

Cost of major renovations to plant (Note 7)

Accounting depreciation

Legal cost on issue of additional share capital (Note 8)

Less: Face value of bonus shares (Note 9)

Gain on revaluation of plant (Note 10) Accounting profit on sale of car (Note 11) Tax loss on sale of car (Note 12)

Initial allowance (Note 13)

Depreciation (Note 14)

Dividend income for separate consideration (Note 15)

Taxable income

Rupees

478,000

105,000 200,000 300,000 300,000 250,000 100,000 900,000 590,000 700,000

0·5 1·5 1 1 1

0·5 1 0·5 1

3,445,000 3,923,000

569,000 1,100,000 100,200 50,000 400,000 752,000 90,000

1 1·5 0·5 1·5

1 3 0·5

3,061,200 861,800

The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income

(1 mark for each item) as follows: 5

22

Items not included in the computation of income:

(1) Any salary in excess of Rs.5,000 per month paid other than by a crossed cheque or a direct transfer of funds to the employee's bank account is not deductible. As the salary payment to the temporary employee is less than Rs.5,000, the payment is deductible.

(2) Any expenditure under a single account head which, in aggregate exceeds Rs.50,000 paid other than by a crossed bank cheque or a crossed bank draft is not deductible except expenditure not exceeding Rs.5,000. One of the other exceptions to this rule is a payment on account of travel fare. Therefore the airfare of Rs.120,000, though paid in cash, is deductible.

(3) The expenditure incurred on the annual eid-milan party is in the nature of an amenity provided to the employees motivated by business reasons. The expenditure which is in the nature of staff welfare is deductible as it is incurred wholly and exclusively for the purposes of the business.

(4) Payment of compensation due to failure to deliver the goods within the time specified in the contract

is a normal expenditure in the carrying on of the business and is deductible. The payment is not in the nature of a penalty or fine for the violation of any law, rule or regulation.

(5) The share of profits received by a company from an association of persons (AOP) is to be added to the taxable income of the company and has therefore been correctly included in the profits of the company. However as the AOP has paid tax on its profits, XYZ Ltd is allowed a tax credit against the tax payable (Note 16).

19

Marks

(d) Tax liability

On taxable income of RS.861 ,800 at 35% Tax credit for tax paid by the AOP (Note 16)

Tax collected at customs stage (Note 6) Balance tax refundable

301,630 229,600

72,030 100,000

27,970

0·5 1·5

0·5

Dividend income - Rs.90,000

Tax deducted at source is the final tax (Note 15)

4,500

0·5 3 27

Note (1) A provision for taxation made in the accounts is not deductible. Any tax paid or payable that is leviable on the profits of the business is not a deductible charge.

Note (2) Deductions are admissible only for business losses, which are incurred, in the relevant accounting year and not for future losses. Anticipated losses in the future however probable or certain cannot be claimed. As the forward contract would be executed in January 2004, the gain or loss on the forward contract would be included in the computation of income for the tax year 2005 (accounting year 31 December 2004).

Note (3) A contribution to an approved gratuity fund is an admissible deduction. Contributions made to any unrecognised provident fund or any other unapproved fund established for the benefit of employees are deductible only if the employer has made effective arrangements to ensure that tax would be deducted from any payment made by the fund in respect of which the recipient is taxable under the income head 'salary'.

Note (4) The advance of Rs.300,000 to an associated company written off as a bad debt is not deductible, since making an advance to an associated company is not in the normal course of XYZ's business.

Note (5) The payment to the non-resident company for rendering techn ical advice on the manufacture of cellular phones is chargeable to tax in Pakistan as income from fees for technical services. It is a Pakistan-source income of the non-resident since the amount has been paid by a resident

(XYZ Ltd) and the techn ical advice received has not been used for any business carried out by XYZ Ltd outside Pakistan through a permanent establishment. Rs.250,000 is not deductible since tax was not deducted at source from the payment made to the non-resident.

Note (6) The tax collected by the Collector of Customs is not deductible. XYZ Ltd is an industrial undertaking and the tax collected at the custom stage on the import of a new plant for XYZ's own use is not

the final tax but is available to XYZ Ltd as a tax credit.

Note (7) Rs.900,000 spent on the renovation to the existing plant is capital in nature since the expenditure has substantially increased the production capacity of the plant - it has added value to the plant. The expenditure is not in the normal course of carrying on the business and is therefore not deductible. Rs.900,000 has been added to the cost of the plant (Note 14).

Note (8) Legal expenditure on raising additional share capital is not deductible since it is not an expenditure in the normal course of carrying on the business. The expenditure is a capital expenditure.

Note (9) The amount representing the face value of the bonus shares issued to XYZ Ltd is not income chargeable to tax. For tax purposes, 'income' does not include, in the case of a shareholder of a company, the face value of any bonus shares issued by the company to its shareholders.

Note (10) There is no concept of revaluation of assets for tax purposes and therefore the gain on the revaluation of plant is not a taxable income.

Note (11) The accounting profit on sale of the car is not income chargeable to tax. The tax profit or loss on disposal of a depreciable asset is chargeable to tax or allowable as a deduction in computing income under the head 'income from business'.

Note (12) Tax loss on sale of motor car:

Rupees

Consideration * 750,000

Less: Tax written down value 800,000

Tax loss 50,000

* The actual cost of the car sold was Rs.1,200,000 (C). As the actual cost, for the purpose of

claiming depreciation, has been restricted to Rs.1,000,000 (8), the amount of Rs.900,000 (A)

20

Marks

received on the sale of the car has to be proportionally reduced to arrive at the sale consideration for the purposes of calculating the tax profit or loss on sale of the car. The sale consideration is arrived as under:

A x B/C

900,000 x 1,000,000/1,200,000 = Rs.750,000

Note (13) Initial allowance
Rupees
Cost of new mach ine 800,000
Initial allowance at 50% 400,000
Note (14) Depreciation
Plant and Factory Office Motor Furniture Total
machinery buildings buildings vehicles depreciation
Rate of depreciation 10% 10% 5% 20% 10%
Rs. Rs. Rs. Rs. Rs. Rs.
Written down value 1,700,000 1,800,000 400,000 1,010,000 100,000
Disposal (800,000)
Renovation cost 900,000
2,600,000 1,800,000 400,000 210,000 100,000
Depreciation 260,000 180,000 20,000 42,000 10,000 512,000
Additions 800,000 1,000,000*
Initial allowance (400,000)
Written down value 400,000 1,000,000
Depreciation 40,000 200,000 240,000
752,000 * The cost of the new car (Rs.2,500,000) has been restricted to Rs.1 ,000,000 for the purpose of claiming depreciation.

Note (15) All dividends received by a public company suffer deduction of tax at 5% of the gross amount of the dividend. The tax so deducted is the final tax on the dividend income.

Note (16) Tax credit is calculated as under:

Share of profit received from the AOP by XYZ Ltd Taxable income of the AOP

Tax assessed on the AOP

A/BxC

800,000/2,000,000 x 574,000 =

(A) (8) (C)

Rupees 800,000 2,000,000 574,000

229,600

21

Marks
2 (a) Ms Mary
Accounting year ended 30 June 2004
Tax year 2004
Computation of income Rupees
Salary
From Chari i (Note 1) 100,000 1·5
From Styles PK
Consideration for agreeing to enter into employment (Note 2) 100,000 1
Basic salary of eight months 800,000 0·5
Entertainment allowance (Note 3) 80,000 0·5
Utility allowance (Note 3) - Rs.160,000 less 10% of basic
salary exempt from tax 80,000 0·5
House rent allowance (Note 4) 130,000 1·5
Special allowance (Note 5) 40,000 1·5
Passage for travel abroad (Note 6) 50,000 1·5
1,380,000
Income from Business
Share of income from Bal-Kaa-Toe
Rs.150,000 - exempt from tax (Note 7) 0 1·5
Income from Property
Rent chargeable to tax (Note 8) 300,000 1
Deductions
Repairs (Note 9) 60,000 1
Profit paid on money borrowed for renovation of the
house (Note 10) 8,000 1·5
Unpaid rent (Note 11) 75,000 1·5
143,000
157,000
Income from Other Sources
Income for providing the services of a gardener connected
with renting of the house (Note 8) 30,000 1
Gratuities from clients of Styles PK (Note 12) 36,000 1
66,000
Taxable income 1,603,000 The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income

(2 marks for item (i) and 1 mark each for the remaining four items). 6

23

Items not included in the computation of income

(i) I n an employee share scheme, where there is any restriction on the transfer of the shares, the benefit accru ing to an employee on the purchase of the shares is not chargeable to tax until the time the employee has the free right to transfer the shares or when the person actually disposes of the shares, whichever is earlier. Mary acquired 700 shares in Styles pic at the exercise price of £10 when the market price of the shares was £13. The difference of £3 per share equivalent to Rs.210,000 [£3 x 700 = £2,100 (Rs.210,000)l, though a benefit of employment is not chargeable to tax until the expiry of

the two years holding period or the time Mary disposes of the shares (if so allowed by the custodian of the Scheme).

(ii) No deductions are allowable for any expenditure incurred by an employee in deriving income chargeable under the head 'salary'. The payment to Charli of Rs.100,000 as compensation for leaving his employment before the end of three months is therefore not deductible

(iii) Legal expenses for preparing a new tenancy agreement are not deductible against income from property.

Only the expenditure for legal services acquired to defend the title to the property or any suit connected with the property in a Court, is an admissible deduction.

(iv) The tax deducted at source from the gross amount of the commission received from the Tourism Department is the final tax on such income. Therefore the commission income is not chargeable to tax under any head of income and is not included in the computation of income.

(v) Rs.5,000 paid to the girls who helped Mary to sell the tickets is not deductible. The expenditure is against the commission earned by Mary from the Tourism Department. As the tax deducted at source from the gross amount of the commission is the final tax, no deduction is allowable for any expenditure incurred.

22

Marks

(b) Computation of tax I iabil ity

Rs.150,000 received from the AOP is included in Mary's taxable income only for the purpose of determining the rate of tax appl icable to her taxable income other than the income from the AOP.

Taxable income

Taxable income if the share of profit from the AOP received by Mary was not exempt from tax (Rs.1,603,000 + Rs.150,000)

Tax on Rs.1,753,000

On Rs.700,000

On Rs.1 ,053,000 at 35%

(C)

Rupees 1,603,000

(8)

1,753,000

(A)

119,000 368,550

487,550

Tax I iabil ity (AlB) X C

487,550/1,753,000 X 1,603,000

Less: Reduction in tax at 5% of Rs.445,831 (Note 13)

445,831 22,291

423,540 375,000

48,540

3 1

Less: Tax deducted at source Balance tax payable

0·5

Tax deducted considered as final tax

Final Tax 2,000

0·5 5 28

Commission - gross Rs.20,000

Note 1

Note 2

Note 3

Note 4

Note 5

Note 6

Note 7

A person is treated as having received an amount inter alia if it is appl ied on behalf of the person at the instructions of the person. The salary of Rs.100,000 earned by Mary for the month of October 2003 is treated as received by her as it was applied by Charli towards the compensation of Rs.100,000 payable to him by Mary under the terms of employment.

An amount received as consideration to enter into an employment relationship is a profit in lieu of salary and is taxable as salary income. Rs.100,000 paid by Styles PK to Mary as a reimbursement of the compensation payable by her to Chari i is treated as consideration for her agreement to enter into employment on 1 November 2003.

Salary including perquisites and allowances is taxable on receipt basis. A person is treated as having received an amount if it is made available to the person. As per the company's policy, Mary should have collected the cash allowances from the company on the last working day in June 2004. The allowances were thus made available to her in June 2004 and are treated to have been received by her in June 2004 despite the fact that the allowances were collected by her in July 2004.

Where salary income including the value of perquisites and benefits in a tax year is Rs.600,000 or more, all cash allowances (except house rent allowance up to a certain limit) are chargeable to tax. As Mary's salary including the value of perquisites exceeds Rs.599,999, the cash allowances for entertainment and utility are chargeable to tax as salary income.

House rent allowance (HRA) is exempt from tax up to 45% of basic salary subject to a maximum of Rs.270,000. HRA received by Mary is Rs.400,000 (Rs.50,000 x 8). As 45% of basic salary (45% of Rs.800,000) is Rs.360,000, the amount exempt from tax is limited to Rs.270,000. The HRA chargeable to tax is Rs.130,000 (Rs.400,000 less Rs.270,000).

A special allowance granted to meet expenses wholly and necessarily incurred in the performance of the duties of an office is exempt from tax except entertainment or conveyance allowance. The special allowance granted to meet entertainment expenses is thus chargeable to tax.

The benefit of free passage for travel is exempt from tax subject to certain conditions, if the employee's salary including the value of perquisites does not exceed Rs.599,999. As Mary's salary and perquisites exceeds Rs.599,999, she is not entitled to any exemption from tax for the benefit of the free passage. The amount of Rs.50,000 is chargeable to tax.

As the income of the AOP has suffered tax, the share of profit received by Mary from the AOP does not form part of her taxable income. However, for determining the rate of tax that would be

23

Marks

applicable to the taxable income of Mary (other than the share of profit from the AOP) the profit from the AOP is to be included in Mary's taxable income as if the share of profit was chargeable to tax.

Note 8 The amount chargeable to tax as income from property is Rs.300,000 (Rs.25,000 x 12). Income from the provision of amenities, utilities or other services connected with the renting of a building is taxable under the head 'income from other sources'. Rs.30,000 (Rs.2,500 x 12) received for providing the services of a gardener, connected with the renting of the building, is taxable as 'income from other sources'.

Note 9 One fifth of the rent chargeable to tax is a deductible charge for repairs irrespective of the amount spent (l/5 x Rs.300,000).

Note 10 Any profit paid or payable in the tax year on money borrowed to acquire, construct, renovate, extend or reconstruct the property is a deductible charge.

Note 11 Unpaid rent of Rs.75,000 is allowable as a deduction, since:

the unpaid rent has been included in the property income of Mary in the tax year 2003 on accrual basis;

reasonable steps were taken by Mary to institute legal proceeding for recovering the rent; and the defaulting tenant M r X has vacated the house.

Note 12 As the gratuities received by Mary have not been paid either by her employer or a past or a prospective employer or a third party under an arrangement with her employer, the amount cannot be treated as a receipt from an employment. However, since the gratu ities were received by Mary by reason of her employment with Styles PK, the Rs.36,000 is taxable. As the income is not from her employment, but by reason of her employment, the amount is chargeable to tax under the head 'income from other sources' and not as income under the head 'salary'.

Note 13 As the salary income of Mary exceeds 50% of her taxable income she is entitled to a reduction in her tax liability at the rates given in Clause (1)(1) of Part III of the Second Schedule. On income slab exceeding Rs.1,000,000, the reduction in tax liability is 5%.

3 (a)

Input tax

Supplies (input tax claimed on accrual basis)

Excess input tax to be carried forward to the next tax period

Value Sales Tax
Rupees Rupees
250,000 37,500
1,000,000 0
15,000,000 2,250,000
2,287,500
20,000,000 3,000,000
712,500 1·5 1·5

Output Tax

Samples (Sales tax is leviable on free samples)

Exports (no sales tax on exports as it is a zero rating supply) Advance from a dealer (against 1,500,000 bottles to be supplied in January 2005)

1·5

1·5 1

(b) Exempt supplies are outside the ambit of the Sales Tax Act, 1990 and as such exempt supplies are not subjected to sales tax. No input tax can be claimed on exempt supplies.

2

Zero rating supplies are charged to sales tax at the rate of zero per cent. Since such supplies are charged to

tax, input tax can be claimed. 2

(e) If any person has collected tax in excess of what is actually payable and the incidence of which has not been

passed on to the consumer, the person is required to pay the amount of the tax to the Federal Government. 2

(d) The tax on goods imported into Pakistan shall be paid in the same manner and at the same time as if it were

custom duties payable under the Customs Act. 1

The tax in respect of taxable supplies made during a tax period shall be payable at the time of filing the sales

tax return for the relevant tax period. 1

15

24

Marks

4

Mr Mohsin

Accounting year ended 30 June 2004 Tax year 2004

Computation of taxable income Salary

Employee share scheme

Sale of the right to purchase shares (Note 1) I ncome from Business

Landscape designing

Set off of brought forward loss (Note 2)

Capital Gains

Shares in M (Private) Ltd

Gain on sale of 1,000 shares (Note 3)

Gain on transfer of 2,000 shares gifted to Babu (Note 4) Gain on transfer of 3,000 shares to wife (Note 4)

Personal assets

Gain on sale of a painting (Note 5)

Gain on sale of shares in XYZ Ltd - exempt (Note 6)

10,000 20,000 30,000

Rupees
110,000 1·5
0·5
0·5
0
0·5
1·5
1·5
1·5
0·5
460,000
570,000 90,000 (90,000)

400,000 o

The relevant notes will be considered in allocating the marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income (2 marks for

item (I) and 1 mark each for the other five items) as follows: 7

15

Items not included in the computation of income

(1) Under the non-recognition rules (s.79), no gain or loss is taken to have arisen on the disposal of a capital asset, inter alia, by reason of a gift of the asset, provided the person receiving the gift is a resident person for Pakistan tax purposes.

The shares gifted by Mohsin to Abu fall within the ambit of the said non-recognition rules since Abu is a resident person for the tax year 2004. There is thus no need to calculate the gain or loss on the disposal of the 2,000 shares since any gain or loss on this account is not taken to have arisen for tax purposes. (Abu is resident for tax purposes since h is presence in Pakistan in the tax year 2004 was more than 181 days)

(2) A motor car held by a person for his personal use is excluded from the definition of a 'capital asset' for capital gains purposes. As a capital gain or loss can only arise on the disposal of a capital asset, the gain of Rs.50,000 made by Mohsin on the disposal of his motor car is not chargeable as income from capital gains.

(3) Movable assets consisting inter alia of paintings and manuscripts even though held for personal use are considered to be capital assets and any gain on its disposal is chargeable as income from capital gains. However, any loss on the disposal of a painting or manuscript is not recognised as a loss. The loss of Rs.1,000,000 on the disposal of the paintings, which Mohsin had inherited from his father, and the loss of Rs.99,000 on the disposal of the manuscript are therefore not capital losses.

(4) Any immovable property is excluded from the definition of a capital asset. Since a capital gain or loss can only arise on the disposal of a capital asset, the gain on the sale of the agricultural land is not chargeable as income from capital gains.

(5) A loss on the disposal of a capital asset is not deductible where the gain on the disposal of such an asset is not chargeable to tax. ABC Ltd is a company listed on the Karachi stock exchange and any gain on the disposal of the shares in ABC Ltd is not chargeable to tax. Therefore the loss of Rs.100,000 sustained on the disposal of the shares in ABC Ltd is not a capital loss.

(6) A capital loss cannot be carried forward to more than six years immediately succeeding the tax year in which the loss was incurred. The capital loss of Rs.730,000 sustained in the accounting year ended 30 June 1997 lapsed on 30 June 2003 (tax year 2003) and is therefore not available to be set off against the capital gains of the tax year 2004.

25

Marks

Note (1) Gain on the sale of the right to purchase shares under employee share scheme:

Consideration on disposal of the right to purchase 500 shares Cost of the right [(£2 x 500 = £1,000 (£1 = RS.90)]

Gain on disposal

Rupees 200,000 (90,000)

110,000

The gain is taxable as income from 'salary' and not as 'capital gains'.

Note (2) The business loss of Rs.140,000 sustained in the tax year 2003 in the business of dealing in antiques is available for set off against any business income of Mohsin. Out of the brought forward business loss of Rs.140,000, only Rs.90,000 can be set-off in the tax year 2004. The balance amount of Rs.50,000 is to be carried forward and is available for setting off against any income from business of Mohsin up

to the tax year 2009 since a business loss can be carried forward for a period of six years immediately succeeding the tax year in which the loss was incurred.

Note (3) Gain on the disposal of 1,000 shares in M (Private) Ltd

Consideration received (Rs.20 x 1,000) Cost (Rs.10 x 1,000 shares)

Gain

Rupees 20,000 (10,000)

10,000

Note (4) Gain on the transfer of shares in M (Private) Ltd to Babu and Seema:

No gain or loss is taken to arise on the disposal of an asset, inter alia, by reason of a gift or between spouses under an agreement to live apart provided the person acquiring the asset is a resident person

for Pakistan tax purposes (s.79 - non-recognition rules). Both Babu and Seema are non-resident persons since their presence in Pakistan during the tax year 2004 was less than 182 days (Babu's and Seema's presence in Pakistan in the tax year 2004 was 153 days and 181 days respectively).

As no amount was received by Mohsin on the transfer of the shares to Babu and Seema, the fair market value (FMV) of the share on 31 March 2004 is to be taken as the consideration received. The FMV of one share is RS.20 - the price per share obtained by Mohsin on sale of 1,000 shares (Note 3).

Gain on the gift of 2,000 shares to Babu:

Consideration received (Rs.20 x 2,000) Cost (Rs.10 x 2,000)

Gain

Rupees 40,000 (20,000)

20,000

Gain on the transfer of 3,000 shares to Seema:

Consideration received (Rs.20 x 3,000) Cost (Rs.10 x 3,000)

Gain

Rupees 60,000 (30,000)

30,000

Note (5) Gain on the sale of a painting

Movable assets (with certain exceptions) held for personal use are excluded from the definition of a capital asset and are therefore outside the ambit of capital gains. One of the exceptions is a painting held for personal use. As a painting is a 'capital asset' for capital gain purposes, the gain of Rs.400,000 (sale proceeds Rs.500,000 less cost Rs.100,000) is chargeable as income from capital gains.

Note (6) Gain on the sale of the shares in XYZ Ltd

A gain on the disposal of the shares in a company I isted on any stock exchange in Pakistan is presently exempt from tax up to the tax year 2007. As XYZ Ltd is a company listed on the Karachi stock exchange, the gain of Rs.150,000 on the disposal of the shares in XYZ Ltd is exempt from tax.

26

Marks

5 Payments by Tahir Pharma:

(i) Under the provisions of s.153 only a 'prescribed person' making a payment to a resident person in full or part including a payment by way of an advance inter alia for the rendering of services or on the execution of a contract is required, at the time of making the payment, to deduct tax from the gross amount payable. An individual is not a 'prescribed person' for the purposes of s.153. Tahir Pharma for tax purposes has the status of an individual.

Builders Ltd and Mr Baber are both resident persons for Pakistan tax purposes. The payment of Rs.500,000 to Builders Ltd is on account of an execution of a contract. The payment of Rs.50,000 to Mr Baber is for the rendering of services. However, since Tah ir Pharma is not a prescribed person for the purposes of s.153,

no tax is to be deducted from the aforementioned payments. 2

(ii) A payment for the right to use a secret process falls within the definition of 'royalty'. ABC Ltd is a non-resident company for Pakistan tax purposes. The payment of US$ 100,000 is the royalty income of ABC Ltd. This income is a Pakistan-source income of the non-resident ABC Ltd since the payment is made by a resident (Tahir Pharma) and the process is not to be used by Tahir Pharma for any business outside Pakistan through

a permanent establishment. The payment of the royalty to ABC Ltd is therefore chargeable to tax and Tahir

Pharma is required to deduct tax at the applicable rate from the gross amount of US$ 100,000. 1·5

(iii) Every person paying an amount to a non-resident person is normally required to deduct tax at the time of the payment unless the non-resident person is not chargeable to tax in respect of the amount paid. A non-resident's business income is chargeable to tax only if the business income is a Pakistan-source income.

XYZ Hospital Inc (XYZ) is a non-resident company. The business income of XYZ derived from the payment of US$ 75,000 by Tahir Pharma is not a Pakistan-source income since the entire activity of the medical treatment provided to Mr Tahir was outside Pakistan and the payment of US$ 75,000 is not attributable to any business activity of XYZ in Pakistan. The remittance of US$ 75,000 to XYZ is therefore not chargeable

to tax and consequently Tahir Pharma is not required to deduct tax from the payment. 1·5

Receipts by Tahir Pharma:

(i) Every 'prescribed person' making a payment to any person on account of rent of immovable property is required to deduct tax provided the annual rent, exceeds Rs.200,000. (After 1 July 2004, tax is required to be deducted if the annual rent exceeds Rs.300,000). A 'prescribed person' for the purposes of tax withholding on a payment of rental income of immovable property (s.155) includes a diplomatic mission of a foreign state.

The Russian diplomatic mission making payment of the rent to Tahir Pharma would deduct tax from the gross amount of the rent at the applicable rate. The tax so deducted is not the final tax of Tahir Pharma on the

rental income. The tax deducted would be allowable as a tax credit to Tahir Pharma. 1·5

(ii) Every 'prescribed person' making a payment to a resident person for the sale of goods is required to deduct tax.

A 'prescribed person' for the purposes of tax withholding on a payment for the sale of goods (s.153) includes the Federal Government.

The Federal Government would deduct tax at the applicable rate from the gross amount payable for the sale of herbs. As Tahir Pharma is a resident, the tax deducted shall be the final tax of Tahir Pharma on the

income arising from the sale of herbs. 1·5

(iii) The authorised dealer in foreign exchange at the time of real isation of the foreign exchange proceeds would

deduct tax at the appl icable rate from the proceeds:

on account of the export of the herbs; and

on account of the indenting commission.

The tax deducted from the proceeds of the export of the herbs shall be the final tax of Tahir Pharma on the income arising from the export.

The tax deducted from the proceeds of the indenting commission is not the final tax of Tahir Pharma on the

amount of the indenting commission. The tax deducted would be allowable as a tax credit to Tahir Pharma. 2

Tax collected from Tahir Pharma

(i) The 'value of goods' means the value of the goods as determined for customs purposes under the Customs Act

increased by the custom duty and the sales tax payable in respect of the import of goods. 1·5

(ii) The tax collected by the Collector of Customs on the import of raw materials is the final tax of Tahir Pharma

on the income arising from the sale of the raw materials. 1

27

Marks

(iii) In the case of an 'industrial undertaking' (as defined for the purposes of s.148) importing goods as raw materials, plant, machinery and equipment for its own use, the tax collected by the Collector of Customs is not the final tax of the importer. Therefore if Tahir Pharma was an 'industrial undertaking' for the purposes of s.148, importing raw materials for its own use, the tax collected by the Collector of Customs on the import of the raw materials would not be the final tax of Tah ir Pharma on the income arising from the imports. The tax

collected would be allowable as a tax credit to Tahir Pharma. 2·5

15

6 (a) (i) The tax implications of the transaction for ABC Ltd and DEF Ltd relating to the disposal of the

crushing plant are as under:

On the basis of the expert's valuation report, there would be strong grounds to contend that the transaction of the disposal of the plant was not on an arm's length basis especially since the valuation done by the expert was at the instance of ABC Ltd. There is apparently no reason for ABC Ltd to sell the plant to DEF Ltd for Rs.10,000,000 when the expert had valued the plant at

RS.15 ,000 ,000 just fifteen days prior to the sale. 2

Rs.15,000,000 would be considered to be the fair market value (FMV) of the plant and since this

amount is higher than the actual consideration received of Rs.10,000,000, Rs.15,000,000 is

treated to be the consideration received by ABC Ltd for tax purposes. 1

As the plant has been disposed of in a non-arm's length transaction, Rs.15,000,000 which is

treated to be the consideration received by ABC Ltd is also treated to be the cost of plant for

DEF Ltd who has acqu ired the plant. 1

(ii) ABC Ltd

Tax year 2004

Accounting year ended 30 September 2003

Disposal of plant

Consideration received - FMV of plant Tax written down value (WDV) (Note)

Rupees 15,000,000 (5,000,000)

0·5 1·5

Tax profit on disposal of the plant

10,000,000

Note. As no depreciation deduction is allowable in the year a depreciable asset is disposed of, the WDV of the crushing plant as on the first day of the tax year 2004 (1 October 2002) amounting to Rs.5,000,000 is the WDV of the plant on the date of its disposal.

(iii) DEF Ltd

Tax year 2004

Accounting year ended 30 September 2003

Cost of crushing plant (Note) Depreciation at 10%

Rupees 15,000,000 1,500,000

0·5 0·5

Note. The amount of Rs.15,000,000 treated as the consideration received by ABC Ltd is also treated to be the cost of the asset acquired by DEF Ltd.

(b) (i) Despite the fact that the definition of a permanent establishment includes an office, which LOABC has in Pakistan, LOABC will not be considered to have a permanent establishment in Pakistan since the

said definition specifically excludes a liaison office. 1

(ii) A liaison office is not considered as having a permanent establishment unless the liaison office engages in the negotiation of contracts except contracts of purchase.

As LOABC besides its usual liaison functions engages only in the negotiation of contracts of purchase,

LOABC will not be considered to have a permanent establishment in Pakistan. 2

(iii) Any person (not necessarily a liaison office) using its office premises for a permanent sales exhibition will be considered to have a permanent establ ishment in Pakistan. LOABC will be considered to have a permanent establishment in Pakistan if LOABC uses its office premises for the purpose of a permanent

sales exhibition for the manufactured garments of ABC. 2

(e) For tax purposes, the application of a personal asset to business use is treated as an acquisition of the asset by the business. For PQR, the Honda Civic would be a depreciable asset and the cost thereof would be the

fair market value of the car on 1 July 2004 - the date the car was put to business use. 3

15

28

Marks

7 (i) Loss on currency exchange

The loss of Rs.200,000, due to the change in the rate of exchange of the US Dollar has been incurred on the part repayment of the loan of US$ 1,000,000. As the foreign loan was utilised for the purposes of a capital nature viz. the purchase of the plant, the loss of Rs.200,000 is on capital account and is not deductible in

computing business profits. 1

However, where a person has acquired an asset with a foreign currency loan (repayable in foreign currency)

and before the loan is fully repaid, there is an increase or decrease in the loan liability of the person in terms

of Pakistan rupees, due to a change in the rate of exchange of the foreign currency, the amount by which the

liability has increased or decreased is to be added to or reduced from the cost of the asset. In other words,

the cost of the asset acquired with the foreign currency loan is recomputed for tax purposes [s.76(5)]. 2

The Chief Financial Officer (CFO) should be advised that:

the loss on currency exchange of Rs.200,000 should not be claimed as a deductible in the return of

income, as the loss is on capital account; and 0·5

Rs.200,000 is to be added to the cost of the plant for tax purposes. 0·5

(ii) Subsidy of Rs.10,000,000 received from the Government of Pakistan (GOP)

The amount of Rs.10,000,000 is not income for tax purposes but is a capital receipt on the grounds that: the amount was voluntarily paid by the GOP without any consideration;

GPL neither asked nor angled for the subsidy;

the amount received did not arise out of any legal or any contractual obligation; and

the amount is neither traceable nor even remotely connected to any source of income. 2·5

However, in determining the cost of an asset for tax purposes the actual amount spent by a person in

acquiring an asset is required to be reduced by the amount of any grant, subsidy, rebate, commission or any

other assistance received or receivable by the person in respect of the acqu isition of the asset except where

the said amount received is chargeable to tax [s.76(10)]. 1·5

The CFO should be advised that:

the subsidy of Rs.10,000,000 is a capital receipt and is not income for tax purposes. The subsidy should not be claimed as exempt from tax in the return of income since only an amount which is income in the

first place, can be claimed as exempt from tax; and 1

the actual amount spent on acquiring the plant has to be reduced by Rs.10,000,000 representing the

subsidy received from the GOP towards the cost of the plant. 1

(iii) Initial allowance and depreciation

For reasons given in items (i) and (ii), the cost of the plant for tax purposes is not Rs.200,000,000 and therefore the amount of initial allowance and depreciation proposed to be claimed by the CFO on the cost of

Rs.200,000,000 is erroneous. 1

The CFO should be advised that:

for tax purposes the cost of the plant is Rs.190,200,000 (Note 1) Rs.95,100,000 is to be claimed as initial allowance (Note 2); and Rs.9,510,000 is to be claimed as depreciation (Note 3)

2 1 1 15

Note (1) Recomputed cost of plant

Actual amount spent by G PL Loss on currency exchange Subsidy received from the GOP

Rupees 200,000,000 200,000 (10,000,000)

190,200,000

Note (2) Initial allowance on plant

50% of cost of RS.190 ,200 ,000

Note (3) Depreciation on plant

10% of Rs.95,100,000 - written down value

[Cost of Rs.190,200,000 less initial allowance Rs.95,100,000]

95,100,000

9,510,000

29

Business Taxation (Pakistan)

PART 2

WEDNESDAY 7 JUNE 2006

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A BOTH questions are compulsory and MUST be answered

Section B THREE questions ONLY to be answered

Tax rates and allowances are on page 3

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

z ~ 0....

N

\,

Q) 0.. CO

0....

This is a blank page.

The question paper begins on Page 3.

2

The following tax rates and information are to be used in answering the questions:

A. Tax rates for individuals where salary income exceeds 50% of taxable income for the tax year 2006

Taxable income Rate of tax

Up to Rs. 100,000 0%

Rs. 100,001 - Rs. 200,000 3·5% of the amount exceeding Rs. 100,000

Rs. 200,001 - Rs. 400,000 Rs. 3,500 plus 12% of the amount exceeding Rs. 200,000.

Rs. 400,001 - Rs. 700,000 Rs. 27,500 plus 25% of the amount exceeding Rs. 400,000.

Rs. 700,001 and above Rs. 102,500 plus 30% of the amount exceeding Rs. 700,000.

B. Tax rates for companies Tax Year

2005 2006

Banking company 41% 38%

Public company other than a banking company 35%

35%

Private company other than a banking company 39%

37%

C. Rates of advance collection or deduction of tax Commission or brokerage

Import of goods

10% of gross payment

6% of value of goods determined for customs purposes

Profit on Special Savings Certificates issued by the National Saving Scheme

10% of the profit

D. Tax rates on dividends received from companies Received by a public company or an insurance company In any other case

5% of the gross dividend 10% of the gross dividend

E. Capital allowances Depreciation

Buildings (all types) Furniture and fittings

Plant and machinery (not otherwise specified) Motor vehicles (all types)

10% t

15 % of the tax written down va I ue

15%

15%

Initial allowance

50% of cost

3

[PT.O.

Section A - BOTH questions are compulsory and MUST be attempted

1 For the purpose of this question, you should assume that today's date is 1 July 2006.

CPL Ltd, an industrial undertaking engaged in the manufacture of electrical goods, requires you to prepare its income tax return for the accounting year ended 31 December 2005. The following information is furnished to you.

(1) All amounts are stated in thousands of Rupees ('000).

(2) CPL is a company incorporated under the Companies Ordinance, 1984 and is not listed on any stock exchange in Pakistan. 50 per cent of the shares in CPL are held by ABC Ltd, a company incorporated in Saudi Arabia. The Kingdom of Saudi Arabia holds 90% of the shares in ABC Ltd.

(3) The accounting profit for the year ended 31 December 2005 after transferring Rs.5,000 to general reserve account is Rs.780,000.

(4) Deductions charged in the accounts include:

(i) Accounting depreciation

(ii) Tax collected by the Collector of Customs on the import of electric ceiling fans for sale. (iii) Expenditure on the provision of perquisites and allowances to the chief executive officer

in excess of 50% of his salary.

(iv) Provision for taxation.

(v) Lump sum paid to a non-resident company for securing the exclusive rights to manufacture 'Coolair' fans in Pakistan for a period of five years commencing from 1 November 2005. CPL commenced manufacturing 'Coolair' fans on 1 December 2005. Tax was deducted at the time of the payment to the non-resident.

(5) Income shown in the accounts includes:

(i) Commission received from the Federal Government for arranging a direct supply of electric fittings from a company in the United Kingdom (net of tax deducted at source).

(ii) Dividend received from a private company (net of tax deducted at source).

(iii) Net income on sale of imported ceiling fans. The fans were sold in the same condition they were in when imported.

(iv) Compensation received from a customer for failure to deliver goods within the time stipulated in the contract for the supply of spare parts.

(v) Accounting profit on sale of office building.

(vi) Recoveries from a debtor whose debt had been written off in the prior years but was not allowed as a tax deduction.

(vii) Share of profits received from an association of persons (AOP) in which CPL Ltd is a member.

The taxable income of the AOP was Rs.20,000 and the tax assessed on the AOP was Rs.5,725.

(6) The provision for bad debts comprises:

Rupees

Balance on 1 January 2005

Provision made during the year (5% of debtors)

Trading debts written off

Advance to a subsidiary company written off

Balance on 31 December 2005

600 700

4

Rupees 136,000

750

2,450 70,000

10,000

Rupees

900 9,000

6,500

200

750

545

8,000

Rupees 1,500 500

2,000

1,300 700

(7) Fixed assets:

(i) The tax written down values on 1 January 2005 were:

Factory and workers' residential buildings Office buildings

Plant and machinery

Motor vehicles

Furniture

(ii) An investment of Rs.8,000 was made in the construction of a new building for the residence of factory workers. The workers occupied the building on 30 December 2005. The Rs.8,000 does not include RS.500 for architect's fees, which amount has been charged as an expenditure in the profit and loss account.

(iii) A new motor car was purchased on 1 September 2005 for Rs.2,000.

(iv) One of the office buildings (cost Rs.3,000 and tax written down value Rs.2,500) was sold on 30 June 2005 for Rs.7,500.

(8) Creditors include:

(i) RS.750 for rent payable which was allowed as a deduction against the income for the year ended 31 December 2003.

(ii) RS.140 for profit on a loan taken from an associated company which amount was allowed

as a deductible charge against the income for the year ended 31 December 200l.

(9) Advance tax paid was RslOO,OOO.

Required:

(a) Briefly state with reasons whether or not CPL Ltd will be a public company for tax purposes.

Rupees

2,500 8,200 9,500

400 250

(2 marks)

(b) Compute the taxable income of CPL Ltd for the relevant tax year. Your answer should show clear reasons/ explanations for the inclusion or exclusion in the computation of each of the items listed above. The reasons/ explanations for the items not included in the computation of income should be shown separately.

(24 marks)

(c) Calculate the tax payable by/refundable to CPL Ltd for the relevant year.

5

(4 marks) (30 marks)

[PT.O.

2 For the purpose of this question you should assume that today's date is 31 July 2006.

(1) Mr Ring is a citizen of Pakistan who on reaching the age of 50 years, retired from the employment of TeleBell Ltd (TBL) on 31 December 2005 despite the fact that the retirement age under the company's terms of employment was 60 years. TBL is a company engaged in the manufacture of telephone instruments. On 1 January 2006, TBL paid Ring Rs.695,000 as consideration for consenting to a restrictive covenant refraining him from entering into employment with any other telephone manufacturing company for a period of two years.

(2) For the period from 1 July 2005 to 31 December 2005 (date of retirement), Ring's terms of employment as the sales manager of TBL provided for the following:

(i) Basic salary of Rs.300,000 per month.

(ii) Cash allowances per month for:

Utilities Rs.25,000

Children's education Rs.20,000 Cost of living Rs.10,000

House rent equal to 45% of basic salary.

(iii) Services of household servants. The monthly cost to the company was Rs.40,000.

(iv) Two company-maintained motor cars. A new car was leased on 1 July 2005 exclusively for Ring's private (non-business) use. Another car was purchased for Rs.1 ,500,000 which was exclusively for his business use. The fair market value of the leased vehicle at the commencement of the lease period was Rs.2,000,000. Rs.2,000 each month is deducted from Ring's salary for the private use of the leased car.

(v) One return air passage to London once in two years. Ring availed of this benefit in December 2005. The cost to TBL was Rs.80,000.

(vi) Reimbursement of hospital charges for Ring and his wife. Rs.375,000 was reimbursed to Ring during the six months ended 31 December 2005 against hospital bills subm itted by him.

(3) On 31 December 2005, TBL voluntarily and not under any terms of employment allowed Ring to purchase a Civic Honda car from the company's fleet of cars for Rs.300,000. The fair market value of the car on 31 December 2005 was Rs.900,000.

(4) The following amounts were received by Ring in the year ended 30 June 2006, after deduction of tax, where

applicable.

Rs.200,000 as a friendly loan free of profit from his brother who paid him the loan in cash. Rs.90,000 as dividend from a private company incorporated in Pakistan.

Rs.180,000 as dividend from companies whose shares were traded on the Karachi Stock Exchange on 30 June 2006.

Rs.5,400 profit on Special Savings Certificates issued by the National Savings Scheme purchased after 1 July 200l.

(5) Tax deducted at source by TBL was Rs.1 ,300,000. (6) Zakat paid was Rs.60,000.

(7) Ring approaches you to prepare his return of income for the year ended 30 June 2006. He also informs you that:

(i) The Rs.695,000 received from TBL should not be included in his taxable income as it is a capital receipt since the restrictive covenant bond signed by him prohibits him from seeking employment with any telephone manufacturing company for a period of two years.

(ii) He wants to claim a deduction of Rs.15,000 for profit paid to a bank on a loan obtained to acquire the shares in companies on which he has earned dividend income.

(iii) TBL transfered Rs.75,000 every month into his bank account as his pension effective from 1 January 2006.

6

(iv) Ring had participated in the employee share scheme (Scheme) of Telephones pic (an associated company of TBU.

On 1 September 2005, the custodian of the Scheme granted Ring the right to acquire 2,000 shares in Telephones pic at the exercise price of £10 per share.

The right to acquire the shares could be exercised at any time before 31 August 2006.

There was no payment to be made for the rights. The custodian estimated the value of one right to be £2 and the exchange rate was £1 equals Rs.lOO.

On retirement from the employment of TBL, Ring disposed of the rights for Rs.30,000 on 31 December 2005.

(v) Ring invested Rs.1,000,000 in the purchase of new shares in ABC Ltd, a public company listed on the Karachi stock exchange. ABC Ltd had offered the new shares to the public and Ring is an original allottee of the shares.

Required:

(a) Compute the taxable income of Mr Ring under the appropriate heads of income for the relevant tax year giving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of the items listed above. The reasons/explanations for the items not included in the computation of income should be shown separately. (21 marks)

(b) Calculate the tax payable by or refundable to Mr Ring for the relevant tax year.

(4 marks) (25 marks)

7

[PT.O.

Section B - THREE questions ONLY to be answered

3 (a) Master Petrochemicals Ltd is engaged in the manufacture of synthetic fabrics. Their business transactions for the

month of May 2006 are summarised as follows:

Purchases of raw materials of Rs.805,000 (inclusive of sales tax at the normal rate of tax). Exempt supplies in local market of Rs.5,000,000.

Taxable supplies in local market of Rs.l,150,000 (inclusive of sales tax at the normal rate of tax).

Additional information:

Creditors' payable as at 31 May 2006 include Rs.575,000 (inclusive of sales tax at the normal rate of tax) on account of purchases of raw materials from a registered supplier in November 2005. The input tax on the said purchases was claimed in the monthly sales tax return of November 2005 and related to taxable supplies only.

The normal rate of sales tax as referred to above is 15%.

Required:

Compute the sales tax liability of Master Petrochemicals Ltd in respect of the sales tax return for the month of May 2006. (5 marks)

(b) Under the Sales Tax Act 1990 (Act), a person who is required to maintain any record or documents, shall retain such record and documents for a prescribed period of time.

Required:

State the period for which a person is required to retain the record and documents under the Act.

(2 marks)

(c) There are certain types of manufactured goods which are chargeable to sales tax at the rate of 15% of the retail price. Such goods have been listed in the Third Schedule to the Sales Tax Act 1990.

Required:

List any FOUR types of goods on which sales tax is chargeable at the rate of 15% of the retail price.

(2 marks)

(d) Mr Khan, a registered person, when preparing his monthly sales tax return for May 2006, discovers that due to a careless mistake in casting, he had inadvertently claimed Rs.300,000 in excess as input tax resulting in a short payment of Rs.300,000 in the monthly sales tax return of April 2006. He is of the view that since the short payment in tax was an inadvertent error and was not a wilful act or a tax fraud, he should neither be penalised nor required to pay default surcharge, if he pays the tax due of Rs.300,000 along with the monthly sales tax return for May 2006 which would be submitted by 15 June 2006.

Required:

(i) State with reasons whether or not you are in agreement with Mr Khan's contention.

(2 marks)

(ii) Assuming that the default surcharge is payable, state the rates at which it will be levied and calculate

the amount payable along with the monthly sales tax return for May 2006. (2 marks)

(e) A supply shall be deemed to have taken place at the earlier of the time of the delivery of goods or the time when any payment is received by the supplier in respect of that supply.

Required:

State in the case of goods supplied under a hire purchase agreement, when the supply is deemed to have taken place. (2 marks)

(15 marks)

8

4 (a) Mung Inc (MI), a company resident in a country which has no tax treaty with Pakistan for the avoidance of double taxation, holds 51 % of the shareholding in XYZ Ltd, a company incorporated under the Companies Ordinance 1984. XYZ Ltd is engaged in the distribution of chemicals and is not a public company for Pakistan tax purposes. MI's only income in Pakistan is from dividends received from XYZ Ltd. In March 2005, MI disposed of its entire shareholding in XYZ Ltd to an enterprise in the United States of America and made a gain of US$l,OOO,OOO on the transaction.

MI is of the view that there are no tax implications in Pakistan in respect of the gain of US$l,OOO,OOO, since the entire transaction of the sale of the shares in XYZ Ltd took place outside Pakistan with another non-resident company and the sale consideration was also received outside Pakistan.

Required:

State, giving reasons, whether or not the aforesaid view of Mung Inc is correct.

(3 marks)

(b) The following information is furnished to you on 1 July 2005 by the executor to the estate of the late Mr Tikam Das:

(i) The last return of income filed by Tikam was for the year ended 30 June 2004. (ii) Tikam expired on 30 April 2005.

(iii) On 15 June 2005, the executor, in accordance with the last will and testament of Tikam, transferred the

following assets to the beneficiaries of the will:

10,000 shares in Das (Private) Ltd to Tikam's daughter, Shirin. Shirin is an employee of the Pakistan Government and was posted to Iran during the year ended 30 June 2005.

10,000 shares in Das (Private) Ltd to Tikam's son, Govind. Govind has been staying with his sister Shirin in Iran and was in Pakistan for only 30 days in the tax year 2005.

Rs.179,496 by a crossed bank cheque in favour of Shirin, drawn on Tikamfs account in Azad Bank, Karachi. Rs.179,496 was the credit balance in Tikam's bank account on 30 April 2005.

(iv) Other information:

(1) Tikam, as the founder member of Das (Private) Ltd, had acquired 20,000 shares in the company at RS.10 per share on 1 April 2000. The break-up value of one share on 30 April 2005, as determined by a reputable firm of chartered accountants, was Rs.13.

(2) As an employee of ABC pic, Pakistan Branch, Tikam had acquired 400 shares in ABC pic on 31 May 2004 (tax year 2004) under an employee share scheme at the exercise price of £10 per share when the price quoted for one share on a stock exchange in the United Kingdom was £13. The rate of exchange on 31 May 2004 was £1 equals Rs.lOO. Tikam resigned from his employment with ABC pic on 30 June 2004 and on 1 July 2004, he sold the 400 shares to an employee of ABC pic, Pakistan Branch for Rs.1 ,000,000.

(3) Tikam was an amateur collector of rare postage stamps. He had inherited a rare postage stamp from his father's estate in 1981 which was then valued by an expert at Rs.50,000. Just prior to his death, Tikam sold the postage stamp for Rs.lOO,OOO.

(4) On 31 March 2005, Tikam received Rs.200,000 for vacating the possession of a building which he had taken on a yearly rental of Rs.60,000. Tikam had paid Rs.150,000 to the previous tenant to acquire possession of the building.

(5) Sale of shares on 31 March 2005 which were acquired by Tikam in the year 200l.

Gain of Rs.3,000 on the sale of shares in PQR Ltd, a company incorporated under the Companies Ordinance 1984, in which 50% of the shares are owned by the Government of Sind.

Loss of Rs.40,000 in DEF Ltd, a company whose shares were traded on the Karachi stock exchange in the tax year 2005 and which remained listed on that exchange on 30 June 2005.

Required:

Compute the taxable income of Tikam Das under the appropriate heads of income for the relevant tax year giving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of the items listed above. The reasons/explanations for the items not included in the computation of income should be shown separately. (12 marks)

(15 marks)

9

[PT.O.

5 (a) Mr Bee was self employed as a retailer dealing in different brands of honey. His accounting year ended on

30 June of each year. On 21 March 2003, there was a fire in his shop and the entire stock of honey valued at Rs.100,000 (at cost) was destroyed. His insurance company refused to entertain the claim for Rs.100,000 for the loss of the stock-in-trade. Bee ceased doing business as and from 30 June 2003. In the return of income furnished for the tax year 2003, Bee claimed the Rs.100,000 as a deductible business loss in computing his income under the head 'Income from business'. The loss was allowed as a deductible charge in that tax year.

During the tax year 2005, the insurance company, on receiving a legal notice from Bee, made a payment of Rs.75,000 against the claim for the loss of stock-in-trade which Bee accepted in full settlement. In June 2005, Bee also received Rs.27,000 as a dividend from a public company on which tax was deducted at source. Bee is exempted from payment of Zakat.

Other information furnished by Bee:

(i) In the return of income furnished to the Commissioner for the tax year 2005, the receipt of Rs.75,000 from the insurance company was neither included in the computation of total income nor was the amount claimed as exempt from tax. Bee was of the view that the receipt was a capital receipt since it was not traceable to any source of income in the tax year 2005. The receipt related to his retail business which had ceased on 30 June 2003 i.e. before the commencement of the tax year 2005.

(ii) Bee was of the view that there was no need to furnish any information or statement to the Commissioner for the dividend income of Rs.27,000 since the income had suffered withholding tax at the applicable rate which tax was the final tax on the dividend income.

Required:

Explain with reasons whether or not you are in agreement with each of the above two contentions of Bee. If you are not in agreement with either of the contentions, advise Bee of the treatment to be adopted to rectify the position.

Marks will be allocated to the two items as (i) 5 marks and (ii) 3 marks.

(8 marks)

(b) Bee wants to restart his retail business operating this time as a private limited company. He recalls that in the budget speech on the Finance Act, 2005, the Finance Minister had referred to a new category of a limited company styled as a 'small company' which appeared to be beneficial to small enterprises.

Required:

Provide a comprehensive note to Bee informing him of:

(i) the requirements for the formation of a small company: and

(4 marks)

(ii) the advantages, if any, that are available to a small company from the tax viewpoint.

(3 marks) (15 marks)

10

6 (a) The following information is made available to you by Murtaza who is the owner of a house property in

Islamabad.

(i) Murtaza accounts for the income from the house on the accrual basis and his accounting year ends on 30 June of each year.

(ii) On 1 July 2002, Murtaza had rented the house to Jack on a monthly rental of Rs.50,000 and had also received from Jack a deposit of Rs.1,000,000 which is not adjustable against the rent payable. On 1 July 2004, Jack vacated the house and the Rs.1,000,000 was retumed to him.

(iii) On I July 2004, Murtaza lets the house to Jill on a monthly rental of Rs.60,000 which includes Rs.10,000 for the services of a security guard. Murtaza received from Jill a deposit of Rs.1,500,000 which is not adjustable against the rent payable

(iv) In the accounting year ended 30 June 2005, Murtaza:

incurred expenditure of Rs.79,600 on repairs to the house; and

received Rs.50,000 from Jack being rent for June 2003, which had remained unpaid. The unpaid rent of Rs.50,000 had been allowed as a deductible charge to Murtaza against the 'Income from property' in the tax year 2004.

Required:

Compute the taxable income of Murtaza under the appropriate heads of income for the tax year 2005, giving explanations for the treatment in the computation of income of each of the items listed above. (7 marks)

(b) The following information is furnished to you by Nadir, a resident individual, relating to his accounting year ended 30 June 2005:

He is the owner of agricultural land in Sind. On 1 January 2005 he entered into an agreement with Bashir for the sale of the land for Rs.1,000,000. Under the terms of the agreement, Bashir paid a deposit of Rs.100,000 and the balance of Rs.900,000 was payable on 31 January 2005. The agreement also provided that if Bashir failed to make payment of the balance of Rs.900,000 by 31 January 2005, the deposit of Rs.lOO,OOO paid under the contract would be forfeited and the agreement for the sale of land would be treated as cancelled. Bashir failed to make payment of Rs.900,000 on 31 January 2005. The deposit amount of Rs.100,000 was retained by Nadir.

He purchased a new building 'Ataghar' in which a new flour milling plant had been installed and leased the property on the same day to Bashir on a composite lease rent of RsAOO,OOO per month. The consideration paid for 'Ataghar' as specified in the purchase deed was Rs.9,000,000 for the building and Rs.5,000,000 for the plant installed in the building.

Nadir wants you to:

(i) explain the tax treatment in respect of the receipt of Rs.1 00,000 being the deposit amount forfeited under the terms of the contract for the sale of the land;

(ii) explain the provisions under which the income from 'Ataghar' would be assessed to tax and briefly state the permissible deductions in computing the income from 'Ataghar' chargeable to tax; and

(iii) advice whether or not he is entitled to claim one-fifth of the lease rent received for 'Ataghar' as a deduction

for repairs to the building.

Required:

Provide the information and advice requested by Nadir relating to the three issues stated above.

Marks will be allocated to the three items as (i) 2 marks; (ii) 4 marks and (iii) 2 marks.

(8 marks)

(15 marks)

11

[PT.O.

7 (a) Under the provisions of s.153( 1) of the Income Tax Ordinance 2001, every prescribed person making a payment

in full or part including a payment by way of an advance to a resident person or a permanent establishment in Pakistan of a non-resident person:

(i) for the sale of goods;

(ii) for the rendering of or providing of services;

(iii) on the execution of a contract, other than a contract for the sale of goods or the rendering of or providing of services,

shall, at the time of making the payment, deduct tax at the applicable rate. Required:

(i) State the conditions to be met to ensure that a prescribed person making payment for the sale of

imported goods does not deduct tax under s.153(1) of the Income Tax Ordinance 2001. (3 marks)

(ii) List any FOUR persons (i.e. a person as defined for Pakistan tax purposes), who are required to deduct tax at the time of making a payment under s.153(1) to a permanent establishment in Pakistan of a nonresident person on the execution of a contract for building an irrigation canal. (2 marks)

(iii) If tax is to be deducted by a prescribed person on payment of an amount under s.153(1), is the tax to be deducted when the amount is credited to the account of the recipient or when it is actually paid? (1 mark)

(b) Sky Adverts is a non-resident company incorporated in a country which does not have a tax treaty with Pakistan for the avoidance of double taxation. SkyAdverts is in the process of submitting a bid to Chaiwalla (Pakistan) Ltd [CPU for providing, under a contract (TV Contract), advertisement services which would be rendered by 'TV Satellite Channels' owned and managed by them. CPL is a company incorporated under the Companies Ordinance 1984 and is not a 'small company' as defined for tax purposes.

Sky Adverts has been informed by CPL that all payments to them under the TV Contract would suffer withholding tax and there are certain provisions under the Pakistan tax statute whereby the tax deducted could be considered to be the final tax on their income arising from the TV Contract.

Sky Adverts wants you to:

(i) explain the tax provisions under which CPL is required to deduct tax from the payments made to Sky Adverts under the TV Contract;

(ii) state whether it is mandatory that the tax deducted from the payments made under the TV Contract would be the final tax of Sky Adverts or can Sky Adverts be taxable on its net income;

(iii) explain the steps to be taken by Sky Adverts to ensure that the tax deducted from the payments made by CPL would be the final tax on the income arising from the TV Contract; and

(iv) explain how the tax deducted on payments made by CPL would be treated for Sky Adverts' tax assessment in Pakistan if for some reason, Sky Adverts is unable to meet the requirements for being assessed on the final tax basis.

Required:

Provide the information required by SkyAdverts relating to the four issues stated above.

Marks will be allocated to the four items as (i) 3 marks; (ii) 1 mark; (iii) 4 marks; and (iv) I mark.

(9 marks)

(15 marks)

End of Question Paper

12

Answers

Part 2 Examination - Paper 2.3(PKN) Business Taxation (Pakistan)

June 2006 Answers and Marking scheme Marks

1 (a) A public company for Pakistan tax purposes, inter alia, means a company in which not less than 50% of

the shares are held by a foreign government or a foreign company owned by a foreign government. 50% of the shares in CPL are owned by ABC Ltd, which is a foreign company but ABC Ltd is not wholly owned by the Kingdom of Saudi Arabia (foreign government). Therefore CPL is not a public company for Pakistan tax purposes.

(b)

CPL Ltd

Accounting year ended 31 December 2005 Tax year 2006

Computation of taxable income

Accounting profit

Add: Transfer to general reserve (Note 1) Accounting depreciation (Note 2)

Tax collected by the Collector of Customs (Note 3) Excess cost of perquisites and allowances (Note 4) Provision for taxation (Note 5)

Acquisition of manufacturing rights (Note 6) Provision for bad debts (Note 7)

Architect's fee for new building (Note 8) Unpaid liability for profit on debt (Note 9) Tax profit on sale of building (Note 10)

Rs. in
thousands
780,000
5,000
136,000
750
2,450
70,000
10,000
500
500
140
500
225,840
1,005,840
170
750
545
600
4,250
3,068
9,383
996,457
900
9,000
6,500
16,400
980,057 Less: Amortisation of an intangible (Note 6)

Accounting profit on sale of office building (Note 10) Recovery against bad debts written off (Note 11) Trading bad debts written off (Note 13)

Initial allowance (Note 14)

Depreciation (Note 15)

Less: Income for separate consideration (Note 12) - Commission from the federal government

- Dividend

- Sale of imported fans

Business income being taxable income

The notes will be considered in allocating the marks against each item. Specific marks will be awarded for the explanations of the treatment of items not included in the computation of income (I mark for each item)

as follows: 4

Items not included in the computation of income

(1) Compensation of RS.200 received from a customer under the terms of the supply contract is a taxable receipt as it was received in the normal course of carrying on the business and has therefore been correctly included as the taxable income of CPL.

(2) The share of profit received from the association of persons (AOP) is to be added to the taxable income of the company and has correctly been included in the taxable income of CPL. As the AOP has paid tax on its profits, CPL is allowed a tax credit against tax payable (Note 16).

(3) No adjustment in the computation is required for the unpaid rent of RS.750. The amount was allowed as a deduction in the year ended 31 December 2003 i.e. tax year 2004. Any amount remaining unpaid out of RS.750 will be treated as taxable income in the tax year 2008. This is because any such amount remaining unpaid for three years from the end of the year it was first allowed, is treated as income chargeable to tax in the first year following the end of the said three years i.e. in the tax year 2008.

15

2

0·5 0·5 1 0·5 0·5 1

0·5 1 1·5 2

1·5 0·5 1·5 0·5

1 4·5

0·5 0·5 0·5

24

(4) The advance of RS.700 to CPL's subsidiary company written off against the provision for bad debts account is not deductible as it is not the business of CPL to advance money.

(e) Tax liability

On business income of Rs.980,057 at 37% Tax credit on tax paid by the AOP (Note 16)

Rupees in thousands 362,621 (2,290)

Less: Advance tax paid

360,331 100,000

Balance tax payable

260,331

Tax deducted/collected considered as the final tax (Note 12) Commission - Rs.1 ,000

- Tax deducted at 10% is the final tax

100

Dividend income - Rs.10,000

- Tax deducted at 10% is the final tax

1,000

I ncome on sale of imported ceil ing fans

- Tax collected at the customs stage is the final tax

750

Note (1) Any amount transferred from the accounting profit to any reserve account is an appropriation of the profit and is not a deductible charge.

Note (2) Accounting depreciation is not a deductible charge. For tax purposes deduction is allowable for depreciation and initial allowance on depreciable assets at the rates prescribed in the Third Schedule.

Note (3) As the ceiling fans imported are for sale, the tax collected at the customs stage is the final tax on the income arising on the sale of fans.

Note (4) Expenditure on the provisions of perquisites and allowances in excess of 50% of the salary of an employee (excluding the value of perquisites and allowances) is not deductible.

Note (5) Provision for taxation is not deductible. Any tax paid or payable that is leviable on the profits of the business is not deductible.

Note (6) Rs.10,000 paid for the acquisition of the right to manufacture Coolair fans (Right) is an intangible for tax purposes and is not a deductible charge. Any expenditure on an intangible is to be amortised over its useful life for the business, proportionate to the number of days, the intangible is used in the tax year for the purposes of the business. As the Right is for a period of five years and was utilised in the business for 31 days (December 2005) in the tax year 2006, the

amount deductible is worked out as under:

Cost of intangible

Rs.10,000

Normal useful life of the Right

5 years

Amortisation for one whole year

Rs.2,000

For 31 days (2,000 x 31/365)

RS.170

Note (7) Since the provision of RS.500 is not against specific debts, the RS.500 is not a deductible charge. Note (8) Architect's fee on the new building is a capital expenditure to be added to the cost of the building. Note (9) The unpaid expenditure of RS.140 for profit on debt was allowed as a deduction in the year ended

31 December 2001. As the amount has remained unpaid for three years from the end of the year the deduction was allowed (31 December 2002,2003 and 2004), RS.140 is chargeable to tax in the tax year 2006 (i.e. the accounting year ended 31 December 2005 which is the first tax year following the end of the said three years).

16

Marks

0·5 1·5

0·5

0·5

0·5

0·5

4

30

Marks

Note (10) The accounting profit or loss on the sale of a depreciable asset is not considered for tax purposes.

It is the tax profit or loss on disposal of the depreciable asset that is chargeable to tax or allowed as a deduction. In the case of the disposal of any immovable property, where the consideration received on disposal exceeds the cost of the property, the sale consideration received shall be treated as the cost of the property.

As the sale consideration (Rs.7,500) on the disposal of the building is more than that its

cost (Rs.3,000), Rs.7,500 is to be treated as the cost of the building for working out the tax profit or loss on sale of the building. Tax depreciation allowed on the building in prior years is

RS.500 (actual cost Rs.3,000 less written down value Rs.2,500).

Tax profit on disposal of building Sale consideration

Less: Tax written down value Deemed cost Depreciation allowed

Rupees 7,500

7,500 (500)

7,000

Tax profit on sale of building

500

Note (11) RS.545 received against debts previously written off is not to be included in the taxable income, since the amount when written off was not allowed as a deductible charge.

Note (12) I ncome for separate consideration:

(i) Rs.IOO being the tax deducted on the commission income of RS.l ,000 (net income RS.900) received from the Federal Government is the final tax on such income.

(ii) Rs.l,OOO tax deducted on the dividend income of Rs.IO,OOO (net income Rs.9,000) is the final tax on such income.

(iii) RS.750 tax collected by the Collector of Customs at the customs stage (Note 3) is the final tax on the income (Rs.6,500) derived from the sale of the imported ceiling fans.

The above income from commission, dividend and sale of ceiling fans is not chargeable to tax under any head of income since the tax deducted or collected is the final tax on such income.

Note (13) Trading debts written off is a deductible charge in the carrying on the business. It is assumed that the amount written off has previously been included in the taxable income and the company has reasonable grounds to believe that the debts are irrecoverable.

Note (14) Initial allowance

Cost of residential building for workers Add: Cost of arch itect's fee (Note 8)

Rupees 8,000 500

8,500

Initial allowance at 50%

4,250

17

(Note 15) Depreciation
Plant and Factory Office Motor Furniture Total
machinery and buildings vehicles depreciation
workers'
residential
buildings
Rate of depreciation 15% 10% 10% 15% 15%
Rs. Rs. Rs. Rs. Rs. Rs.
Written down value 9,500 2,500 8,200 400 250
Disposal (2,500)
9,500 2,500 5,700 400 250
Depreciation 1,425 250 570 60 38 2,343
Additions 8,500 2,000
Initial allowance (4,250)
Written down value 4,250 2,000
Depreciation for 12 months 425 300 725
3,068
Note (16) Tax credit is calculated as under:
Rs.
Share of profit received from the AOP (A) 8,000
Taxable income of the AOP (8) 20,000
Tax assessed on the AOP (C) 5,725
A/BxC
Rs.8,000/Rs.20,000 x Rs.5,725 = Rs.2,290 18

2 (a)

Mr Ring

Accounting year ended 30 June 2006 Tax year 2006

Computation of income Salary income

Consideration for agreeing to a restrictive covenant (Note II Basic salary (6 months)

Cash allowances:

Utilities (Note 2) - Rs.150,000 - exempt from tax Ch ildren's education (Note 2)

Cost of I iving (Note 2)

House rent (Note 2.ll

Household servants (Note 3)

Benefit of company maintained car (Note 4) Passage for travel abroad (Note 5)

Reimbursement of hospital charges exempt from tax (Note 6) Benefit on purchase of car (Note 7)

Pension exempt from tax (Note 8)

Employee share scheme - sale of rights (Note 9)

Rupees
695,000
1,800,000
0
120,000
60,000
540,000
240,000
88,000
80,000
0
600,000
0
30,000
4,253,000
200,000
6,000 206,000
4,459,000
(60,000)
4,399,000 Income from other sources

Amount of loan received in cash (Note 10) Profit on Special Savings Certificates (Note III

Total income Zakat paid

Taxable income

The relevant notes will be considered in allocating marks against each item. In addition, specific marks will be awarded for the explanations of the treatment of items not included in the computation of income

(1 mark for each item) as follows: 4

Items not included in the computation of income

(l ) The value of a right or option granted to an employee under an employee share scheme (Scheme) is normally a benefit since the holder of the right is entitled to purchase the shares offered under the Scheme at a price usually below its market value. However, the Pakistan tax statute has specifically legislated that 'the value of a right or option to acquire shares under an employee share scheme granted to an employee shall not be chargeable to tax' [s.14(ll]. Accordingly the value of the rights at £2 for one right, as estimated by the custodian of the Scheme, is not treated as income in the computation.

(2) As the company-maintained car purchased for Rs.1 ,500,000 is used by Ring exclusively for the business use of TBL, there is no taxable benefit for Ring.

(3) The tax deducted at source from the gross amount of the dividend income is the final tax on such income.

The dividend income is therefore not chargeable to tax under any head of income and correspondingly is not included in the computation of income.

(4) As the tax deducted on the dividend income is the final tax, no deduction is allowable for any expenditure incurred in earning such income. Rs.15,000 which Ring wants to claim as profit paid against the dividend income is therefore not deductible.

19

Marks

2 0·5

1 0·5 0·5 1·5

1 1·5 0·5 1 1 1 2

2 0·5

0·5

21

(b) Computation of tax liability Taxable income

Tax thereon

Tax on Rs.700,000

Tax on balance of Rs.3,699,000 at 30%

Rupees 4,399,000

102,500 1,109,700

1,212,200 (41,334)

1,170,866

Tax credit on purchase of new shares in ABC Ltd (Note 12)

Tax deducted at source On salary income

On profit on special savings certificates (Note 11)

1,300,000 600

1,300,600 129,734

Balance tax refundable

Tax deducted as final tax

Dividends - gross amount Rs.300,000 (Note 13)

Final tax 30,000

Note (1) Any amount received as consideration for an employee's agreement to a restrictive covenant in respect of any past, present or prospective employment is a profit in lieu of or in addition to salary and is taxable as salary income. The Rs.695,000 received by Ring for his agreement not to enter into employment with any other telephone manufacturing company is chargeable to tax as salary income. Normally under the general law, such a receipt would be a capital receipt; however, the tax statute has specifically legislated that such a receipt is chargeable to tax [s.12(2)(e)(v)].

Note (2) All cash allowances (except house rent allowance upto a certain limit and utility allowance up to 10% of basic salary) are chargeable to tax if the salary income including the value of perquisites and benefits in a tax year is Rs.600,000 or more. As Ring's salary income including perquisites and benefits exceeds Rs.599,999, the cash allowances for utilities, children education, cost of

I iving and house rent (Note 2.1) are chargeable to tax as salary income.

Note (2.1) As Ring's salary including perquisites and allowances exceeds Rs.599,999, house rent allowance (HRA) is exempt from tax up to 45% of basic salary subject to a maximum of Rs.270,000.

Rupees 810,000 270,000

HRA - 45% of basic salary (45% of Rs.1,800,000) Exempt from tax

Chargeable to tax

540,000

Note (3) The cost of household servants borne by TBL is a benefit of employment and is therefore chargeable to tax as salary income.

Note (4) The fair market value (FMV) of the car, taken on lease, at the commencement of the lease period is Rs.2,000,000. As the car is exclusively for Ring's private (non-business) use, Rs.200,000 being 10% of the FMV of the car is the annual benefit. The amount chargeable to tax is Rs.88,000 made up as under:

Annual benefit

Rupees 200,000

100,000 12,000

88,000

For 6 months

Less: Deduction from Ring's salary (Rs.2,000 x 6)

Chargeable to tax

Note (5) The benefit of free passage for travel abroad is exempt from tax (subject to certain conditions), if the employee's salary including the value of perquisites and benefits does not exceed Rs.599,999. As Ring's total salary exceeds Rs.599,999, the amount of Rs.80,000 paid by TBL for the passage cost is chargeable to tax as salary income.

Note (6) The reimbursement of hospital charges is exempt from tax as the reimbursement of such charges is in accordance with the terms of employment of Ring. It is assumed that the national tax numbers of the hospitals or clinics have been furnished by Ring and TBL has certified and attested the hospital bills [Clause 139(a) of Part I of the Second Schedule].

20

Marks

0·5 2

1

0·5 4 25

Marks

Note (7) Where any asset is transferred by an employer to an employee, the amount chargeable to tax is the fair market value (FMV) of the asset on the date of its transfer as reduced by any payment made by the employee. The FMV of the Civic Honda car purchased by Ring from TBL on 31 December 2005 was Rs.900,000 as against the amount of Rs.300,000 paid by Ring. The difference of Rs.600,000 is a benefit chargeable to tax as salary income. A benefit to be chargeable to tax need not be in accordance with the terms of employment.

Note (8) Any pension received by a citizen of Pakistan from a former employer is exempt from tax provided the person receiving the pension does not continue to work for the former employer or an associate of the former employer. The exemption is neither dependent on the age of the person receiving the pension nor the retirement age under the terms of employment. As the above requirements are fulfilled, the monthly pension received by Ring is exempt from tax [Clause 8 of Part I of the Second Schedule].

Note (9) The gain on the disposal of rights or options entitling the holder to acquire shares under an employee share scheme is chargeable to tax as salary income and not as 'capital gains'. As no payment was made by Ring for the rights, the entire amount of Rs.30,000 is chargeable to tax as salary income [s.14(5)].

Note (10) An amount received by a person, inter alia, as a loan from another person (not being a banking company or financial institution) which is not paid by a crossed bank cheque or through a banking channel from a person holding a national tax number card, is treated as the income of the recipient chargeable to tax in the tax year of receipt under the head 'Income from other sources'. As the loan was received by Ring in cash, Rs.200,000 is treated as Ring's income chargeable to tax [s.39(3)].

Note (11) Profit on Special Savings Certificates issued by the National Savings Scheme purchased after 1 July 2001 are taxed at 10% of the gross amount of the profit.

Net amount of profit received after deduction of tax Gross amount of the profit

Tax deducted at source (available as a tax credit)

Rupees 5,400 6,000 600

Note (12) The tax credit on the investment of new shares [s.62(1) and (2)] in ABC Ltd is calculated as under:

- Tax assessed before allowance of tax credit

- Taxable income for the year

- Amount of investment on which tax credit is to be

calculated (Note 12A)

Tax credit allowable A/BxC

Rs.l,212,200/Rs.4,399,000 x Rs.150,000

Note (12A) The amount of the investment on which tax credit is calculated is the lesser of: - the cost of acqu iring the shares;

- 10% of the taxable income; or

- one hundred and fifty thousand.

The cost of acqu iring the shares is Rs.l ,000,000 10% of taxable income is Rs.439,900.

As both the above amounts are more than Rs.150,000, the amount of the investment on which tax credit is to be calculated is Rs.150,000.

Note (13) Dividend income of an individual is taxed at 10% of the gross amount of the dividend irrespective of whether the dividend is received from a public or private company.

Rupees
(A) 1,212,200
(8) 4,399,000
(C) 150,000
41,334 Net amount of dividend after deduction of tax (Rs.90,000 + Rs.180,000) Gross amount of the dividend

Tax deducted at source

Rupees 270,000 300,000 30,000

Rs.30,000 being the tax deducted at source is the final tax on the dividend income.

21

Marks

3 (a) The sales tax liability for the month of May 2006 would be computed as follows:

Output tax Exempt supplies-

Taxable supplies in local market (Rs.1,150,000 x 100/115 = 1,000,000 x 15%).

As the credit purchases of Rs.575,00 remains unpaid on 31 May 2006 (i.e. the payment of Rs.575,000 has not been made within 180 days) the input tax previously claimed needs to be reversed [s.73(2)J

(Rs.575,000 x 100/115 x 15%)

Rupees o 150,000

0·5 0·5

75,000

2

225,000

I nput tax

Purchases of raw materials (inclusive of sales tax)

I nput tax (Rs.805,000 x 100/115 = 700,000 x 15%) Apportionment of input tax on purchases

Taxable supplies/(Taxable supplies + exempt supplies) x input tax 1,000,000/(1,000,000 + 5,000,000) x 105,000

RS.805000 RS.105000

(17,500)

2

Sales tax payable

207,500

(b) A person is required to retain the record and documents for a period of three years after the end of the tax

period to which such record or documents relate. [s.24J 2

(e) The following goods are chargeable to sales tax at the rate of 15% of the retail price: l. Fruit and vegetable juices

2. Ice cream

3. Aerated waters or beverages

4. Syrups and squashes

5. Cigarettes

6. Toilet soap

7. Detergents

8. Shampoo

9. Toothpaste

10. Shaving cream

11. Perfumery and cosmetics

12. Biscuits

13. Confectionery

14. Tea

15. Powder drinks

16. Milky drinks

17. Footwea r

Any 4 items at 1/2 mark each.

2

(d) (i) M Khan's contention is not correct. Payment of default surcharge (which has been substituted for additional tax) is mandatory if a registered person does not pay the tax due or any part thereof whether

wilful or otherwise, in time. 2

(ii) As the default was not on account of a tax fraud, default surcharge is

payable at the rates given below:

For the first six months of default

From the seventh month onwards till such time as the entire liability including default surcharge is paid.

Rate per month 1%

1·5%

1

As the tax due for the month of April 2006, which was due for payment on 15 May 2006, is intended to be paid along with the monthly sales tax return for May 2006 to be submitted on 15 June 2006,

the default surcharge at the rate of 1 % per month would be Rs.3,000 (1 % of Rs.300,000). 1

(e) Where goods are supplied under a hire purchase agreement, the time of supply shall be the time at which the

agreement is entered into [s.2(44)(b)J. 2

15

22

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