Income Tax: Chapter #02: Tax evasion, avoidance, and ethics

Misc. Areas:

Tax evasion is an attempt to minimize tax liability by use of illegal means. It is a punishable act.

Federal government may by notification in official gazette for reasons to be recoded in writing, exempt
any person from payment of default surcharge or penalty or fines.

Reward to whistleblower shall be rejected if the information is of no use or the information is publicly
available information, or the department already has the information, or the information is of no value,
or no tax collection has been made from the information provided by whistleblower.

Tax avoidance is an attempt to minimize tax liability through legal means and without violating taxation
laws.

Commissioner cannot probe source of income in case foreign exchange remitted from outside Pakistan
not exceeding 5 million in a tax year through normal banking channel and is encashed in rupees by a
schedule bank and a certificate from such bank is produced. If the amount of remittance is more than 5
million than only the source of income needs to be explained and no such amount is taxable. If the
source of income is not explainable then amount above 5 million is added in income from other sources
and is taxable in this case only.

Transfer pricing (Rule 20-27):

Transfer pricing rules are rules which give commissioner the power to distribute income, expenses, loses
and tax credits between associates relating to transactions not recorded at arm’s length.

Method1: comparable uncontrolled price method

Under this method, comparison is made with prices charged in comparable transactions between
independent parties.

Method2: Resale price method

Purchase price paid to related parties based on its resale price to unrelated parties. It is typically useful
to determine Arm’s length price of purchases made by the distributor (trader) from related parties.

Method3: Cost plus method

Cost plus markup is Arm’s Length price.

Method4: profit split method

It is applied when above 3 methods cannot be applied.

Foreign income and assets statement (Section 116A):

Every resident person who has foreign income of not less than 10,000$ or foreign assets of not less than
100,000$ shall furnish a statement of foreign income and assets with the return filling.

Capital value tax on foreign assets (Circular):

If value of foreign assets at the closing day of the year exceeds 100 million than CVT @1% is charged.

It is also applicable on purchase or import of motor vehicle @1% with engine capacity increases 1300 cc
or 50Khw for electric cars.

Controlled Foreign Company (Section – 109A):

A non-resident company is said to controlled foreign company if all of the following conditions are
fulfilled:

1) One resident person holds directly or indirectly more than 40% of the capital or voting rights or
two or more persons hold more than 50% of the voting rights directly or indirectly.

2) Tax paid in respect of the income derived or accrued in a foreign tax year is less than 60% of the
tax payable on the said income under ITO.

3) Non-resident company is not a listed company in that jurisdiction.

4) A non-resident company is not deriving active business income.

Active business income:

Income of a non-resident company shall be active business income if more than 80% of the income does
not include income from dividend, profit on debt, property, capital gains, royalty, annuity, supply of
goods and services to an associate, sale or licensing of intangibles and management, holding or
investment in securities and financial assets ; and the company principally derives income under the
head income from business in the country or jurisdiction of which it is resident.

Taxability of CFC:

It is taxed as dividend income and at rates of tax charged at dividend income.

The income of CFC shall be added in the income of the resident person who has direct or indirect control
in the company using the following formula:

A*(B/100)

Where A is the income of CFC and B is the voting or capital right of the person in CFC.

However, if the person has voting or capital right less than 10% and/or the income of CFC is less than 10
million than the income of CFC is exempt from tax.

CFC income is taxed when it is earned so the same will not be taxed when it is received in Pakistan.
Similarly, where tax has been paid by the resident person on the income attributable to CFC and in
subsequent year resident person receives dividend distributed by CFC after deduction of tax on
dividend, the resident person shall be allowed a tax credit equal to lower of

i) Foreign tax paid on dividend

ii) Pakistan tax payable or the tax year on which the dividend is received by resident taxpayer
Furnishing of information by banks:

1) A list of persons containing particulars of cash withdrawals exceeding Rs50,000 or more in a day
and tax deductions thereon, aggregating to Rs 1 million or more during each preceding period.

2) Deposits aggregating Rs 10 million or more during the preceding month

3) Payment made by person of bills by credit card aggregating Rs 200,000 or more during the
preceding month

4) A list of persons receiving profit on debt and tax deductions thereon during the preceding
month

5) A list of persons containing particulars of business accounts opened or re-designated during

each preceding month.

Ethics:

Integrity:

To be straight forward and honest in all professional and business relationships.

Objectivity:

To not allow bias, conflict of interest or undue influence of others to override professional judgements.

Professional competence and Due care:

To maintain professional knowledge and skill at the level required to ensure that client or employer
receives competent professional services based on current developments and act diligently in
accordance with applicable technical and professional standards.

Confidentiality:

To respect the confidential information obtained as a result of professional and business relationship
and therefore not disclose such information to third parties without proper and specific authority unless
there is a professional right or duty to disclose. Also not use the information received for personal
advantage or the advantage of third parties.

Professional behavior:

To comply with relevant laws and regulations and avoid any action that discredit the profession.

Self-interest threat:

The threat that a financial or other interest will inappropriately influence the chartered accountant’s
judgement or decision.
Self-review threat:

The threat that chartered accountant will not appropriately evaluate the results of a previous
judgement made or activity or service performed by the chartered accountant or by another individual
in the chartered accountancy firm or employing organization on which the accountant will rely when
forming a judgement as part of providing a current service.

Advocacy threat:

The threat that chartered accountant will promote a client’s or employer’s position to the point that
chartered accountant’s objectivity is compromised.

Familiarity threat:

A threat that due to a long or close relationship with a client or employer, a chartered accountant will be
too sympathetic of their work or too accepting of their work.

Intimidation threat:

A threat that chartered accountant will be deterred from acting objectively due to actual or perceived
pressure, including attempts to exercise undue influence over the chartered accountant.

Safeguards:

Having an appropriate independent reviewer review the work performed by the chartered accountant.
Include members in the team who are independent of the client. Have strong internal controls. Have
strong leadership. Obtain technical advice. Obtain legal advice. Consult with higher management.
Consult with ICAP. Consult with internal/external auditors. Inform relevant authorities. If threats cannot
be eliminated or cannot be reduced to an acceptable level, then resign or refuse to do the
project/service.

Tax return preparation:

Tax return preparation services generally based on historical information and principally involves
analysis and presentation of such historically transactions and information under existing laws.

Providing such services do not create a threat to independence if management takes responsibility for
the returns including any significant judgements made.

Tax calculations for the purpose of preparing accounting entries:

For audit clients that are not public interest entities, this would create self interest threat. Significance of
threat depends on factors such as: the complexity of relevant tax laws and regulations and degree of
judgements involved, the level of tax expertise of client’s personal, and the materiality of the amounts
involved.

Safeguards include using professionals who are not part of audit team to perform tax services. Obtaining
advice from external tax professional. If the service is provided by the member of audit team then use
appropriate partner or senior staff member to review the work done by the team member involved in
providing tax services.

For clients that are public interest entities, auditors shall not prepare accounting entries of income and
deferred tax that are material to financials. These may be provided in case of emergency or other
unusual situation when it is not practicable for the audit client to make other arrangements. This maybe
the case when only the firm has the resources and knowledge of client’s business to assist in timely
preparation of its current and deferred tax and a restriction on firm’s ability to provide the service would
result in significant difficulties for the client. In these situations, those who are involved in providing the
taxation service are not part of the audit team, the services are only for a short period of time and are
not expected to recur and the situation is discussed with those charged with governance.

Tax planning and other advisory services:

A self-interest threat might be created by providing these services. Significance of threat depends on
factors such as the complexity of relevant tax laws and regulations and degree of judgements involved,
the level of tax expertise of client’s personal, and the materiality of the amounts involved.

Safeguards include using professionals who are not part of audit team to perform tax services. Obtaining
advice from external tax professional. If the service is provided by the member of audit team, then use
appropriate partner or senior staff member to review the work done by the team member involved in
providing tax services. Having a tax professional who was not involved in providing tax services, advice
the audit team on the services and review of financials. Obtain advice on the services from external tax
professional. Obtain preclearance from tax authorities.

Assisting in Resolution of tax disputes:

Self-interest threat or advocacy threat may be created. The existence and significance of threat depends
on factors such as the extent to which the matter is supported by tax law or regulation, whether
proceedings are conducted in public and the role of management in resolution of dispute.

Safeguards include using professionals who are not part of audit team to perform tax services. Obtaining
advice from external tax professional. If the service is provided by the member of audit team, then use
appropriate partner or senior staff member to review the work done by the team member involved in
providing tax services. Having a tax professional who was not involved in providing tax services, advice
the audit team on the services and review of financials. Obtain advice on the services from external tax
professional. Obtain preclearance from tax authorities.

Where the taxation services include acting as an advocate for an audit client before a public tribunal and
the amounts involved are material to financials, then the threats would be so significant that no
safeguards could eliminate threats or reduce them to an acceptable level. In these circumstances the
auditor should not provide such services to the audit client.

Canon of taxation:

Canon of equity, economy, certainty, convenience.

Canon of productivity, elasticity, flexibility, simplicity, diversity.