Chapter 1

Basic Concepts of Taxation

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

 What is Federal Budget?
“How does it work?”
 The federal budget is the government's estimate of revenue
(income) and spending for each fiscal year.
 
 Like a family budget, the federal budget itemizes the expenditure
of public funds for the upcoming fiscal year.

 Some budget expenses are mandatory spending such as money

allocated for Medicare. Other spending is discretionary and will get
approved or disapproved through the passage of appropriation
bills.

 The Pakistan federal government's fiscal year begins each July 1 st

and concludes on June 30th of the following year.
 Where does the money come from?
 The revenue for most governments—including the
Pakistan—comes from tax revenues.
 These taxes include those on family incomes,
business profits, and imports, such as customs duties
and tariffs.
 It also includes sin taxes on activities the government
wants to discourage, such as cigarette smoking and
alcohol use.
 Countries also derive revenues from state-owned
businesses, such as oil companies. The revenue from
these companies supplies revenue directly to these
governments eg. PSO, LESCo, PTCL, etc
What are the three types of Government
budgets
 Government Budget: A government budget is an annual
financial statement which outlines the estimated government
expenditure and expected government receipts or revenues
for the forthcoming fiscal year.
 Depending on the feasibility of these estimates, budgets are
of three types.

 Balanced budget
 Surplus budget
 Deficit budget.
 1) Balanced Budget

 A government budget is said to be a balanced budget if the

estimated government expenditure is equal to expected
government receipts in a particular fiscal year.
 They believed the government’s expenditure should not
exceed their revenue. Though an ideal approach to achieve a
balanced economy and maintain fiscal discipline.
 Theoretically, it’s easy to balance the estimated expenditure
and anticipated revenues but when it comes to practical
implementation, such balance is hard to achieve.
Surplus Budget

 A government budget is said to be a surplus budget if the

expected government revenues (earnings) exceed the
estimated government expenditure in a particular
financial year(Fiscal Year)
 This means that the government’s earnings from taxes
levied are greater than the amount the government
spends on public welfare.
 A surplus budget denotes the financial prosperity of a
country. Such a budget can be implemented at times of
inflation to reduce aggregate demand
 Deficit Budget

 A government budget is said to be a deficit budget if the estimated

government expenditure exceeds the expected government revenue
in a particular financial year.
 This type of budget is best suited for developing economies, such as
Pakistan. Especially helpful at times of recession, a deficit budget
helps generate additional demand and boost the rate of economic
growth.
 Here, the government incurs the excessive expenditure to improve
the employment rate. This results in an increase in demand for goods
and services which helps in reviving the economy.
 1-8

FEDERAL BUDGET of PAKISTAN

Revenue 2020-2021 2019-2020 2018-2019

% % %
Income Tax 31 33 31
Sales Tax 32 30 31
Customs Duty 15 14 12
Federal Excise 05 05 05
Petroleum Levy 04 05 04
Non Tax Revenue 13 13 17
100 100 100
Gross Revenue Rs. In billion 6,716 5,032 4,992
 1-9

FEDERAL BUDGET

Expenditure 2020-2021 2019-2020 2018-2019

% % %
Debt Servicing 34 25 21

Defense 10 13 13
Development 08 13 15
General Services 20 19 18
Provincial Share 28 30 33
100 100 100
Gross Expenditure Rs. In billion 10,291 8,046 7,829
 1-10

TAX

 Amount levied by a Government

 on its Citizens

 used to run the Government

 1-11

Classification of Taxes :

Taxes can be classified according to their tax base,

what is being taxed:

 Income
 Assets
 Consumption
1.INCOME

 Personal Income Tax

 Company Income Tax

 1-13

INCOME

1) Personal Income Tax: Personal income refers to

an individual's total earnings from wages,
investment enterprises, and other ventures. It is the
sum of all the incomes received by all the individuals
or household during a given period with some
permissible deductions.

2) Company Income Tax: A corporate tax, also

called corporation tax or company tax, is a
direct tax imposed by a jurisdiction(tax authority) on
the profits or capital of corporations 
 1-14

ASSETS

1)Wealth Tax: A number of countries levy wealth taxes,

either on individuals or on enterprises or on both.
This involves measurement and valuation of assets
each year.
The tax rate is usually a straight percentage, for
example 2%, of total net worth (total assets less total
liabilities).

2)Property Tax: a tax levied directly on property usually

land and buildings.
Assets … Continued

3)Tax on Capital gains: buying at low and selling at

high.
A capital gains tax (abbreviated: CGT) is a tax
charged on capital gains, the profit realized on the
sale of a non-inventory asset that was purchased at
a lower price.
 The most common capital gains are realized from
the sale of stocks, bonds, precious metals and
property.
 1-16

CONSUMPTION

1) Sales Tax: A tax on sales or on the receipts from

sales.
2) Federal Excise Duty: Excise duty refers to the
taxes levied on the manufacture of goods within the
country. There is no requirement for the actual sale of
the goods for imposing the excise duty because it
is imposed on the manufacture of such goods.
3) Customs: Customs Duty is a tax imposed on
imports and exports of goods. The rates of customs
duties are either specific which are levied as per the
quantity or weight of goods. Also called tariff, duty is
based generally on the value of goods.
 1-17

FORMS OF TAXATION

 Direct Taxation

 Indirect Taxation
DIRECT TAXATION

Direct Taxation is charged directly on the person, or

enterprise, who is intended to pay the tax :

 Personal Income Tax( on income, salary)

 Company Income Tax(on the profit )
 Tax on Capital Gains.( on shares or stocks)
 INDIRECT TAXATION

 Indirect Taxation is charged indirectly on the final

consumer of the goods or services.
 Indirect Taxes are not actually paid by the company,
but the company acts as a tax collector on behalf of
the government.
 Examples of Indirect Taxes:
 Sales Tax (tax on sales)
 Federal Excise (tax on production)
 Customs (tax on import or exports)
 Forms of Tax Systems

Tax systems fall into three main

categories:

1) Regressive
2) Proportional,
3) Progressive
Forms of Tax Systems

 Regressive taxes have a greater impact on low-

income individuals than they do on high-income
earners.
 Proportional tax, also referred to as a flat tax,
impacts low-, middle-, and high-income earners
relatively equally. They all pay the same tax rate,
regardless of income.
 Progressive tax has more of a financial impact on
higher-income individuals and businesses than on
low-income earners.
 1-22

DEFINITIONS: TAX
 “Tax” means a person who derives any income which
is chargeable/ leviable or payable under any provision
of the Income Tax Ordinance, 2001. therefore:
Tax= Base × Rate
It may be:
1)Income tax
2)Penalty
3)Default surcharge
4)Fee
5)Any other charge that come under the Income Tax
Ordinance.
 Revenue is total tax collected by the government
 Increased by increasing either rate or base

 Competent Jurisdiction:
The tax authority able to charge tax is called the
Competent Jurisdiction.
 Categories of Taxpayers

The person liable to pay tax is called Taxable person. The

ordinance 2001 includes
An individual (salaried and non-salaried)
A Companies (banking companies, small companies and other
companies
An Association of Person (AOP)
Any other body set up to carry out a trade for profit (eg. Bar at
the golf club).
Each of the above referred classes may further classified into
resident and non-resident. A person pays tax in the country
where he or she is resident.
 1-25

TAXABLE INCOME

 The total income of a person for a tax year as reduced

by the total of any deductible allowances.
 The sum of the person’ income under each of the
heads of income for a tax year is called total income.
 Heads of Income:
 Salary
 Income from property
 Income from business
 Capital gains
 Income from other sources
 1-26

DEDUCTIBLE ALLOWANCES

Deductible Allowance means an allowance that is deductible from

total income in order to arrive at the taxable income.
Under Income Tax Ordinance, the following payments made by a
person during the tax year shall be included in “deductible
allowance”
1) An amount of Zakat paid under the Zakat and Ushr
Ordinance, 1980
2) Amount of Workers’ Welfare Fund paid under the
Worker’s Welfare Ordinance, 1971
3) Amount of any Workers’ Participation Fund under the
Companies Profit (Workers’ Participation) Act, 1968.
DEDUCTIBLE ALLOWANCES

4) Deductible allowance for the “profit on debt’ paid

by an individual on loan for the construction of a new
house or acquisition of a house

5) Deductible allowance for the tuition fee paid by an

individual for education of his children
 Example:

Compute the taxable income of a person who has provided the

following incomes (determined as per tax rules) and other
information:
Income:
Salary income Rs. 240,000
Business income 360,000
Income from sales of shares of private company 30,000
Miscellaneous Incomes 10,000
Payments and Contributions:
Zakat paid under Zakat and Ushr Ordinance 15,000
Zakat privately paid to the poor 5,000
Contribution made for the Worker’s Welfare Fund under WWF Ordinance
1971 20,000
 7-29

Imposition of taxes and sources of Income

Tax Law (Jurisdiction)
Article -77 of the constitution of Pakistan empowers the federal
Government to levy tax for the purposes of the federation. The Federal
Government may levy a tax through an Act of the Parliament or an
Ordinance disseminated by the President.
The following are the main sources of Income Tax Law.
 The Legislative Law (Enacted Law) i.e Income Tax Ordinance, 2001
 Sections - 240
 Schedules - 9
 The Procedural Law i.e. Income Tax Rules, 2002
 The federal board of Revenue (FBR) being the regulatory body in
respect of Federal Taxes is empowered to make rules regarding the
procedural matters connected with the implementation of the
concerned laws.
 The board under the authority of section 237 of the income tax
ordinance, 2001 made the Income Tax Rules, 2002. These rules were
published on July 1st , 2002 and it came into force immediately
 7-30

Income Tax Ordinance, 2001

 Schedules:
 1st - Rates of Tax
 2nd - Exemptions and Concessions
 3rd - Depreciation
 4th - Insurance Business
 5th - Petroleum Exploration and Production
 6th - Recognized Provident Fund
 7th - Banking Company
 8th - Capital Gains Listed Companies
 9th - Special Provisions relating to Traders
 10th - Rules for not appearing in Active Taxpayers’ List
 1-31
EXEMPTIONS AND CONCESSIONS
(2nd Schedule): Sections 41 through 55 of the Income Tax Ordinance , 2001 deal with
the exemptions and concessions available to tax payer

 The FG may specify the incomes or classes of incomes, persons or classes of persons
which shall either be exempt from tax or whose tax liability shall be reduced. The
incomes or classes of incomes, persons or classes of persons specified in the Second
Schedule fall under any of the following categories.

 1) Exempt from tax (i.e. the incomes specified in this part shall not be included in the
total income of the persons).[Part-I].

 2) Liable to tax at the rates lower than the rates specified in the First Schedule. [Part-II]

 3) Enjoy reduction in tax liability of a tax payer. [Part III]

 4) Exempt from the operation of any specified provision of the income tax ordinance ,
2001. [Part-IV]
 1-32
EXEMPTIONS AND CONCESSIONS
(2nd Schedule):
 Exempt from Total Income
 Agricultural Income
 Income from Industries in KPK and Baluchistan
 Pension of Pakistani is exempted from Tax
 Income of Mutual Funds (Mutual funds invested in government or municipal bonds are
often referred to as tax-exempt funds because the interest generated by these bonds
is not subject to income tax)
 Subject to Tax at Reduced Rates
 Services rendered outside Pakistan - 50% of normal rates
 Income of Pakistan Cricket Board - 4% of gross receipts
 Import of Hybrid Cars up to 1200 cc - Nil
 Reduction in Tax Liability
 Foreign Film Makers - 50%
 Teachers or Researchers - 25%
 Exemption from the specific provisions
 Provisions of Carry forward of Losses is not applicable for industry undertaking setup in Export
Processing Zones (EPZ)
 Provisions of Donations to Agha Khan Hospital and Medical College
 1-33

TAX FILER

 A taxpayer whose name appears in the Active

Taxpayers List (ATL) issued by the Federal Board of
Revenue (FBR).
 1-34

NORMAL TAX YEAR

 A period of twelve months ending on 30th day of June.

 Tax year is denoted by the calendar year in which the

last day of tax year falls.
 Special Tax Year

It is a period of 12 months which is different from the normal

tax year. A person is allowed to have a special tax year under
the following cases:

1) where a person has an income year under the Income Tax
Ordinance , 1979 different from normal tax year i.e Income Tax
Ordinance 2001.

2) Where the Commissioner Inland Revenue (CIR) has

allowed a person through an application to use a special tax
year
Special Tax Year

Classes of Tax Payers Income year

Starting From Ending On

Insurance Companies 1st Jan 31st Dec

Business in 1st April 31st March

manufacturing and
dealing in “Shawls”
Rice export 1st Jan 31st Dec

Rice husking 1st September 31st August

Sugar Manufacturing 1st October 30th September

Oil Milling 1st September 31st August

 1-37

ASSESSMENT YEAR

 Assessment is the act through which the taxable income

and the tax liability of a taxpayer is determined.

 Assessment year is a period of twelve months.

 Assessment year starts on the 1st day of July after the

close of the income year.
Income year Assessment year
 1st Jul 2019 – 30th Jun 2010
 1st Oct 2019 – 30th Sep 2020
 1st Jan 2019 – 31st Dec 2019
 1st April 2019 – 31st Mar 2020
1st Jul 2020 – 30th Jun 2021
1st Jul 2021 – 30th Jun 2022
1st Jul 2020 – 30th Jun 2021
1st Jul 2020 – 30th Jun 2021
 1-38

RESIDENTIAL STATUS

Resident Individual Resident Company

 He is in Pakistan for a period of  The company is formed under

183 days or more during the tax any law in Pakistan.
year.
 The management and control of
 He is in Pakistan for a period of company’s affairs is situated
120 days or more during the tax wholly in Pakistan at any time in
year and 365 days during four the year.
years preceding tax year.

 He is an employee or official of
federal / provincial government
posted abroad in the tax year.
 1-39

RESIDENTIAL STATUS

Source of Income Resident Non Resident

Pakistan source Chargeable Chargeable

Foreign source Chargeable Not Chargeable

 1-40

NON PROFIT ORGANIZATION

 The organization is established for:

 Religious
 Educational
 Charitable
 Welfare
 Developmental
 A promotion of an amateur sports
 Formed and registered as a non profit organization
 Approved by Commissioner Inland Revenue (CIT) for a
specified period
 Assets and properties cannot be applied for private benefit
 1-41

INCOME TAX AUTHORITIES

 Federal Board of Revenue

 Chief Commissioner Inland Revenue
 Commissioner Inland Revenue
 Commissioner Inland Revenue (Appeals)
 Additional Commissioner Inland Revenue
 Deputy Commissioner Inland Revenue
 Assistant Commissioner Inland Revenue
 District Taxation Officer
 Inland Revenue Officer
 Auditor Inland Revenue
 1-42

FEDERAL LEGISLATIVE LIST

 Taxes on income other than agricultural income.

 Taxes on corporations.
 Taxes on mineral oil, natural gas and minerals for use
in generation of nuclear energy.
 Taxes on the sales and purchases of goods imported,
exported, produced, manufactured or consumed.
 Taxes and duties on the production capacity of any
plant, machinery or, undertaking.
 Taxes on the capital value of the assets, not including
taxes on immovable property.
 1-43

PROVINCIAL LEGISLATIVE LIST

 Sales tax on services

 Taxes on transfer of immoveable property

 Professional tax

 Tax on luxury houses

 Tax on registration of luxury vehicles

 Property tax
 1-44

DISRIBUTION OF REVENUE

 Within six months of the beginning day and thereafter at

intervals not exceeding five years, the President shall
constitute a National Finance Commission (NFC).
 NFC consists of:
 Minister of Finance of the Federal Government
 Ministers of Finance of the Provincial Governments
 Other persons as may be appointed by the President
 NFC makes the following recommendations to President:
 Distribution of net proceeds of taxes between the
Federation and the Provinces
 Exercise by the Federal and Provincial Governments of
the borrowing powers conferred by the Constitution.
 1-45

OBJECTIVES OF TAXATION

 To collect revenue to run and administer the Government.

 To use as a tool for implementation of its policies.
 To carry out the national objective of social and economic
development.
 To protect local industries against foreign competition by
increasing import duties.
 To strengthen anaemic enterprises by granting them tax
exemptions or incentives for growth.
 To reduce inequalities in the distribution of wealth.
 1-46

TAXES AS MEANS OF DEVELOPMENT

 Government can declare some areas as free zone, industrial

zone or economic zone by providing tax incentives.
 Taxing the rich at higher rates to reduce inequalities in the
distribution of wealth.
 Imposition of high custom duties on items which are also
manufactured in Pakistan to promote local industry.
 Tax credits on charity/donations to promote welfare activities.

 Tax incentives for agro based projects to promote agriculture.

1-47