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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 beanswered

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 examinationhall

The Association of Chartered Certified Accountants

Pape

r 2.3

(PK

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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 taxUp to Rs. 80,000 0%Rs. 180,001 – Rs. 150,000 7·5% of the amount exceeding Rs. 80,000Rs. 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 incomeIncome slab Reduction in tax liabilityUp to Rs. 60,000 10%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 15%

C. Tax rates for companies Tax Year Banking Public company other Private company other

company than a banking company than a banking company2003 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 companiesReceived by a public company or an insurance company 5% of the gross dividendIn any other case 10% of the gross dividend

E. Tax rates on certain payments to non-residentsFees for technical services (FTS) 15% of the gross amountOther than for royalty or FTS 30% of the gross amount

F. Rates of advance collection or deduction of tax at sourceProfit on bank deposits 10% of the profit paidYield on certificates under the National Savings Scheme or Post Office Saving Account 10% of the yield paidSale of goods 3·5% of the gross amount payable Prizes and winnings 10% of the gross amount paid Contracts up to the value of Rs.30 million 5% of the amount of the payment

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G. Capital allowances DepreciationFactory buildings 10%Residential quarters for labour 10%Other buildings 5% of the tax written down valuePlant and machinery (not otherwise specified) 10%Motor vehicles (all types) 20%

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 limitsUp to 250 sq. yards Rs. 40,000251 to 500 sq. yards Rs. 106,000501 to 1000 sq. yards Rs. 199,0001001 to 2000 sq. yards Rs. 370,0002001 sq. yards and over Rs. 462,000

3 [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 onthe Karachi stock exchange from 1 July 2002 until 29 June 2003 on which date the company was delisted on theexchange. The control and management of the affairs of the company was situated partly outside Pakistan during theyear ended 30 June 2003.

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

Note Rupees in thousands Sales 718,000Cost of sales (2) 575,000

––––––––Gross profit 143,000Administration expenses (3) 48,500Selling and distribution expenses (4) 29,200

––––––– 77,700––––––––

65,300Financial charges (5) 35,000Provision for bad debts (7) 850

––––––– 35,850––––––––

29,450Other income (6) 4,200

––––––––33,650

Provision for taxation 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. 20,500Contributions 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. 3,900Payment 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. 6,300Donations to the Board of Education (Federal Government) paid by a crossed bank cheque. 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. 5,600Salary to a part time sales representative paid in cash. 800

(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

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(6) Other income includes: Accounting profit on the sale of a car. 600Dividend from a public company as defined for tax purposes (gross amount of dividend). 200Recoveries against bad debts written off but not allowed as a deduction in prior years. 300

(7) The provision for bad debts comprises: Balance on 1 July 2002 1,750Provision made during the year (5% of debtors) 850

––––––2,600

Trading debts written off (1,200)Loan to employee written off (100)

––––––1,300

––––––

(8) Creditors include rent payable which was allowed as a deduction against the income for the year ended 30 June 2002. 500

(9) The tax written down values on 1 July 2002 were: Factory buildings 25,000Office buildings 30,000Plant and machinery 225,000Motor vehicles 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: 30,000This business loss was determined in the assessment year 2002–2003 (income year ended on 30 June 2002).

(11)Tax deducted at source: 20,000The 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)

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

(d) Calculate the tax liability of ABC Limited for the relevant tax year. (3 marks)

(30 marks)

5 [P.T.O.



2 The following information has been made available to you by Mr Irfan Zaidi, for his accounting year ended 30 June2003.

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

(2) In January 2003, Irfan as a self-employed individual entered into a one time contract with Builders Ltd to providetemporary workers during the month of January. Irfan received Rs.475,000 (after deduction of tax at theapplicable 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 termsof 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 utilitiesand entertainment respectively.

Medical allowance of Rs.15,000 per month. The terms of employment do not provide for free medical treatmentor 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 monthto the Karachi Grammar School.

Rent free accommodation in the company’s fully furnished house on a land area of 1000 square yards. Thehouse 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 leasingcompany for Irfan’s private and business use and another car was purchased by the company for Rs.1,300,000which was exclusively for his business use. The fair market value of the leased vehicle at the commencement ofthe 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 Arabiaas consideration for his agreement to enter into an employment contract with the company. XYZ Limited atthe same time paid Rs.200,000 to PQR Bank in Saudi Arabia in discharge of a loan taken out by Irfan fromthe bank.

(iii) On a business trip to the USA in March 2003 Irfan incurred expenses of Rs.350,000 which werereimbursed 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 firstday of the following month.

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

RupeesRepairs 70,000Property tax paid to Karachi Municipal Corporation 25,000Ground rent 2,000Legal expenses for defending the title to the house 20,000Profit paid to a bank on money borrowed to acquire the property 10,000

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

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(vi) The following amounts were also received by Irfan in the year ended 30 June 2003 after deduction of taxat 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 yearended 30 June 2003. (2 marks)

(b) Compute Irfan’s taxable income for the tax year relevant to the income year ended 30 June 2003 givingexplanations 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)

7 [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 followingtransactions took place in the month of May 2004:

– Purchased raw materials aggregating to Rs.1,150,000 inclusive of sales tax of Rs.150,000, to be used formaking 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 thesales 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 hasbeen self-employed as a management consultant. His income from self-employment adjusted for tax purposesfor 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 plc(an associated company), the details of which are as follows:

– He was granted the right to purchase 500 shares of Prime Foods plc 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 theright 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 heexercised the right to acquire the balance of 300 shares and made a payment of £9 per share having alreadypaid £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 plc 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 forRs.9,000,000. The jewellery was held for the personal use of his wife. Out of the sale proceeds, he purchaseda rare manuscript for Rs.10,000,000 and old coins for Rs.2,000,000. On 30 June 2003, he disposed of themanuscript for Rs.15,000,000 and of the coins for Rs.1,000,000.

(4) He sold a residential house for Rs.7,000,000. The house had been inherited from his father in 1930 when themarket value of the house was Rs.1,000,000.

(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 yearsafter 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 bythe Federal Government. The sale was within one year of the acquisition of the shares.

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

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(7) Unadjusted losses brought forward:

– Business loss of Rs.1,000,000 sustained in the immediate preceding year which includes a loss ofRs.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 June1997.

(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 orexclusion 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 notconsidered 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. (2 marks)

(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)

(c) Under s.34, in the tax year 2003, a person accounting for income chargeable to tax under the head ‘Incomefrom 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 manufactureof circuit breakers.

– PEPL closes its accounts on 30 June of each year.

– PEPL’s 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 asfollows:

11 Tax year Turnover Taxable income Rs. Rs.

2004 10,000,000 1,500,0002005 12,000,000 1,920,0002006 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 andmachinery. The cost of the new plant is estimated to be Rs.10 million. The plant is expected to be commissionedfor 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 theturnover. The estimated profit has been adjusted for tax purposes except that no adjustments have been madefor 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 thefinal 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 saleof circuit breakers, and if so the steps to be taken by PEPL to ensure that the assessment for the tax year 2004is 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 forPEPL 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 statedabove. 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)

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

Usman Pakistan Limited (UPL) a company incorporated in Pakistan is engaged in the business of manufactureand marketing of fertilizers. Under an agreement, Urea Ltd, a company incorporated in Australia regularly sendsUPL reports on the latest technical developments in the field of manufacture of fertilizers. This information istransmitted by Urea Ltd to UPL by electronic mail and is utilised by UPL for its business in Pakistan. Theconsideration under the agreement is received by Urea Ltd in Australia. Urea Ltd neither has any presence inPakistan, 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 fromUrea Ltd were used by UPL for its business outside Pakistan. Your answer should include a brief outlineof 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 carry on business asmanagement consultants under the name of Tausif Associates. The profit of Tausif Associates for the year ended30 June 2003 as adjusted for tax purposes is Rs.500,000. Each partner is entitled to one-half of the profit ofthe 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 allowedto him as a deduction against his income. On 30 June 2003, he received Rs.9,000 as profit on debt on DefenceSaving Certificates (National Savings Scheme) on which tax had been deducted at source. Mr Tausif paidRs.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 enterinto 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 givento 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 toeach of the amounts received, and calculate the tax payable by Nadir. (3 marks)

(15 marks)

End of Question Paper

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Answers



Part 2 Examination – Paper 2.3 (PKN) December 2004 AnswersBusiness Taxation (Pakistan) and Marking Scheme

Marks1 (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 2003Tax year 2003

Computation of taxable income Rs. in thousands

Accounting profit before taxation 33,650Add: Accounting depreciation 20,500 0·5Add: Accounting software (Note 1) 6,300 1Add: Donation to an approved institution (Note 2) 700 1Add: Excess cost of perquisites (Note 3) 5,600 0·5 Add: Salary to part time sales representative (Note 4) 800 1Add: Profit on debt on foreign currency loan (Note 5) 750 1Add: Tax gain on sale of motor car (Note 6) 650 0·5Add: Provision for bad debts (Note 8) 850 0·5Add: Installation cost of plant (Note 10) 5,000 1

––––––– 41,150–––––––74,800

Less: Recoveries against bad debts (Note 7) 300 1Less: Bad debts written off (Note 9) 1,200 1Less: Amortisation of accounting software (Note 1) 211 2Less: Accounting profit on sale of car (Note 6) 600 0·5Less: Initial allowance (Note 11) 6,000 1Less: Tax depreciation (Note 12) 28,920 4

––––––– 37,231––––––––

37,569Less: Dividend income for separate consideration 200 1

––––––––37,369

Less: Unadjusted business loss brought forward from Less: assessment year 2002–2003 (income year endedLess: 30 June 2002) 30,000 0·5

––––––––Less: 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 liability On taxable income of Rs.7,369 at 43% 3,169 0·5Tax credit on donation of Rs.700 (Note 13) (301) 1

––––––––2,868

Tax deducted at source (Note 14) (20,000) 1––––––––

Balance tax refundable 17,132––––––––

Dividend income – Rs.200Tax deducted at source is the final tax 20 0·5

–––––––– –––3

–––30–––

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MarksNote (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.211).

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 allowanceRs.

Residential quarters for factory workers 12,000–––––––

Initial allowance at 50% 16,000–––––––

Note (12) Depreciation Plant and Residential Factory Other Motor Totalmachinery labour building building vehicle depreciation

quartersRates of depreciation 10% 10% 10% 5% 20%

Rs. Rs. Rs. Rs. Rs. Rs.Written down value 225,000 25,000 30,000 10,000Less: Disposal 11(150)

––––––– ––––––– ––––––– ––––––225,000 25,000 30,000 19,850––––––– ––––––– ––––––– ––––––

Depreciation 122,500 12,500 11,500 11,970 28,470–––––––– ––––––– ––––––– ––––––

Additions 12,000 – 11,000 –Initial allowance 1(6,000) – – –

––––––– ––––––Written down value 16,000 – 11,000 –

––––––– ––––––Depreciation for six months 11,300 – 11,300Depreciation for nine months – – 11,150 11,150

–––––––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 incomewhichever is lower; Rs.700 paid as donation is lower than 15% of taxable income. Tax credit allowable is 3169/7369x 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 betaxed on the final tax basis.

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MarksItems not included in the computation of income:

(1) Cost of salesFreight 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) Administration expensesContribution 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 debtsLoan 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 taxyear 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 ZaidiIncome year ended 30 June 2003Tax year 2003Computation of taxable income

RupeesSALARY INCOME– From the Federal Government

Service in Saudi Arabia (Rs.300,000 x 6) 1,800,000 0·5– From XYZ Ltd

Consideration received for agreeing to enter into the contract for employment (Note 1) 1,000,000 1Payment to PQR Bank by XYZ Ltd against loan takenby Irfan (Note 2) 200,000 1Basic salary for four months (Note 3) 2,000,000 0·5Utility allowance for four months (Rs.240,000 less

10% of basic salary exempt) 40,000 0.5Medical allowance – exempt (Note 4) – 0.5Entertainment allowance for four months 40,000 0·5School fees for five months (Note 5) 75,000 0.5Rent free furnished accommodation (Note 6) 95,354 1Benefit of company maintained car (Note 7) 62,500 1

––––––––– 5,312,854

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MarksRupees

INCOME FROM PROPERTYRent chargeable to taxRent for 12 months (Rs.150,000 x 12) 1,800,000 0·5Non-adjustable deposit (Note 8) 30,000 1‚5

––––––––– 1,830,000DeductionsRepairs (Note 9) 366,000 1Property tax 25,000 0·5Ground rent 2,000 0·5Legal expenses 20,000 0·5Profit on debt 10,000 0·5

––––––––– 423,000 1,407,000––––––––

INCOME FROM OTHER SOURCESProfit on debt (tax deducted at source Rs.20,000) 200,000 0·5

––––––––––Total income 6,919,854Zakat paid 250,000 0·5

––––––––––Taxable income 6,669,854

––––––––––The notes should be considered in allocating the marks against each itemSpecific 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–––

(c) COMPUTATION OF TAX LIABILITYTax on Rs.700,000 119,000Tax on balance Rs.5,969,854 at 35% 2,089,449

––––––––––2,208,449 0·5

Reduction in tax liability on Rs.2,208,449 at 5% (110,422) 0·5––––––––––2,098,027

Deducted at sourceOn salary income by XYZ Ltd 750,000On profit on debt 20,000

–––––––– (770,000) 1––––––––––

Balance tax payable 1,328,027––––––––––

TAX DEDUCTED AT SOURCE CONSIDERED AS FINAL TAXGross Tax deducted

receipts is the final taxLabour contract 500,000 25,000 1Dividends 150,000 15,000 0·5Prize on prize bonds 100,000 10,000 0·5

–––4

–––25–––

18



MarksNote (1) Rs.1,000,000 received as consideration for Irfan’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 (1/5 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



Marks3 (a) (i) The input tax claim is to be calculated according to the formula given below by the Apportionment of

Input Tax Rules, 1996 as follows:

Taxable supplies/(Taxable supplies + Exempt supplies) x Input tax700,000/(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. 4

(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. 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

HotelsMarriage halls and lawnsClubsCaterersLaundriesDry cleaners

(2) Services provided or rendered by persons authorised to transact business on behalf of othersCustom agentsShip chandlersStevedores

(3) Courier services

(4) Services provided or rendered for personal care byBeauty parloursBeauty clinicsSlimming clinics

(5) Advertisement on T.V. and RadioAny 8 items at a 1/2 mark each 4

(c) Under the provisions of s.23 of the Sales Tax Act, 1990 the following are the particulars to be included on asales 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 tax1/2 mark per item 4

–––15–––

20



Marks4 Mr Idrees

Income year ended 30 June 2003Tax year 2003Computation of taxable income RupeesIncome from business Consulting income 850,000 0·5Set off of brought forward loss (Note 1) (850,000) – 2

–––––––––SalaryEmployee share scheme – sale of rights (Note 2(i)) 20,000 1– benefit on acquisition of shares (Note 2(ii)) 150,000 1

––––––––– 170,000Capital gainsGain on sale of shares acquired under employee share scheme (Note 3) 150,000 3Gain on sale of jewellery (Note 4) 2,250,000 1Gain on sale of manuscript (Note 5) 5,000,000 1Gain on sale of shares (Note 6) 56,250 1

––––––––––7,456,250

Set off of brought forward capital loss (Note 7) (50,000) 1–––––––––– 7,406,250

––––––––––Total income 7,576,250Zakat paid (6,000) 0·5

–––––––––Taxable income 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) 3

–––15–––

Note (1) Losses brought forwardRs.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 SpeculationTotal Loss Loss Depreciation Loss

Rs. Rs. Rs. Rs.1,000,000 300,000 600,000 100,000

Loss set-off 1,850,000 300,000 550,000 ––––––––––– –––––––– –––––––– ––––––––

Loss carried forward 1,150,000 – 150,000 100,000–––––––––– –––––––– –––––––– ––––––––

Note (2) Employee share scheme(i) Idrees agreed to accept the offer of the right to purchase 500 shares in Prime Foods plc 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)]. This gain is not taxable as capital gains but as salary income.

(ii) 300 shares of Prime Foods plc 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



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

RupeesConsideration on disposal of 300 shares 600,000Cost of 300 shares£10 per share paid on acquisition including £1 paid for the right – £10 x 300 = £3,000 300,000Amount chargeable to tax as salary income on acquisition of shares (Note 2) 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.1,000,000 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. 2

(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 which would have been earned by the persons in an arm’s length transaction. 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 0·5– the Commissioner of Income Tax 0·5

CBR circulars are not binding on – the Commissioner of Income Tax (Appeals) 0·5 – taxpayers. 0·5

22



Marks(c) (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 required 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 Tax liabilitydeducted income

Rs. Rs. Rs. Rs.2004 10,000,000 1,350,000 1,500,000 41% 615,000 0·52005 12,000,000 1,420,000 1,920,000 39% 748,800 0·52006 14,000,000 1,490,000 2,380,000 37% 880,600 0·5

–––––––––– ––––––––––1,260,000 2,244,400–––––––––– ––––––––––

Rs.Tax liability on basis of taxable income 2,244,400Tax liability if the tax deducted is the final tax 1,260,000

––––––––––1,984,400 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.

RupeesCost of new plant 10,000,000Initial allowance at 50% 15,000,000 0·5Depreciation at 10% on written down value of Rs.5,000,000 (Rs.10,000,000 less Rs.5,000,000) 1,,500,000 0·5Tax deducted at source at 3·5% on turnover of Rs.16,000,000 1,,560,000 0·5

Computation of taxable income Taxable profit prior to initial allowance and depreciation (18% of Rs.16,000,000) ,2,880,000Initial allowance and depreciation (5,000,000 + 500,000) ,(5,500,000)

––––––––––Loss to be carried forward ,2,620,000 0·5

––––––––––

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



Marks7 (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 UPL. 1

However, UPL, before making payment to Urea Ltd has to furnish 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

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

Tausif AssociatesIncome year ended 30 June 2003 Tax year 2003Computation of taxable income Income from business 500,000

––––––––Taxable income 500,000 0·5

––––––––Tax payableOn Rs.400,000 44,000On balance of Rs.100,000 at 25% 25,000

––––––– 69,000 0·5––––––––

(ii) Mr Tausif Income year ended 30 June 2003 Tax year 2003 Computation of taxable income

RupeesIncome from business Share of income from Tausif Associates Rs.250,000 – exempt from tax – Note 1 – 0·5Income from other sources Consideration for vacating possession of the flat (Note 2) 120,000 1·5Profit on debt (tax deducted at source Rs,1,000) 10,000 0·5

––––––––Total income 130,000Zakat paid (1,000) 0·5

––––––––Taxable income 129,000

––––––––Tax liability (Note 3(i)) 13,547 1·5Tax deducted at source 1,000 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 1,000,000 1Income from business Share of income from Tausif Associates Rs.250,000 – exempt from tax (Note 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.

RupeesNote (2) Consideration received for vacating his flat 1,800,000

Amount paid to acquire possession of the flat (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 RupeesTaxable income (C) 129,000

––––––––Income if share of profit from AOP was not exempt from tax (129,000 + 250,000) (B) 379,000

––––––––Tax on Rs.379,000On Rs.300,000 24,000On Rs.79,000 at 20% 15,800

––––––––(A) 39,800

––––––––Tax liability (A/B) x C39,800/379,000 x 129,000 = 13,547

––––––––

(ii) Nadir Taxable income (C) 1,000,000

–––––––––Income if share of profit from AOP was not exempt from tax (1,000,000 + 250,000) (B) 1,250,000

–––––––––Tax on Rs.1,250,000On Rs.700,000 119,000On Rs.550,000 at 35 % 192,500

–––––––––(A) 311,500

–––––––––Tax payable (A/B) x C 311,500/1,250,000 x 1,000,000 = 249,200

–––––––––

26




PART 2

WEDNESDAY 8 JUNE 2005

QUESTION PAPER









Pape

r 2.3

(PK

N)




A. Tax rates for individuals and associations of persons for the tax year 2004Taxable income Rate of taxUp to Rs. 80,000 0%Rs. 180,001 – Rs. 150,000 7·5% of the amount exceeding Rs. 80,000Rs. 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 taxUp to Rs. 100,000 0%Rs. 100,001 – Rs. 150,000 7·5% of the amount exceeding Rs. 100,000Rs. 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 incomeIncome slab Reduction in tax liabilityUp to Rs. 60,000 10%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 15%

D. Tax rates for companies Tax Year Banking Public company other Private company other

company than a banking company than a banking company2004 44% 35% 41%

E. Tax rates on dividends received from companiesReceived by a public company or an insurance company 5% of the gross dividendIn any other case 10% of the gross dividend

F. Rates of advance collection or deduction of tax at sourceImport of goods 6% of the value of the goods determined for

custom purposesYield on certificates under the National Savings Scheme or Post Office Savings Account 10% of the yield paid

G. Capital allowances DepreciationFactory buildings 10%Other buildings 5% Furniture and fittings 10% of the tax written down valuePlant and machinery (not otherwise specified) 10%Motor vehicles (all types) 20%


2



H. Value of free unfurnished accommodation where salary is Rs. 600,000 or more Land area Value for areas outside municipal limitsUp to 250 sq. yards Rs. 27,000251 to 500 sq. yards Rs. 66,000501 to 1000 sq. yards Rs. 106,0001001 to 2000 sq. yards Rs. 198,0002001 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 rateif any which the Federal Gevernment may specify for any tax year.

3 [P.T.O.




1 PQR Ltd, an industrial undertaking engaged in the manufacturing of pesticides, requires you to prepare its income taxreturn 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 theKarachi stock exchange on 1 December 2003 and the shares of the company commenced trading on thatexchange on 1 June 2004. The company remained listed on that exchange until 31 December 2004 on whichdate 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.10,500

(4) Cost of sales include:Excise duty paid in cash 700Demurrage paid to the Karachi Port Trust for the late lifting of imported raw materials 300Tax collected by the Collector of Customs on the value of raw materials imported by the company for its own use 8,000Amount paid to the Collector of Customs for an erroneous declaration in a bill of entry 90Expenditure 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 (1/3 of Rs.9,600) 3,200Depreciation charged in the accounts 1,125

(5) Administration expenses include:Legal expenses incurred in defending the title to the company’s building 165Legal costs incurred in defending a director of the company for a traffic accident 60Purchases 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 750Amortisation of preliminary expenses incurred on incorporation of the company in 1996. 10% of the expenditure is being written off each year 650

(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 1,600

(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 nopermanent establishment in Pakistan and the profit on the debt has been received by Rich Bank in the Bahamas where no income tax is payable 9,800

(8) Other income includes:Recoveries against bad debts written off in prior years which were allowed as a deduction 250Dividend received (gross amount) from PQR’s wholly owned subsidiary company, which is a private company 200Dividend received (gross amount) from a public company 100

(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 2,500Office buildings 8,200Plant and machinery 9,500Motor vehicles 400Furniture 250

(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: 2,750This 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 sourceTax of Rs.465 was deducted by the customers from payments made to PQR Ltd for the sale of its ownmanufactured goods. PQR Ltd has furnished a declaration to be assessed on a final tax basis to the Commissionerof Income Tax on 30 October 2003.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 inclusionor 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. (3 marks)

(30 marks)

5 [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 employedby Chemicals plc (CPLC). He retired from CPLC on 1 October 2003 having accepted CPLC’s offer to work as the chiefchemist of Pakistan Chemical Ltd (PKC), an associate company of CPLC from 1 January 2004. The directors of CPLCin appreciation of Iqbal’s agreement to serve PKC, voluntarily informed him that PKC would pay him Rs.500,000 onhis joining the Pakistan company.

Iqbal has approached you to prepare his return of income for the tax year 2004. The following information has beenmade 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 formfrom the United Kingdom. The value of the imported goods as determined for custom purposes wasRs.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 wereincurred 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 taxof £ 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 thecompany on 1 January 2004. As the payment was dependent upon the goodwill of CPLC, neither theemployment 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 receivedby 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 Rs.4,750,000. 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 ofunits 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 profitwas 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 rightto purchase 1,000 shares of CPLC at the exercise price £15 for one share. On 1 February 2004, he exercisedhis right to purchase 500 shares and remitted £7,500 to the custodian of the Scheme. The rights for theremaining 500 shares were disposed of for Rs.50,000. The market price of one share of CPLC on the date ofissue 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.100,000.On 1 July 2003 he collected two years rent in advance and a refundable deposit of Rs.100,000 which is notadjustable against the rent payable. Iqbal is of the view that the deposit of Rs.100,000 is taxable over a periodof 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.1,467,800

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

6



Required:

(a) Compute the total income and taxable income of Iqbal for the tax year relevant to his accounting year ended30 June 2004 giving reasons/explanations for the inclusion or exclusion in the computation of income foreach 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.




3 (a) Certain persons engaged in making taxable supplies in Pakistan are required to be registered under the Sales TaxAct 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 SalesTax 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, hasspecified 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 taxshall not be claimed. (4 marks)

(d) State the basis for calculating the compensation payable to a claimant on a refund of sales tax, when therefund 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 thepayment 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 thefollowing 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 personalbank account of the buyer.

(iv) Payment of Rs.150,000 made, for new materials purchased on credit, after one hundred and eightydays of the issuance of the tax invoice through a crossed bank draft drawn on the business bank accountof 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 hisaccounting 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 Ordinance1984. ABC Ltd is not listed on any stock exchange in Pakistan. The sale was within one year of theacquisition of the shares.

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

– 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 Government of Sindh. The sale was made more than one year after the acquisition of theshares.

(2) Prior to his self-employment as a broker, Saleem, as the investment manager of Securities Pakistan Limited, asubsidiary of Securities plc, had participated in an employee share scheme of Securities plc. The details of thetransactions 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

plc 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 plc 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.10 for each share.

(4) On 1 September 2003 Saleem transferred the 50,000 shares in Bingo (Private) Ltd to his wife under anagreement to live 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.1,000,000, the Indian postage stamp for Rs.45,000and the Chinese stamp for Rs.20,000.

(6) In July 2003 Saleem had purchased a motor car for Rs.1,300,000 for the personal use of his wife, He sold thecar in August 2003 for Rs.1,400,000.

(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 ofRs.50,000 suffered in the money market on forward contracts for the purchase and sale of US Dollars. All thecontracts were settled by Saleem Sons other than by actual delivery or transfer of US Dollars.

A loss of Rs.1,039,725 sustained under the income head ‘Capital gains’ which is made up as follows:Accounting year ended Rupees

30 June 2003 1,147,50030 June 1998 1,637,22530 June 1997 1,355,000

–––––––––1,039,725–––––––––

(8) Zakat paid was Rs.10,000.

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

1,1,Required:

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

(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.113A has been inserted in the Income TaxOrdinance 2001 whereby a retailer has the option to pay income tax at the rate of 0·75% of the total turnoverfor a tax year, which payment is treated as the final tax on the income arising from the said turnover. He wantsyou 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 turnoverwhich 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, hepurchased a house in Clifton for Rs.3,000,000 out of his earnings as a part-time property broker which earningshad 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 ofincome and the statement of assets and liabilities (wealth statement) as at 30 June 2004. The return and thewealth statement furnished were on the prescribed form and complete in all respects. No amended assessmentorder 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 propertybelonging to Mr X had been impounded by the Property Tax Department of the Government of Sindh for non-payment 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 theinterest 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 commenceemployment on 1 July 2004.

ABC LimitedUnder the offer of employment from ABC Ltd, Aban would receive an annual salary of Rs.1,000,000 which wouldbe structured as under:

RupeesBasic salary 1,600,000House rent allowance 1,200,000Cost of living allowance 1,175,000Conveyance allowance 1,175,000Entertainment allowance 1,150,000

––––––––––1,000,000––––––––––

Aban requested permission from ABC Limited to restructure the salary to make it more tax efficient. Her request is notacceded to for the reason that the company has a uniform policy for the salary structure of its employees.

PQR LimitedUnder the offer of employment from PQR Ltd, Aban will receive a gross annual salary of Rs.1,000,000. Aban’srequest to restructuring her salary to make it more tax efficient has been accepted by the company. She is howeverinformed that the company does not provide for free medical treatment or hospitalisation or for the reimbursement ofsuch charges.

Required

(a) Calculate Aban’s salary income after deduction of tax for the year ended 30 June 2005 if she accepts theoffer of ABC Limited. (5 marks)

(b) Advise Aban as to how she can structure the offer of Rs.1,000,000 from PQR Limited so as to give her themaximum 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 theoffer 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 ofoperating ships which are owned by it. CCC’s operations in Pakistan are limited to the carriage of goods fromPakistan to destinations outside Pakistan and the carriage of goods imported into Pakistan embarked outsidePakistan.

You are informed by CCC’s local shipping agent that CCC is of the view that the company’s income from itsPakistan 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 Pakistanon 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 computingthe 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 usedfor 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 allowedto leave a Pakistan port.

(iv) The procedure for obtaining a port clearance certificate allowing a ship to depart from a Pakistan port, whenthe 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 recordsof any proceedings in which an order has been passed by certain taxation officers. After making such inquiriesas 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)


12



Answers



15

Part 2 Examination – Paper 2.3(PKN) June 2005 Answers Business Taxation (Pakistan) and Marking scheme

Marks1 (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 public 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 LtdAccounting year ended 30 June 2004

Tax year 2004Computation of taxable income Rs. in thousandsAccounting profit 10,500Add: Provision for taxation (Note 1) 3,500 0·5Tax collected by the Collector of Customs (Note 2) 8,000 1Penalty paid to the Collector of Customs (Note 3) 90 1Amortisation of the cost of new process (Note 4) 3,200 0·5Accounting depreciation 1,125 0·5Legal costs (Note 5) 60 1Purchase of furniture (Note 6) 750 0·5Amortisation of preliminary expenses (Note 7) 650 0·5Prize for sales promotion (Note 8) 1,600 1·5Profit on debt (Note 9) 9,800 1·5Unpaid excise duty (Note 10) 900 1·5Tax profit on sale of building (Note 11) 1,800 1·5Renovation cost of mixing machine (Note 12) 576 0·5

–––––– 32,051–––––––42,551

Less: Accounting profit on sale of a building (Note 11) 745 0·5Amortisation of intangible (Note 4) 533 1·5Initial allowance (Note 13) 1,538 1Depreciation (Note 14) 1,984 4

–––––– 4,800–––––––37,751

Less: Dividend income for separate consideration 300 1–––––––37,451

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



16

MarksItems 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

(c) Tax liabilityRs. in

thousandsOn business income of Rs.35,951 at 35% 12,583 0·5Taxes paid, deducted at source or collected (Note 17) (16,465) 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 theprofits 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 taxcollected at the customs stage on the import of raw materials for PQR’S own use is not the final tax on the incomearising 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 natureof 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 ofthe new process is three years, the expenditure for tax purposes is to be amortised over three years proportionateto the number of days the intangible is used in the tax year for the purposes of business. As the intangible hasbeen 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 businessand is therefore not deductible.

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



17

Note (7) Preliminary expenditure is capital in nature and amortisation of this expenditure is not a deductible charge. (Itdoes 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 onthe fair market value of the prize. Rs.1,600 is not deductible since tax was not collected by PQR Ltd fromMr Baig.

Note (9) The profit on the debt received by Rich Bank is chargeable to tax in Pakistan. It is a Pakistan-source income ofRich Bank since the amount has been paid by a resident (PQR Ltd) and the debt has not been used for anybusiness carried out by PQR Ltd outside Pakistan. The profit on the debt paid by PQR Ltd is not deductible sincetax 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 thededuction was allowed (30 June 2001, 2002, 2003) the amount is chargeable to tax in the tax year 2004 (thefirst 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 thecost 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.6,000is 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.1,800 (actual cost Rs.5,000 less written down valueRs.3,200).Tax profit on disposal of building Rs.Sale consideration 6,000Less: Tax written down valueDeemed cost 6,000Depreciation allowed (1,800) 4,200

––––––– –––––Tax profit on sale of building 1,800

––––––

Note (12) Expenditure on renovations necessary at the time of purchase of an asset to render the asset capable of beingused in the business is capital in nature and adds to the cost of the asset. Rs.576 is not deductible and has tobe added to the cost of the machine.

Note (13) Initial allowanceRs.

Cost of mixing machine 2,500Add: Cost of renovation (Note 12) 576

––––––3,076

––––––Initial allowance at 50% 1,538

––––––(Note 14) Depreciation

Plant and Factory Office Motor Furniture Totalmachinery building building vehicle depreciation

Rate of depreciation 10% 10% 5% 20% 10%Rs. Rs. Rs. Rs. Rs. Rs.

Written down value 9,500 2,500 8,200 400 250Disposal – – (3,200) – –

–––––– –––––– ––––––– –––––– –––––9,500 2,500 5,000 400 250

–––––– –––––– ––––––– –––––– –––––Depreciation 950 250 250 80 25 1,555

–––––– –––––– ––––––– –––––– –––––Additions 3,076 – – 1,000 750Initial allowance (1,538) – – – –

–––––– –––––– ––––––– –––––– –––––Written down value 1,538 – – 1,000 750

–––––– –––––– ––––––– –––––– –––––Depreciation for 12 months 154 – – 200 75 429

––––––1,984

––––––

The cost of the new car (Rs.1,500) has been restricted to Rs.1,000 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. Thetax so deducted is the final tax on such dividend income.



Note (16) The unadjusted business loss of Rs.2,750 determined in the accounting year ended 30 June 1997 is made upas under: Rs.Business loss (excluding unabsorbed depreciation) 1,250Unabsorbed 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 forwardthe loss had lapsed on 30 June 2003. A business loss cannot be carried forward for more than six yearsimmediately succeeding the tax year in which it was determined. Unabsorbed depreciation can be carried forwarduntil 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 collectedRs.

Advance tax paid 8,000Tax deducted at source on sale of manufactured goods (Note 17A) 465Tax collected at import stage by the Collector of Customs 8,000

–––––––16,465–––––––

Note (17A) PQR Ltd as a manufacturer has the option to be taxed on a final tax basis on the income from its ownmanufactured goods. To avail the option PQR Ltd was required to furnish a declaration in writing to theCommissioner 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 wassubmitted after 30 September 2003. Therefore the tax deducted has been allowed as a tax credit.

2 (a) Mr IqbalAccounting year ended 30 June 2004

Tax year 2004Computation of income RupeesSALARY INCOME– From Chemicals plc – £12,000 exempt from tax (Note 1) 0 1·5– From Chemicals Pakistan LtdVoluntary / non-contractual payment (Note 2) 500,000 1Basic salary – six months 1,800,000 0·5Cost of living allowance (Note 3) 180,000 0·5Entertainment allowance (Note 3) 180,000 0·5Relocation allowance (Note 3) 308,000 0·5Air fare for wife (Note 4) 375,000 1Benefit of company maintained car (Note 5) 100,750 1Rent free accommodation (Note 6) 53,000 0·5Value of electricity (Note 7) 30,000 1·5Gardener’s salary (Note 8) 48,000 0·5Benefit of concessional loan (Note 9) 9,000 1·5Reimbursement of medical and hospital charges exempt from

tax (Note 10) 0 1Waiver of loan (Note 11) 150,000 1Employee share scheme– Sale of rights [Note 12 (i)] 50,000 1– Benefit of acquisition of shares [Note 12(ii)] 400,000 1·5

––––––––– 4,183,750

INCOME FROM PROPERTYConsideration for the use of land (Note 13) 100,000 1

INCOME FROM OTHER SOURCESProfit on debt (tax deducted at source Rs.30,000) 300,000 0·5


––––––––––Taxable income 4,508,750

––––––––––

18



MarksThe 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.100,000 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 RupeesTax on Rs.700,000 119,000Tax on balance of Rs.3,808,750 at 35% 1,333,063

––––––––––1,452,063 0·5

Reduction in tax liability on Rs.1,452,063 at 5% (Note 14) 72,603 1––––––––––1,379,460

Tax deducted at sourceOn salary income by PKC 1,467,800On profit on debt 30,000

––––––––– (1,497,800) 1–––––––––––

Balance tax refundable 118,340–––––––––––

TAX DEDUCTED / COLLECTED AS FINAL TAX Final taxImport of pharmaceuticals (Note 15) 329,310 2Dividends – gross receipts Rs.8,333 833 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 waspresent in Pakistan in the tax year. £12,000 is foreign-source salary income of Iqbal because the employmentwas not exercised in Pakistan. Such income of a resident individual is exempt from Pakistan tax, if foreign incometax has been paid on the income or if tax has been withheld by the foreign employer and paid to the revenueauthorities of the foreign country. The above conditions having been fulfilled, £12,000 is exempt from Pakistantax.

Note (2) The payment of Rs.500,000 is chargeable to tax as it is a profit of employment. All voluntary payments eventhose depending upon the goodwill of a past, future or present employer for services rendered or to be renderedare 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 cashallowances (except house rent allowance up to 45% of basic salary subject to a maximum of Rs.270,000) arechargeable to tax. As Iqbal’s salary in the tax year 2004 is more than Rs.599,999, the cash allowances (for sixmonths) 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 inthe 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. Theamount chargeable to tax for six months is Rs.118,750 which is to be reduced by the monthly payment ofRs.3,000 made by Iqbal to the company (Rs.118,750 – Rs.18,000 = Rs.100,750).

Note (6) The annual value of rent free housing on a land area of 1,000 sq. yards outside municipal limits is Rs.106,000.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 KarachiElectric Supply Corporation. The value of electricity provided free of charge to an employee is exempt from tax upto 10% of basic salary. Therefore the benefit chargeable to tax is Rs.30,000 [Rs.210,000 less Rs.180,000 (10%of basic salary)].

Note (8) The services of a gardener provided to Iqbal is a perquisite chargeable to tax. Salary paid for six monthsRs.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 amountcomputed 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 chargesis in accordance with the terms of employment. It is assumed that the National Tax Numbers of the hospitals orclinics have been furnished by Iqbal and the employer has certified and attested the medical and hospitalisationcharges.

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

Note (12) Employee share scheme of Chemicals plc (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 taxablebenefit [£8 x 500 = £4,000 (Rs.400,000)].

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 paidor 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 theRs.200,000 received in advance, Rs.100,000 is for the tax year 2004 which is chargeable to tax in the tax year2004.

Note (14) As the salary income of Iqbal exceeds 50% of his taxable income he is entitled to a reduction in his tax liabilityat the rates given in Clause (1)(1) of Part III of the Second Schedule. On income slab exceeding Rs.1,000,000the 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 goodsimported as determined for custom purposes) collected under S.148 by the Collector of Customs is the final taxon the amount of income/loss arising from the imports.

Marks3 (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 blacklist 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

(c) 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

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21

Marks(e) (i) Utility bills paid by cash are admissible for claiming input tax. 1

(ii) The payment of Rs.17,000 made by cash for the purchase of aluminum foils is admissible for claiminginput tax as the payment is for a transaction of purchase not exceeding Rs.50,000 1

(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. 1

(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. 1

–––15–––

4 Mr Saleem Accounting year ended 30 June 2004

Tax year 2004Computation of taxable income RupeesIncome from businessBrokerage income 785,000 0·5Set off of brought forward loss (Note 1) 700,000 1

–––––––– 85,000Capital gainsGain on disposal of shares held by Saleem Sons (Note 2) 5,000 1·5Gain on disposal of shares acquired under employee share

scheme (Note 3) 375,000 3Gain on sale of sculpture (Note 4) 225,000 1·5Gain on sale of one postage stamp (Note 5) 15,000 1·5

––––––––620,000

Set off of brought forward capital loss (Note 6) 620,000 0 1·5–––––––– ––––––

Total income 85,000Zakat paid (10,000) 0·5


––––––––

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 FMV of 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–––



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MarksNote (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 brokerageincome.

Note (2) Disposal of shares by Saleem SonsRupees

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 schemeRupees

Consideration on disposal of 1,000 shares on 30 June 2004 2,000,000Cost of 1,000 shares– £5 paid on acquisition of the shares in Securities plc on

1 January 2003 (Tax year 2003) – £ 5 x 1,000 = £ 5,000 500,000– Amount charged to tax as salary income in the tax year

2003 (Note 3A) 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 fromcapital gain.

Note (3A) 1,000 shares of Securities plc 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 isthe taxable benefit, £10 x 1,000 = £10,000 (Rs.1,000,000). Rs.1,000,000 would have been charged to tax assalary 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 personby inheritance, the fair market value (FMV) of the asset on the date the asset become the property of the person istreated as the cost of the asset. The asset was transferred to Saleem on 1 June 1980. The asset was then valued byan 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 costof the asset.

RupeesSale consideration 1,000,000Cost being the FMV of the sculpture on the date it was acquired by inheritance (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

–––––––––



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RupeesNote (5) Gain on sale of one postage stamp

Sale proceeds of the Indian postage stamp 45,000Cost being the FMV of the stamp on the date it was acquired by inheritance 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 forwardA loss incurred under the income head of capital gains can only be set off against profits under the head of capitalgains. The brought forward loss of Rs.355,000 determined in the accounting year ended 30 June 1997 had lapsedon 30 June 2003 (tax year 2003) because a capital loss cannot be carried forward to more than six years immediatelysucceeding 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 offbefore the capital loss of the tax year 2003.

RupeesLoss brought forward 637,225Set off against capital gains of Rs.620,000 620,000

––––––––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 yearsexpired 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



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 2005Rupees

Salary income after deduction of taxBasic salary 600,000 0·5House rent allowance (exempt from tax – Note 1) 0 1Cost of living allowance 75,000 0·5Conveyance allowance 75,000 0·5Entertainment allowance 50,000 0·5

––––––––––800,000

––––––––––Income tax On Rs.700,000 117,500On Rs.100,000 at 35% 35,000

––––––––––152,500 0·5

Reduction in tax liability on Rs.152,500 at 10% (Note 2) (15,250) 1––––––––––

137,250––––––––––

Gross salary 1,000,000Tax 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:

RupeesBasic salary 608,334House rent allowance 270,000Utility allowance 60,833Medical allowance 60,833

––––––––––1,000,000––––––––––

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25

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 salaryOut 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). 2

(c) Salary income after deduction of taxRupees

Basic salary 608,334 0·5House rent allowance (exempt from tax – Note 1) 0Utility allowance (exempt from tax ) 0Medical allowance (exempt from tax) 0


––––––––Income taxOn Rs.400,000 42,500On Rs.208,334 at 25% 52,083

––––––––––94,583 0·5

Reduction in tax liability of Rs.94,583 at 10% (Note 2) (9,458) 0·5––––––––––

85,125––––––––––

Gross salary 1,000,000Tax deduction at source (85,125)

––––––––––Salary income after deduction of tax 914,875 0·5

–––––––––– –––15–––

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%.



Marks7 (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 ships used for the carriage were chartered by CCC. 1

(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

(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 bythe 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




PART 2


QUESTION PAPER





Tax rates and allowances are on page 3




Pape

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A. Tax rates for individuals and associations of persons for the tax year 2004Taxable income Rate of taxUp to Rs. 80,000 0%Rs. 180,001 – Rs. 150,000 7·5% of the amount exceeding Rs. 80,000Rs. 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 incomeIncome slab Reduction in tax liabilityUp to Rs. 60,000 10%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 15%

C. Tax rates for companies Tax Year Banking Public company other Private company other


D. Rates of advance collection or deduction of taxCommission or brokerage 10% of gross paymentImport of goods 6% of value of goods determined for customs

purposes

E. Tax rates on dividends received from companiesReceived by a public company or an insurance company 5% of the gross dividendIn any other case 10% of the gross dividend

F. Capital allowances DepreciationFactory buildings 10%Other buildings 5% Furniture and fittings 10% of the tax written down valuePlant and machinery (not otherwise specified) 10%Motor vehicles (all types) 20%Aircraft, aero-engines and aerial photographic apparatus 30%


3 [P.T.O.




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

The finance director of the company requires you to prepare the income tax return of the company for the tax yearrelevant 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 isRs.478,000.

(2) Deductions charged in the accounts include:Rupees

(i) Anticipated loss on a forward contract for the purchase of raw material ‘X’ on 1 January 2004. 200,000

(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. 300,000

(iii) Advance to an associated company written off as a bad debt. 300,000

(iv) Payment in cash of salary to a temporary worker. 4,800

(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. 120,000

(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 by e-mail and the non-resident has no permanent establishment in Pakistan. 250,000

(vii) Tax collected by the Collector of Customs on the value of plant imported by the company for its own use. 100,000

(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. 900,000

(ix) Payment to Zumzum Hotel for holding the annual eid-milan party for the employees and their families. 215,000

(x) Depreciation 590,000

(xi) Legal costs on the issue of additional share capital. 700,000

(xii) Compensation paid to a customer for failure to deliver goods within the time stipulated in the contract for the supply of cellular phones. 1,000,000

(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. 569,000

(ii) Gain on revaluation of the plant. 1,100,000

(iii) Accounting profit on the sale of a motor car. 100,200

(iv) Dividend received (gross amount) from a private company. 90,000

(v) Share of profits received from Bigli Associates, an association of persons (AOP) in which XYZ Ltd is a member. 800,000The taxable income of the AOP was Rs.2,000,000 and the tax assessed on the AOP was Rs.574,000

4



(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 1,700,000Factory buildings 1,800,000Office buildings 400,000Motor vehicles 1,010,000Furniture 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.2,100,000.

(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 theinclusion or exclusion in the computation of each of the items listed above. The reasons/explanations for theitems 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 carry on 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 September2003 and the firm ceased doing business on that date. Bal-Kaa-Toe is an AOP for tax purposes. The AOP has paidincome tax on its taxable income for the three months ended 30 September 2003. Rs.150,000 was received by Maryas her share of the income of the AOP.

Mary took up temporary employment on 1 October 2003 for three months with Charli – a hairdressing establishmenton a monthly salary of Rs.100,000. The terms of employment specifically stated that if Mary should leave theemployment before the end of the three months period, she would pay Charli Rs.100,000 as compensation for breachof 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 plc. As an inducement, Styles PK agreed to reimburseMary the Rs.100,000 she would have to pay Charli, provided Mary agreed to join the company from 1 November2003. 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 thecompensation 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.100,000 and a monthly cash allowance of Rs.20,000 for utilities and Rs.10,000for 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 whollyand 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 June2004. 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 depositedinto 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 thelast working day of each month.

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

(3) Mary was entitled to participate in the Styles plc employee share scheme (Scheme). Under the Scheme aparticipant has the free right to transfer the shares acquired under the Scheme only after a minimum holdingperiod of two years unless permission was granted by the custodian of the Scheme for the transfer of the sharesbefore 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 January2004, she exercised her right to purchase 700 shares and remitted £7,000 to the custodian of the Scheme. Themarket price of one share on 1 January 2004 was £13. The 700 shares purchased by Mary were in herpossession 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, whichincluded Rs.2,500 for the services of a gardener. For tax purposes, Mary accounts for the income from the houseon accrual basis.

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

6



Mary incurred the following expenditure in respect of the house:Rupees

Repairs 35,000Profit paid to a bank on a loan utilised for renovating the house 8,000Legal expenses for preparing a new tenancy agreement 5,000

(5) Mary received Rs.18,000 (after deduction of tax) from the Tourism Department of the Government of Sind as acommission on the sale of tickets for a whole day excursion to Moenjodaro. Mary paid Rs.5,000 to the girlsworking 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.100

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

– on an average she receives about Rs.4,500 a month as gratuities from the clients of Styles PK which in her viewis not taxable income, since the receipts are not from her employer but are casual and non-recurring receiptsdepending upon the goodwill of the clients of Styles PK; and

– the Rs.100,000 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 clearreasons/explanations for the inclusion or exclusion in the computation of income of each of the items listedabove. The reasons/explanations for the items not included in the computation of income should be shownseparately. (23 marks)

(b) Calculate the tax payable by Mary for the tax year 2004. (5 marks)

(28 marks)

7 [P.T.O.




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 thebeverage ‘Zeecola’. Zee Cola Ltd started its business operations on 1 December 2004 and the followingtransactions 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 timeof launching the beverage;

(2) 100,000 bottles of Zeecola were exported to Afghanistan valued at Rs.1,000,000;

(3) Rs.15,000,000 was received as an advance from a dealer for 1,500,000 bottles to be supplied in January2005; 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 December2004. (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 amisapprehension of the law. (2 marks)

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

(i) Import of goods (1 mark)

(ii) Taxable supplies. (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.10per 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 July2003.

(iv) 2,000 shares were gifted to his son Babu, who is a citizen of Pakistan and has been living in the USA since1 December 2003.

(v) 3,000 shares were transferred to his wife Seema under an agreement to live apart. Seema is a citizen ofPakistan 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 plc, hewas granted the right to purchase 500 shares in Eatmore plc at the exercise price of £15 per share, whichwas 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) andacquired the right to purchase 500 shares at the exercise price of £15 per share. The right to purchase theshares 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 marketprice of one share was £20 and the exchange rate was £1 equals to Rs.100.

(3) Movable assets held for personal use.

(i) Motor carThe car which had been acquired in January 2004 for Rs.1,200,000 was sold for Rs.1,250,000.

(ii) PaintingsA painting which had been acquired on 1 January 2004 for Rs.100,000 was sold for Rs.500,000. Hisfather’s collection of paintings which he had inherited in 1974 was sold for Rs.1,000,000. In 1974 thepaintings had been valued by an expert at Rs.2,000,000.

(iii) ManuscriptA manuscript which had been acquired for Rs.100,000 was alleged to be an original document of the EastIndia Company. The manuscript turned out to be a reproduction and was sold for Rs.1,000.

(4) Ancestral agricultural land

The agricultural land, which Mohsin had inherited in 1974, was sold for Rs.10,000,000. In 1974, the marketvalue of the land was Rs.700,000.

(5) Shares in two companies both listed on the Karachi stock exchange

(i) Loss of Rs.100,000 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 selfemployed 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 taxyear 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 givingclear reasons/explanations for the inclusion or exclusion in the computation of income of each of the items listedabove. The reasons/explanations for the items not included in the computation of income should be listedseparately.

(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 thebusiness 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 forthe 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 withPakistan) for the right to use a secret process only in Pakistan for the formulation of a herbal cough syrup. Theprocess is not to be used by Tahir Pharma for any business outside Pakistan. Tahir Pharma plans to commencethe manufacture of the cough syrup in Pakistan in the tax year 2005. ABC Ltd has no permanent establishmentin 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 medicaltreatment at a hospital in Houston. XYZ is a company incorporated in the USA and is a non-resident companyfor 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 bythe 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 ofthe 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 TahirPharma; and

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

(ii) state whether the tax collected by the Collector of Customs at the import stage on the value of rawmaterials 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 ‘industrialundertaking’ 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 Ltdsold its crushing plant to DEF Ltd on 31 October 2002 for Rs.10,000,000.

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 plantand machinery. In the valuer’s report issued on 15 October 2002 the crushing plant was valued atRs.15,000,000.

Required:

(i) Explain the tax implications for each of the parties (ABC Ltd and DEF Ltd) to the transaction of thedisposal of the crushing plant. (4 marks)

(ii) Calculate the profit chargeable/loss deductible on the disposal of the crushing plant for the purposes ofcomputing 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 taxableincome 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 doesnot conduct any business in Pakistan or engage in any income generating activity. The expenditure of LOABC isborne by ABC.

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

Required:

(i) State, giving reasons, whether LOABC will be considered to have a permanent establishment inPakistan. (1 mark)

(ii) Explain whether or not your conclusion to (i) above would differ if LOABC, in addition to its liaisonactivities, 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 itsliaison activities and the negotiation of contracts of purchase of denim cloth, used its office premises asa 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) forRs.1,800,000 for his personal use. The Honda Civic was shown as an asset in Mr Q’s statement of wealth asat 30 June 2004.

On 1 July 2004, it was mutually agreed between Mr Q and the partners of PQR that the Honda Civic would beused 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 beeninvolved in the expansion of its distribution network to the rural areas outside the municipal limits of Quetta. Thisexpansion activity is hereinafter referred to as ‘the Project’. The Project includes the laying of new pipelines, pumpingmachinery, 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 purchasingthe 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 atRs.58,000,000.

Other information:

(1) The Project was completed in June 2003, but was only commissioned for use on 31 July 2003. The totalamount 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.10,000,000 as a subsidy in respectof the plant installed in the Project. GPL treated the Rs.10,000,000 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 returnof 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 notthe result of a mere translation difference, but arose on the remittance of US$ 100,000 and is therefore adetermined 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 depreciationof Rs.10,000,000 being 10% of Rs.100,000,000 (cost Rs.200,000,000 less initial allowanceRs.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 thepurpose of preparing the return of income for the tax year 2004. If you are not in agreement with any of thecontentions of the CFO, advise the CFO of the treatment to be adopted for the purposes of the return of incomefor the tax year 2004.

Note: The allocation of marks is shown against each of the three proposals raised by the CFO.

(15 marks)


15



Answers



19

Part 2 Examination – Paper 2.3(PKN) December 2005 Answers andBusiness Taxation (Pakistan) Marking Scheme

Marks1 (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. 1

(c) XYZ LtdAccounting year ended 31 December 2003

Tax year 2004Rupees

Computation of taxable incomeAccounting profit 478,000Add: Provision for taxation (Note 1) 105,000 0·5

Anticipated loss on forward contract (Note 2) 200,000 1·5Contribution to unapproved gratuity fund (Note 3) 300,000 1Advance to an associated company written off (Note 4) 300,000 1Payment to a non-resident for technical advice (Note 5) 250,000 1Tax collected by the Collector of Customs (Note 6) 100,000 0·5Cost of major renovations to plant (Note 7) 900,000 1Accounting depreciation 590,000 0·5Legal cost on issue of additional share capital (Note 8) 700,000 1

––––––––––3,445,000––––––––––3,923,000

Less: Face value of bonus shares (Note 9) 569,000 1Gain on revaluation of plant (Note 10) 1,100,000 1·5Accounting profit on sale of car (Note 11) 100,200 0·5Tax loss on sale of car (Note 12) 50,000 1·5Initial allowance (Note 13) 400,000 1Depreciation (Note 14) 752,000 3Dividend income for separate consideration (Note 15) 90,000 0·5

––––––––––3,061,200––––––––––

Taxable income 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


(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).



Marks(d) Tax liability

On taxable income of Rs.861,800 at 35% 301,630 0·5Tax credit for tax paid by the AOP (Note 16) 229,600 1·5

––––––––72,030

Tax collected at customs stage (Note 6) 100,000 0·5––––––––

Balance tax refundable 27,970––––––––

Dividend income – Rs.90,000Tax 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 technical 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 technical 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 * 750,000Less: Tax written down value 800,000Tax 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 (B), the amount of Rs.900,000 (A)

20



Marksreceived 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/C900,000 x 1,000,000/1,200,000 = Rs.750,000

Note (13) Initial allowanceRupees

Cost of new machine 800,000Initial allowance at 50% 400,000

Note (14) DepreciationPlant and Factory Office Motor Furniture Totalmachinery buildings buildings vehicles depreciation


Written down value 1,700,000 1,800,000 400,000 1,010,000 100,000Disposal – – – (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:Rupees

Share of profit received from the AOP by XYZ Ltd (A) 800,000Taxable income of the AOP (B) 2,000,000Tax assessed on the AOP (C) 574,000A/B x C800,000/2,000,000 x 574,000 = 229,600

21



22

Marks2 (a) Ms Mary

Accounting year ended 30 June 2004Tax year 2004

Computation of income RupeesSalary From Charli (Note 1) 100,000 1·5From Styles PK

Consideration for agreeing to enter into employment (Note 2) 100,000 1Basic salary of eight months 800,000 0·5Entertainment allowance (Note 3) 80,000 0·5Utility allowance (Note 3) – Rs.160,000 less 10% of basic salary exempt from tax 80,000 0·5House rent allowance (Note 4) 130,000 1·5Special allowance (Note 5) 40,000 1·5Passage for travel abroad (Note 6) 50,000 1·5

––––––––1,380,000

Income from BusinessShare of income from Bal-Kaa-ToeRs.150,000 – exempt from tax (Note 7) 0 1·5

Income from PropertyRent chargeable to tax (Note 8) 300,000 1Deductions Repairs (Note 9) 60,000 1Profit paid on money borrowed for renovation of the house (Note 10) 8,000 1·5Unpaid rent (Note 11) 75,000 1·5

––––––––143,000––––––––

157,000Income from Other Sources

Income for providing the services of a gardener connected with renting of the house (Note 8) 30,000 1Gratuities 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


(i) In an employee share scheme, where there is any restriction on the transfer of the shares, the benefit accruing 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 plc 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)], 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.



Marks(b) Computation of tax liability

Rs.150,000 received from the AOP is included in Mary’s taxable income only for the purpose of determining the rate of tax applicable to her taxable income other than the income from the AOP.

RupeesTaxable income (C) 1,603,000

––––––––––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) (B) 1,753,000

––––––––––Tax on Rs.1,753,000On Rs.700,000 119,000On Rs.1,053,000 at 35% 368,550

––––––––––(A) 487,550

––––––––––Tax liability(A/B) X C487,550/1,753,000 X 1,603,000 445,831 3Less: Reduction in tax at 5% of Rs.445,831 (Note 13) 22,291 1

––––––––––423,540

Less: Tax deducted at source 375,000 0·5––––––––––

Balance tax payable 48,540––––––––––

Tax deducted considered as final taxFinal Tax

Commission – gross Rs.20,000 2,000 0·5–––5

–––28–––

Note 1 A person is treated as having received an amount inter alia if it is applied 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.

Note 2 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 Charli is treated as consideration for her agreement to enter into employment on 1 November 2003.

Note 3 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.

Note 4 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).

Note 5 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.

Note 6 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.

Note 7 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



Marksapplicable 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 (1/5 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 Mr 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 gratuities 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) Value Sales TaxRupees Rupees

Output Tax Samples (Sales tax is leviable on free samples) 250,000 37,500 1·5Exports (no sales tax on exports as it is a zero rating supply) 1,000,000 0 1·5Advance from a dealer (against 1,500,000 bottles to be suppliedin January 2005) 15,000,000 2,250,000 1·5

––––––––––2,287,500

Input tax Supplies (input tax claimed on accrual basis) 20,000,000 3,000,000 1·5

––––––––––Excess input tax to be carried forward to the next tax period 712,500 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

(c) 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



Marks4 Mr Mohsin


Computation of taxable income RupeesSalaryEmployee share scheme

Sale of the right to purchase shares (Note 1) 110,000 1·5Income from Business

Landscape designing 90,000 0·5Set off of brought forward loss (Note 2) (90,000) 0·5

––––––––0

Capital GainsShares in M (Private) Ltd

Gain on sale of 1,000 shares (Note 3) 10,000 0·5Gain on transfer of 2,000 shares gifted to Babu (Note 4) 20,000 1·5Gain on transfer of 3,000 shares to wife (Note 4) 30,000 1·5

Personal assetsGain on sale of a painting (Note 5) 400,000 1·5Gain on sale of shares in XYZ Ltd – exempt (Note 6) 0 0·5

––––––––460,000––––––––570,000––––––––

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 other five items) as follows: 7

–––15–––


(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 his 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



MarksNote (1) Gain on the sale of the right to purchase shares under employee share scheme:

RupeesConsideration on disposal of the right to purchase 500 shares 200,000Cost of the right [(£2 x 500 = £1,000 (£1 = Rs.90)] (90,000)

––––––––Gain on disposal 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) LtdRupees

Consideration received (Rs.20 x 1,000) 20,000Cost (Rs.10 x 1,000 shares) (10,000)

––––––––Gain 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: Rupees

Consideration received (Rs.20 x 2,000) 40,000Cost (Rs.10 x 2,000) (20,000)

––––––––Gain 20,000

––––––––

Gain on the transfer of 3,000 shares to Seema: Rupees

Consideration received (Rs.20 x 3,000) 60,000Cost (Rs.10 x 3,000) (30,000)

––––––––Gain 30,000

––––––––

Note (5) Gain on the sale of a paintingMovable 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 LtdA gain on the disposal of the shares in a company listed 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



Marks5 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 Tahir 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 realisation of the foreign exchange proceeds would deduct tax at the applicable 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



28

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 Tahir 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 acquired the plant. 1

(ii) ABC LtdTax year 2004Accounting year ended 30 September 2003

Disposal of plant RupeesConsideration received – FMV of plant 15,000,000 0·5Tax written down value (WDV) (Note) (5,000,000) 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 LtdTax year 2004Accounting year ended 30 September 2003

RupeesCost of crushing plant (Note) 15,000,000 0·5Depreciation at 10% 1,500,000 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 establishment 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

(c) 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–––



Marks7 (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 acquisition 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) 2

– Rs.95,100,000 is to be claimed as initial allowance (Note 2); and 1

– Rs.9,510,000 is to be claimed as depreciation (Note 3) 1–––15–––

Note (1) Recomputed cost of plantRupees

Actual amount spent by GPL 200,000,000Loss on currency exchange 200,000Subsidy received from the GOP (10,000,000)

––––––––––––190,200,000––––––––––––

Note (2) Initial allowance on plant50% of cost of Rs.190,200,000 95,100,000

Note (3) Depreciation on plant10% of Rs.95,100,000 – written down value[Cost of Rs.190,200,000 less initial allowance Rs.95,100,000] 9,510,000

29




PART 2


QUESTION PAPER









Pape

r 2.3

(PK

N)




2




A. Tax rates for individuals where salary income exceeds 50% of taxable income for the tax year 2006Taxable income Rate of taxUp to Rs. 100,000 0%Rs. 100,001 – Rs. 200,000 3·5% of the amount exceeding Rs. 100,000Rs. 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 Banking Public company other Private company other

company than a banking company than a banking company2005 41% 35% 39%2006 38% 35% 37%

C. Rates of advance collection or deduction of taxCommission or brokerage 10% of gross paymentImport of goods 6% of value of goods determined for customs

purposesProfit on Special Savings Certificates issued by the NationalSaving Scheme 10% of the profit


E. Capital allowances DepreciationBuildings (all types) 10% Furniture and fittings 15% of the tax written down valuePlant and machinery (not otherwise specified) 15%Motor vehicles (all types) 15%


3 [P.T.O.

⎫

⎬⎪

⎭⎪




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 incometax 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 exchangein Pakistan. 50 per cent of the shares in CPL are held by ABC Ltd, a company incorporated in Saudi Arabia. TheKingdom 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 reserveaccount is Rs.780,000.


(i) Accounting depreciation 136,000

(ii) Tax collected by the Collector of Customs on the import of electric ceiling fans for sale. 750

(iii) Expenditure on the provision of perquisites and allowances to the chief executive officer in excess of 50% of his salary. 2,450

(iv) Provision for taxation. 70,000

(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. 10,000

(5) Income shown in the accounts includes:Rupees

(i) Commission received from the Federal Government for arranging a direct supply of electricfittings from a company in the United Kingdom (net of tax deducted at source). 900

(ii) Dividend received from a private company (net of tax deducted at source). 9,000

(iii) Net income on sale of imported ceiling fans. The fans were sold in the same condition they were in when imported. 6,500

(iv) Compensation received from a customer for failure to deliver goods within the time stipulated in the contract for the supply of spare parts. 200

(v) Accounting profit on sale of office building. 750

(vi) Recoveries from a debtor whose debt had been written off in the prior years but was not allowed as a tax deduction. 545

(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. 8,000

(6) The provision for bad debts comprises:Rupees Rupees

Balance on 1 January 2005 1,500Provision made during the year (5% of debtors) 500

––––––2,000

Trading debts written off 600Advance to a subsidiary company written off 700 1,300

––––– ––––––Balance on 31 December 2005 700

––––––––––––

4



(7) Fixed assets:Rupees

(i) The tax written down values on 1 January 2005 were: Factory and workers’ residential buildings 2,500 Office buildings 8,200 Plant and machinery 9,500 Motor vehicles 400 Furniture 250

(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 2001.

(9) Advance tax paid was Rs100,000.

Required:

(a) Briefly state with reasons whether or not CPL Ltd will be a public company for tax purposes. (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. (4 marks)

(30 marks)

5 [P.T.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 TeleBellLtd (TBL) on 31 December 2005 despite the fact that the retirement age under the company’s terms ofemployment was 60 years. TBL is a company engaged in the manufacture of telephone instruments. On 1January 2006, TBL paid Ring Rs.695,000 as consideration for consenting to a restrictive covenant refraininghim 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 thesales 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 businessuse. The fair market value of the leased vehicle at the commencement of the lease period wasRs.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. Thecost to TBL was Rs.80,000.

(vi) Reimbursement of hospital charges for Ring and his wife. Rs.375,000 was reimbursed to Ring during thesix months ended 31 December 2005 against hospital bills submitted by him.

(3) On 31 December 2005, TBL voluntarily and not under any terms of employment allowed Ring to purchase aCivic 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, whereapplicable.

– 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 2001.

(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 youthat:

(i) The Rs.695,000 received from TBL should not be included in his taxable income as it is a capital receiptsince the restrictive covenant bond signed by him prohibits him from seeking employment with anytelephone 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 theshares 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 plc (an associated companyof TBL).

– On 1 September 2005, the custodian of the Scheme granted Ring the right to acquire 2,000 shares inTelephones plc 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.100.

– On retirement from the employment of TBL, Ring disposed of the rights for Rs.30,000 on 31 December2005.

(v) Ring invested Rs.1,000,000 in the purchase of new shares in ABC Ltd, a public company listed on theKarachi stock exchange. ABC Ltd had offered the new shares to the public and Ring is an original allotteeof the shares.

Required:

(a) Compute the taxable income of Mr Ring under the appropriate heads of income for the relevant tax yeargiving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of theitems listed above. The reasons/explanations for the items not included in the computation of income shouldbe 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 [P.T.O.




3 (a) Master Petrochemicals Ltd is engaged in the manufacture of synthetic fabrics. Their business transactions for themonth 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.1,150,000 (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 onthe said purchases was claimed in the monthly sales tax return of November 2005 and related to taxablesupplies 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 monthof May 2006. (5 marks)

(b) Under the Sales Tax Act 1990 (Act), a person who is required to maintain any record or documents, shall retainsuch 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 retailprice. 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 toa careless mistake in casting, he had inadvertently claimed Rs.300,000 in excess as input tax resulting in a shortpayment of Rs.300,000 in the monthly sales tax return of April 2006. He is of the view that since the shortpayment in tax was an inadvertent error and was not a wilful act or a tax fraud, he should neither be penalisednor required to pay default surcharge, if he pays the tax due of Rs.300,000 along with the monthly sales taxreturn 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 calculatethe 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 whenany 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 havetaken 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 doubletaxation, holds 51% of the shareholding in XYZ Ltd, a company incorporated under the Companies Ordinance1984. 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 entireshareholding in XYZ Ltd to an enterprise in the United States of America and made a gain of US$1,000,000 onthe transaction.

MI is of the view that there are no tax implications in Pakistan in respect of the gain of US$1,000,000, sincethe entire transaction of the sale of the shares in XYZ Ltd took place outside Pakistan with another non-residentcompany 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 TikamDas:

(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 thefollowing 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 Tikamís 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 atRs.10 per share on 1 April 2000. The break-up value of one share on 30 April 2005, as determinedby a reputable firm of chartered accountants, was Rs.13.

(2) As an employee of ABC plc, Pakistan Branch, Tikam had acquired 400 shares in ABC plc on 31 May2004 (tax year 2004) under an employee share scheme at the exercise price of £10 per share whenthe price quoted for one share on a stock exchange in the United Kingdom was £13. The rate ofexchange on 31 May 2004 was £1 equals Rs.100. Tikam resigned from his employment with ABC plcon 30 June 2004 and on 1 July 2004, he sold the 400 shares to an employee of ABC plc, PakistanBranch for Rs.1,000,000.

(3) Tikam was an amateur collector of rare postage stamps. He had inherited a rare postage stamp fromhis 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.100,000.

(4) On 31 March 2005, Tikam received Rs.200,000 for vacating the possession of a building which hehad taken on a yearly rental of Rs.60,000. Tikam had paid Rs.150,000 to the previous tenant toacquire possession of the building.

(5) Sale of shares on 31 March 2005 which were acquired by Tikam in the year 2001.

– Gain of Rs.3,000 on the sale of shares in PQR Ltd, a company incorporated under the CompaniesOrdinance 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 stockexchange 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 yeargiving clear reasons/explanations for the inclusion or exclusion in the computation of income of each of theitems listed above. The reasons/explanations for the items not included in the computation of income shouldbe shown separately. (12 marks)

(15 marks)

9 [P.T.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 atRs.100,000 (at cost) was destroyed. His insurance company refused to entertain the claim for Rs.100,000 forthe loss of the stock-in-trade. Bee ceased doing business as and from 30 June 2003. In the return of incomefurnished for the tax year 2003, Bee claimed the Rs.100,000 as a deductible business loss in computing hisincome 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 ofRs.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. Beeis 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 amountclaimed as exempt from tax. Bee was of the view that the receipt was a capital receipt since it was nottraceable to any source of income in the tax year 2005. The receipt related to his retail business which hadceased 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 Commissionerfor the dividend income of Rs.27,000 since the income had suffered withholding tax at the applicable ratewhich 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. Ifyou are not in agreement with either of the contentions, advise Bee of the treatment to be adopted to rectifythe 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 thebudget speech on the Finance Act, 2005, the Finance Minister had referred to a new category of a limitedcompany 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 inIslamabad.

(i) Murtaza accounts for the income from the house on the accrual basis and his accounting year ends on 30June 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 alsoreceived from Jack a deposit of Rs.1,000,000 which is not adjustable against the rent payable. On 1 July2004, Jack vacated the house and the Rs.1,000,000 was returned to him.

(iii) On I July 2004, Murtaza lets the house to Jill on a monthly rental of Rs.60,000 which includes Rs.10,000for the services of a security guard. Murtaza received from Jill a deposit of Rs.1,500,000 which is notadjustable 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 rentof 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, givingexplanations 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 ended30 June 2005:

– He is the owner of agricultural land in Sind. On 1 January 2005 he entered into an agreement with Bashirfor the sale of the land for Rs.1,000,000. Under the terms of the agreement, Bashir paid a deposit ofRs.100,000 and the balance of Rs.900,000 was payable on 31 January 2005. The agreement alsoprovided that if Bashir failed to make payment of the balance of Rs.900,000 by 31 January 2005, thedeposit of Rs.100,000 paid under the contract would be forfeited and the agreement for the sale of landwould be treated as cancelled. Bashir failed to make payment of Rs.900,000 on 31 January 2005. Thedeposit 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 theproperty on the same day to Bashir on a composite lease rent of Rs.400,000 per month. The considerationpaid for ‘Ataghar’ as specified in the purchase deed was Rs.9,000,000 for the building and Rs.5,000,000for the plant installed in the building.

Nadir wants you to:

(i) explain the tax treatment in respect of the receipt of Rs.100,000 being the deposit amount forfeited underthe 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 thepermissible 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 deductionfor 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 [P.T.O.



7 (a) Under the provisions of s.153(1) of the Income Tax Ordinance 2001, every prescribed person making a paymentin full or part including a payment by way of an advance to a resident person or a permanent establishment inPakistan 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 ofservices,

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 ofimported 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 deducttax at the time of making a payment under s.153(1) to a permanent establishment in Pakistan of a non-resident 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 tobe deducted when the amount is credited to the account of the recipient or when it is actually paid?

(1 mark)

(b) SkyAdverts is a non-resident company incorporated in a country which does not have a tax treaty with Pakistanfor the avoidance of double taxation. SkyAdverts is in the process of submitting a bid to Chaiwalla (Pakistan) Ltd[CPL] for providing, under a contract (TV Contract), advertisement services which would be rendered by ‘TVSatellite Channels’ owned and managed by them. CPL is a company incorporated under the CompaniesOrdinance 1984 and is not a ‘small company’ as defined for tax purposes.

SkyAdverts has been informed by CPL that all payments to them under the TV Contract would suffer withholdingtax and there are certain provisions under the Pakistan tax statute whereby the tax deducted could be consideredto be the final tax on their income arising from the TV Contract.

SkyAdverts wants you to:

(i) explain the tax provisions under which CPL is required to deduct tax from the payments made to SkyAdvertsunder the TV Contract;

(ii) state whether it is mandatory that the tax deducted from the payments made under the TV Contract wouldbe the final tax of SkyAdverts or can SkyAdverts be taxable on its net income;

(iii) explain the steps to be taken by SkyAdverts to ensure that the tax deducted from the payments made byCPL 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 SkyAdverts’ tax assessmentin Pakistan if for some reason, SkyAdverts is unable to meet the requirements for being assessed on the finaltax 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)


12



Answers



Part 2 Examination – Paper 2.3(PKN) June 2006 AnswersBusiness Taxation (Pakistan) and Marking scheme

Marks1 (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 bythe Kingdom of Saudi Arabia (foreign government). Therefore CPL is not a public company for Pakistan tax purposes. 2

(b) CPL Ltd Accounting year ended 31 December 2005

Tax year 2006 Computation of taxable income

Rs. inthousands

Accounting profit 780,000Add: Transfer to general reserve (Note 1) 5,000 0·5

Accounting depreciation (Note 2) 136,000 0·5Tax collected by the Collector of Customs (Note 3) 750 1Excess cost of perquisites and allowances (Note 4) 2,450 0·5Provision for taxation (Note 5) 70,000 0·5Acquisition of manufacturing rights (Note 6) 10,000 1Provision for bad debts (Note 7) 500 0·5Architect’s fee for new building (Note 8) 500 1Unpaid liability for profit on debt (Note 9) 140 1·5Tax profit on sale of building (Note 10) 500 2

––––––– 225,840––––––––––1,005,840

Less: Amortisation of an intangible (Note 6) 170 1·5Accounting profit on sale of office building (Note 10) 750 0·5Recovery against bad debts written off (Note 11) 545 1·5Trading bad debts written off (Note 13) 600 0·5Initial allowance (Note 14) 4,250 1Depreciation (Note 15) 3,068 4·5

––––––– 9,383––––––––––

996,457Less: Income for separate consideration (Note 12)

– Commission from the federal government 900 0·5– Dividend 9,000 0·5– Sale of imported fans 6,500 0·5

––––––– 16,400–––––––––

Business income being taxable income 980,057––––––––––––––––––

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

–––24


(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 incomeof 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



Marks(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.

(c) Tax liability Rupees in thousandsOn business income of Rs.980,057 at 37% 362,621 0·5Tax credit on tax paid by the AOP (Note 16) (2,290) 1·5

––––––––360,331

Less: Advance tax paid 100,000 0·5––––––––

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 0·5

––––––Dividend income – Rs.10,000 – Tax deducted at 10% is the final tax 1,000 0·5

––––––Income on sale of imported ceiling fans– Tax collected at the customs stage is the final tax 750 0·5

–––––––––––– –––4

–––30–––

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 beamortised 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



MarksNote (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 profitor loss on sale of the building. Tax depreciation allowed on the building in prior years isRs.500 (actual cost Rs.3,000 less written down value Rs.2,500).

Tax profit on disposal of building RupeesSale consideration 7,500Less: Tax written down valueLess: Deemed cost 7,500Less: Depreciation allowed (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) Income for separate consideration:

(i) Rs.100 being the tax deducted on the commission income of Rs.1,000 (net income Rs.900) received from the Federal Government is the final tax on such income.

(ii) Rs.1,000 tax deducted on the dividend income of Rs.10,000 (net income Rs.9,000) isthe final tax on such income.

(iii) Rs.750 tax collected by the Collector of Customs at the customs stage (Note 3) is thefinal 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 companyhas reasonable grounds to believe that the debts are irrecoverable.


Cost of residential building for workers 8,000Add: Cost of architect’s fee (Note 8) 500

––––––8,500

––––––Initial allowance at 50% 4,250

––––––––––––

17



(Note 15) DepreciationPlant and Factory Office Motor Furniture Totalmachinery and buildings vehicles depreciation

workers’residentialbuildings


Written down value 9,500 2,500 8,200 400 250Disposal – – (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) 8,000Taxable income of the AOP (B) 20,000Tax assessed on the AOP (C) 5,725A/B x CRs.8,000/Rs.20,000 x Rs.5,725 = Rs.2,290

18



Marks2 (a) Mr Ring


Computation of income Rupees

Salary incomeConsideration for agreeing to a restrictive covenant (Note 1) 695,000 2Basic salary (6 months) 1,800,000 0·5Cash allowances:

Utilities (Note 2) – Rs.150,000 – exempt from tax 0 1Children’s education (Note 2) 120,000 0·5Cost of living (Note 2) 60,000 0·5House rent (Note 2.1) 540,000 1·5

Household servants (Note 3) 240,000 1Benefit of company maintained car (Note 4) 88,000 1·5Passage for travel abroad (Note 5) 80,000 0·5Reimbursement of hospital charges exempt from tax (Note 6) 0 1Benefit on purchase of car (Note 7) 600,000 1Pension exempt from tax (Note 8) 0 1Employee share scheme – sale of rights (Note 9) 30,000 2

–––––––– 4,253,000Income from other sourcesAmount of loan received in cash (Note 10) 200,000 2Profit on Special Savings Certificates (Note 11) 6,000 206,000 0·5

–––––––– ––––––––––Total income 4,459,000Zakat paid (60,000) 0·5

––––––––––Taxable income 4,399,000

––––––––––––––––––––

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

–––21

Items not included in the computation of income(1) 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 grantedto an employee shall not be chargeable to tax’ [s.14(1)]. 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 expenditureincurred 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(b) Computation of tax liability Rupees

Taxable income 4,399,000Tax thereonTax on Rs.700,000 102,500Tax on balance of Rs.3,699,000 at 30% 1,109,700

–––––––––– 1,212,200 0·5Tax credit on purchase of new shares in ABC Ltd (Note 12) (41,334) 2

––––––––––1,170,866

Tax deducted at sourceOn salary income 1,300,000On profit on special savings certificates (Note 11) 600

–––––––––– 1,300,600 1––––––––––

Balance tax refundable 129,734––––––––––––––––––––

Tax deducted as final taxFinal tax

Dividends – gross amount Rs.300,000 (Note 13) 30,000 0·5–––––––––– –––

4–––25–––

Note (1) Any amount received as consideration for an employee’s agreement to a restrictive covenant inrespect of any past, present or prospective employment is a profit in lieu of or in addition to salaryand is taxable as salary income. The Rs.695,000 received by Ring for his agreement not to enterinto employment with any other telephone manufacturing company is chargeable to tax as salaryincome. Normally under the general law, such a receipt would be a capital receipt; however, the taxstatute 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 to10% 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 living 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.

RupeesHRA – 45% of basic salary (45% of Rs.1,800,000) 810,000Exempt from tax 270,000

––––––––Chargeable to tax 540,000

––––––––

Note (3) The cost of household servants borne by TBL is a benefit of employment and is therefore chargeableto tax as salary income.

Note (4) The fair market value (FMV) of the car, taken on lease, at the commencement of the lease period isRs.2,000,000. As the car is exclusively for Ring’s private (non-business) use, Rs.200,000 being10% of the FMV of the car is the annual benefit. The amount chargeable to tax is Rs.88,000 madeup as under:

RupeesAnnual benefit 200,000

––––––––For 6 months 100,000Less: Deduction from Ring’s salary (Rs.2,000 x 6) 12,000


––––––––

Note (5) The benefit of free passage for travel abroad is exempt from tax (subject to certain conditions), if theemployee’s salary including the value of perquisites and benefits does not exceed Rs.599,999. AsRing’s total salary exceeds Rs.599,999, the amount of Rs.80,000 paid by TBL for the passage costis chargeable to tax as salary income.

Note (6) The reimbursement of hospital charges is exempt from tax as the reimbursement of such charges isin accordance with the terms of employment of Ring. It is assumed that the national tax numbers ofthe hospitals or clinics have been furnished by Ring and TBL has certified and attested the hospitalbills [Clause 139(a) of Part I of the Second Schedule].

20



MarksNote (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 bythe employee. The FMV of the Civic Honda car purchased by Ring from TBL on 31 December 2005was Rs.900,000 as against the amount of Rs.300,000 paid by Ring. The difference of Rs.600,000is a benefit chargeable to tax as salary income. A benefit to be chargeable to tax need not be inaccordance with the terms of employment.

Note (8) Any pension received by a citizen of Pakistan from a former employer is exempt from tax provided theperson receiving the pension does not continue to work for the former employer or an associate of theformer employer. The exemption is neither dependent on the age of the person receiving the pensionnor the retirement age under the terms of employment. As the above requirements are fulfilled, themonthly 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 employeeshare scheme is chargeable to tax as salary income and not as ‘capital gains’. As no payment wasmade 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 bankingcompany or financial institution) which is not paid by a crossed bank cheque or through a bankingchannel from a person holding a national tax number card, is treated as the income of the recipientchargeable to tax in the tax year of receipt under the head ‘Income from other sources’. As the loanwas 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.

RupeesNet amount of profit received after deduction of tax 5,400Gross amount of the profit 6,000Tax deducted at source (available as a tax credit) 600

––––––

Note (12) The tax credit on the investment of new shares [s.62(1) and (2)] in ABC Ltd is calculated as under:

Rupees– Tax assessed before allowance of tax credit (A) 1,212,200– Taxable income for the year (B) 4,399,000– Amount of investment on which tax credit is to be – calculated (Note 12A) (C) 150,000

Tax credit allowableA/B x CRs.1,212,200/Rs.4,399,000 x Rs.150,000 41,334

Note (12A) The amount of the investment on which tax credit is calculated is the lesser of: – the cost of acquiring the shares; – 10% of the taxable income; or – one hundred and fifty thousand.

The cost of acquiring the shares is Rs.1,000,00010% of taxable income is Rs.439,900.As both the above amounts are more than Rs.150,000, the amount of the investment on whichtax 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.

RupeesNet amount of dividend after deduction of tax (Rs.90,000 + Rs.180,000) 270,000Gross amount of the dividend 300,000Tax deducted at source 30,000

––––––––

Rs.30,000 being the tax deducted at source is the final tax on the dividend income.

21



Marks3 (a) The sales tax liability for the month of May 2006 would be computed as follows:

Output tax RupeesExempt supplies – 0 0·5Taxable supplies in local market (Rs.1,150,000 x 100/115 = 1,000,000 x 15%). 150,000 0·5As 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)](Rs.575,000 x 100/115 x 15%) 75,000 2

––––––––225,000

Input taxPurchases of raw materials (inclusive of sales tax) Rs.805,000Input tax (Rs.805,000 x 100/115 = 700,000 x 15%) Rs.105,000Apportionment 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 (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.24] 2

(c) The following goods are chargeable to sales tax at the rate of 15% of the retail price:

1. Fruit and vegetable juices2. Ice cream3. Aerated waters or beverages4. Syrups and squashes5. Cigarettes6. Toilet soap7. Detergents8. Shampoo9. Toothpaste10. Shaving cream11. Perfumery and cosmetics12. Biscuits13. Confectionery14. Tea15. Powder drinks16. Milky drinks17. FootwearAny 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:

Rate per month– For the first six months of default 1%

– From the seventh month onwards till such time as the entire liability including default surcharge is paid. 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)]. 2

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22



Marks4 (a) Mung Inc is a non-resident company for Pakistan tax purposes and its income under any head of income is

to be computed by taking into account its Pakistan-source income only.

Section 101 (geographical source of income) specifies the conditions under which different sources of income are Pakistan-source income. Under the provisions of s.101(13) any gain arising on the disposal of shares in a resident company shall be Pakistan-source income.

As the gain arose on the disposal of shares in XYZ Ltd which is a resident company, Mung Inc is chargeable totax on the US$ 1,000,000 under the head ‘Capital gains’, irrespective of whether or not the sale took placeoutside Pakistan with another non-resident person or that the sale consideration was received outside Pakistan. 3

(b) Mr Tikam Das (Deceased) Accounting year ended 30 June 2005

Tax year 2005

Computation of taxable income Rupees

Capital gainsTransfer of shares in Das (Private) Ltd to Govind (Note 1) 22,500 2Employee share schemeGain on sale of shares in ABC plc (Note 2) 480,000 3Gain on sale of postage stamp (Note 3) 37,500 1·5Gain on sale of shares in PQR Ltd – exempt (Note 4) 0 0·5

–––––––– 540,000

Income from other sourcesIncome on vacating possession of a building (Note 5) 50,000 1

––––––––Total income being the taxable income 590,000

––––––––

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 (a) and one mark each for items (b) and (c)] as follows: 4

–––15–––


(a) Transmission of 10,000 shares in Das (Private) Ltd to Shirin.Under the non-recognition rules [s.79(1)(b) and s.79(2)] no gain or loss is taken to have arisen on thedisposal of an asset, by reason of the transmission of the asset to an executor or a beneficiary on thedeath of a person, provided the person acquiring the asset is not a non-resident person for Pakistan taxpurposes at the time of the acquisition.

The transfer of the shares to Shirin on 15 June 2005 (tax year 2005) falls within the ambit of the non-recognition rules, as Shirin was not a non-resident person for Pakistan tax purposes in the tax year 2005.Shirin was a resident individual, since she was an employee of the Federal Government in the tax year2005 [s.82(c)]. Therefore the question of any gain or loss on the transfer of the 10,000 shares does notarise.

(b) The transfer of Rs.179,496 from Tikam’s bank account to Shirin, also falls within the ambit of the non-recognition rules (s.79) referred to in item (a), since Shirin is not a non-resident. Furthermore in a transferof cash in Pakistan rupees, there is no gain or loss on the transfer.

(c) A loss on the disposal of a capital asset is not deductible where a gain on the disposal of such an asset isexempt from tax. As DEF Ltd is a public company for tax purposes, any gain on the disposal of its sharesis exempt from tax up to the tax year 2007. Therefore, the loss of Rs.40,000 on the disposal of the sharesin DEF Ltd is not deductible. DEF Ltd is a ‘public company’ since its shares were traded on the Karachistock exchange in the tax year 2005 and DEF Ltd remained listed on that exchange on 30 June 2005.

23



MarksNote (1) Transmission of 10,000 shares in Das (Private) Ltd to Govind.

The non-recognition rules [s.79(1)(b) and s.79(2) referred to in item (a) of ‘Items not included in thecomputation of income’] under which no gain or loss is required to be computed on a disposal of an asset by reason of transmission of the asset to a beneficiary on the death of a person, is notapplicable to the transfer of 10,000 shares in Das (Private) Ltd to Govind since he was a non-resident individual at the time of acquiring the shares. He was a non-resident individual since he wasneither present in Pakistan for at least 182 days in the tax year 2005 nor was he an employee of theFederal or a Provincial Government posted abroad in the tax year 2005 [s.82].

As no consideration was paid by Govind for the shares, the fair market value (FMV) of the shares atthe time of its transmission to him is treated as the consideration for the shares [s.77(1)]. The FMVof an asset shall be the price, which the asset would ordinarily fetch on sale in the open market[s.68(1)]. Das (Private) Ltd being a private company, its shares were not quoted on any stockexchange. In the circumstances, the break-up value of the shares at Rs.13 per share, as determinedby the firm of chartered accountants, is taken as its FMV.

RupeesConsideration – FMV of the 10,000 shares (Rs.13 x 10,000) 130,000Cost – Rs.10 per share (Rs.10 x 10,000) 100,000

––––––––Capital gain 30,000

––––––––

As the shares were held by Tikam for more than one year, 75% of the gain is chargeable to tax. 22,500

––––––––

Note (2) Gain on the disposal of 400 shares in ABC plc acquired under an employee share scheme

RupeesConsideration received on the disposal of the 400 shares on 1 July 2004 1,000,000Cost of 400 shares (Note 2A) (520,000)

–––––––––Gain on disposal 480,000

––––––––––––––––––As the shares were held for less than one year, the entire gain of Rs.480,000 is chargeable to tax as income from capital gains.

Note (2A) The cost of the shares acquired under an employee share scheme is the sum of (i) the consideration,if any, paid by the employee for the shares; (ii) the consideration, if any, paid by the employee for theright or option to acquire the shares; and (iii) the amount chargeable to tax as the salary income ofthe employee on acquiring the shares [s.14(4)].

Rupees(i) £10 paid on the acquisition of 400 shares on 31 May 2004 (Tax year

2004) – £10 x 400 = £4,000 (£1 = Rs.100) 400,000

(ii) Amount charged to tax as salary income in the tax year 2004. 400 shares were acquired at the exercise price of £10 per share when the FMV of one share was £13. The difference of £3 per share equal to Rs.120,000 (£3 x 400 = £1200 i.e. Rs.120,000) is the taxable benefit which would have been taxed under the head ‘salary’ in the tax year 2004. 120,000

––––––––520,000––––––––––––––––

24



MarksNote (3) Gain on sale of one postage stamp

A gain or loss under the head ‘capital gains’ can only arise on the disposal of a ‘capital asset’.Moveable assets held for personal use (with certain exceptions) are excluded from the definition of a‘capital asset’ and therefore any gain or loss on the disposal of such moveable assets (which are notin the list of the exceptions) are outside the ambit of capital gains. One of the exceptions to the aboveis a postage stamp. A postage stamp even if held for personal use is treated to be a ‘capital asset’and any gain on its disposal is chargeable to tax as income from capital gains. However, any loss onthe disposal of a postage stamp is not recognised as a capital loss.

For assets acquired by inheritance (there is no cost of acquisition for the person acquiring the asset),the FMV of the asset at the time of its transfer is treated as the cost of the asset [s.37(4A)]. Thepostage stamp inherited by Tikam in 1981 was valued by an expert to be worth Rs.50,000 whichcan be taken to be the FMV of the postage stamp at the time of its transfer to Tikam in 1981.Rs.50,000 is accordingly treated to be the cost of the postage stamp.

RupeesSale consideration of the postage stamp 100,000Cost being the FMV of the postage stamp in 1981 (50,000)

–––––––Gain on sale 50,000

––––––––––––––75% of Rs.50,000 is chargeable to tax since the postage stamp was held by Tikam for more than a year. 37,500

Note (4) A gain on the disposal of shares in a company which is a ‘public company’ for tax purposes ispresently exempt from tax up to the tax year 2007. PQR Ltd is a ‘public company’ for tax purposes,since not less than 50% of its shares are held by a Provincial Government. Therefore the gain ofRs.3,000 on the disposal of the shares is exempt from tax.

Note (5) Any amount received by a person as consideration for vacating the possession of a building asreduced by the amount paid by the person to acquire the possession of the said building ischargeable to tax as ‘Income from other sources’ [s.39(1)(k)]. Rs.50,000 [Rs.200,000 –Rs.150,000] is the amount chargeable to tax as ‘Income from other sources’.

5 (a) (i) Bee’s contention for not treating the Rs.75,000 as taxable income in the tax year 2005 is erroneous. 1

The tax law specifically provides that if there is any income that has been derived by a person in a tax year from a business, activity, investment or other source that has either ceased before the commencement of that year or during the year and if that income would have been taxable had there been no cessation, then the provision of the tax statute would apply as if there was no cessation [s.72]. 2

In other words, s.72 deems the business, activity, investment or other source to have been carried on by the person in the tax year in which the income was derived despite the cessation of the business,activity, investment or other source. 1

To rectify the above error, Bee should furnish a revised return of income to the Commissioner [s.114(6)]showing the Rs.75,000 as taxable income under the head ‘Income from business’. 1

(ii) Bee’s contention that the tax deducted at source from the dividend income is the final tax on such incomeis correct. Such dividend income is not chargeable to tax under any head of income and is therefore not tobe included in the return of income under s.114. However, Bee was required to file a statement of finaltaxation in respect of the dividend income in the prescribed form [s.115.(4)].

To rectify the above error, Bee should furnish the statement under s.115(4) to the Commissioner 3

(b) (i) The requirements for the formation of a ‘small company’ are:

(a) the company has to be registered under the Companies Ordinance, 1984 on or after 1 July 2005;

(b) its paid up capital plus undistributed reserves should not exceed Rs.25 million;

(c) its annual turnover should not exceed Rs.200 million; and

(d) it is not formed by the splitting up or the reconstitution of a company already in existence. 4

(ii) The advantages of a small company are:

(a) The corporate rate of tax on its taxable income is 20% for the tax year 2006 and onwards as against the rate of 35% for public companies and 37% for private companies for the tax year 2006;

(b) small companies are not required to withhold tax at the time of making a payment to a resident person or a permanent establishment in Pakistan of a non-resident person for the sale of goods, for the rendering of or providing of services or on the execution of a contact, other than a contact for the sale of goods or the rendering of or providing of services; and

25



Marks(c) small companies are exempted from the provisions of payment of minimum tax which is applicable

to a resident company, where no tax is payable or paid for a tax year or the tax payable or paid for a tax year, is less than 1/2% of the company’s turnover from all sources. [The exemption from the payment of minimum tax is given in clause (11) (XV) of part IV of the Second Schedule]. 3

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6 (a) Mr Murtaza Accounting year ended 30 June 2005

Tax year 2005Computation of taxable income RupeesIncome from propertyRent chargeable to taxRent for 12 months (Note 1) 600,000 1Non-adjustable deposit treated as rent (Note 2) 130,000 3

––––––––730,000

Deduction for repairs (Note 3) 146,000 1––––––––584,000

Recovery of unpaid rent (Note 4) 50,000 1–––––––– 634,000

Income from other sourcesIncome connected with renting of the house (Note 5) 120,000 1

––––––––Total income which is also the taxable income 754,000

––––––––

Note (1) Rent for 12 monthsWhere the rent receivable by an owner of a building includes an amount for the provision ofamenities, utilities or any other services which are connected with the renting of a building suchamount is not chargeable to tax under the head ‘Income from property’. As the monthly rent ofRs.60,000 payable by Jill includes Rs.10,000 for the provision of the services of a security guard,the amount chargeable to tax as ‘Income from property’ is Rs.600,000 [Rs.60,000 less Rs.10,000for the services of the security guard (Rs.50,000 x 12)].

Note (2) Non-adjustable deposit treated as rent (i) An amount (Amount) received by an owner of a building from a tenant which is not adjustable

against the rent payable is treated as rent chargeable to tax under the head ‘Income fromproperty’. The Amount is taxable over a period of 10 years in equal proportion including the yearin which the Amount is received [s.16(1)]. If the Amount is refunded to the tenant before theexpiry of the 10 years, no portion of the Amount is chargeable to tax in the tax year in which theAmount is refunded or in any subsequent year [s.16(2)].

(ii) Non-adjustable deposit received from Jill on 1 July 2004:Rupees

Amount received 1,500,000Portion of amount charged to tax out of the deposit of Rs.1,000,000 received from Jack (Note 2A) 200,000

–––––––––1,300,000–––––––––

1/10 chargeable to tax in the tax year 2005 130,000–––––––––

Note (2A) Non-adjustable deposit of Rs.1,000,000 (Previous Deposit) received from Jack on 1 July 2002 (tax year 2003) was charged to tax as under:

Tax year 2003: 1/10 of Rs.1,000,000 100,000Tax year 2004 1/10 of Rs.1,000,000 100,000Tax year 2005: Not chargeable to tax as the amount was refunded on 1 July 2004 0

––––––––200,000––––––––

26



MarksAs the Previous Deposit was refunded before the expiry of 10 years, the Rs.200,000 charged to taxout of the Previous Deposit is required to be deducted from Rs.1,500,000 [Subsequent Deposit]received from Jill on 1 July 2004 (tax year 2005) to arrive at the amount chargeable to tax over aperiod of ten years in equal proportion including the tax year 2005 in which the Subsequent Depositwas received [s.16(3)].

Note (3) An amount equal to one-fifth of the ‘rent chargeable to tax’ is allowed as a statutory deduction incomputing income chargeable as ‘Income from property’ irrespective of whether or not any amounthas been spent on repairs to the house property. The statutory allowance is to be calculated on theamount of the ‘rent chargeable to tax’ and not on the amount of the rent received or receivable. Therent chargeable to tax also includes Rs.130,000 being the portion of the deposit amount receivedfrom Jill which is not adjustable against the rent payable. Therefore the deductions for repairs isRs.146,000 being one-fifth of Rs.730,000 (Rs.600,000 + Rs.130,000)

Note (4) Where any unpaid rent, which has been allowed as a deduction in any year in computing incomechargeable as ‘Income from property’, is subsequently wholly or partly recovered, the amountrecovered is chargeable to tax in the tax year in which it is recovered [s.17(2)]. The unpaid rent ofRs.50,000 for June 2003 received from Jack in the tax year 2005 is therefore chargeable to taxunder the head ‘Income from property’ in the tax year 2005.

Note (5) Income from the provision of amenities or any other service connected with the renting of a buildingis chargeable to tax under the head ‘Income from other sources’ [s.39(1)(fa)]. Out of the monthly rentof Rs.60,000, Rs.10,000 is for the services of a security guard. Therefore Rs.120,000 (Rs.10,000 x12) is chargeable to tax as ‘Income from other sources’.

(b) (i) ‘Rent’ received or receivable by the owner of a building or land for the use or occupation of, or the right touse or occupy the land or building is chargeable to tax under the head ‘Income from property’. ‘Rent’ alsoincludes any forfeited deposit paid under a contract for the sale of land or a building [s.15(1) and (2)].

The amount of Rs.100,000 paid by Bashir against the contract for the sale of land which was forfeitedunder the terms of the contract for the sale of the land is rent chargeable to tax under the head ‘Incomefrom property’.

2

(ii) A composite rent of Rs.400,000 per month is receivable as consideration for the lease of the property‘Ataghar’ since the letting of the building is inseparable from the letting of the plant. The income from suchletting is chargeable to tax under the head ‘Income from other sources’ [s.39(1)(f)].

In computing the income arising from the lease of ‘Ataghar’ in a tax year, the permissible deductions are:

(a) deductions for any expenditure paid by Nadir in the relevant tax year in deriving the income from thelease other than any expenditure of a capital nature [s.40(1)]. Expenditure is considered to be of acapital nature for the purposes of s.40 if it has a normal useful life of more than one year; [s.40(6)];

(b) a deduction for the depreciation of the building and the plant [s.40(3)(a)]; and

(c) an initial allowance for the plant [s.40(3)(b)].

No deduction is allowed for an expenditure which is not deductible in computing income under the head ‘Income from business’ [s.40(5)]. 4

(iii) Nadir is not entitled to claim one-fifth of the lease rent as a deduction for repairs to the building. Such a deduction for repairs is allowable only against rent chargeable to tax as ‘Income from property’. As the income from ‘Ataghar’ is chargeable to tax under the head ‘Income from other sources’, only the expenditure which has been paid in deriving such income would be deductible. The actual amount paid for repairs to the building would be a deductible charge. 2

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27



Marks7 (a) (i) The following conditions have to be met to ensure that no tax is deducted under s.153(1) from the

payments made for the sale of imported goods:

(i) the sale should be made by the same person who has imported the goods;

(ii) the person who has imported the goods should have paid advance tax at the customs stage under s.148 on the value of the goods imported as determined for customs purposes; and

(iii) the goods should be sold in the same condition they were in when it was imported. 3

(ii) The following persons are ‘a prescribed person’ for the purposes of s.153(1): – the Federal Government; – a company other than a ‘small company’ as defined for tax purposes; – an association of persons constituted by or under any law; – a foreign contractor or consultant; – a consortium; or – a joint venture. Any four persons at a 1/2 mark each 2

(iii) The tax is to be deducted when the amount is actually paid and not when it is credited to the account of the recipient [s.158(b)]. 1

[Note: The only exception to the above rule is in the case of deduction of tax on a payment for profit ona debt (s.151) in which case the tax is to be deducted at the time the amount is paid or credited to theaccount of the recipient, whichever is earlier [s.158(a)].

(b) (i) SkyAdverts is a non-resident person for Pakistan tax purposes. A prescribed person making a payment to a non-resident person inter alia on the execution of a contract for advertisement services by ‘TV Satellite Channels’, is required to deduct tax [s.153(3)(e)] at the rate of 6% of the gross amount payable. A company, other than a ‘small company’ is a prescribed person and therefore Chaiwalla Pakistan Ltd (CPL) would deduct tax from the gross amount payable under the contract. 3

(ii) It is not mandatory that the tax deducted from the payments to SkyAdverts would be its final tax on the income arising from the TV Contract. SkyAdverts can be taxed on the net income basis if it does not opt for assessment on the final tax basis. 1

(iii) The tax deducted under s.153(3)(e) by CPL will be the final tax of SkyAdverts if SkyAdverts 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 i.e. the tax year in which the option is furnished and the succeeding two years [clause (41) of Part IV of the Second Schedule]. 4

(iv) If SkyAdverts is unable to comply with any of the requirements for being assessed on the final tax basis (say if the declaration is not furnished to the Commissioner in time), the tax assessment of SkyAdverts would be on its net taxable income and the tax deducted by CPL would be allowed as a tax credit. 1

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28




PART 2


QUESTION PAPER









Pape

r 2.3

(PK

N)




2




A. Tax rates for individuals where salary income exceeds 50% of taxable income for the tax year 2006Taxable income Rate of taxUp to Rs.100,000 0%Rs.100,001 – Rs.200,000 3·5% of the amount exceeding Rs.100,000Rs.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 Banking Public company other Private company other


C. Rates of advance collection or deduction of taxPrize on prize bonds 10% of gross payment


E. Capital allowances DepreciationBuildings (all types) 10%Furniture and fittings 15%Plant and machinery (not otherwise specified) 15% of the tax written down valueMotor vehicles (all types) 15%Computer hardware 30%


F. Benchmark rateFor determining the value of the perquisite on loans given to employees, the benchmark rate is:

For the tax year 2006A rate of 8% per annum of the loan amount

3 [P.T.O.

⎫

⎬⎪

⎭⎪




1 Jingo Ltd, an industrial undertaking engaged in the manufacture of textiles, requires you to compute its taxable incomefor the year ended 30 June 2006. The following information is furnished to you:

(1) Jingo Ltd is a public company under the Companies Ordinance 1984. 50% of the shares are held by ABC Ltd,a company incorporated in Saudi Arabia which is wholly owned by the Kingdom of Saudi Arabia. Jingo Ltd isnot listed on any stock exchange of Pakistan.

(2) The control and management of the affairs of Jingo Ltd was situated partly outside Pakistan during the year ended30 June 2006.

(3) The accounting profit for the year ended 30 June 2006, prior to the transfer of Rs.500,000 to general reserveaccount was Rs.1,960,000.

(4) Deductions charged in the accounts include: Rupees

(i) Tax collected by the Collector of Customs on the value of the import of an item of second-hand plant for the company’s own use. 20,000

(ii) Payment to a supplier to prematurely terminate a forward contract for the purchase of cotton bales to avoid a loss expected to arise. 300,000

(iii) Legal expenses in connection with the issue of Term Finance Certificates which is a long-term loan for working capital requirements. 900,000

(iv) Telephone and electricity bills paid in cash. 200,000

(v) Depreciation on the company’s owned assets written off in the books. 855,507

(vi) First yearly instalment of the lease rental paid to a scheduled bank (lessor) in respect of an item of plant taken on lease which is used by Jingo Ltd for its business. The ownership of the plant would be transferred to Jingo Ltd by the lessor on payment of the final sixth yearly instalment of the lease rental. 700,000

(vii) Depreciation written off on the leased plant. 100,000

(viii) Donation to a medical university established by the Federal Government. 350,000

(5) Income shown in the accounts includes dividends received (net of tax deducted at source) from:

– a private company; and 90,000

– a public company listed on the Karachi stock exchange. 195,000

(6) Creditors include

Rs.1,000,000 received from Mr Chamanlal in cash as a loan in June 2006.

(7) Fixed assets(i) The tax written down values of the fixed assets on 1 July 2005 were:

Plant and machinery 1,800,000Buildings 5,000,000Motor vehicles 500,000Computer hardware 600,000Furniture 400,000

(ii) An item of second-hand plant (previously used in Pakistan) was imported in October 2005 at a cost of Rs.3,000,000. Rs.660,000 was incurred on repairs to bring the plant up to the standard required and render it serviceable. The plant was commissioned for use on 15 June 2006. The Rs.660,000 on repairs has been claimed as deductible expenditure.

(iii) New computers were purchased on 1 September 2005 for Rs.250,000.

(iv) During the year ended 30 June 2006, Rs.4,000,000 was expended on the construction of workers’ residential quarters which includes Rs.1,000,000 for the cost of land.

4



Rupees(v) One of the office buildings was sold on 29 June 2006 for Rs.9,000,000. The cost of the

building sold was Rs.5,000,000 and its tax written down value at the time of the sale was Rs.3,500,000. The accounting profit of Rs.2,000,000 on the sale of the building has beenincluded in the profit and loss account under the heading ‘Other income’.

(8) During the year ended 30 June 2006, 10,000 shares in Cleangas Ltd were acquired from the Privatisation Commission of Pakistan for Rs.600,000.

(9) Other information:

(i) Rs.1,250,000 was expended on the in-house development of computer software for textile designs. The Rs.1,250,000 has been shown as an asset in the balance sheet. The software has been used in the business since 31 March 2006 and its normal useful life has been estimated by the company’s engineering department to be twelve years.

(ii) It is the company’s consistent accounting policy that any item of furniture costing less thanRs.50,000 is charged off immediately in the accounts. Purchases of such items in the accounting year ended 30 June 2006 amounted to Rs.250,000.

(iii) Provisions for bad debts comprises:

Balance on 1 July 2005 700,000Provision made during the year (3% of debtors) and charged to the profit and loss account 300,000Received against a debt written off in the tax year 2003 which was allowed as a deductionunder the head ‘Income from business’. 350,000

––––––––––1,350,000

Trading debts written off during the year 250,000––––––––––

Balance on 30 June 2006 1,100,000––––––––––

(iv) Advance tax paid in quarterly instalments for the relevant tax year 400,000

Required:

(a) Briefly state with reasons whether or not Jingo Ltd will be a public company for tax purposes. (2 marks)

(b) Briefly state with reasons whether you consider Jingo Ltd to be a resident company or a non-residentcompany. (1 mark)

(c) Compute the taxable income of Jingo Ltd for the relevant tax year under the appropriate heads of income.Your answer should give clear reasons/explanations for the inclusion or exclusion in the computation of eachof the items listed above. The reasons/explanations for the items not included in the computation of incomeshould be shown separately. (23 marks)

(d) Calculate the tax payable by/refundable to Jingo Ltd in the relevant tax year. Taxes deducted or collected atsource which are considered as the final tax should be shown separately. (4 marks)

(30 marks)

5 [P.T.O.




The following information is furnished to you by Mr Sultan for his accounting year ended 30 June 2006.

(1) Sultan is a citizen of Pakistan and until 30 June 2005 he was an employee of PQR Ltd

(i) On reaching the age of 50 years, he opted for early retirement on 1 July 2005 under the PQR EarlyRetirement Scheme (Scheme). The management accepted his resignation and under the terms of theScheme he received Rs.1,000,000 for loss of employment on 2 July 2005.

(ii) On retirement, he also received:

– Rs.500,000 as a gratuity from the PQR Gratuity Fund. The Fund has been approved by theCommissioner under Part III of the Sixth Schedule.

– Rs.1,600,000 being the accumulated balance in his account in the recognised PQR Employee’sProvident Fund.

(iii) He is also eligible for a monthly pension of Rs.75,000 which is paid by PQR Ltd by the direct transfer offunds to his bank account.

(2) ABC Ltd is a wholly owned subsidiary of PQR Ltd. Both companies are anxious that Sultan should take over asthe chief financial officer of ABC Ltd. Sultan agreed to join ABC Ltd from 1 September 2005. Prior to issuing aletter of appointment, ABC Ltd, as a gesture of goodwill, voluntarily made a gratis payment of Rs.300,000 toSultan on 15 July 2005. In the records of ABC Ltd the payment is described as a gift and not attributable to anyservices rendered or to any right to receive the amount on the part of Sultan.

(3) Sultan’s terms of employment with ABC Ltd provided for the following from 1 September 2005:

(i) A basic salary of Rs.200,000 per month

(ii) Monthly cash allowance of:

– Rs.20,000 for leave fare assistance

– Rs.50,000 for house rent

– Rs.20,000 for utilities

– Rs.30,000 for medical expenses (the terms of employment do not provide for free medical treatmentor hospitalisation, or any reimbursement for such expenses)

(iii) A company maintained motor car for personal and business use. Rs.3,000 to be reimbursed each monthby Sultan towards the cost of personal use of the car.

(4) In order to provide the benefit of the company car to Sultan, a new Honda Accord was leased by ABC Ltd on 1 October 2005. The market value of the car on that date was Rs.4,000,000.

(5) On 1 January 2006, Sultan took a loan of Rs.500,000 from ABC Ltd repayable in 10 equal yearly instalments.No profit on the loan is payable. On 30 June 2006, Rs.127,000 of the loan amount was waived by ABC Ltd.

(6) Salaries and allowances of all employees for each month are disbursed by ABC Ltd on the first working day ofthe following month.

(7) Tax deducted at source by ABC Ltd on the salary income of Sultan was Rs.1,200,000.

(8) On 1 July 2005 Sultan leased a piece of land from A for an annual rent of Rs.100,000 payable in advance. Onthe same day, he sub-leased the land to B for an annual rent of Rs.150,000 payable in advance.

(9) Sultan is the owner of a house

(i) He rented out the house on 1 July 2005 to Mr Dee and received:

– Rs.300,000 as rent for six months in advance; and

– Rs.600,000 as a refundable deposit which is not adjustable against the rent.

On 31 December 2005, Dee vacated the house and the deposit of Rs.600,000 was returned to him.

(ii) The house remained vacant for three months from 1 January 2006 to 31 March 2006.

6



(iii) The house was let out to Mr Cee on 1 April 2006. Sultan received Rs.150,000 as rent for three months inadvance and he also collected Rs.600,000 as a refundable deposit which is not adjustable against the rent.

(iv) Sultan wants to claim the following deductions:

– Rs.150,000 at the rate of Rs.50,000 per month for the three months the house remained vacant.

– Rs.60,000 for legal expenses for defending his title to the house.

(10)Sultan approaches you to prepare his return of income for the year ended 30 June 2006. He informs you thatprior to 30 June 2006:

(i) He has invested Rs.600,000 in the acquisition of shares in Cleangas Ltd from the Privatisation Commissionof Pakistan.

(ii) He has elected to be taxed on the amount of the compensation for loss of employment received from PQRLtd at the average rate of tax paid by him on his total income for the preceding three years, which is at therate of 25%.

(iii) He received Rs.90,000 (net of tax deducted at source) as a prize on a prize bond.

Required:

(a) Compute the taxable income of Mr Sultan under the relevant heads of income for the relevant tax year givingclear reasons/explanations for the inclusion or exclusion in the computation of income of each of the itemslisted above. The reasons/explanations for the items not included in the computation of income should beshown separately. (20 marks)

(b) Calculate the tax payable by/refundable to Mr Sultan for the relevant tax year. (5 marks)

(25 marks)

7 [P.T.O.



Section B – THREE questions ONLY to be attempted

3 (a) Cinderella Ltd is engaged in the manufacture of ready-to-wear clothing. The company’s business transactions forthe month of May 2006 are summarised as follows:

Rupees

(i) Purchase of raw materials used exclusively in making taxable supplies 1,350,000

(ii) Purchase of raw materials used in making both taxable and exempt supplies, the payments for which were made as under: 2,285,000

Online transfer of funds from the business bank account of the company to the business bank account of the supplier 1,150,000

Cash payment into the business bank account of the supplier 65,500

Payment by credit card into the business bank account of the supplier 1,069,500––––––––––2,285,000––––––––––

(iii) Purchase of raw materials used exclusively in making exempt supplies 900,000

(iv) Raw material and spare parts purchased exclusively for making zero rated supplies 1,600,000

(v) Payment to a courier company 365,000

(vi) Sale of taxable goods 6,850,000

(vii) Sale of exempt goods 1,175,000

(viii) Sale of zero rated goods 2,220,000

(ix) Goods sold in January 2006 to Mr Bee were returned by him in May 2006 due to defectiveworkmanship for which the company issued credit notes to Bee and received debit notes from Bee. 694,000

(x) Advance payment received in May 2006 for the supply of goods to be made in September 2006 750,000

NoteAll payments for the purchases and the payment to the courier company are stated inclusive of sales tax at therate of 15%. The figures for the sales, the advance payment received and the credit notes issued are statedexclusive of sales tax.

Required:

Calculate the sales tax payable by Cinderella Ltd in respect of the sales tax return for the month of May2006. (10 marks)

(b) Section 7 of the Sales Tax Act, 1990, determines the liability of a registered person to pay sales tax. A registeredperson is not entitled to deduct the input tax from the output tax for the purposes of payment of sales tax unlesshe holds certain documents required under the law.

Required:

Specify the documents that a registered person should hold for the purposes of claiming input tax in the caseof:

– a taxable supply made;

– goods imported into Pakistan; and

– goods purchased in an auction. (3 marks)

8



(c) A registered person is preparing his sales tax return for the month of May 2006. He finds that he has omitted toclaim input tax paid on goods purchased in the month of August 2005.

Required:

State whether or not it is still possible to claim the omitted input tax for August 2005 and if so, the procedurefor claiming it. (2 marks)

(15 marks)

9 [P.T.O.



4 For the purpose of this question, you should assume that today’s date is 2 September 2006.

Mr Jamshed is preparing his return of income for the tax year 2006 and furnishes you with the following informationfor his accounting year ended 30 June 2006.

(1) Airaids plc (AAP) employee share scheme (Scheme).As an employee of AAP Karachi branch he had participated in the Scheme and on 1 July 2005 he was giventhe option to purchase 500 shares in AAP at the exercise price of £10 per share. The value of the option, asgiven by the custodian of the Scheme, was to be calculated at the rate of £1 for every share offered. (The rateof exchange to be taken as £1 = Rs.100.)

Jamshed’s contention in respect of the transactionAs the option was acquired free of cost, it is a perquisite of employment and its monetary value is a taxableincome. As the price of one option as declared by the custodian of the Scheme was £1 for every share offered,£500 is chargeable to tax under the income head of ‘salary’. (2 marks)

(2) Sale of the option to acquire 500 shares in AAP.On 7 June 2006 Jamshed sold the option for Rs.100,000.

Jamshed’s contention in respect of the transactionAs the option to acquire the 500 shares was held for less than one year, the entire gain is chargeable to taxunder the income head of ‘Capital gains’. (2 marks)

(3) 300 shares in XYZ plc.Prior to joining Airaids plc, as an employee of XYZ plc, Jamshed had in the tax year 2005, acquired 300 sharesin XYZ plc under an employee share scheme at the exercise price of £10 per share when the price of one shareon the stock exchange in the UK was £15. On 31 May 2006, he gifted the 300 shares to his son Sorab, whohad left Pakistan on 28 December 2005 to reside in India and has been living in India ever since. For the purposeof the deed of gift, the shares were valued at £20 per share being the price quoted on the stock exchange in theUK on 31 May 2006. (The rate of exchange to be taken as £1 = Rs.100)

Jamshed’s contention in respect of the transactionThere are no tax implications on this transaction due to the non-recognition rules [s.79] which provide thatno gain or loss shall be taken to have arisen on the disposal of an asset, inter alia, by reason of a gift of theasset. (5 marks)

(4) Moveable assets consisting of jewellery and an antique vase held for personal use.

(i) The jewellery was inherited by Jamshed in the year 1960, when it was valued by the family jeweller atRs.700,000. The jewellery was sold for Rs.1,300,000 on 7 June 2006.

(ii) Jamshed was a partner in a firm dealing in antiques. The vase became his property on the dissolution ofthe firm in the year 2000, when it was valued by an expert at Rs.300,000. The vase was sold forRs.200,000 on 7 June 2006.

Jamshed’s contention in respect of the transactionA capital gain can only arise on the disposal of a ‘capital asset’. As jewellery held for personal use is excludedfrom the definition of a ‘capital asset’, the gain of Rs.600,000 on the disposal of the jewellery is not incomechargeable to tax as capital gains. However, the loss of Rs.100,000 on the sale of the vase is to be claimedas a capital loss. (2 marks)

(5) Shares in Zee LtdJamshed suffered a loss of Rs.50,000 on the sale of 1,000 shares in Zee Ltd. Zee Ltd is a public company fortax purposes

Jamshed’s contention in respect of the transactionThe loss of Rs.50,000 on the sale of the shares is to be claimed as a capital loss. (2 marks)

(6) Unadjusted lossA capital loss of Rs.40,000 determined in the accounting year ended 30 June 1999 remains unadjusted.

Jamshed’s contention in respect of the transactionThe capital loss of Rs.40,000 is to be adjusted against the capital gains for the tax year 2006 and the balanceof the loss is to be carried forward. (2 marks)

10



Required:

State, giving reasons, whether or not you agree with each of the six contentions of Mr Jamshed. If you are not inagreement with any of his contentions, explain the correct treatment to be adopted (including if necessarycomputation of the income/loss for the particular transaction) for the determination of income under the correctheads of income for the tax year 2006.

Note: The allocation of marks is as shown against each of the six contentions of Mr Jamshed.

(15 marks)

5 Q Ltd is a company incorporated under the Companies Ordinance, 1984 and is not a ‘small company’ for taxpurposes. The following payments were made by Q Ltd during its accounting year ended 30 June 2006:

(1) Rs.100,000 to Mr PlusMinus for providing accounting services. The payment was made under a contract dated1 June 2006. During the period from 1 July 2005 to 31 May 2006, PlusMinus was not present in Pakistan. Hewas serving in Dubai as an employee of the Ministry of Foreign Affairs, Government of Pakistan. (4 marks)

(2) Rs.750,000 to Retailers Pakistan Ltd (RP) for goods purchased from them. RP is operating in Pakistan as abranch of Retailers Inc, a company incorporated in a country outside Pakistan which has no tax treaty withPakistan. (3 marks)

(3) Rs.1,000,000 to Builders Associates (BA) as an advance towards the execution of a civil contract for theconstruction of a building. The payment was made at the time of signing the agreement between Q Ltd and BAand no work on the building had commenced at the time of payment. BA is a firm registered under thePartnership Act and the control and management of its affairs was situated partly in Pakistan during the tax year2006. (3 marks)

(4) Rs.400,000 to Mr Property being rent of a building paid in advance for the year ended 30 June 2006. TheRs.400,000 includes Rs.50,000 for rent of the furniture and fixtures in the building. (2 marks)

(5) £100,000 remitted through regular banking channels to Machinery Suppliers plc (MSP) for the cost of a packingmachine inclusive of sea freight. The title in the machine passed to Q Ltd at the time the machine was handedover to the ship at the London docks for transportation to Karachi. Dealing in packing machines is the businessof MSP. MSP has neither any presence in Pakistan, nor any activity in Pakistan. (3 marks)

Required:

For each of the payments made by Q Ltd:

(a) briefly explain the nature of the payment in the context of the relevant provisions relating to the deductionof tax, if any, at the time of the payment; and

(b) identify the transactions where the tax deducted, if any, would be the final tax of the recipients on the incomearising from the transaction.

Note: The allocation of marks is as shown against each of the five scenarios given in the question.

(15 marks)

11 [P.T.O.



6 (a) The following information is provided to you:

(1) GoldFinger Ltd (GL) is a non-resident company incorporated in a country which has no tax treaty withPakistan for the avoidance of double taxation.

(2) GL is a private company wholly owned by Diamond Jim and his family members.

(3) GL has been operating in Pakistan since 1 June 2000 as a branch.

(4) GL entered into an agreement on 1 June 2000 with the provincial government of Balochistan under whichGL was given the right to explore and exploit mineral deposits in a specified area of Balochistan for a periodof ten years.

(5) In June 2006 Diamond Jim and his family members sold their entire shareholding in GL to an enterprise inthe United Kingdom and made a gain of £100,000.

(6) Diamond Jim and his family members were non-residents for Pakistan tax purposes in the tax year 2006.

Diamond Jim is of the view that since he and his family were non-residents in the tax year 2006 and the gainarose from the sale of the shares in a non-resident company (GL), the gain of £100,000 is not chargeable to taxin Pakistan.

Required:

(i) State, giving reasons, whether or not the view of Diamond Jim is correct. (6 marks)

(ii) Explain whether or not your conclusion would be different and if so how, if the branch in Pakistan ofGoldFinger Ltd was engaged in the distribution of petroleum products and its income was principallyfrom the distribution of petroleum products. (4 marks)

(b) Under the concept of ‘group relief’, a subsidiary company, owning and managing an industrial undertaking or anundertaking engaged in providing services can surrender its assessed loss for the tax year, other than broughtforward losses, to its holding company, if such company is a public company listed on a stock exchange inPakistan and the holding company owns or acquires 75% or more of the share capital of the subsidiary company.The loss surrendered by the subsidiary company will be available to the holding company for set off against its‘Income from business’.

Required:

(i) State whether the concession for the set-off of the loss (surrendered by the subsidiary company) by theholding company is subject to any conditions and if so, state the conditions. (2 marks)

(ii) State the limitation period within which the holding company should set-off the loss surrendered by thesubsidiary company. (1 mark)

(iii) State what would happen to any part of the loss surrendered by the subsidiary company which cannotbe adjusted by the holding company within the limitation period. (2 marks)

(15 marks)

12



7 You are furnished with the following information by the local agent of Skylines Air (SA).

(1) SA is a company incorporated in Australia. Pakistan does not have an agreement for the avoidance of doubletaxation with Australia. SA is in the business of operating aircraft which are owned by it.

(2) SA intends to commence operations in Pakistan which would be limited to the carriage of goods embarked fromPakistan to destinations outside Pakistan and the carriage of goods imported into Pakistan embarked outsidePakistan.

(3) The world income of SA is taxed in Australia.

The local agent of SA wants you to prepare a comprehensive note explaining:

(I) The tax provisions under which SA’s income would be chargeable to tax in Pakistan, the basis of computingthe amount chargeable to tax and the tax payable.

(ii) Whether the above basis for the computation of income would change if some of the aircraft used for thePakistan operations are chartered by SA.

(iii) The basis to be adopted for the apportionment of the expenditure incurred in deriving SA’s world income(including Pakistan operations) which can be claimed as a deduction in determining the income chargeableto tax in Pakistan.

(iv) Whether proportionate tax credit, in respect of the tax paid in Australia by SA on its world income would beallowed against the tax assessed in Pakistan.

(v) The procedure for filing the return of income and the payment of tax.

Required:

(a) Prepare the note required by the local agent.

Marks will be allocated to the five items as (i) 5 marks; (ii) 1 mark; (iii) 1 mark; (iv) 1 mark and (v) 3 marks.(11 marks)

(b) Briefly state with reasons whether your answer to item (a) above regarding the taxability of SA’s income inPakistan would be different, and if so how:

(i) If SA was incorporated in a country where its income was exempt from tax. (1 mark)

(ii) If SA was incorporated in a country which has a tax treaty with Pakistan and the treaty provides thatthe income from the operation of aircraft would not be taxable except in that country. (3 marks)

(15 marks)


13



Answers



Part 2 Examination – Paper 2.3(PKN) December 2006 AnswersBusiness Taxation (Pakistan) and Marking Scheme

Marks1 (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 [s.2(47)(ab)]. 50% of the shares in Jingo Ltd are owned by ABC Ltd, which is a foreign company wholly owned by the Kingdom of Saudi Arabia (foreign government). Therefore, Jingo Ltd is a public company for Pakistan tax purposes. 2

(b) Jingo 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 the company’s affairs does not apply to a company incorporated or formed by or under any law in force in Pakistan [s.83]. 1

(c) Jingo LtdAccounting year ended 30 June 2006

Tax year 2006Rupees

Computation of taxable incomeIncome from businessAccounting profit 1,960,000Add: Tax collected by the Collector of Customs (Note 1) 20,000 0·5

Accounting depreciation (Note 2) 855,507 0·5Depreciation on leased asset (Note 3) 100,000 1Donation (Note 4) 350,000 1Repairs to imported plant (Note 5) 660,000 1Tax profit on sale of building (Note 6) 1,500,000 2Cost of furniture written off (Note 7) 250,000 1Provision for bad debts (Note 8) 300,000 0·5Recovery against bad debts written off (Note 9) 350,000 1

––––––––––4,385,507

Less: Accounting profit on sale of building (Note 6) 2,000,000 0·5Amortisation of intangible (Note 10) 31,507 1Bad debts written off (Note 11) 250,000 0·5Initial allowance (Note 12) 1,625,000 1Depreciation (Note 13) 1,509,000 3·5Dividend income (net of tax deducted) for separate consideration (Note 14) 285,000 0·5

––––––––––(5,700,507)––––––––––

645,000Income from other sources

Loan received in cash (Note 15) 1,000,000 1·5––––––––––

Taxable income 1,645,000––––––––––


–––23


(1) No adjustment is required in the computation of income for the Rs.500,000 transferred to generalreserve since the transfer is after determination of the net profit of Rs.1,960,000. Rs.500,000transferred to general reserve is an appropriation of the profit.

(2) Any expenditure incurred to terminate a disadvantageous contract or a trading relationship in order toavoid monetary losses or commercial inconveniences occurring in the future or to remove a difficulty inthe carrying on of the business is a revenue expenditure. The payment of Rs.300,000 paid for thepremature termination of the contract for the purchase of cotton bales to avoid a loss expected to arise,is a deductible expenditure.

(3) Legal expenses in connection with a loan taken for working capital requirements is an expenditureincurred wholly and exclusively for the purposes of the business and is a deductible expenditure.

17



Marks(4) Any expenditures paid or payable under a single account head which, in aggregate exceed Rs.50,000

made other than by a crossed bank cheque or a crossed bank draft are not deductible exceptexpenditure not exceeding Rs.10,000. One of the other exceptions to this rule is a payment on accountof utilities. Therefore Rs.200,000 for telephone and electricity bills, though paid in cash, is deductible.

(5) The entire amount of the instalment of the lease rent incurred by a taxpayer (lessee), inter alia, to ascheduled bank (lessor), for the lease of an asset to be used by the taxpayer for the purposes of itsbusiness, is an allowable deduction [s.28(1)(b)]. Rs.700,000 paid as the first instalment of the leaserental is deductible.

(6) A tax credit is allowable to a person, except a company, on the investment in new shares offered to thepublic by a public company listed on a stock exchange in Pakistan provided the person is an originalallottee of the shares or the shares are acquired from the Privatisation Commission (s.62). Jingo Ltdbeing a company is not entitled to the tax credit and therefore the investment of Rs.600,000 has noimpact on the computation of income or the tax liability.

(d) Computation of tax liability

Tax on Rs.1,645,000 at 35% 575,750 0·5Tax credit on donation of Rs.350,000 (Note A) (86,362) 2

–––––––––489,388

Taxes deducted/collected at source:Collected by the Collector of Customs 20,000 0·5Advance tax paid 400,000 0·5

–––––––––(420,000)

–––––––––Balance of tax payable 69,388

–––––––––Tax deducted treated as the final tax (Note 14) 0·5Dividend income – gross amount Rs.300,000Tax deducted at 5% – Rs.15,000 –––

4–––30–––

Note (A) Tax credit on specified charitable donations is allowed at the average rate of tax (before allowance of any tax credit) on the amount of the donation paid or 15% of the taxable income whichever is lower [s.61(2)].

Tax credit is calculated as under:Rupees

Tax on taxable income before tax credit (A) 575,750Taxable income (B) 1,645,000Lower of amount of donation (Rs.350,000) or 15% of taxable income(15% of Rs.1,645,000 = Rs.246,750) (C) 246,750A/B x CRs.575,750/Rs.1,645,000 x Rs.246,750 86,362

Note (1) As Jingo Ltd is an industrial undertaking, the tax of Rs.20,000 collected at the customs stage onthe import of the second-hand plant for its own use is not the final tax on the income arising outof the import [s.148(7)]. Rs.20,000 is available to Jingo Ltd as a tax credit.

Note (2) For tax purposes accounting depreciation is not a deductible charge. Depreciation is allowable ondepreciable assets at the rates prescribed in the Third Schedule.

Note (3) Depreciation on the plant taken on lease is not deductible as the ownership of the plant has notbeen transferred by the scheduled bank (lessor) to Jingo Ltd (lessee).

Note (4) The donation of Rs.350,000 to the medical university is not deductible but Jingo Ltd is entitledto a tax credit calculated under a prescribed formula [s.61(1)(b) and (2)]. The tax credit availableis Rs.86,362. (The calculation of the tax credit has been given in the computation of tax liability).

Note (5) Rs.660,000 spent on repairs to the imported second-hand plant at the time of its purchase torender the plant serviceable is a capital expenditure. The amount is added to the initial cost of theplant (Note 13), since the plant could not be commissioned for use without the repairs.

18



Note (6) The accounting profit or loss on the disposal of a depreciable asset is not considered for taxpurposes. It is the tax profit or loss that is chargeable to tax or allowed as a deduction. The taxprofit or loss is the difference between the consideration received and the tax written down valueof the asset [s.22(8)]. In the case of immovable property (other than land) where the considerationreceived on the disposal exceeds the cost of the property, the consideration received is treated asthe cost of the property [s.22(13)(d)] for calculating the tax profit or loss.

As the consideration received (Rs.9,000,000) for the building sold is more than the cost of thebuilding (Rs.5,000,000), Rs.9,000,000 is treated as the cost of the building (deemed cost) forworking out the tax profit/loss on the sale of the building.

The tax profit on the disposal of the building is worked out as under:

Sale consideration 9,000,000Less: Tax written down value

Deemed cost 9,000,000Depreciation allowed [actual cost Rs.5,000,000 lesstax written down value Rs.3,500,000] (1,500,000)

––––––––––7,500,000––––––––––

Tax profit 1,500,000––––––––––

Note (7) The cost of the furniture purchased is capital expenditure and is not deductible. The accountingpolicy of the company to treat such expenditure as revenue expenditure cannot override theprovisions of the tax statute. For tax purposes Rs.250,000 is treated as a depreciable asset (Note 13).

Note (8) Since the provision of Rs.300,000 is not against specific debts, it is not a deductible charge.

Note (9) Rs.350,000 credited to the provision for bad debts account represents a receipt against a debtwhich was allowed as a deduction (bad debts) in the tax year 2003 under the head ‘Income frombusiness’. The receipt of Rs.350,000 in the tax year 2006 is a recoupment of the loss allowed inthe tax year 2003 and is now chargeable to tax as ‘Income from business’ [s.70].

Note (10) Rs.1,250,000 expended on the development of computer software is an intangible for taxpurposes [s.24(11)]. The normal useful life (NUL) of the software has been estimated by thecompany to be 12 years. For tax purposes an intangible with a NUL of more than 10 years is totreated as if it has a NUL of 10 years. The expenditure of Rs.1,250,000 is to be amortised overten years proportionate to the number of days the intangible is used in the tax year in derivingincome from business chargeable to tax [s.24(3), (4) and (6)]. As the software has been used for92 days (31 March 2006 to 30 June 2006) in the tax year 2006, the amount deductible isworked out as under:

Cost of the intangible Rs.1,250,000––––––––––––––––––––––––––

Normal useful life 10 years––––––––––––––––––––––––––

Amortisation deduction for one whole year Rs.125,000––––––––––––––––––––––––––

For 92 days in a year of 365 days Rs.31,507––––––––––––––––––––––––––

Note (11) Trading debts amounting to Rs.250,000 have been written off in the tax year 2006 against theprovision for bad debts account. Rs.250,000 has been claimed as a deductible charge on theassumption that the amount written off has previously been included in the income of thecompany chargeable to tax and the company has reasonable grounds to believe that the debts areirrecoverable [s.29].

19



Note (12) Initial allowanceBuildings Computers Initial

Allowance

Cost of workers’ residential quarters 4,000,000Less: Cost of land (Note 12.1) 1,000,000

––––––––––3,000,000––––––––––

Initial allowance at 50% 1,500,000Cost of computers 250,000

––––––––––Initial allowance at 50% 125,000

––––––––––1,625,000––––––––––

Note (12.1) The cost of land is not to be included in the cost of the building for the purposes of initialallowance and depreciation.

Note (13) DepreciationPlant and Buildings Computer Motor Furniture Totalmachinery hardware vehicles depreciation


Written down value 1,800,000 5,000,000 600,000 500,000 400,000Disposal – (3,500,000) – – – –

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––1,800,000 1,500,000 600,000 500,000 400,000–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Depreciation 270,000 150,000 180,000 75,000 60,000 735,000–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Additions 3,660,000* 3,000,000 250,000 250,000Initial allowance ** – (1,500,000) (125,000) – –

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––Written down value 3,660,000 1,500,000 125,000 250,000

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––Depreciation for 12 months 549,000 150,000 37,500 – 37,500 774,000

––––––––––1,509,000––––––––––

** Cost of plant Rs.3,000,000 plus Rs.660,000 expended to bring the plant into a serviceable condition.

** A second-hand plant which has previously been used in Pakistan and furniture, do not qualifyfor initial allowance [s.23(5)].

Note (14) Dividends received by a public company (for tax purposes) are taxed at 5% of the gross amountof the dividends irrespective of whether the dividends are received from a public or privatecompany.

RupeesNet amount of dividends received after deduction of tax (Rs.90,000 +Rs.195,000) 285,000Gross amount of dividends 300,000Tax deducted at source 15,000

Rs.15,000 being the tax deducted at source is the final tax on the dividend income.

Note (15) An amount received by a person, inter alia, as a loan from another person (not being a bankingcompany or a financial institution) which is not paid by a crossed cheque or through a bankingchannel from a person holding a national tax number card, is treated as the income of the recipientchargeable to tax in the year of receipt under the head ‘Income from other sources’ [s.39.(3)]. Asthe loan was received in cash Rs.1,000,000 is the income of Jingo Ltd (recipient) chargeable totax under the head ‘Income from other sources’.

20



Marks2 Mr Sultan


(a) Computation of incomeSalary RupeesFrom PQR Ltd

– Compensation for loss of employment (Note 1) 1,000,000 1– Pension (note 2) 900,000 1·5

From ABC LtdGratis payment (Note 3) 300,000 1·5Basic salary – nine months (Note 4) 1,800,000 0·5Cash allowances

– Leave fare assistance (Note 5) 180,000 0·5– House rent (Note 5.1) 180,000 1·5– Utilities (Note 5.2) 0 1– Medical (Note 5.3) 90,000 1

Benefit of company maintained car (Note 6) 123,000 1Benefit of concessional loan (Note 7) 20,000 1Waiver of loan (Note 8) 127,000 0·5

––––––––––4,720,000

Income from propertyRent chargeable to tax (Note 9) 510,000 2DeductionsRepairs (Note 10) 102,000 1Legal expenses (Note 11) 60,000 1

––––––––––162,000

––––––––––348,000

Income from other sourcesSub-lease of land (Note 12) 50,000 1

––––––––––Taxable income 5,118,000

––––––––––––––––––––

The relevant notes will be considered in allocating marks against each item. In addition, specific marks willbe awarded for the explanations of the treatment of items not included in the computation of income (1 mark for each item) as follows: 4

–––20


(1) Rs.500,000 received as a gratuity from the PQR Gratuity Fund (Fund) is exempt from tax since theFund is approved by the Commissioner in accordance with the rules in Part III of the Sixth Schedule[clause 13(ii) of Part I of the Second Schedule].

(2) The accumulated balance due and becoming payable to an employee participating in a recognisedprovident fund is exempt from tax [clause 23 of Part I of the Second Schedule].

(3) Since only the rent received or receivable by the owner from a tenant is chargeable to tax, the questionof claiming a deduction for vacancy does not arise.

(4) The tax deducted from the gross amount of the prize on the prize bond is the final tax on such income.The income is not chargeable to tax under any head of income and consequently is not included in thecomputation of income.

21



Marks(b) Computation of tax

Taxable income 5,118,000Less: Amount of compensation for loss of employment to be taxed separately (Note 1) 1,000,000 1

––––––––––4,118,000––––––––––––––––––––

Tax on Rs.700,000 102,500Tax on balance of Rs.3,418,000 at 30% 1,025,400

––––––––––1,127,900 0·5

Tax on Rs.1,000,000 (compensation for loss of employment) at 25% (Note 1) 250,000 1––––––––––

Tax assessed before tax credit 1,377,900Less: Tax credit on purchase of shares in Cleangas Ltd (Note 13) 40,383 1·5

––––––––––1,337,517

Tax deducted at source 1,200,000 0·5––––––––––

Balance payable 137,517––––––––––––––––––––

Tax Deducted/Collected as Final Tax Final taxPrize on prize bond – gross amount Rs.100,000 10,000 0·5

–––5

–––25–––

Note (1) Any amount received, whether paid voluntarily or under an agreement, inter alia, for loss ofemployment, is a profit in lieu of or in addition to salary and is taxable as salary income[12(2)(e)(iii)]. Sultan has elected to have the Rs.1,000,000 received from PQR Ltd(compensation for loss of employment) taxed at the average rate of tax paid on his total incomefor the preceding three years [s.12(6)]. Tax on Rs.1,000,000 is calculated separately at 25%being the average rate of tax of the preceding three years.

Note (2) Any pension received by a citizen of Pakistan from a former employer is exempt from tax providedthe person does not continue to work for the same employer or an associate of the employer. Theexemption is not dependent upon the age of the person receiving the pension [clause (8) of PartI of the Second Schedule]. As Sultan, after retiring from PQR Ltd continued to work for ABC Ltd,which is an associate of PQR Ltd [s.85], the pension is not exempt from tax but is chargeableto tax as salary income.

Note (3) An amount or perquisite is treated as received by an employee from any employment regardlessof whether the amount or perquisite is paid or provided, inter alia, by a past, future or presentemployer [s.12(5)]. All voluntary payments not attributable to any services rendered, dependingupon the goodwill of the employer (past or present) and even if the recipient has no right of actionin the case of non-payment, are chargeable to tax as the recipient’s salary. The gratis paymentof Rs.300,000 is thus chargeable to tax in the hands of Sultan as his salary income.

Note (4) Salary is taxable on a receipt basis. As the salary and allowances of the month are paid on thefirst day of the following month, the salary and the cash allowances for June 2006 were paid inJuly 2006 [tax year 2007]. The salary and allowances for nine months (September 2005 to May2006] are thus chargeable to tax in the tax year 2006.

Note (5) All cash allowances (except for certain exemptions for house rent, utilities and medical) arechargeable to tax if the salary income including the value of perquisites and benefits in a tax yearis Rs.600,000 or more. As Sultan’s salary income including perquisites and benefits exceedsRs.599,999 the cash allowances for leave fare, house rent (Note 5.1), utilities (Note 5.2) andmedical (Note 5.3) are chargeable to tax as salary income.

22



Note (5.1) As Sultan’s salary including perquisites and allowances exceeds Rs.599,999, house rentallowance (HRA) is exempt from tax up to 45% of basic salary subject to a maximum ofRs.270,000. As 45% of basic salary (45% of Rs.1,800,000) is Rs.810,000 the amountexempt from tax is limited to Rs.270,000.

RupeesHRA – (Rs.50,000 x 9 months) 450,000Exempt from tax 270,000


––––––––

Note (5.2) Utilities allowance (Rs.20,000 x 9 months) 180,000Exempt from tax is 10% of basic salary (10% of Rs.1,800,000) 180,000

––––––––Chargeable to tax 0

––––––––

Note (5.3) Medical allowance (Rs.30,000 x 9 months) 270,000Exempt from tax is 10% of basic salary (10% of Rs.1,800,000) 180,000


––––––––

Medical allowance is exempt up to 10% of basic salary because Sultan’s terms of employmentdo not provide for free medical treatment or hospitalisation or any reimbursement for suchexpenses. [Clause (139)(b) of Part I of the Second Schedule]

Note (6) The fair market value (FMV) of the car, taken on lease, at the commencement of the lease period(1 October 2005) is Rs.4,000,000. As the car is for Sultan’s private (non-business) andbusiness use, Rs.200,000 being 5% of the FMV of the car is the annual benefit. As the car wasavailable for Sultan’s private use only from 1 October 2005, the value of the benefit is calculatedfor nine months. The amount chargeable to tax is Rs.123,000 made up as under:

RupeesAnnual benefit 200,000

––––––––––––––––For nine months (1 October 2005 to 30 June 2006) 150,000Less: Reimbursed by Sultan (Rs.3,000 x 9 months) 27,000


––––––––––––––––

Note (7) The taxable benefit of a loan given by an employee is computed on the basis of the ‘bench mark’rate of profit applicable to the tax year. The benchmark rate applicable to the tax year 2006 is8% per annum on the loan amount [The benchmark rate is given in the preamble to theexamination paper]. As no profit is payable by Sultan on the loan of Rs.500,000, the profit onthe loan chargeable to tax for six months (1 January 2006 to 30 June 2006) is Rs.20,000 (8%of Rs.500,000 x 6/12) [s.13(7) and (14)].

Note (8) The waiver of an obligation of an employee to repay an amount owing by the employee to theemployer, is a perquisite chargeable to tax in the year the amount is waived. Therefore the waiverof Rs.127,000 of the loan advanced by ABC Ltd is a taxable perquisite and is chargeable to tax[s.13(9)].

Note (9) The ‘rent chargeable to tax’ is made up as under:Rupees

Rent received from Dee 300,000Rent received from Cee 150,000Non-adjustable deposit (Note 9.1) 60,000

––––––––510,000––––––––

Note (9.1) A non-adjustable deposit received by the owner of a building from a tenant is chargeable to taxin 10 years in equal proportion including the year in which the deposit is received. However, ifthe deposit is refunded to the tenant before the expiry of 10 years, no portion of the deposit ischargeable to tax in the tax year the deposit is refunded. As the deposit of Rs.600,000 receivedfrom Dee was refunded in the tax year 2006, no portion of this deposit is chargeable to tax.However one-tenth of the deposit received from Cee is treated as rent chargeable to tax (1/10 x Rs.600,000) [s.16].

23



Note (10) One-fifth of the rent chargeable to tax (1/5 of Rs.510,000 = Rs.102,000) is allowable as astatutory deduction in computing income under the head ‘income from property’ irrespective ofwhether or not any amount has been spent on repairs. The statutory allowance is calculated onthe ‘rent chargeable to tax’ and not on the rent received. The ‘rent chargeable to tax’ besides therent received from Dee and Cee also includes Rs.60,000 which is the taxable one-tenth portionof the non-adjustable deposit received from Cee [s.17(1)(a)].

Note (11) Not all legal expenses are deductible in computing income under the head ‘income fromproperty’. Only expenditure for legal services acquired to defend the owner’s title to the propertyor any suit connected with the property in a Court is deductible. [s.17(1)(h)]

Note (12) Any rent received from the sub-lease of land or a building is chargeable to tax under the head‘income from other sources’ [s.39(1)(e)]. Deductions allowable in computing income under thishead include any expenditure paid in deriving income chargeable to tax under that head otherthan any expenditure of a capital nature [s.40(1)]. Expenditure is considered to be of a capitalnature for the purposes of s.40, if it has a normal useful life of more than one year [s.40(6)].Income chargeable to tax from the sub-lease of the land is Rs.50,000 (Rs.150,000 rentalreceived from B less Rs.100,000 rental paid for the land).

Note (13) A person (other than a company) is allowed a tax credit, inter alia, on the cost of acquiring sharesfrom the Privatisation Commission of Pakistan. The credit is to be calculated on the lower of (a)the cost of acquiring the shares, (b) 10% of the person’s taxable income for the year or (c)Rs.150,000.

The amount of the investment on which the tax credit is to be calculated is Rs.150,000 sinceboth the cost of acquiring the shares (Rs.600,000) and 10% of Sultan’s taxable income(Rs.511,800) are more than Rs.150,000.

The calculation of the tax credit [s.62(1) and (2)] on the investment in the acquisition of theshares in Cleangas Ltd is calculated as under:

RupeesTax assessed before allowance of tax credit (A) 1,377,900Taxable income for the tax year (B) 5,118,000Amount of investment on which tax credit is to be calculated (C) 150,000

Tax credit allowedA/B x CRs.1,377,900/Rs.5,118,000 x Rs.150,000 40,383

24



Marks3 (a) Cinderella Ltd Rupees

Calculation of input taxOn purchase of raw material used exclusively for making taxablesupplies (Rs.1,350,000 x 15/115) 176,087 0·5On purchases of raw materials used for making both taxable andexempt supplies 2,285,000 0·5Less: Payment of a transaction in cash 65,500 0·5

––––––––––2,219,500––––––––––

Input tax (2,219,500 x 15/115) 289,500 0·5––––––––––

Apportionment of input tax (Note) 258,562 3·5

On purchase of raw material and spare parts for making zerorated supplies (Rs.1,600,000 x 15/115) 208,696 0·5On payment to courier service company (Rs.365,000 x 15/115) 47,609 0·5

––––––––––Admissible amount of input tax 690,954

––––––––––

Calculation of output taxOn sale of taxable goods – (Rs.6,850,000 at 15%) 1,027,500 0·5On sale of zero-rated goods – (Rs.2,220,000 at 0%) – 0·5On advance payment received – (Rs.750,000 at 15%) 112,500 1

––––––––––1,140,000

Less: Credit note issued for return of supply (Rs.694,000 at 15%) –[s.9 read with Chapter III of the Sales Tax Rules 2005] 104,100 1

––––––––––1,035,900––––––––––

Sales Tax Payable – May 2006Output tax 1,035,900Input tax 690,954

––––––––––344,946 0·5

––––––––––––––––––––

Note:Apportionment of input tax of Rs.289,500Taxable supplies/(taxable supplies + exempt supplies) x input taxRs.9,820,000 (A)/[9,820,000 + 1,175,000 (B)] x 289,500 258,562

(A) Rs.9,820,000 is made up as under:Sale of taxable goods 6,850,000Sale of zero rated goods 2,220,000Advance received for future supplies 750,000

––––––––––––Rs.9,820,000––––––––––––

(B) Rs.1,175,000 is the sale of exempt goods

(b) (i) To claim input tax for a taxable supply, the registered person should hold a tax invoice showing his name and registration number in respect of the supply made. 1

(ii) To claim input tax for goods imported into Pakistan, the registered person should hold a bill of entry or a goods declaration showing his name and registration number. The bill of entry or the goods declarationshould be duty cleared by the customs authorities. 1

(iii) To claim input tax for goods purchased in an auction, the registered person should hold the treasury receipt showing his name, his registration number and the amount of sales tax paid. 1

(c) The registered person can claim the input tax for goods purchased in the month of August 2005 by filing a revised sales tax return for August 2005 provided he specifies the reasons for such delayed input tax adjustment in the revised sales tax return. 2

–––15–––

25



Marks4 (1) The option to acquire shares in Airaids plc (AAP) under an employee share scheme.

Jamshed’s contention of offering to tax Rs.50,000 (£500) is not correct since the Income Tax Ordinance specifically provides that the value of a right or option to acquire shares under an employee share scheme is not chargeable to tax. [s.14(1)]. 2

(2) Sale of the option to acquire 500 shares in AAP.Jamshed is correct in contending that Rs.100,000 (the consideration received Rs.100,000 less his cost of acquisition Rs.0) is chargeable to tax. However the amount is chargeable to tax under the head ‘Salary’ [s.14(5)] and not as capital gains as erroneously contended by Jamshed. 2

(3) Gift of 300 shares in XYZ plc.Jamshed’s contention is not correct since under the non-recognition rules relied upon by him, no gain or lossis taken to have arisen on the disposal of an asset, inter alia, by reason of a gift, provided the person acquiring the gift is not a non-resident person for Pakistan tax purposes at the time of the acquisition of the asset [s.79(1)(c) read with s.79(2)].When Sorab acquired the shares on 31 May 2006 (his tax year 2006), he was a non-resident individualfor Pakistan tax purposes in the tax year 2006 since he was neither present in Pakistan for at least 182 days in the tax year 2006 [1 July 2005 to 27 December 2005 = 180 days] nor was he an employee of the Federal Government or a provincial government posted abroad during that tax year [s.82].The non-recognition rules under s.79 are therefore not applicable to the transfer of 300 shares in XYZ plc to Sorab. The profit on the disposal of the 300 shares is calculated as under: 2

RupeesConsideration (Note 1) 600,000 1Cost (Note 2) 450,000 1·5

––––––––Profit on disposal 150,000

––––––––

As the shares were held for less than a year, the entire profit of Rs.150,000 is chargeable to tax as Jamshed’s income for the tax year 2006 under the income head of ‘capital gain’. 0·5

Note 1As the disposal of the shares was by way of a gift, the fair market value (FMV) of the shares at the timeof its disposal is treated as the consideration received [s.77(1)]. The price of £20 per share quoted on the stock exchange is taken as the FMV [300 x £20 = £6,000 (Rs.600,000)].

Note 2The cost of the 300 shares acquired by Jamshed is the amount paid for the shares plus the amount charged to tax as the salary income of Jamshed on acquiring the shares. [s.14(4)].

RupeesAmount paid for the shares – £10 x 300 =£3,000 (£1 = Rs.100). 300,000Amount charged to tax as salary income in the tax year 2005.300 shares were acquired at the exercise price of £10 per share when theFMV of one share was £15 (i.e. the price quoted on the stock exchange).The difference of £5 per share equal to Rs.150,000 (£5 x 300 = £1,500 i.e.Rs.150,000) is the taxable benefit which would have been taxed under thehead ‘salary’ in the tax year 2005. 150,000

––––––––450,000––––––––

(4) Moveable assets held for personal use.Moveable assets held for personal use (with certain exceptions) are excluded from the definition of a ‘capital asset’. Since capital gains can only arise on the disposal of a capital asset, moveable assets heldfor personal use (which are not in the list of the exceptions) are outside the ambit of capital gains (s.37(5)(d) read with s.38(5)]. Jewellery and antiques are included in the aforesaid exceptions and any gain on their disposal is chargeable to tax under the head of ‘capital gains’. However any loss on the disposalof jewellery or antiques is not recognised as a loss.Jamshed’s contention is not correct since:– the gain of Rs.600,000 on the disposal of the jewellery is chargeable to tax as ‘capital gains’ and 1– the loss of Rs.100,000 on the disposal of the antique vase is not deductible as a capital loss. 1

(5) Shares in Zee Ltd.A loss on the disposal of a capital asset is not deductible as a capital loss where a gain on the disposal of such an asset is not chargeable to tax [s.38(2)].

Zee Ltd being a public company for tax purposes any gain made on the sale of its shares is exempt from tax (Clause 110 of Part I of the Second Schedule). Therefore the loss of Rs.50,000 on the sale of the sharesin Zee Ltd is not deductible as a capital loss. 2

26



Marks(6) Unadjusted loss

A capital loss cannot be carried forward for more than six years immediately succeeding the tax year in which the loss was incurred [s.59(2)]. The capital loss sustained in the accounting year ended 30 June 1999 lapsed on 30 June 2005 (tax year 2005). The unadjusted capital loss of Rs.40,000 istherefore neither available to be set-off against capital gains for the tax year 2006 nor to be carried forward. 2

–––15–––

5 (1) PlusMinus is a resident individual since in the tax year 2006 (accounting year ended 30 June 2006), he was an employee of the Federal Government of Pakistan and was posted outside Pakistan [s.82(c)].The payment of Rs.100,000 made to PlusMinus, a resident individual, was for the provision of services. Every prescribed person making a payment to a resident person for the provision of services is required to deduct tax at the time of making the payment [s.153(1)(b)].A ‘prescribed person’ for the purpose of deduction of tax from payments for the sale of goods, for the rendering of or the provision of services, or on the execution of a contract inter alia includes a company other than a ‘small company’ [s.153(9)(b)].As Q Ltd is not a small company, it is a prescribed person. As the payment was made to a residentperson for the provision of services, Q Ltd was required to deduct tax at the time of the payment of Rs.100,000.The tax deducted from a payment to a resident person for the sale of goods or on the execution of a contract shall be the final tax on the income of the resident person [s.153(6)]. As the payment made was for the provision of services the tax deducted is not the final tax of PlusMinus on the income arising from the transaction but would be allowable to him as a tax credit. 4

(2) Retailers Pakistan Ltd (RP)A prescribed person making a payment to a permanent establishment in Pakistan of a non-resident person for the sale of goods is required to deduct tax at the time of making the payment [s.153(1)(a)].RP operating in Pakistan as a branch of the non-resident Retailers Inc, would be construed to be a permanent establishment in Pakistan of a non-resident person. As the payment of Rs.750,000 to RP was for the sale of goods, Q Ltd as a prescribed person [for reasons given in (1) above] was required to deduct tax at the time of payment. The tax deducted from the payment of Rs.750,000 is not the final tax of the recipient on the income arising from the transaction since the payment was not made to a resident person. The tax deducted would be allowable as a tax credit. 3

(3) Builders Associates (BA)A prescribed person making a payment to a resident person on the execution of a contract is required to deduct tax at the time of payment [s.153(1)(c)].BA being a partnership firm is an association of person (AOP) [s.80(2)(a)]. The AOP is a resident AOP. An AOP shall be resident if the control and management of its affairs is situated wholly or partly in Pakistan during the relevant tax year [s.84]. The payment of Rs.1,000,000 made by Q Ltd was to a resident person on the execution of a contract and Q Ltd as a prescribed person (for reasons given in(1) above) was therefore required to deduct tax at the time of payment. The fact that no work had commenced on the building is immaterial since tax is to be deducted from all payments made including payments by way of an advance.The tax deducted from a resident person on the execution of a contract is the final tax of the resident person [s.153(6)]. The tax deducted from the payment of Rs.1,000,000 is the final tax of BA on theincome arising from the transaction since BA is a resident person and the payment was made on theexecution of a contract. 3

(4) Mr PropertyA prescribed person making a payment on account of rent of immovable property is required to deduct tax from the amount of rent payable provided the annual rent exceeds Rs.300,000. Rent of immovable property for the purpose of deduction of tax includes rent payable in advance and also any rent for furniture, fittings and services relating to the property [s.155(1) and (2)].A prescribed person for the purpose of deduction of tax from a payment of rent of immovable property includes a company. As the annual rent (including the rent for furniture and fixtures) exceeds Rs.300,000, Q Ltd as a prescribed person was required to deduct tax.The tax deducted from the payment of Rs.400,000 is not the final tax on the rental income received by Mr Property but would be allowable to him as a tax credit. 2

27



Marks(5) Machinery Suppliers plc (MSP)

Any person paying an amount to a non-resident is required to deduct tax from the amount paid except, inter alia, when the non-resident is not chargeable to tax in respect of the amount paid. The business income of a non-resident is chargeable to tax if the income is a Pakistan-source income.MSP is a non-resident company. The business income of MSP derived from the sale of the packing machine to Q Ltd is not a Pakistan-source income since the sale of the machine was completed outside Pakistan when the title in the machine passed to Q Ltd in London (outside Pakistan). The payment of £100,000 is therefore not chargeable to tax in Pakistan and Q Ltd was not required to deduct tax from the payment. 3

–––15–––

6 (a) (i) Diamond Jim and his family members being non-residents for Pakistan tax purposes in the taxyear 2006 are chargeable to tax only on income which is a Pakistan-source income [s.11(6)].One of the sources of income which is considered to be a Pakistan-source income is any gain from the alienation of any share in a company, the assets of which consist wholly or principally, directly or indirectly of immovable property in Pakistan or of the right to explore for or exploit natural resources in Pakistan [s.101(10) – geographical source of income]. The chargeability to tax is on the gain on the disposal of shares in a particular type of a company – a company whose principal assets are those as specified above.

The income of £100,000 has arisen from the disposal of the shares in GoldFinger Ltd (GL) which is a non-resident company operating in Pakistan as a branch. Since the principal asset of GL inPakistan is the right to explore and exploit mineral deposits in an area of Balochistan, the gain of £100,000 made by Diamond Jim and his family is their Pakistan-source income and therefore chargeable to tax. Therefore the contention of Diamond Jim that because GL is a non-resident company, the gain of £100,000 is not chargeable to tax in Pakistan is erroneous. 6

(ii) Under the provisions of the geographical source of income any gain arising from the disposal of shares in a resident company shall be Pakistan-source income [s.101(13)]. In other words, normally a gain on the disposal of shares in a non-resident company would not be a Pakistan-source income except where the assets of the company consist principally of immovable property or of the right to explore for or exploit natural resources in Pakistan [s.101(10)].

If GL was engaged in the business of the distribution of petroleum products and its income was principally from the distribution of petroleum products, its assets wholly or principally, directly or indirectly would not consist of immovable property or the right to explore for or exploit natural resources in Pakistan. GL being a non-resident company, any gain from the disposal of its shares would be a foreign-source income for Diamond Jim and his family members and thereforethe gain would not be chargeable to tax in Pakistan. 4

(b) (i) The conditions to be fulfiled to enable the holding company to set-off the loss surrendered bythe subsidiary company are:– the ownership to the extent of 75% or more in the subsidiary company continues for

a period of five years; and 1– the subsidiary company continues the same business during the said five years. [s.59B(2)] 1

(ii) The loss surrendered by the subsidiary company can be claimed by the holding company for set off against its income from ‘Income from business’ in the tax year of the surrender of the loss and the following two years. [s.59B(2)] 1

(iii) If the loss surrendered cannot be adjusted by the holding company within the limitation period, theloss will revert back to the subsidiary company who would then carry forward the loss in accordance with the provisions of the law for set off of business losses. [s.59B(4)] 2

–––15–––

28



Marks7 (a) The note required by the local agent

(i) The mode and manner of the tax assessment of air transport business carried on by a non-residentis not on the net-income basis. A fixed rate of 3% is imposed on the aggregate of the freight received or receivable by the non-resident from the carriage of goods, passengers, livestock or mail depending upon whether the shipment is from an airport in Pakistan (embarked in Pakistan) or anairport outside Pakistan (embarked outside Pakistan).SA would be a non-resident for Pakistan tax purposes. A fixed tax of 3% would be imposed on the aggregate of the following:– For goods embarked from an airport in Pakistan, the gross amount received or receivable

by SA for the carriage of goods irrespective of whether the amount is received or receivablein Pakistan or outside Pakistan.

– For goods embarked from an airport outside Pakistan, the gross amount received or receivableby SA for the carriage of goods only if the said amount is received or receivable in Pakistan. [s.7]

The tax imposed at 3% would be the final tax of SA on the aforesaid aggregate amounts receivedor receivable. The aggregate amounts are hereinafter referred to as the ‘Amount’. 5

(ii) The above basis of computing income would not change if the aircraft used for the carriage of goodswere chartered by SA. 1

(iii)/(iv) As the tax of 3% is the final tax on the Amount, the tax statute provides that no deduction shallbe allowable for any expenditure incurred in deriving the Amount [s.8(b)] and the tax payable on the Amount shall not be reduced by any tax credit [s.8(d)].

In view of the above– the question of determining the allocation of the expenditure incurred by SA which is

attributable to the Pakistan operations does not arise since such expenditure cannot be claimed against the Amount which is chargeable to tax; and 1

– no credit would be allowed for the tax paid in Australia against the Pakistan tax payable 1

(v) SA or the local agent authorised by SA would have to furnish the Commissioner with a return for each quarter ending on 30 September, 31 December, 31 March and 30 June showing the Amount [specified in item (i) above]. The return has to be furnished within 45 days from the last day of each quarter. SA or the agent has also to furnish any particulars, accounts or documents which may be required by the Commissioner. The Commissioner, after being satisfiedthat the return furnished is complete in all respects, would determine the amount of the tax payablefor the quarter and notify SA in writing of the tax due which is to be paid within the time specifiedin the notice. In practice, tax would be calculated by SA and paid at the time of furnishing thereturn for each quarter. [s.144] 3

(b) (i) If SA was incorporated in a country where its world income was exempt from tax, SA would still be chargeable to tax in Pakistan despite its tax exempt status in the country of its incorporation. As a non-resident, SA is chargeable to tax on its income derived in Pakistan. 1

(ii) Under the Income Tax Ordinance, 2001 (Ordinance) the Federal Government can enter into an agreement with the government of any other country (foreign government) for the avoidance of double taxation, with respect to taxes on income imposed under this Ordinance [s.107]. The provisions of a tax treaty on a particular matter would override the provisions of the local legislation on a similar matter.A tax treaty can, inter alia, provide for relief from the tax payable under the Ordinance. Accordingly if SA was incorporated in a country which has a tax treaty with Pakistan and the treaty provided that the income from the operation of aircraft would be taxable only in that country,the income from SA arising from the operation of its aircraft in Pakistan would not be chargeable to tax in Pakistan. 3

–––15–––

29




PART 2


QUESTION PAPER









Pape

r 2.3

(PK

N)




A. Tax rates for individuals where salary income exceeds 50% of taxable income for the tax year 2007Taxable income Rate of taxUp to Rs. 150,000* 0%Rs. 150,001 – Rs. 200,000 0·25%Rs. 200,001 – Rs. 250,000 0·50%Rs. 250,001 – Rs. 300,000 0·75%Rs. 300,001 – Rs. 350,000 1·50%Rs. 350,001 – Rs. 400,000 2·50%Rs. 400,001 – Rs. 500,000 3·50%Rs. 500,001 – Rs. 600,000 4·50%Rs. 600,001 – Rs. 700,000 6·00%Rs. 700,001 – Rs. 850,000 7·50%Rs. 850,001 – Rs. 950,000 9·00%Rs. 950,001 – Rs. 1,050,000 10·00%Rs. 1,050,001 – Rs. 1,200,000 11·00%Rs. 1,200,001 – Rs. 1,500,000 12·50%Rs. 1,500,001 – Rs. 1,700,000 14·00%Rs. 1,700,001 – Rs. 2,000,000 15·00%Rs. 2,000,001 – Rs. 3,150,000 16·00%Rs. 3,150,001 – Rs. 3,700,000 17·50%Rs. 3,700,001 – Rs. 4,450,000 18·50%Rs. 4,450,001 – Rs. 8,400,000 19·00%Rs. 8,400,001 and over 20·00%

* For a woman taxpayer where salary income exceeds 50% of taxable income for the tax year 2007, no tax is chargeableif taxable income does not exceed Rs. 200,000

B. Tax rates for companies Tax year Banking Public company other Private company other Small

company than a banking company than a banking company company2006 38% 35% 37% 20%2007 35% 35% 35% 20%

C. Rates of advance collection or deduction of taxFor the rendering of or providing of services 6% of gross amount payable

D. Tax rates on dividends received from companiesReceived by a public company or an insurance company orany other resident company 5% of the gross amount of the dividendIn any other case 10% of the gross amount of the dividend

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E. Capital allowances DepreciationBuildings (all types) 10%Furniture and fittings 15%Plant and machinery (not otherwise specified) 15% of the tax written down valueMotor vehicles (all types) 15%Computer hardware 30%


F. Benchmark rateFor determining the value of the perquisite on loans given to employees, the benchmark rate for the tax year 2007 is 9%per annum of the loan amount

3 [P.T.O.

⎫

⎬⎪

⎭⎪




1 (a) A-Bee-Cee plc, a public company incorporated under the law of the United Kingdom relating to the incorporationof companies, has been operating in Pakistan for over 50 years. The control and management of the Pakistanbranch for the accounting year ended 31 December 2006 was situated wholly outside Pakistan.

Required:

Briefly state, with reasons:

(i) Whether A-Bee-Cee plc will be assessed as a company for Pakistan tax purposes for the relevant taxyear. (2 marks)

(ii) Whether you consider A-Bee-Cee plc to be a resident or a non-resident for Pakistan tax purposes for therelevant tax year. (2 marks)

(b) PQR Ltd is an industrial undertaking engaged in the manufacture of fertilisers. The following information isfurnished to you for the year ended 31 December 2006.

(1) PQR Ltd is a private company for Pakistan tax purposes, but is a public company under the CompaniesOrdinance, 1984.

(2) The accounting profit for the year ended 31 December 2006, after transferring Rs. 500,000 to a provisionfor taxation was Rs. 10,600,000.

(3) Deductions claimed in the accounts include: Rupees

(i) Accounting depreciation on company owned assets. 1,360,000

(ii) Expenditure on the provision of perquisites and allowances to the chief financial officer in excess of 50% of his basic salary. 350,000

(iii) Amount collected by the Collector of Customs for an erroneous declaration in an import document. 150,000

(iv) Tax collected by the Collector of Customs at the customs stage on the import of fertiliser in finished form for sale. 600,000

(v) Net loss (adjusted for tax purposes) on the sale of the imported fertiliser. 300,000

(vi) Accounting depreciation on an item of plant taken on lease from an approved leasing company (lessor). The ownership of the plant is to be transferred to PQR Ltd (lessee) on payment of the final lease instalment due on 31 March 2007. 230,000

(vii) Legal expenses incurred in connection with an infringement of a trade mark of a wholly owned subsidiary of PQR Ltd. 400,000

(viii) Payment to the Workers’ Participation Fund under the provisions of the Companies Profit (Workers’ Participation) Act, 1968. 850,000


(i) Accounting profit on the sale of a motor car. 90,000

(ii) Recoveries against debts written off in prior years and allowed as a tax deduction under the head ‘Income from business’. 310,000

(iii) Share of profit received from an association of persons (AOP) in which PQR Ltd is a member. 1,250,000

The taxable income of the AOP was Rs. 5,000,000 and the tax assessed on the AOP was Rs. 1,250,000.

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(5) Fixed assets

(i) The tax written down values on 1 January 2006 were:

Plant and machinery 9,500,000Buildings 8,200,000Computer hardware 2,500,000Motor vehicles 2,400,000Furniture 1,250,000

(ii) An item of second-hand plant (not previously used in Pakistan) was imported at a cost of Rs. 5,500,000 and commissioned for use on 15 December 2006. Customs duty thereon of Rs. 1,500,000 has been charged as an expenditure in the profit and loss account.

(iii) New computers were purchased on 1 December 2006 for Rs. 5,000,000 and commissioned for use on 1 January 2007.

(iv) During the year a motor car (cost Rs. 1,200,000 and tax written down value Rs. 650,000) was sold for Rs. 900,000. The cost of the car had been restricted to Rs. 1,000,000 for the purpose of claiming tax depreciation.

(v) On 30 November 2006, a new motor car was purchased for Rs. 2,000,000.


(i) Rs. 600,000 payable against a loan taken in the accounting year ended 31 December 2002 from an associated company.

(ii) Rs. 300,000 received in cash from a shareholder as a deposit for the issuance of shares in the company.

(7) Advance tax paid was Rs. 1,500,000.

Required:

(i) Compute the total income and the taxable income of PQR Ltd for the relevant tax year under theappropriate heads of income. Your answer should give clear reasons/explanations for the inclusion orexclusion of each of the items listed above. The reasons/explanations for the items not included in thecomputation of income should be shown separately. (23 marks)

(ii) Calculate the tax payable by/refundable to PQR Ltd for the relevant tax year. (3 marks)

(30 marks)

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Pestonji has approached you to compute his taxable income and tax payable for his accounting year ended 30 June2007 and the following information is furnished to you.

(1) Since 1 January 2004. Pestonji was working in the United Kingdom as the Chief Financial Officer of HotelSplendid plc (HSP). He retired from HSP on 25 September 2006 and immediately returned to Pakistan. Histaxable income from HSP for the period 1 July 2006 to 25 September 2006 was £15,000 on which tax of£2,000 was deducted by HSP and paid to the UK revenue authority.

(2) Pestonji had participated in the HSP employee share scheme (Scheme):

– Under the Scheme, a participant has a free right to transfer the shares acquired under the Scheme only aftera minimum holding period of three years.

– On 1 July 2006, the custodian of the Scheme granted Pestonji the right to acquire 1,000 shares in HSP atthe exercise price of £10 per share.

– There was no payment to be made for the right to acquire these 1,000 shares in HSP. The value of one rightwas estimated by the custodian to be £2.

– On 1 July 2006, Pestonji sold the rights for 500 shares for Rs. 100,000.

– On 1 September 2006, Pestonji exercised his remaining rights to purchase 500 shares in HSP at theexercise price of £10 per share. The market price of one share on that date was £15. The 500 sharespurchased were in Pestonji’s possession on 30 June 2007.

(3) On returning to Pakistan, Pestonji, as a self-employed individual, commenced business on 1 October 2006 as amanagement consultant to Oriental Hotels Pakistan Ltd (OHPL) on a fixed fee of Rs. 400,000 per month. At thetime of payment of the fee, tax at the relevant rate was deducted by OHPL.

On 30 November 2006, XYZ Bank required Pestonji to repay a loan of Rs. 1,000,000 taken by him for hisbusiness. OHPL offered to pay XYZ Bank the Rs. 1,000,000 if Pestonji agreed to join OHPL as its FinanceDirector on 1 January 2007. On Pestonji’s agreement to the offer of employment, OHPL, prior to the issuanceof the letter of employment to Pestonji, paid Rs. 1,000,000 to XYZ Bank in discharge of the loan taken byPestonji.

Pestonji closed his business on 31 December 2006. The summarised income statement, prepared by him, forthe period 1 October 2006 to 31 December 2006 was as under:

RupeesFees for services rendered (net of tax deducted at source) 1,128,000Less: Expenditure and depreciation adjusted for tax purposes 1,160,000

––––––––––Net business loss 32,000

––––––––––––––––––––

(4) Pestonji received Rs. 600,000 as consideration for vacating the premises occupied by him on rent for hisbusiness.

(5) Pestonji’s terms of employment with OHPL provided for the following from 1 January 2007.

(i) A basic salary of Rs. 500,000 per month.

(ii) Monthly cash allowances of:– Rs. 50,000 for utilities– Rs. 60,000 for medical– 45% of basic salary for housing

(iii) Two company maintained cars. A new car was purchased for Rs. 2,000,000 on 1 January 2007 forPestonji’s private and business use and another car was leased by the company which was exclusively forhis business use. The fair market value of the leased vehicle at the commencement of the lease was Rs.2,500,000.

(iv) A monthly payment of Rs. 30,000 to an approved pension fund to provide for Pestonji’s retirement.

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(v) The terms of employment do not provide for free medical treatment or hospitalisation or any reimbursementof such expenses.

(6) On 1 January 2007, Pestonji took a loan of Rs. 500,000 repayable in ten equal instalments, from OHPL. Profiton the loan is payable at the rate of 9% per annum.

(7) On 30 June 2007, OHPL waived Rs. 250,000 of the loan amount due from Pestonji.

(8) Pestonji was reimbursed Rs. 175,000 for hospitalisation charges of his wife.

(9) Due to disturbances in the city the salary and cash allowances for the month of June 2007 of all employees weredisbursed by OHPL on 2 July 2007.

(10)Zakat paid was Rs. 10,000.

(11)Tax deducted at source by OHPL on Pestonji’s salary income was Rs. 700,000

Pestonji also informs you that:

(i) On 30 June 2006, he had acquired 1,000 shares in ABC Ltd for Rs. 500,000 from the Privatization Commissionof Pakistan and had claimed a tax credit thereon of Rs. 50,500.

(ii) On 1 June 2007, he sold the 1,000 shares in ABC Ltd for Rs. 500,000 and from the proceeds acquired 1,000shares in FGH Ltd for Rs. 500,000 from the Privatization Commission of Pakistan.

(iii) The following amounts were received by him during the year ended 30 June 2007 (net of tax deducted at sourcewhere applicable).

– Dividend from a public company Rs. 90,000– Dividend from a private company Rs. 9,000

The rate of exchange is to be taken as £1 = Rs. 100.

Required:

(a) Compute the taxable income of Mr Pestonji under the relevant heads of income for the relevant tax yeargiving clear reasons/explanations for the inclusion or exclusion of each of the items listed above. Thereasons/explanations for the items not included in the computation of income and tax payable should beshown separately. (18 marks)

(b) Calculate the tax payable by/refundable to Mr Pestonji for the relevant tax year. (4 marks)

(c) Identify and briefly comment on the taxes deducted at source which are considered to be the final tax on theincome arising from the transactions which have suffered deduction of tax at source. (3 marks)

(25 marks)

7 [P.T.O.



Section B – THREE questions ONLY to be attempted

3 (a) Section 7A of the Sales Tax Act, 1990 empowers the Federal Government to levy and collect sales tax on specifiedgoods on a minimum value addition which is to be declared by certain persons or categories of person for thesupply of goods. Under the Sales Tax Special Procedures Rules, 2006, a commercial importer is required to paysales tax on the supply of imported goods (other than those specified in the Third Schedule) on a value additionof not less than ten percent on the value of goods declared for customs purposes.

Hamza and Hisham is a partnership firm registered as a commercial importer with the sales tax authorities inPakistan. During the month of March 2007 the firm imported a large consignment of DVD players. DVD playersare not included in the Third Schedule. The landed value of the DVD players amounted to Rs. 50,000,000 onwhich customs duty and other taxes amounting to Rs. 2,500,000 was payable.

Required:

(i) Calculate the amount of value addition on the goods imported by Hamza and Hisham. (2 marks)

(ii) Calculate the total sales tax payable on these imported goods. (2 marks)

(iii) State when the sales tax on these imported goods must be paid. (1 mark)

(b) ABC is registered as a retailer with the sales tax authorities.

Required:

(i) State the circumstances under which ABC can apply for de-registration. (2 marks)

(ii) State the circumstances under which the registration of ABC can be suspended by the Collector.(3 marks)

(c) Sales tax is charged on the value of the taxable supplies made by a registered person in the course of any taxableactivity carried on by that person.

Required:

State how the value of supply would be determined:

– where the consideration for a supply is partly in kind and partly in money, and (2 marks)– where goods are provided at a discounted price (trade discount). (3 marks)

(15 marks)

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This is a blank page.Question 4 begins on page 10.

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4 (a) Secure Securities Ltd (SSL) is in the business of stocks, shares and finance brokers. SSL closes its accounts on31 December each year. At the close of business on 31 December 2005, SSL held 50,000 shares in ChemicalsLtd as its stock-in-trade. These 50,000 shares had been purchased on 1 July 2002 at Rs. 10 per share.Chemicals Ltd is a public company for tax purposes.

On 31 December 2006, SSL disposed of the 50,000 shares in Chemicals Ltd resulting in a gain of Rs. 5,000,000. SSL’s chief accountant is of the view that the gain of Rs. 5,000,000 would be incomechargeable under the head ‘Income from business’ since:

– the 50,000 shares in Chemicals Ltd ever since their acquisition on 1 July 2002 have always been shownas SSL’s stock-in-trade in the accounts furnished to the tax authorities; and

– any income on the sale of stock-in-trade of a business is chargeable to tax under the head ‘Income frombusiness’.

Required:

(i) State giving reasons whether or not the view of the chief accountant is correct. (4 marks)

(ii) State how the gain of Rs. 5,000,000 on the disposal of the shares in Chemicals Ltd would be shown inthe return of income of Secure Securities Ltd for the tax year 2007. (2 marks)

(b) The following information is furnished to you by Mr Hamid on 1 June 2007.

(1) Hamid became a member of the Karachi Stock Exchange (KSE) on 1 July 2006 by purchasing one sharein Karachi Stock Exchange (Guarantee) Ltd (KSEG), from Mr Ali, for Rs. 2,000,000. He also acquired fromAli the occupancy rights of a room in the stock exchange for Rs. 300,000.

(2) On 31 May 2007, Hamid, having reached the age of 61 years, decided to retire from his business as astock and shares broker. On 1 June 2007, Hamid gave up his membership rights in KSE by transferring toABC (Private) Ltd:

– the one share in KSEG for Rs. 4,000,000; and– the occupancy rights of the room in the KSE for Rs. 700,000.

Required:

Explain the tax implications for Mr Hamid in the tax year 2007 in respect of the disposal of the one sharein Karachi Stock Exchange (Guarantee) Ltd and the transfer of the occupancy rights of the room in the stockexchange. (3 marks)

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(c) For this part of the question, you should assume that today’s date is 31 July 2007.

Mr Patel is preparing his return of income for his accounting year ended 30 June 2007 and furnishes you withthe following details:

(1) On 1 June 2007, Patel sold 5,000 shares in XYZ (Private) Ltd for Rs. 100,000. The shares had becomehis property on 1 July 2006 on the distribution of assets on the liquidation of LMN Ltd in which companyhe was a shareholder.

(2) On 1 June 2007, Patel transferred 10,000 shares in Q (Private) Ltd to his wife Seema under an agreementto live apart. Seema is an employee of the Ministry of Foreign Affairs, Government of Pakistan and wasposted to South Africa during the tax year 2007. In the tax year 2007 Seema was present in Pakistan for30 days when she was on leave from her foreign posting.

The 10,000 shares in Q (Private) Ltd were purchased by Patel in the tax year 2004 for Rs. 100,000. Thefair market value of the 10,000 shares on 1 June 2007, based on a valuation done by the auditors of Q(Private) Ltd, was Rs. 200,000.

Patel is of the view that:

(i) The Rs. 100,000 representing the sale consideration of the 5,000 shares in XYZ (Private) Ltd is his incomechargeable to tax under the head ‘Capital gains’ since he had not paid anything to acquire the shares andthe shares were not held for more than one year since their acquisition.

(ii) The shares transferred to his wife Seema under an agreement to live apart would be treated as a disposalof a capital asset and Rs. 100,000 representing the difference between the fair market value of the shares(Rs. 200,000) and the cost (Rs. 100,000) would be chargeable to tax under the head ‘Capital gains’.

Required:

State, giving reasons, whether or not you are in agreement with each of the two views expressed by Mr Patel.If you are not in agreement with any of his views, explain the correct treatment to be adopted for thedetermination of the income, if any, chargeable under the correct head(s) of income for the tax year 2007.

(6 marks)

(15 marks)

11 [P.T.O.



5 For the purposes of this question you should assume that today’s date is 31 July 2007.

(a) The following information is furnished to you by Mr Kapadia, a resident individual.

(1) Kapadia is the owner of an apartment in a residential building. On 1 July 2006 he entered into a contractwith Mr Usman for the sale of the apartment for Rs. 1,000,000. Under the terms of the contract Usmanpaid Kapadia Rs. 100,000 as a deposit and the balance amount of Rs. 900,000 was payable on 31 July2006 failing which the contract for sale would be terminated and the deposit amount of Rs. 100,000 wouldbe forfeited. Usman failed to make payment of the Rs. 900,000 on 31 July 2006 and the deposit amountwas duly forfeited.

(2) On 1 August 2006, Kapadia rented out the apartment to his brother at a monthly rent of Rs. 20,000. Similarapartments in the building fetch a monthly rent of Rs. 25,000.

(3) Kapadia has incurred the following expenditure on the apartment:

RupeesRepairs 60,000Insurance against risk 50,000Taxes to a local authority 20,000Profit paid to a bank for money borrowed to acquire the apartment 10,000Legal expenses for defending the title to the apartment 5,000

––––––––145,000––––––––––––––––

(4) Kapadia has no other taxable income under any other head of income.

Kapadia informs you that for the tax year 2007 (accounting year ended 30 June 2007) he is not required to payany tax, since his income for the said tax year [rent received Rs. 220,000 (Rs. 20,000 x 11 months) minus theexpenditure of Rs. 145,000] is less than Rs. 100,000, the basic threshold of taxable income on which no taxis payable.

Required:

(i) Explain why Mr Kapadia’s contention is not correct; (3 marks)

(ii) Compute the tax payable by Mr Kapadia for the tax year 2007, if the applicable rate of tax is 5%.(4 marks)

(iii) Explain whether or not your answer to (ii) above would be different and if so how, if the income fromthe apartment chargeable to tax was Rs. 150,000 in the tax year 2007. (4 marks)

(b) ABC (Pakistan) Ltd discarded an item of plant, which was used for the carrying on of its business in its accountsfor the accounting year ended 31 December 2006, as the plant had become obsolete. The tax written down valueof the discarded plant on 1 January 2006 was Rs. 500,000.

Required:

Explain the tax implications for ABC (Pakistan) Ltd for the relevant tax year relating to the plant discarded.(4 marks)

(15 marks)

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6 Under the provisions of s.177 of the Income Tax Ordinance, 2001, the Commissioner has the power to conduct anaudit of the tax affairs (including examination of the accounts and records and any inquiry into expenditure, assetsand liabilities) of a taxpayer selected for audit.

The assessment of Usman Pakistan Ltd (UPL) for the tax year 2006 has been selected for audit under s.177.

(1) On completion of the audit, the Commissioner informed UPL that he intends to amend the assessment for thetax year 2006 to:

(i) treat Rs. 500,000 credited to capital reserve account as the taxable income of UPL;

(ii) disallow the tax credit of Rs. 315,540 claimed against the tax payable;

(iii) disallow Rs. 700,000 paid to an expert valuer for the valuation of the company’s office building;

(iv) disallow Rs. 300,000 out of the tax depreciation claimed on the office building (as above); and

(v) disallow Rs. 875,000 paid to a legal counsel for defending UPL’s title to its factory building.

The Commissioner has required UPL to furnish explanations/reasons as to why he should not amend theassessment on the lines indicated.

(2) The following information and details on the issues raised by the Commissioner are provided to you:

(i) Rs. 500,000 credited to capital reserve.

Rs. 500,000 is the face value of 50,000 shares in JKL Ltd issued to UPL as bonus shares on itsshareholding in JKL Ltd.

(ii) Tax credit of Rs. 315,540.

The tax credit was claimed on the cost of acquiring in the tax year new shares in STY Ltd which is a publiccompany listed on the Karachi stock exchange.

(iii) Rs. 700,000 paid to the expert valuer.

The valuation of the office building was required by Zee Bank as the building was pledged to the bankagainst a loan taken by UPL for its business purposes.

(iv) Tax depreciation on office building.

The value of the office building as estimated by the expert valuer was Rs. 6,000,000 as against its bookvalue of Rs. 3,000,000. The book value of the building and its tax written down value were each enhancedby Rs. 3,000,000. The addition of Rs. 3,000,000 to the tax written down value of the building resulted inan increase in the tax depreciation claimed by Rs. 300,000 (10% of Rs. 3,000,000).

(v) Legal fees paid.

UPL had received a legal notice from Super Bank stating that UPL does not have a clear title to the factorybuilding which UPL had purchased from Mr. Sarvar. The building had been pledged to the bank against aloan taken by Sarvar.

(3) The Finance Director of UPL wants you to explain the relevant tax provisions on the issues raised by theCommissioner.

Required:

State, giving reasons, whether or not, in each case, the amendment proposed by the Commissioner is or is notin accordance with the provisions of the tax statute.

The allocation of marks is as follows: issues (i), (ii) and (v), 3 marks each; issue (iii) 2 marks; and issue (iv), 4 marks.

(15 marks)

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7 (a) Mungali Moosta (Private) Ltd (MMPL) was incorporated on 1 July 2005 and closed its first accounts on 30 June2006. MMPL commenced business on 1 September 2005 as an industrial undertaking engaged in themanufacture of component parts for the automobile assembly industry. Prior to the commencement of business,MMPL had incurred the following expenditure in July and August 2005.

RupeesPreparation of a feasibility report 8,000,000Construction of prototypes 5,000,000Trial production activities 2,000,000

–––––––––––15,000,000––––––––––––––––––––––

MMPL’s return of income for the tax year 2006 was furnished to the Commissioner in the proper form and withinthe due date of filing. The aforesaid three items of expenditure were not claimed as deductible expenditure onthe reasoning that they were incurred prior to commencement of business and the expenditure was in the natureof capital expenditure. The taxable income declared was Rs. 2,500,000 and tax thereon was paid along withthe return of income. The statutory auditors have pointed out to MMPL, that the tax treatment accorded to thethree items of expenditure totaling Rs. 15,000,000 was not correct.

Required:

(i) State, explaining the relevant provision of the law, why the tax treatment accorded to the three items ofexpenditure in the return of income for the tax year 2006 was incorrect. (6 marks)

(ii) State what action Mungali Moosta (Private) Ltd should take to rectify the mistake and compute the taxrefundable for the tax year. (5 marks)

(b) A person who holds an asset shall be treated as having made a disposal of the asset at the time the person partswith the ownership of the asset.

Required:

Briefly explain how you would determine the amount of the consideration received by a person in respect ofan asset which the person has transferred to another person by reason of a gift. (4 marks)

(15 marks)


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Answers



Part 2 Examination – Paper 2.3(PKN) June 2007 AnswersBusiness Taxation (Pakistan) and Marking Scheme

Marks1 (a) (i) A company for Pakistan tax purposes, inter alia, means a body incorporated by or under the law of a

country outside Pakistan relating to the incorporation of companies [s.80(2)(b)(iv)]. As A-Bee-Cee plc is a company incorporated under the law of the United Kingdom, A-Bee-Cee plc is a company for Pakistan tax purposes. 2

(ii) As A-Bee-Cee plc is incorporated under the law of the United Kingdom relating to the incorporation of companies, it would be a resident company for Pakistan tax purposes, if the control and management of its affairs was situated wholly in Pakistan at any time in the year [s.83(b)]. A-Bee-Cee plc is a non-resident company for Pakistan tax purposes in the tax year 2007, since the control and management of its affairs was situated wholly outside Pakistan during that year. 2

–––4

–––

(b) (i) PQR LtdAccounting year ended 31 December 2006

Tax year 2007Rupees Rupees

Computation of taxable incomeIncome from businessAccounting profit 10,600,000Add: Provision for taxation (Note 1) 500,000 0·5

Accounting depreciation (Note 2) 1,360,000 0·5Penalty paid to the Collector of Customs (Note 3) 150,000 1Tax collected by the Collector of Customs (Note 4) 600,000 1Accounting depreciation on a leased asset (Note 5) 230,000 1Legal expenses (Note 6) 400,000 1Payment to the Workers’ Participation Fund (Note 7) 850,000 1Tax profit on disposal of a motor car (Note 8) 100,000 2Customs duty paid on the import of second-hand plant (Note 9)1,500,000 1

––––––––––5,690,000

Less: Accounting profit on disposal of a motor car (Note 8) 90,000 0·5Initial allowance (Note 10) 3,500,000 1Depreciation (Note 11) 4,270,000 3·5

––––––––––(7,860,000)––––––––––8,430,000

Income from other sourcesAmount received in cash from a shareholder as a deposit for theissuance of shares in the company (Note 12) 300,000 2

––––––––––Total income 8,730,000Less: Payment to the Workers’ Participation Fund (Note 7) 850,000 1

––––––––––Taxable income 7,880,000

––––––––––––––––––––


–––23–––

Items not included in the computation of income.

(1) Up to the tax year 2006 any expenditure incurred by an employer on the provision of perquisites and allowances to an employee in excess of 50% of the employee’s salary was not deductible. The Finance Act 2006 deleted this provision and therefore all such expenditure is now allowed as a deductible expenditure.

(2) The net loss (adjusted for tax purposes) on the sale of the imported fertiliser is an allowable deduction. The Finance Act, 2006, legislated that the tax collected by the Collector of Customs on the import of fertiliser by a manufacturer of fertiliser is not the final tax [s.148(7)(b)].

(3) Rs. 310,000 represents a receipt against a bad debt written off in a prior year and allowed as a deductible charge under the head ‘Income from business’. The receipt of Rs. 310,000 is a recoupment of the loss allowed in a prior year and is now chargeable to tax as ‘Income from business’ [s.70].

17



Marks(4) The share of profit received from an association of persons (AOP) is the taxable income of PQR Ltd

[s.88A(I)]. However, as the AOP has already paid tax on its income, PQR Ltd is allowed a tax credit against its tax payable [s.88A(2)].

(5) No initial allowance or depreciation is allowable on the new computers purchased on 1 December 2006 (tax year 2007) since it was not commissioned for use in the business in the tax year 2007. Initial allowance (s.23) and depreciation (s.22) are allowable only if the depreciable asset is used in the taxpayer’s business in the tax year .

(6) Any expenditure which has previously been allowed as a deduction 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 [s.34(5)]. However, no adjustment is required for the amount of Rs. 600,000 representing the amount of a loan unpaid as this amount is not an expenditure which could have been claimed as a deductible charge.

(ii) Computation of tax payable Rupees RupeesTax on taxable income of Rs. 7,880,000 at 35% 2,758,000 0·5Tax credit on tax paid by the AOP (Note 13) (312,500) 1

––––––––––2,445,500

Tax collected by the Collector of Customs (Note 4) 600,000 1Advance tax paid 1,500,000 0·5

––––––––––(2,100,000)–––––––––– –––

Balance of tax payable 345,500 3–––––––––––––––––––– –––

30–––

Notes as referred to in the computation of income and tax payable.

Note (1) Any tax paid or payable that is leviable on the profits of the business is not a deductible charge [s.21(a)]. Any provision made in the accounts for taxation is therefore not deductible.

Note (2) Accounting depreciation is not a deductible charge. Initial allowance and depreciation is allowable at the rates prescribed in the Third Schedule.

Note (3) The amount paid to the Collector of Customs for the erroneous declaration in an import document is in the nature of a penalty for violation of the customs law and is not deductible [s.21(g)].

Note (4) Tax collected by the Collector of Customs on the import of fertilisers by a manufacturer of fertilisers is not the final tax on the income arising out of the import [s.148(7)(b)]. The tax collected is available to PQR Ltd as a tax credit.

Note (5) Depreciation is allowable only on depreciable assets owned by a taxpayer [s.22(I) and (15)]. As the ownership of the plant has not been transferred to PQR Ltd by the approved leasing company (lessor), the charge for depreciation is not deductible.

Note (6) Expenditure that is incurred by a taxpayer wholly and exclusively for the purpose of its business is a deductible expenditure [s.20(I)]. The legal expenses incurred by PQR Ltd in connection with the infringement of a trade mark of its wholly owned subsidiary is not deductible since it is not incurred wholly and exclusively for the business of PQR Ltd. For Pakistan tax purposes, PQR Ltd is a separate legal entity from its wholly owned subsidiary.

Note (7) A payment to the Workers’ Participation Fund (WPF) is not a deductible expenditure in determining the total income of a taxpayer. However a payment to WPF in accordance with the provisions of the Companies Profit (Workers’ Participation) Act, 1968 is a deductible allowance from the total income to arrive at the taxable income (s.9 read with s.60B)

Note (8) Accounting profit or loss on the disposal of a depreciable asset is ignored for tax purposes. The tax profit or loss on the disposal of a depreciable asset is the difference between the consideration received and the tax written down value of the asset.

18



MarksIn the case of the disposal of a motor car whose cost has been restricted for claming tax depreciation, the consideration received is to be adjusted as under:

RupeesSale consideration received (A) 900,000Restricted cost for depreciation purposes (B) 1,000,000Actual cost (C) 1,200,000A x B/C900,000 x 1,000,000/1,200,000 750,000Rs. 750,000 is to be treated as the sale consideration for calculating the tax profit or loss on the disposal of the motor carSale consideration 750,000Tax written down value 650,000

––––––––Tax profit on the disposal of the motor car 100,000

––––––––––––––––

Note (9) Customs duty on the import of the second-hand plant is capital expenditure to be added to the initial cost of the plant.


Cost of second-hand plant 5,500,000Add: Customs duty (Note 9) 1,500,000

––––––––––7,000,000––––––––––––––––––––

Initial allowance at 50% 3,500,000––––––––––––––––––––

A second-hand plant which has not previously been used in Pakistan is entitled to initial allowance [s.23(1) and (5)(c)]

Note (11) DepreciationPlant and Building Computer Motor Furniture Totalmachinery hardware vehicles depreciation


Written down value 9,500,000 8,200,000 2,500,000 2,400,000 1,250,000Disposal – – – (650,000) –

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––9,500,000 8,200,000 2,500,000 1,750,000 1,250,000–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Depreciation 1,425,000 820,000 750,000 262,500 187,500 3,445,000–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Additions 7,000,000 – – 2,000,000 –Initial allowance (3,500,000) – – * – –

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––Written down value 3,500,000 – – 2,000,000 –

–––––––––– –––––––––– –––––––––– –––––––––– ––––––––––Depreciation 525,000 – – 300,000 – 825,000

––––––––––4,270,000––––––––––––––––––––

* Any road transport vehicle not plying for hire is not eligible for initial allowance

Note (12) An amount received by a person, inter alia, as a deposit for the issuance of shares from another person (not being a banking company or a financial institution) which is not paid by a crossed 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 year of receipt under the head ‘Income from other sources’ [s.39(3)]. The Rs. 300,000 received in cash is the income of PQR Ltd (recipient) chargeable to tax under the head ‘Income from other sources’.

Note (13) Tax credit on the tax paid by the AOPRupees

Share of profit received from the AOP (A) 1,250,000Taxable income of the AOP (B) 5,000,000Tax assessed on the AOP (C) 1,250,000A/B x C1,250,000/5,000,000 x 1,250,000 312,500

19



Marks2 Mr Pestonji

Accounting year ended 30 June 2007 Tax year 2007

Rupees(a) Computation of taxable income

SalaryFrom Hotel Splendid plcForeign-source salary exempt from tax (Note 1) 0 1·5Employee share scheme – sale of rights (Note 2) 100,000 1From Oriental Hotels Pakistan Limited (OHPL)Payment by OHPL to XYZ bank against loan liability (Note 3) 1,000,000 1Basic salary – Rs. 500,000 x 5 months (Note 4) 2,500,000 1Cash allowances (Note 4)Utilities – Rs. 50,000 x 5 months (Note 5) 250,000 1Housing – 45% of basic salary (Note 5) 1,125,000 1Medical (Note 6) 50,000 1Benefit of company maintained car (Note 7) 50,000 1Waiver of loan taken from the company (Note 8) 250,000 1Reimbursement of wife’s hospitalisation charges (Note 9) 175,000 1

––––––––––5,500,000

Income from other sourcesConsideration for vacating premises (Note 10) 60,000 2

––––––––––Total income 5,560,000Zakat paid 10,000 0·5

––––––––––Taxable income 5,550,000

––––––––––––––––––––

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 or tax payable (1 mark for each item) as follows: 5

–––18–––

Items not included in the computation of income or tax payable.

(1) In an employee share scheme, where there is any restriction on the transfer of the shares acquired under an employee share scheme, the benefit accruing to the employee on the purchase of such shares is not chargeable to tax until the employee has the free right to transfer the shares or when the employee disposes of the shares (if so allowed by the custodian of the scheme), whichever is earlier [s.14(3)(a)].

Pestonji acquired 500 shares in the HSP employee share scheme (Scheme) at the exercise price of £10 per share when the market value of one share was £15. The difference of £5 per share equivalent to Rs. 250,000 [£5 x 500 = £2,500 (Rs. 250,000)] though a benefit of employment is not chargeable to tax until the expiry of the three year holding period or the time Pestonji sells the shares (if so allowed by the custodian of Scheme).

(2) The value of a right or option granted to an employee to acquire shares under an employee share scheme is not chargeable to tax [s.14(1)]. Therefore £2 being the value of one right as estimated by the custodian of the Scheme is irrelevant for the computation of income or tax payable.

(3) As the company maintained car taken on lease is used by Pestonji for business use only, there is no taxable benefit for him.

(4) Until such time as Pestonji retires, he has no right to any part of the contribution made by OHPL to the pension fund. Therefore the monthly contribution made by OHPL to the pension fund is not Pestonji’s income.

(5) A taxable benefit on a loan given by the employer would arise, if no profit on the loan is payable by the employee or the rate of profit on the loan is less than the benchmark rate for the relevant tax year. As the profit payable on the loan is 9% per annum which is equal to the benchmark rate for the tax year 2007, there is no impact on the computation of income or tax payable.

20



Marks(b) Computation of tax Rupees

Tax at 19% on taxable income of Rs. 5,550,000 1,054,500 0·5Less: Tax credit on purchase of shares in FGH Ltd (Note 11) 38,000 1·5

––––––––––1,016,500

Add: Tax credit recouped which was allowed in the tax year 2006 on the purchase Add: of shares, disposed of during the year (Note 12) 50,500 1·5

––––––––––1,067,000

Less: Tax deducted at source on salary 700,000 0·5–––––––––– –––

Tax payable 367,000 4–––––––––– –––––––––––––

(c) Income derived which is subject to final tax.

(i) Dividend income received by an individual is taxed at 10% of the gross amount of the dividend irrespective of whether the dividend is received from a public or a private company. Rs. 11,000 being the tax deducted at source (on the gross dividend of Rs. 110,000) is the final tax and the dividend income is not chargeable to tax under any head of income. 1

(ii) Fees for rendering services to Oriental Hotels (Pakistan) Ltd.

The tax deducted at source on a payment to a resident person, inter alia, for the rendering of or providing of services, by a ‘prescribed person’, is the final tax on the income of the resident person arising from the rendering of or providing of services. A company is one of the categories included in the definition of a ‘prescribed person’.

Rs. 72,000 being the tax deducted at source (6% of gross fees of Rs. 1,200,000 for three months) is the final tax on the income arising from the rendering of services to OHPL [s.153(6)]. The income is not chargeable to tax under any head of income and no deduction is allowable for any expenditure incurred in deriving the income [s.169]. 2

–––3

–––25–––

Notes referred to in the computation of income and tax payable.

Note (1) Foreign source salary received by a resident individual is exempt from Pakistan tax, if the individual has paid foreign income tax on the salary or if tax has been withheld by the foreign employer and paid to the revenue authority of the foreign country in which the employment was exercised [s.102(1) and (2)]. £15,000 salary received by Pestonji is his foreign-source salary since the employment was exercised outside Pakistan. It is exempt from Pakistan tax since Pestonji is a resident individual and foreign income tax was deducted by the foreign employer in the United Kingdom and paid to the UK revenue authority.

Note (2) Any gain made on the disposal of a right or an option entitling the holder to acquire shares under an employee share scheme is chargeable to tax under the head ‘salary’ [s.14(5)]. As no payment was made for the right to acquire 1,000 shares under the HSP employee share scheme, Rs. 100,000 received for the sale of the rights for 500 shares is the gain chargeable to tax as salary income.

Note (3) An amount or perquisite is treated as received by an employee from employment regardless of whether the amount or perquisite is paid or provided, inter alia, by a past or a prospective employer [s.12(5)(b)]. Furthermore where an obligation of an employee to repay an amount owing by the employee to another person is paid by the employer, the amount so paid is chargeable to tax under the head ‘salary’ [s.13(10)]. The payment of Rs. 1,000,000 by Oriental Hotels (Pakistan) Ltd (prospective employer) to the XYZ Bank against the loan owing by Pestonji is a perquisite provided by the employer and is chargeable to tax as salary income.

Note (4) All income chargeable under the head ‘salary’ is taxable on a receipt basis. As the salary and cash allowances for June 2007 were paid on 2 July 2007 (tax year 2008), the salary and cash allowances for only five months (January 2007 to May 2007) are chargeable to tax.

Note (5) The cash allowances for utilities and housing are fully taxable. Prior to the Finance Act, 2006 certain exemptions were available for such cash allowances.

21



MarksNote (6) Rupees

Medical allowance (Rs. 60,000 x 5 months) 300,00010% of basic salary is exempt from tax (10% of Rs. 2,500,000) 250,000


––––––––––––––––

Medical allowance is exempt from tax up to 10% of basic salary only if the employee’s terms of employment do not provide for free medical treatment or hospitalisation or reimbursement for such expenses [clause 139(b) of Part I of the Second Schedule].

Note (7) As the car purchased for Rs. 2,000,000 is for Pestonji’s private (non-business) and business use, Rs. 100,000 being 5% of Rs. 2,000,000 is the annual benefit. Since the car was used for six months (January 2007 to June 2007), the amount chargeable to tax is Rs. 50,000.

Note (8) The waiver of an obligation of an employee to repay an amount owing by the employee to the employer, is a perquisite chargeable to tax, under the head ‘salary’ in the tax year the amount is waived [s.13(9)]. Rs. 250,000 of the loan amount waived by OHPL is thus chargeable to tax as salary income.

Note (9) The reimbursement of Rs. 175,000 is chargeable to tax as Pestonji’s salary income, since under the terms of employment Pestonji is not entitled to free medical treatment or hospitalisation or any reimbursement of such expenses.

Note (10) Any amount received by a person as consideration for vacating the possession of a building or part thereof as reduced by the amount paid to acquire such building is chargeable to tax under the head ‘Income from other sources’ over 10 years in equal proportion including the year in which the consideration is received. Therefore Rs. 60,000, being one-tenth of Rs. 600,000 consideration received, is chargeable to tax [s.39(I)(k) and (2)].

Note (11) A person (other than a company) is allowed a tax credit, inter alia, on the cost of acquiring shares from the Privatisation Commission of Pakistan. The credit is to be calculated on the lower of (a) the cost of acquiring the shares, (b) 10% of the person’s taxable income for the year or (c) Rs. 200,000. Since both the cost of acquiring the shares (Rs. 500,000) and 10% of Pestonji’s taxable income (Rs. 555,000) are more than Rs. 200,000, the tax credit is to be calculated on Rs. 200,000 only as against Rs. 500,000 invested in the purchase of shares in FGH Ltd.

The calculation of the tax credit [s.62(1) and (2)] on the investment in the acquisition of the shares in FGH Ltd is calculated as under:

RupeesTax assessed before allowance of tax credit (A) 1,054,500Taxable income for the tax year (B) 5,550,000Amount of investment on which tax credit is to be calculated (C) 200,000Tax credit allowedA/B x CRs. 1,054,500/Rs. 5,550,000 x Rs. 200,000 38,000

Note (12) On 30 June 2006 (tax year 2006) Pestonji had purchased 1,000 shares in ABC Ltd from the Privatization Commission of Pakistan and was allowed a tax credit of Rs. 50,500 against the tax payable for the tax year 2006. The 1,000 shares were sold on 1 June 2007 (tax year 2007). As the shares were disposed of within twelve months of the date of acquisition, the tax credit allowed in the tax year 2006 is recouped and the amount of tax payable for the tax year 2007 (tax year in which the shares were disposed of) is increased by Rs. 50,500 being the amount of tax credit allowed in the tax year 2006 [s.62(3)].

3 (a) (i) Amount of value addition on the goods imported.Rupees

Value of DVD players as determined for customs purposes. 50,000,000Customs duty and other taxes payable at the customs stage. 2,500,000

–––––––––––Assessed import value. 52,500,000

––––––––––––––––––––––

The amount of value addition is 10% of the assessed import value of the goods (10% of Rs. 52,500,000). 5,250,000 2

––––––––––– ––––––––––––––

(ii) Total sales tax payable. – On the assessed import value (15% of Rs. 52,500,000). 7,875,000 1– On the value addition (15% of Rs. 5,250,000). 787,500 1

––––––––––– –––8,662,500 2

––––––––––– ––––––––––––––

22



Marks(iii) Hamza and Hisham, as a commercial importer is required to pay the sales tax of Rs. 8,662,500 at

the same time as making payment of the customs duty and other taxes. 1–––

(b) (i) ABC can apply for de-registration when:

– it ceases to carry on its business; or 1– its supplies become exempt from sales tax 1

–––2

–––

(ii) ABC’s registration can be suspended when the Collector has reason to believe that ABC has:

– committed tax fraud; 1– evaded tax; or 1– failed to deposit the sales tax due after having recovered the tax from the buyers. 1

–––3

–––

(c) (i) Where the consideration for a supply is partly in kind and partly in money, the value of the supply would be the open market price of the supply excluding the amount of tax. 2

–––(ii) Where goods are supplied at a discounted price (trade discount), the value of the supply would be the

discounted price excluding the amount of tax, provided:

– the discounted price and the related tax is shown on the tax invoice; and – the trade discount allowed is in conformity with normal business practices. 3

–––15–––

4 (a) (i) The chief accountant’s view that the gain of Rs. 5,000,000 on the disposal of the shares in Chemicals Ltd is income chargeable to tax under the head ‘Income from business’, is erroneous. 1

A ‘capital asset’ has been very broadly defined to mean property of any kind held by a person, whether or not connected with a business. However there are certain exclusions to this definition. One of the exclusions is ‘any stock-in-trade (not being stocks and shares), consumable stores or raw materials held for the purpose of business’ [s.37(5)(a)]. Stock-in-trade is excluded from the definition of a capital asset unless the stock-in-trade represents stocks and shares. In other words stocks and shares held by a taxpayer as his stock-in-trade would fall within the definition of a ‘capital asset’ and any gain or loss on the disposal of such stock-in-trade would be chargeable to tax under the head ‘Capital gains’ unless the capital gain is exempt from tax. 2

For Secure Securities Ltd, being in business as stock and shares brokers, the 50,000 shares in Chemical Ltd held as its stock-in-trade is a capital asset and therefore the gain of Rs. 5,000,000 on the disposal of the shares is a capital gain. 1

–––4

–––

(ii) The gain of Rs. 5,000,000 should be shown in the return of income for the tax year 2007 as capital gains exempt from tax being a gain from the sale of shares of Chemicals Ltd which is a public company for tax purposes. Any income chargeable under the head ‘Capital gains’ being income from the sale, inter alia, of shares in a public company is exempt from tax up to the tax year ending on 30 June 2007 [clause (110) of Part I of the Second Schedule]. 2

–––

(b) Any income derived by an individual from the transfer of his membership rights or shares in a stock exchange in Pakistan along with a room in the stock exchange to a company at any time between 1 July 2005 and 30 June 2007 is exempt from tax [clause 133A of Part I of the Second Schedule].

As Mr Hamid, an individual, transferred his one share in the Karachi Stock Exchange (Guarantee) Ltd along with the room occupied by him in the stock exchange to a company [ABC (Private) Ltd] prior to 30 June 2007, the entire income derived by Mr Hamid from the transaction is exempt from tax. 3

–––

(c) (i) Sale of 5,000 shares in XYZ (Private) Ltd.

Where a capital asset becomes the property of a person, inter alia, on the distribution of assets on theliquidation of a company, the fair market value of the asset on the date of its acquisition is treated as the cost of the asset [s.37(4A)(d)]. 1

23



MarksIn the circumstances, Patel’s view that the sale consideration is his income chargeable to tax as capital gains is not correct. The capital gain or loss on the sale of the shares would be the difference between the consideration received and the cost of the asset which in this case would be the fair market value of the shares on the date of acquisition. 2

(ii) Mr Patel’s view is not correct. Under the non-recognition rules, no gain or loss is taken to have arisen on the disposal of an asset, inter alia, under an agreement between spouses to live apart provided the person acquiring the asset is not a non-resident for Pakistan tax purposes at the time of the acquisition [s.79(1)(a) and (2)]. 2

When Seema acquired the 10,000 shares in Q (Private) Ltd on 1 June 2007 (tax year 2007) she was a resident for Pakistan tax purposes in the tax year 2007 since during that year she was an employee of the Federal Government of Pakistan posted abroad [s.82(c)]. 1

Accordingly under the non-recognition rules no gain is taken to have arisen on the transfer of the 10,000 shares in Q (Private) Ltd by Patel to his wife Seema, since the transfer was under an agreement between spouses to live apart and Seema was resident for Pakistan tax purposes at –––the time she acquired the shares. 6

–––15–––

5 (a) (i) Mr Kapadia’s contention of not being required to pay any tax for the tax year 2007 is not correct because the Finance Act, 2006 changed the basis of taxation for income chargeable to tax under the head ‘Income from property’. No deductions are now permissible against the rent chargeable to tax (previous s.17 deleted). Tax at the rate of 5% is payable on the gross amount of rent chargeable to tax [s.15(6) and –––Division VI of Part I of the First Schedule]. 3

–––

(ii) Tax payable by Mr Kapaida

RupeesRent chargeable to taxRental income (Note 1) 275,000 2Forfeited deposit (Note 2) 100,000 1·5

––––––––375,000––––––––

Tax on Rs. 375,000 at 5% 18,750 0·5––––––––––––––––

Note (1) Where the rent received or receivable is less than the fair market rent for the property, the owner of the property is treated as having derived the fair market rent for the period the property is let on rent [s.15(4)]. As similar apartments to the one rented by Kapadia to his brother ordinarily fetch a rent of Rs. 25,000 per month, Rs. 275,000 (Rs. 25,000 x 11 months) is taken as the rental income for the apartment.

Note (2) The forfeited deposit amount of Rs. 100,000 paid under the contract for the sale of the apartment is treated as rent chargeable to tax [s.15(2)].

–––4

–––

(iii) The Finance Act, 2006 also legislated that income classified under the head ‘Income from property’ would not be chargeable to tax if the taxpayer:

(i) is an individual or association of persons;

(ii) derives income chargeable to tax under the head ‘Income from property’ not exceeding Rs. 150,000 in a tax year; and

(iii) has no taxable income under any other head of income [s.15(7)]. 3

In view of the above, if Mr Kapadia’s income chargeable to tax from the apartment under the head ‘Income from property’ was Rs. 150,000 in the tax year 2007, no tax would have been payable by him for the tax year 2007 as he is assessed as an individual and has no taxable income under any other head of income. 1

–––4

–––

24



Marks(b) The tax implications for ABC (Pakistan) Ltd for the tax year 2007 relating to the item of plant discarded are

as under:

(i) The event of discarding the item of plant is treated as a disposal of the asset in the tax year 2007 [s.75(3A)]. 1

(ii) The fair market value (FMV) of the asset determined at the time the asset was discarded is treated as the consideration received on its disposal [s.77(3)]. 1

(iii) As the item of plant discarded is treated as a disposal of the asset and the plant was used by ABC (Pakistan) Ltd in the carrying on of the business, the tax profit or loss on its disposal would be its business income or business loss. If the consideration received (the FMV) exceeded Rs. 500,000 being the tax written down value of the plant, the excess is chargeable to tax under the head ‘Income from business’. If the consideration received (the FMV) was less than Rs. 500,000 the difference is allowable as a deduction under the head ‘Income from business’. 2

–––4

–––15–––

Marks6 (1) The following issues raised by the Commissioner are in accordance with the provisions of the tax statute.

(i) Disallowance of the tax credit of Rs. 315,540 claimed against the tax payable.A tax credit, based on a specified formula, is allowable to all taxpayers except a company, on the investment, inter alia, in new shares offered to the public by a public company listed on a stock exchange in Pakistan provided the taxpayer is an original allottee of the shares [s.62(1) and (2)]. Usman Pakistan Ltd (UPL) being a company is not entitled to the tax credit. 3

(ii) Disallowance of Rs. 300,000 out of tax depreciation claimed on office building.A person is allowed a deduction for depreciation on its depreciable assets used in the business in the tax year. The depreciation deduction is computed by applying specified rates of depreciation against the tax written down value (WDV) of the asset at the beginning of the year [s.22(1) and (2)]. The WDV of an asset in the year of its acquisition is the actual cost of the asset as reduced by initial allowance and in subsequent years it is the cost as reduced by total depreciation (including initial allowance) allowed as a deduction [s.22(5)]. In other words, for tax purposes, the WDV of an asset can only be increased by the cost of any addition to the asset.

Rs. 300,000 queried by the Commissioner represents 10% of Rs. 3,000,000 which was added to the tax WDV of the building. This addition to the WDV is erroneous since the Rs. 3,000,000 is not the cost of any addition to the building but is the difference between the book value of the building and the value as estimated by the expert valuer. In the circumstances the claim of Rs. 300,000 for depreciation is not allowable under the law. 4

(2) The following issues raised by the Commissioner are not in accordance with the provisions of the tax statute.

(i) Rs. 500,000 credited to capital reserve.The definition of ‘income’ [s.2(29)] specifically excludes from its ambit, in the case of a shareholder of a company, the amount representing the face value of any bonus shares issued by a company to the shareholders. UPL is a shareholder of JKL Ltd and therefore Rs. 500,000 representing the face value of 50,000 bonus shares issued by JKL Ltd is not UPL’s income chargeable to tax. 3

(ii) Rs. 700,000 paid to the expert valuer.The valuation of the office building was at the requirement of Zee Bank. The valuation was required by the bank against a loan taken by UPL for business purposes. It is therefore an expenditure incurred wholly and exclusively for the purposes of the business and is a deductible expenditure [s.20(1)]. 2

(iii) Rs. 875,000 paid to a legal counsel The expenditure incurred in defending the title to the factory building is a revenue disbursement. The expenditure has not created any new asset nor has it added value to the factory building. It was incurred in the ordinary course of maintaining the assets of the company. The expenditure has been incurred wholly and exclusively for the purposes of the business and is therefore a deductible expenditure [s.20(1)]. 3

–––15–––

25



Marks7 (a) (i) As the three items of expenditure were incurred after Mungali Moosta (Private) Ltd [MMPL] was

incorporated but prior to the commencement of business, such expenditure is classified in the tax statute as ‘pre-commencement expenditure’ [s.25]. ‘Pre-commencement expenditure’ has been defined to mean any expenditure incurred before the commencement of a business wholly and exclusively to derive income chargeable to tax and specifically includes the cost of feasibility studies, construction of prototypes and trial production activities [s.25(5)]. 3

Pre-commencement expenditure is not allowed as a direct deduction but is allowed to be amortised for tax purposes on a straight line basis over five years in equal proportion [20% per year]. The total deductions allowed for amortisation are not to exceed the amount of the pre-commencement expenditure. In the circumstances the treatment accorded to the three items of expenditure is not correct. 3

–––6

–––

(ii) Each of the three items of expenditure falls within the definition of ‘pre-commencement expenditure’ and therefore MMPL is entitled to a deduction for amortization at the rate of 20% of Rs. 15,000,000 in the tax year 2006 and the succeeding four tax years on a straight line basis. To claim this amortisation deduction, MMPL would have to file a revised return of income. 2

Tax year 2006Revised computation of income

RupeesTaxable income as per original return of income 2,500,000Less: Amortisation of pre-commencement expenditure (20% of Rs. 15,000,000) 3,000,000 1

––––––––––Tax loss 500,000

––––––––––––––––––––Tax paid with original return of income (37% of Rs. 2,500,000) 925,000 1

––––––––––––––––––––Tax refundable 925,000 1

–––––––––––––––––––– –––5

–––

(b) The consideration received by a person on the disposal of an asset shall be the amount received or the fair market value (FMV) of the asset whichever is higher at the time of the disposal. If any part of the consideration is received in kind, the FMV thereof is to be included in determining the amount of consideration received. 3

In the case of an asset disposed of by a person by reason of a gift, the person does not receive any thing. Therefore the FMV of the asset at the time the person parts with the asset, will be treated as the consideration received by that person. 1

–––4

–––15–––

26



Fundamentals Level – Skills Module

Time allowedReading and planning: 15 minutesWriting: 3 hours

ALL FIVE questions are compulsory and MUST be attempted.Tax rates and allowances are on page 3.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet untilinstructed by the supervisor.

This question paper must not be removed from the examination hall.

Pape

r F6

(PK

N)

Taxation(Pakistan)

Monday 3 December 2007




This is a blank page.The question paper begins on page 3.

2



SUPPLEMENTARY INSTRUCTIONS

1. Calculations and workings need only be made to the nearest rupee.2. All apportionments should be made to the nearest month.3. All workings should be shown.

TAX RATES AND ALLOWANCESThe following tax rates and allowances 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 2007.Taxable income Rate of taxUp to Rs. 150,000 0%Rs. 150,001 – Rs. 200,000 0.25%Rs. 200,001 – Rs. 250,000 0.50%Rs. 250,001 – Rs. 300,000 0.75%Rs. 300,001 – Rs. 350,000 1.50%Rs. 350,001 – Rs. 400,000 2.50%Rs. 400,001 – Rs. 500,000 3.50%Rs. 500,001 – Rs. 600,000 4.50%Rs. 600,001 – Rs. 700,000 6.00%Rs. 700,001 – Rs. 850,000 7.50%Rs. 850,001 – Rs. 950,000 9.00%Rs. 950,001 – Rs. 1,050,000 10.00%Rs. 1,050,001 – Rs. 1,200,000 11.00%Rs. 1,200,001 – Rs. 1,500,000 12.50%Rs. 1,500,001 – Rs. 1,700,000 14.00%Rs. 1,700,001 – Rs. 2,000,000 15.00%Rs. 2,000,001 – Rs. 3,150,000 16.00%Rs. 3,150,001 – Rs. 3,700,000 17.50%Rs. 3,700,001 – Rs. 4,450,000 18.50%Rs. 4,450,001 – Rs. 8,400,000 19.00%Rs. 8,400,001 and over 20.00%

* For a woman taxpayer where salary income exceeds 50% of taxable income for the tax year 2007, no tax ischargeable if taxable income does not exceed Rs. 200,000

B. Tax rates for companiesTax year Public company Private company Small company2007 35% 35% 20%

C. Rates of advance collection or deduction of taxFor rent of immovable property (including rent of furniture and fixtures and amounts for services relating to such property) 5% of gross rent paid

D. Tax rates on dividends received from companiesReceived by a public company or any other resident company 5% of the gross amount of the dividend In any other case 10% of the gross amount of the dividend

E. Capital allowancesDepreciationBuildings (all types) 10% Furniture and fittings 15% Plant and machinery (not otherwise specified) 15% of the tax written down valueMotor vehicles (all types) 15% Computer hardware 30%


3 [P.T.O.



ALL FIVE questions are compulsory and MUST be attempted

1 Wheels Pakistan Limited (WPL), an industrial undertaking, is engaged in the manufacture of motor cars. The followinginformation is available for the accounting year ended 30 June 2007.

(1) WPL is a public company under the Companies Ordinance, 1984. 40% of its shares are held by the FederalGovernment, 50% by the Government of Kuwait and 10% by individuals. WPL is not listed on any stockexchange in Pakistan

(2) WPL’s accounting profit for the year ended 30 June 2007 before the transfer of Rs. 2,000,000 to the generalreserve account is Rs. 20,000,000


(i) Accounting depreciation 6,000,000

(ii) Tax collected by the Collector of Customs on the import of motor cars in CBU (completely built unit) condition 11,000,000

(iii) Donation to a relief fund established in Pakistan by the Federal Government 700,000

(iv) Major renovations to upgrade the assembly line to meet the increasing demand for deluxe cars 3,000,000


(i) Accounting profit on the sale of a building 6,000,000

(ii) The face value of bonus shares received from Gears Limited, a public company not listed on any stock exchange in Pakistan. WPL holds shares in Gears Limited as an investment 500,000

(iii) Dividends (net of tax) received from Poshcars (Private) Ltd, a company incorporated under the Companies Ordinance, 1984 95,000

(iv) Received against a debt written off in the tax year 2006, which write off was then not allowed as a deduction against taxable income 175,000

(v) Net income (adjusted for tax purposes) on the sale of the imported cars in CBU condition (as in 3(ii) above) 5,000,000

(5) Fixed assets

(i) The tax written down values of WPL’s fixed assets on 1 July 2006 were:Buildings 13,800,000Furniture and fitting 1,570,000Plant and machinery 2,700,000Motor vehicles 2,500,000

(ii) A deluxe motor car was purchased on 1 January 2007 for Rs. 6,000,000, for the Chief Executive

(iii) One of the buildings (cost Rs. 10,000,000 and tax written down value Rs. 7,000,000) was sold on30 June 2007 for Rs. 15,000,000

(iv) An item of second-hand plant, not previously used in Pakistan, was imported from Japan at a cost ofRs. 3,500,000. Rs. 500,000 was incurred on the installation of the plant, which was commissioned foruse on 1 January 2007. The Rs. 500,000 installation cost has been shown as revenue expenditure in theaccounts.

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(i) Rs. 3,000,000 payable in respect of a loan taken out for business purposes in the accounting year ended30 June 2003. The Rs. 3,000,000 includes an amount of Rs. 400,000 profit payable on the loan, whichamount was allowed as a deduction in the accounting year ended 30 June 2003.

(ii) Rs. 1,000,000 received in cash from a director as a temporary advance to meet working capitalrequirements.

(iii) Rs. 4,000,000 received in cash from Carsales Associates, a customer, as an advance payment for the saleof cars.

Radiators Pakistan Limited (RPL), an industrial undertaking, which is the 100 per cent subsidiary of WPL, furnishedits complete return of income for the tax year 2007 to the tax department on 1 October 2007, declaring a tax lossfor its accounting year ended 30 June 2007 (other than brought forward losses) of Rs. 1,750,000. The said loss wassurrendered by RPL in favour of its holding company WPL. The Chief Financial Officer of WPL wants you to set-offthe surrendered loss of Rs. 1,750,000 against the taxable income of WPL.

Required:

(a) Briefly state, with reasons, whether or not Wheels Pakistan Limited (WPL) is a public company for taxpurposes. (2 marks)

(b) Compute the taxable income of WPL for the relevant tax year under the appropriate heads of income. Youranswer should give clear reasons/explanations for the inclusion or exclusion in the computation of taxableincome of each of the items listed above. The reasons/explanations for the items not listed in the computationof taxable income should be shown separately. Specific marks are allocated for this part of the requirement.

(24 marks)

(c) Calculate the tax payable by/refundable to WPL for the relevant tax year. (4 marks)

(30 marks)

5 [P.T.O.



2 The following information is furnished to you by Mr Cyrus Banaji for his accounting year ended 30 June 2007.

(1) On 31 December 2006, Cyrus, a citizen of Pakistan, retired from the employment of the Karachi branch of ABCLimited (ABC), a company incorporated under the law of a country outside Pakistan. Cyrus has been in theemployment of ABC since 1 January 1990 and on retirement he received:

– Rs. 1,000,000 from ABC as a gratuity. The amount received was not from any gratuity fund approved bythe Commissioner or a gratuity scheme approved by the Central Board of Revenue.

– Rs. 9,000,000 from the ABC Employees Provident Fund being the accumulated balance in his account ofthe fund. The fund has been recognised by the Commissioner.

(2) Cyrus was also eligible to receive a monthly pension of Rs. 50,000 from 1 January 2007. At the end of eachmonth ABC transfers Rs. 50,000 to his bank account.

(3) On 1 June 2007 (on which date Cyrus was no longer in the employment of ABC), DEF Ltd Singapore transferredthe equivalent of Rs. 4,000,000 in US Dollars to Cyrus’s bank account in Singapore. The payment was inconsideration of Cyrus consenting to a restrictive covenant restraining him from entering into employment withany competitor company of ABC for a period of five years. DEF Ltd Singapore is an associate company of ABC.

(4) The terms of employment of Cyrus with ABC provided for the following:


(ii) Monthly cash allowances of:– Rs. 25,000 for utilities– Rs. 25,000 for medical treatment– Rs. 45,000 for house rent assistance

(iii) A company maintained car (purchased for Rs. 2,000,000 on 1 January 2003) for Cyrus’s personal andbusiness use.

(iv) No entitlement to free medical treatment or hospitalisation or reimbursement of such expenses.

(5) Under the ABC car policy, a retiring employee, with at least three years service, has the option to purchase thecompany maintained car used by that employee at the accounting written down value (WDV) of the car. Cyrusexercised this option and purchased the car at its WDV of Rs. 100,000 on 30 December 2006. He sold the caron 1 January 2007 for Rs. 250,000.

(6) Tax deducted at source by ABC from Cyrus’ salary income for the relevant tax year was Rs. 1,200,000

(7) Cyrus and his friend Sorab entered into a partnership agreement on 1 January 2006, to carry on business asmanufacturers of washing machines under the name of Sorab Associates. The partnership agreement providesthat profits or losses in the business are to be shared equally. The taxable income of the partnership for the yearended 31 December 2006 [Special tax year 2007] was Rs. 2,500,000 and the tax paid by the partnership onthis Rs. 2,500,000 was Rs. 625,000.

(8) On 15 December 2006, Cyrus purchased a building which had previously been used as a factory in the KorangiIndustrial Estate for Rs. 4,000,000 and installed in the building an item of second-hand plant previously usedin Pakistan, for the preparation of bakery products, costing Rs. 2,000,000. Cyrus leased the Korangi propertyconsisting of the building together with the plant on 1 January 2007 to Mr Double Roti, for a composite rent ofRs. 200,000 per month payable in advance.

Cyrus is also the owner of a residential building in Gulshan which was let to Gulab (Private) Limited on 1 July2006, for a monthly rental of Rs. 150,000. Rent for the year ended 30 June 2007 was received in advance on1 July 2006 after deduction of tax at the prescribed rate.

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The following expenditure was incurred by Cyrus on the two properties for the tax year 2007:

Korangi Gulshanproperty building

Rs. Rs.Repairs to building 80,000 50,000Repairs to plant 50,000 –Ground rent 2,000 2,000Insurance 38,000 10,000

———— ————170,000 62,000———— ———————— ————

(9) Cyrus has also furnished you with the following information in respect of amounts received by him in theaccounting year ended 30 June 2007:

(i) Rs. 54,000 as a dividend on his shareholding in XYZ Ltd, a company listed on the Karachi Stock Exchange.He wants to claim, as a deductible charge against this dividend income, Rs. 10,000 paid as profit on a loanobtained to acquire the shares in XYZ Ltd.

(ii) Rs. 65,000 as arrears of salary for the year ended 30 June 2006 received from ABC on 21 March 2007.He does not want to include this Rs. 65,000 in the computation of income for the year ended 30 June2007 since:

– he was not an employee of ABC on 21 March 2007 and therefore the Rs. 65,000 can not be treatedas received from any employment; and

– the receipt of the Rs. 65,000 pertains to the year ended 30 June 2006 and is not his taxable incomefor the year ended 30 June 2007.

Required:

(a) Compute the taxable income of Mr Cyrus Banaji for the relevant tax year under the appropriate heads ofincome. Your answer should give clear reasons/explanations for the inclusion or exclusion in the computationof taxable income of each of the items listed above. The reasons/explanations for the items not listed in thecomputation of taxable income should be shown separately. Specific marks have been allocated for this partof the requirement. (21 marks)

(b) Calculate the tax payable by/refundable to Mr Cyrus Banaji for the relevant tax year. (4 marks)

(25 marks)

7 [P.T.O.



3 (a) Mr Murad, a resident for Pakistan tax purposes, is preparing his return of income for the accounting year ended30 June 2007 and the following information is furnished to you:

(1) On 1 July 2006, Murad became a member of the Karachi Stock Exchange (KSE) by purchasing from Mr Govind one share in Karachi Stock Exchange (Guarantee) Ltd (KSEG) for Rs. 30,000,000. He alsoacquired from Govind the occupancy rights of a room in the stock exchange building for Rs. 800,000.

(2) On 31 May 2007 Murad and Govind formed a partnership firm under the name of Murind Associates. On 1 June 2007 Murad gave up his membership rights in KSE and transferred to Murind Associates theone share in KSEG for Rs. 40,000,000 and the occupancy rights of the room in the stock exchange for Rs.800,000.

Murad is of the view that there are no tax implications of the transaction relating to the transfer of the one sharein KSEG and the occupancy rights in the room in the stock exchange, due to a specific exemption from tax forsuch transactions available under a clause in Part I of the Second Schedule.

Required:

State, giving reasons, whether or not Mr Murad’s contention is correct. (3 marks)

(b) The following information is furnished to you by Mr Noman relating to his accounting year ended 30 June 2007.

(1) As an employee of the Karachi branch of Winners Bank plc (WBP), Noman, prior to his retirement fromWBP, had participated in the Winners Employee Share Scheme (Scheme), the details of which are asfollows:

– Under the Scheme, a participant has the free right to transfer the shares acquired only after a minimumholding period of six months, unless permission is granted by the custodian of the Scheme for thetransfer of the shares before the expiry of the holding period.

– On 1 July 2006, Noman was granted the right to purchase 2,000 shares in WBP at the exercise priceof £10 per share. The £10 was inclusive of a consideration of £1 for the right to acquire the shares.Noman accepted the right offered and made a payment of £2,000.

– On 31 July 2006 Noman disposed of the right relating to 1,000 shares for Rs. 150,000.

– On 1 August 2006 Noman exercised the right to acquire the balance of 1,000 shares in WBP andmade a payment of £9 per share, having already paid £1 per share at the time of accepting the right.On 1 August 2006 the price quoted for one share in WBP on a stock exchange in the United Kingdom(UK) was £12.

– On 1 February 2007 (i.e. the end of the minimum holding period of six months for the shares acquiredunder the Scheme) the price of one share in WBP quoted on a stock exchange in the UK was £14.

– On 15 June 2007, Noman sold 500 shares in WBP for Rs. 1,200,000.

– The rate of exchange is to be taken as £1 = Rs. 100 on all relevant dates.

(2) On 31 May 2007 Noman sold some shares all of which had been acquired by him on 30 April 2006. Thedetails of the gain or loss on the sale of these shares is as under:

– Gain of Rs. 100,000 on the sale of shares in Lowlands (Private) Limited.

– Gain of Rs. 40,000 on the sale of shares in Highlands Ltd a company incorporated under theCompanies Ordinance, 1984, in which 50% of the shares are held by a company incorporated in SaudiArabia which is wholly owned by the Kingdom of Saudi Arabia. Highlands Ltd is not listed on any stockexchange in Pakistan.

– Loss of Rs. 60,000 on the sale of shares in Fibres Ltd a company whose shares were traded on theLahore Stock Exchange in the tax year 2007 and which remained listed on that exchange on 30 June2007.

(3) On 31 May 2007 Noman sold agricultural land for Rs. 700,000, which he had purchased in April 2007for Rs. 500,000.

8



(4) On 15 June 2007, Noman sold personal jewellery for Rs. 1,200,000. The jewellery had been gifted to himat the time of his marriage on 1 January 2006, on which date it had been valued by a reputed firm ofjewellers at Rs. 900,000.

(5) In the accounting year ended 30 June 2007, Noman paid Rs. 50,000 as zakat under the Zakat and UshrOrdinance, 1980.

Required:

Compute the total income and the taxable income of Noman under the appropriate heads of income for therelevant tax year, giving clear reasons/explanations for the inclusion or exclusion of each of the items listedabove. The reasons/explanations for the items not included in the computation of total/taxable income shouldbe shown separately. Specific marks are allocated for this part of the requirement. (17 marks)

(20 marks)

9 [P.T.O.



4 Jasmine Pharmaceuticals Company (JPC), a partnership firm, registered under the Partnership Act 1938, is in thebusiness of manufacturing pharmaceuticals. The assessment of JPC for the tax year 2007 (accounting year ended 30June 2007) was selected for audit under s.177 of the Income Tax Ordinance, 2001.

(1) On completion of the audit, the Commissioner informs JPC that he intends to amend the assessment for the taxyear 2007 to:

(i) Levy minimum tax of 0·5% on the firm’s turnover of Rs. 9,000,000.

(ii) Disallow Rs. 1,530,000 out of travelling expenses, being the travel and hotel expenses for JPC’s technicalmanager’s visit to Japan.

(iii) Disallow Rs. 400,000 being the contribution paid by JPC to the unrecognised Jasmine Employees ProvidentFund.

(iv) Disallow Rs. 75,600 expended on the annual Eid-Milan party for JPC’s employees and their families.

(v) Disallow Rs. 500,000 being damages paid to JPC’s sole distributor.

(vi) Disallow the donation of Rs. 1,000,000 paid to a hospital.

(vii) Disallow the Rs. 1,200,000 salary paid to Mr A.

The Commissioner has required JPC to furnish explanations/reasons as to why he should not amend theassessment on the lines indicated.

(2) The following information on the issues raised by the Commissioner is provided to you:

(i) Minimum taxJPC was not aware of the concept of minimum tax payable.

(ii) Travelling expenses The travel to Japan was entirely for business purposes. It was necessary for the firm’s technical manager totravel to Japan for the purpose of selecting a second-hand mixing machine, so as to ensure that the machinewas compatible with the company’s existing plant.

(iii) Contribution to the unrecognised provident fund.JPC, in its accounting system, has ensured that when any payment is made from the fund to an employee,tax would be deducted at source from the amount of the payment, if the amount is chargeable to tax as thesalary income of the employee.

(iv) Eid-Milan party The expenditure on the party was motivated by the purpose of maintaining cordial relations between theemployees and the management.

(v) Damages paid to the sole distributor Due to the failure to deliver supplies within the time stipulated in the contract, JPC had to pay damages totheir sole distributor. The failure to deliver the supplies in time was due to the negligence of the despatchdepartment of the firm and not due to the violation of any law.

(vi) Donation The donation was not paid to any private hospital but to a hospital which was established in Pakistan bythe Federal Government.

(vii) Salary paid to Mr AMr A is a partner in the firm of JPC. He is also the Chief Executive Officer (CEO) of the firm devoting his fulltime to managing the affairs of the firm. His salary was approved by the partners.

Mr A, as CEO of JPC, wants you to explain the relevant statutory tax provisions on the issues raised by theCommissioner.

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Required:

State giving reasons whether or not in each case, the amendment proposed by the Commissioner is or is not inaccordance with the provisions of the tax statute.

Note: the allocation of marks is as follows:Item (iii), 3 marks; all of the other six items, 2 marks each.

(15 marks)

5 Mr Miskeen, a registered person for sales tax purposes, is engaged in the manufacture of electrical appliances inGujranwala.

Miskeen’s business transactions for the month of June 2007 are summarised as follows:

RupeesPurchases of raw materials from registered persons 2,500,000Purchases of packing materials from unregistered persons 950,000Sale of electrical appliances to: – registered persons 1,890,000– unregistered persons 2,150,000Sale of old model electric toasters to registered persons (Note 1) 422,800

Notes:(1) Prior to the introduction of a new model of electric toasters, Miskeen sold his entire stock of the old model

toasters, allowing a trade discount of 35% (shown on the face of the invoice). This trade discount given to thedealers is not in accordance with Miskeen’s normal business practice. Had the old model toasters been sold atthe normal discounted price, the sale proceeds would have been Rs. 650,000 as against the Rs. 422,800actually received.

(2) All payments for purchases made are stated inclusive of sales tax at the rate of 15%, where applicable. Allamounts for the sale of electric appliances are stated exclusive of sales tax.

Required:

(a) Calculate the sales tax payable by/refundable to Mr Miskeen for the month of June 2007. (5 marks)

(b) Give clear explanations of the treatment accorded to the following items in calculating the sales tax payableby/refundable to Mr Miskeen in part (a):

(i) The purchases of packing material from unregistered persons. (1 mark)

(ii) The supply of goods to unregistered persons. (1 mark)

(iii) The supply of goods to registered persons at a trade discount of 35%. (3 marks)

(10 marks)


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Answers



15

Fundamentals Level – Skills Module, Paper F6 (PKN) December 2007 Answers Taxation (Pakistan) and Marking Scheme

Marks1 (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 [s.2(47)(ab)]. Since 50% of the shares in Wheels Pakistan Limited(WPL) are held by the Government of Kuwait, WPL is a public company for tax purposes. 2

—–

(b) Wheels Pakistan Limited Accounting year ended 30 June 2007

Tax year 2007

Computation of taxable income Rupees RupeesIncome from businessAccounting profit 20,000,000Add: Accounting depreciation (Note 1) 6,000,000 0·5

Tax collected by the Collector of Customs (Note 2) 11,000,000 1Donation to a relief fund (Note 3) 700,000 1Major renovations to plant (Note 4) 3,000,000 1Plant installation expenses (Note 5) 500,000 1Unpaid liability (Note 6) 400,000 1Tax profit on the sale of the building (Note 7) 3,000,000 2

—————– 24,600,000Less: Accounting profit on the sale of the building (Note 8) 6,000,000 0·5

Bonus shares received (Note 9) 500,000 2Dividend income (Note 10) 95,000 1Recovery of a debt previously written off (Note 11) 175,000 1Initial allowance (Note 12) 2,000,000 1Depreciation (Note 13) 3,345,500 4

—————–(12,115,500)

——————32,484,500

Income from other sourcesTemporary advance received in cash for working capital (Note 14) 1,000,000 2

——————Taxable income 33,484,500

————————————

The relevant notes will be considered in allocating marks against each item. In addition, specific marks willbe awarded for the explanations of the treatment of items not included in the computation of income [1 markeach for items (i), (ii) and (iii) and 2 marks for item (iv)] as follows. 5

—–24—–

Items not included in the computation of taxable income

(1) No adjustment is required in the computation of income for Rs. 2,000,000 transferred to the general reserveaccount, since the transfer is after determination of the profit of Rs. 20,000,000.

(2) The net income of Rs. 5,000,000 (adjusted for tax purposes), on the sale of the imported cars in CBUcondition, is income chargeable to tax, since the tax of Rs. 11,000,000 collected at the customs stage is notthe final tax [s.148(7)(c)]. No adjustment is, therefore, required for the Rs. 5,000,000 in the computation ofincome.

(3) An advance received by a person from another person (not being a banking company or a financial institution)which is not paid by a crossed cheque or through a banking channel from a person holding a national taxnumber, is treated as the income of the recipient chargeable to tax in the year of receipt under the head‘Income from other sources’ [s.39(3)]. However, the provisions of s.39(3) does not apply to an advancepayment for the sale of goods or supply of services [s.39(4)]. No adjustment is, therefore, required in thecomputation of income for the Rs. 4,000,000 received in cash from Carsales Associates as an advancepayment for the sale of cars.

(4) Under the provisions of group relief (s·59B), a subsidiary of a public company can surrender its assessed lossfor the year in favour of its holding company provided certain conditions are fulfilled, one of which is that theholding company should be a public company listed on a registered stock exchange in Pakistan. As WheelsPakistan Limited is not listed on any stock exchange in Pakistan, Radiators Pakistan Limited cannot surrenderits tax loss of Rs. 1,750,000 to Wheels Pakistan Limited and therefore, the Rs. 1,750,000 cannot be set offby Wheels Pakistan Limited against its taxable income.



16

Marks(c) Computation of tax payable Rupees

Tax on taxable income of Rs. 33,484,500 at 35% 11,719,575 0·5Tax credit on donation (Note A) (245,000) 2·5

———–——11,474,575

Tax collected by the Collector of Customs (11,000,000) 1—————–

Balance of tax payable 474,575—————–—————– —–

4—–30—–

Note (A)As the donation is to a relief fund established in Pakistan by the Federal Government, a tax credit is allowedat the average rate of tax (before allowance of any tax credit) on the lower of the amount of the donation paidor 15% of the taxable income [s.61(1)(b) and (2)].

Rupees

Tax credit is calculated as under:Tax on taxable income before tax credit (A) 11,719,575Taxable income for the year (B) 33,484,500The lesser of the amount of the donation (Rs. 700,000) or 15%

of taxable income (15% of Rs. 33,484,500 = Rs. 5,022,675) (C) 700,000

A/B × CRs. 11,719,575/Rs. 33,484,500 × Rs. 700,000 245,000

Notes referred to in the computation of taxable income and tax payable

Note (1) Accounting depreciation is not a deductible charge. Depreciation calculated at the rates prescribedin the Third Schedule is a deductible charge.

Note (2) The tax of Rs. 11,000,000 collected by the Collector of Customs is not a deductible charge. It isalso not the final tax on the income derived from the sale of the imported cars in CBU condition[s.148(7)(c)]. The Rs. 11,000,000 collected as tax is available to Wheels Pakistan Limited as atax credit.

Note (3) Rs. 700,000 paid as a donation is not deductible but Wheels Pakistan Limited is entitled to a taxcredit calculated under a prescribed formula [s.61(1)(b)].

Note (4) Rs. 3,000,000 expended on upgrading the assembly line is capital expenditure, since theexpenditure incurred has increased the capacity of the assembly plant – it has added value to adepreciable asset. For tax purposes the written down value of plant and machinery has beenincreased by Rs. 3,000,000 (Note 13).

Note (5) Rs. 500,000 spent on the installation of the item of plant imported from Japan is not anexpenditure for the carrying on of the business, but is capital expenditure. The cost of the plant hasbeen increased by Rs. 500,000 (Note 12).

Note (6) The unpaid amount of Rs. 400,000 for profit on debt (included in sundry creditors) was allowedas a deduction in the tax year 2003 (accounting year ended 30 June 2003). As the amount hasremained unpaid for three years from the end of the tax year in which the deduction was allowed, the Rs. 400,000 is chargeable to tax in the tax year 2007 (i.e. the first tax year following the endof the said three years).

Note (7) The tax profit or loss on the disposal of a depreciable asset is the difference between theconsideration received and the tax written down value of the asset [s.22(8)]. However, in the caseof immovable property (other than land) where the consideration received on the disposal exceedsthe cost of the immovable property, the consideration received is to be treated as the cost of theproperty for calculating the tax profit or loss on the disposal of the immovable property[s.22(13)(d)].

As the consideration received (Rs. 15,000,000) for the sale of the building is more than the costof the building (Rs. 10,000,000), Rs. 15,000,000 is treated as the cost of the building (deemedcost) for working out the tax profit/loss on the sale of the building.



17

MarksThe tax profit on the disposal of the building is worked out as under:

RupeesSale consideration 15,000,000Less: Tax written down value

Deemed cost 15,000,000Depreciation allowed (actual cost Rs. 10,000,000less tax written down value Rs. 7,000,000) (3,000,000)

—————– 12,000,000—————–

Tax profit 3,000,000—————–—————–

Note (8) The accounting profit or loss on the disposal of a depreciable asset is not to be considered in thedetermination of taxable income. It is the tax profit or loss that is chargeable to tax or allowed as adeduction. The accounting profit of Rs. 6,000,000 is, therefore, not chargeable to tax.

Note (9) Rs. 500,000 representing the face value of bonus shares issued to Wheels Pakistan Limited is notincome chargeable to tax. For tax purposes ‘income’ does not include, in the case of a shareholderof a company, the face value of any bonus shares issued by the said company to its shareholders[s.2(29)].

Note (10) Dividends received by a public company (for tax purposes) are taxed at 5% of the gross amount ofthe dividends irrespective of whether the dividends are received from a public or private company.

RupeesNet amount of dividend received from Poshcars (Private) Ltd after deduction of tax 95,000Gross amount of dividend 100,000Tax deducted at source 5,000

Rs. 5,000 being the tax deducted at source is the final tax on the dividend income

Note (11) A recovery of a debt previously written off and allowed as a deductible charge is income chargeableto tax. However, as the debt of Rs. 175,000 written off in the tax year 2006, was not allowed asa deductible charge, the receipt of the Rs. 175,000 is not income chargeable to tax.

Note (12) Initial allowance Rupees

Cost of second-hand item of plant 3,500,000Add: Installation cost 500,000

—————4,000,000—————

Initial allowance at 50% 2,000,000——————————

A second hand plant which has not previously been used in Pakistan is entitled to the initialallowance [s.23(1) and (5)(c)]

Note (13) DepreciationPlant and Buildings Motor Furniture Totalmachinery vehicles depreciation

Rate of depreciation 15% 10% 15% 15%

Rs. Rs. Rs. Rs. Rs.Written down value 2,700,000 13,800,000 2,500,000 1,570,000Disposal (7,000,000)Renovation cost 3,000,000

————— —————– ————— —————5,700,000 6,800,000 2,500,000 1,570,000————— —————– ————— —————

Depreciation 855,000 680,000 375,000 235,500 2,145,500————— —————– ————— —————

Additions 4,000,000 6,000,000Initial allowance 2,000,000 *

————— —————Written down value 2,000,000 6,000,000

————— —————Depreciation 300,000 900,000 1,200,000

—————3,345,500——————————

* Road transport vehicles not plying for hire are not eligible for initial allowance



MarksNote (14) Any advance received in cash otherwise than as an advance payment for the goods or supply of

services is treated as the income of the recipient chargeable to tax as ‘Income from other sources’[s.39(3) and (4)]. As the temporary advance of Rs. 1,000,000 from a director of the company wasreceived in cash, the said Rs. 1,000,000 is chargeable to tax under the head ‘Income from othersources’.

2 (a) Mr Cyrus BanajiAccounting year ended 30 June 2007

Tax year 2007

Computation of taxable income Rupees RupeesSalaryFrom ABC

Consideration for agreeing to a restrictive covenant (Note 1) 4,000,000 1·5Gratuity (Note 2) 925,000 2Basic salary – Rs. 250,000 × 6 months

(1 July 2006 to 31 December 2006) 1,500,000 0·5Cash allowances– Utilities - Rs. 25,000 × 6 months (Note 3) 150,000 0·5– House rent – Rs. 45,000 × 6 months (Note 3) 270,000 0·5– Medical – Rs. 150,000 – exempt from tax (Note 4) – 1

Benefit of company maintained car (Note 5) 50,000 1Benefit on purchase of car (Note 6) 150,000 1Pension exempt from tax (Note 7) – 1Arrears of salary (Note 8) 65,000 1

————— 7,110,000Income from businessShare of profit from the partnership firm – Rs. 1,250,000 exempt from tax (Note 9) – 2Income from other sourcesIncome from the Korangi property (Note 10) 330,000 4

—————Taxable income 7,440,000

——————————

The relevant notes will be considered in allocating marks against each item. In addition, specific marks willbe awarded for the explanation of the treatment of items not included in the computation of income or taxpayable (1 mark for item (1) and 2 marks each for items (2) and (3)). 5

—–21—–

Items not included in the computation of taxable income(1) The accumulated balance due and becoming payable to an employee participating in a recognised

provident fund is exempt from tax (clause 23 of Part 1 of the Second Schedule).

(2) A tax is imposed at prescribed rates on every person who receives a dividend from a company. The taximposed is computed by applying the relevant rate of tax on the gross amount of the dividend (s·5).Dividend income received by an individual is taxed at the rate of 10% of the gross amount of thedividend, irrespective of the status of the company from which the dividend is received. Rs. 6,000, beingthe tax deducted at source [10% of the gross dividend of Rs. 60,000 (s.150)], is the final tax on thedividend income and it is, therefore, not included in the computation of taxable income or tax payable.

As tax at 10% is imposed on the gross amount (Rs. 60,000) of the dividend received, the question ofany deductible charges does not arise. The Rs. 10,000 profit paid by Cyrus on the loan obtained toacquire the shares in XYZ Ltd is, therefore, not deductible.

(3) Every ‘prescribed person’ making a payment on account of the rent of immovable property (including therent of furniture and fixtures and amounts for services relating to the property) is required to deduct taxat the rate of 5% of the gross rent paid [s.155(1)]. The tax so deducted is the final tax on the incomefrom property. A company is one of the categories included in the definition of a ‘prescribed person’[s.155(3)(iv)]. Gulab (Private) Ltd being a company is a prescribed person and is, therefore, required todeduct tax on the rent paid to Cyrus.

Rs. 90,000 being the tax deducted at source (5% of the gross rent of Rs. 1,800,000) is the final tax[s.155(2)] on the income from the Gulshan building. The Rs. 1,800,000 is not chargeable to tax underany head of income in computing the taxable income of Cyrus and no deduction is allowable for theexpenditure of Rs. 62,000 incurred by Cyrus in deriving the income from property [s.169(2)(a) and (b)].

18



19

Marks(b) Computation of tax payable

The share of profit from the AOP received by Cyrus is exempt from tax and does not form part of his taxableincome. However, for the purpose of determining the rate of tax that would be applicable to the taxable income(i.e. income other than the share of profit from the AOP), the share of profit from the AOP is included in Cyrus’staxable income as if the said profit was chargeable to tax.

RupeesTax at 20% on taxable income if the share of profit from the AOP were chargeable to tax [20% of Rs. 8,690,000 (Rs. 7,440,000 + Rs. 1,250,000)] (A) 1,738,000Taxable income if the share of profit from the AOP were chargeable to tax [Rs. 7,440,000 + Rs. 1,250,000] (B) 8,690,000Actual taxable income (C) 7,440,000

(A/B × C)Rs. 1,738,000/Rs. 8,690,000 × Rs. 7,440,000 1,488,000 3·5Less: Tax deducted at source by ABC (1,200,000) 0·5

————— —–Tax payable 288,000 4

—————————— —–25—–


Note (1) An amount paid, inter alia, by a past employer or an associate of the employer to a past employee,is treated as received by the employee from an employment [s.12(5)]. Furthermore anyconsideration paid for an employee’s agreement to a restrictive covenant in respect of any past,present or future employment is a profit in lieu, or in addition to salary [s.12(2)(e)(v)].

The equivalent of Rs. 4,000,000 in US Dollars transferred to the bank account of Cyrus inSingapore by DEF Ltd Singapore, an associate company of ABC is considered to be a payment byABC to Cyrus. This payment, being in consideration of Cyrus consenting to a restrictive covenantrestraining him from entering into employment with any competitor company of ABC for a periodof five years, is a profit in lieu of or in addition to salary and is chargeable to tax as the salaryincome of Cyrus.

Note (2) Under the provisions of clause (13) of Part I of the Second Schedule, any amount receivable as agratuity by an employee on his retirement:

(i) from any gratuity fund approved by the Commissioner under the applicable rules is exemptfrom tax;

(ii) from an employer under a gratuity scheme of the employer applicable to all employees andapproved by the Central Board of Revenue for the purposes of the said clause (13), amaximum of Rs. 200,000 is exempt from tax; and

(iii) in any other case, 50% of the amount receivable from the employer or Rs. 75,000 whicheveris the less, is exempt from tax.

As the gratuity received by Cyrus was neither from an approved gratuity fund nor from an approvedgratuity scheme of ABC, item (iii) would be applicable:

RupeesGratuity received 1,000,000Exempt from tax 75,000

—————Taxable as salary 925,000

——————————

Note (3) The cash allowances for utilities and housing are fully taxable.

Note (4) A medical allowance received by an employee not exceeding 10% of the basic salary of theemployee is exempt from tax, provided free medical treatment or hospitalisation charges is notprovided for in the terms of employment [Clause 139(b) of Part I of the Second Schedule].

As the terms of employment of Cyrus state that he is not entitled to free medical treatment orhospitalisation, the entire amount of Rs. 150,000 (Rs. 25,000 x 6 months), being not more than10% of his basic salary, is exempt from tax.

Note (5) As the company maintained car is used by Cyrus partly for his personal use, Rs. 50,000, being5% of the cost of the car proportionate to the number of months the car was used by Cyrus, (5%of Rs. 2,000,000 × 6/12 = Rs. 50,000) is chargeable to tax as salary income [s.13(3) and Rule5 of the Income Tax Rules].



20

MarksNote (6) Where any asset is transferred by an employer to an employee, the amount chargeable to tax in

the hands of the employee is the fair market value (FMV) of the asset on the date of its transfer asreduced by any payment made by the employee [s.13(11)]. The car purchased by Cyrus for Rs. 100,000 was sold by him within two days of its acquisition for Rs. 250,000. It is, therefore,reasonable to take the said Rs. 250,000 as the FMV of the car on the date of its transfer. Rs. 150,000 being the difference between the FMV (Rs. 250,000) and the payment made byCyrus for the car (Rs. 100,000), is chargeable to tax as salary income.

Note (7) Under clause (8) of Part I of the Second Schedule, any pension received by a citizen of Pakistanfrom a former employer is exempt from tax, unless the person continues to work for the employeror an associate of the employer. The pension received by Cyrus is exempt from tax since he fulfillsthe conditions of the said clause (8)

Note (8) An amount is treated as received from an employment regardless of whether the amount is paidinter-alia by a past employer [s.12(5)(b)]. The Rs. 65,000 received from ABC (a past employer)is, therefore, income from employment (salary income). Furthermore, any income chargeable to taxunder the head ‘salary’ is taxable on a receipt basis. Since the arrears of salary for the year ended30 June 2006 were received in the accounting year ended 30 June 2007, the Rs. 65,000 ischargeable to tax as salary in the tax year 2007.

Note (9) Sorab Associates (a partnership) is assessed to tax in the status of an association of persons (AOP)[s.80(2)(a)]. An AOP which is not a professional firm prohibited from incorporating by any law orthe rules of the body regulating the profession, is taxed separately from its members and where theAOP has paid any tax, any amount received by a member out of the income of the AOP, is exemptfrom tax [s.92(I)]. As Sorab Associates has paid tax on its assessed income, the Rs. 1,250,000received by Cyrus from the firm in his capacity as a member of the AOP, is exempt from tax.

Note (10) A composite rent of Rs. 1,200,000 (Rs. 200,000 × 6 months) was received as consideration forthe lease of the Korangi property consisting of the building together with the plant installed in thebuilding. Such income after permissible deductions is chargeable to tax as ‘Income from othersources’ [s.39(1)(f)]. Permissible deductions allowable in computing such income are (a) anyexpenditure paid by the person in deriving income chargeable to tax other than expenditure of acapital nature [s.40(1)] (b), depreciation of any plant, machinery or building used to derive thatincome [s.40(3)(a)] and initial depreciation for any plant or machinery used to derive that income[s.40(3)(b)].

The taxable income of the Korangi property is computed as under:

RupeesLease rent received (Rs. 200,000 × 6 months) 1,200,000Less: Repairs to building 80,000

Repairs to plant 50,000Ground rent 2,000Insurance 38,000Depreciation (see note) 700,000

————– 870,000—————

Taxable income 330,000——————————

Note: Depreciation

Building Plant Totaldepreciation

Rate of depreciation 10% 15%Rs. Rs. Rs.

Cost 4,000,000 2,000,000Depreciation 400,000 300,000 700,000

————————

The initial allowance is not allowed on second-hand plant or machinery that has been usedpreviously in Pakistan [s.23(5)(c)].



21

Marks3 (a) The exemption clause referred to by Mr Murad is in respect of any income derived by an individual from the

transfer of his membership rights or share in a stock exchange in Pakistan, along with a room in the stockexchange, to a company at any time between 1 July 2005 and 30 June 2007 [clause (133A) of Part I of theSecond Schedule].

The exemption under the said clause (133A) is not available to Murad, since the transfer of his share inKarachi Stock Exchange (Guarantee) Ltd [KSEG] along with the occupancy rights of the room in the stockexchange was not to a company but to Murind Associates, a partnership firm which is treated as an‘association of persons’ for tax purposes [s.80(2)(a)]. 3

—–

(b) Mr NomanAccounting year ended 30 June 2007

Tax year 2007

Rupees RupeesComputation of total/taxable incomeSalaryEmployee share scheme– gain on the disposal of the right to acquire 1,000 shares (Note 1) 50,000 1·5– benefit on the acquisition of 1,000 shares (Note 2) 400,000 3

———— 450,000Capital gainsGain on the sale of shares acquired under the employee share scheme (Note 3) 500,000 3Gain on the sale of shares in Lowlands (Private) Limited (Note 4) 75,000 1·5Gain on the sale of shares in Highlands Limited – exempt from tax (Note 5) – 1·5Gain on the sale of personal jewellery (Note 6) 225,000 2

———— 800,000—————

Total income 1,250,000Zakat paid (Note 7) (50,000) 0·5

—————Taxable income 1,200,000

——————————

The relevant notes will be considered in allocating marks against each item. In addition, specific marks willbe awarded for the explanation of the treatment of items not included in the computation of income [2 marksfor item (1) and 1 mark each for items (2) and (3)] as follows:

4—–17—–20—–

Items not included in the computation of total/taxable income

(1) In an employee share scheme, where shares issued to an employee are subject to a restriction on thetransfer of the shares, no amount is chargeable to tax on the employee until the earlier of, the time theemployee has the free right to transfer the shares or the time the employee disposes of the shares[s.14(3a)].

Noman acquired 1,000 shares in Winners plc on 1 August 2006 at the exercise price of £10 per share,when the price quoted on a stock exchange in the UK was £12. The benefit of £2 per share is notchargeable to tax since under the Winners Employee Share Scheme, there is a restriction on the transferof the shares. There is a holding period of six months before Noman has the free right to transfer theshares.

(2) A loss on the disposal of a capital asset is not deductible where a gain on the disposal of such an assetis not chargeable to tax [s.38(2)]. Fibres Ltd is a public company for tax purposes and any gain on thesale of its shares is exempt from tax up to the tax year ending on 30 June 2007 (clause 110 of Part 1of the Second Schedule). Therefore, the loss of Rs. 60,000 incurred on the disposal of the shares inFibres Ltd is not deductible.

(3) A gain or loss under the head ‘Capital gains’ can only arise on the disposal of a ‘capital asset’. Anyimmovable property is excluded from the definition of a capital asset and, therefore, any gain or loss onthe disposal of an immovable property is outside the ambit of capital gains. The gain of Rs. 200,000 onthe sale of the agricultural land is, therefore, not included in the computation of income.



22

MarksNotes referred to in the computation of total/taxable income

Note (1) The gain on the disposal of a right or option to acquire shares under an employee share schemeis chargeable to tax under the head ‘Salary’ [s.14(5)]. The gain of Rs. 50,000 is made up as under:

RupeesConsideration received on the disposal of the right to acquire 1,000 shares in Winners Bank plc (WBP) under the Winners Employee Share Scheme (Scheme) 150,000Consideration paid for the right to acquire the 1,000 shares [£1 × 1,000 = £1,000 (£1 = Rs. 100)] 100,000

————Gain on disposal 50,000

————————

Note (2) Where shares issued under an employee share scheme are subject to a restriction on the transferof the shares the amount chargeable to tax on the employee under the head ‘Salary’ is the fairmarket value (FMV) of the shares at the earlier of the time the employee has the free right to transferthe shares or disposes of the shares, as reduced by the amount paid to acquire the shares includingany amount paid for the grant of a right to acquire the shares [s.14(3) (a) and (b)].

On 1 August 2006, Noman exercised the right to purchase 1,000 shares in WBP under theScheme for £10 per share. The 1,000 shares issued were subject to a restriction on their transferas the shares could only be transferred after a minimum holding period of six months. On 1 February 2007 (i.e. six months after 1 August 2006) Noman had the free right to transfer theshares. The FMV of one share in WBP on 1 February 2007 was £14 being the price quoted on astock exchange in the UK on that date. The benefit of Rs. 400,000 on the acquisition of the 1,000shares in WBP under the Scheme is made up as under:

RupeesFMV of 1,000 shares in WBP [£14 × 1,000 = £14,000 (£1 = Rs. 100)] 1,400,000Consideration paid at the time of:– accepting the right to acquire the 1,000 shares

[£1 × 1,000 = £1,000 [£1 = Rs. 100] 100,000– exercising the right to acquire the 1,000 shares

[£9 × 1,000 = £9,000 [£1 = Rs. 100] 900,000———— 1,000,000

—––———Benefit on acquisition of the 1,000 shares 400,000

——————————

Note (3) Gain on the disposal of 500 shares in WBP acquired under the Scheme. Rupees

Consideration received on the disposal of 500 shares 1,200,000Cost of 500 shares to Noman (Note 3A) 700,000

—————Gain on disposal 500,000

——————————

As the shares were held for less than one year, the entire gain of Rs. 500,000 is chargeable to taxunder the head ‘Capital gains’.

Note (3A) The cost of the shares to an employee acquired under an employee share scheme is the sum of (i)the consideration, if any, paid by the employee for the right or option to acquire the shares, (ii) theconsideration, if any, paid by the employee for the shares, and (iii) the amount chargeable to taxas the salary income of the employee on acquisition of the shares [s.14(4)].

Rupees(i) £1 paid on accepting the right to acquire 1,000 shares [£1 × 1,000 = £1,000

(£1 = Rs. 100)] 100,000(ii) £9 paid on the acquisition of 1,000 shares £9 × 1,000 = £9,000

(£1 = Rs. 100) 900,000(iii) Amount charged to tax as salary income on the acquisition of the

shares (Note 2) 400,000—————

Cost of 1,000 shares 1,400,000——————————

Cost of 500 shares (1/2 × 1,400,000) 700,000——————————



MarksNote (4) As the shares in Lowland (Private) Ltd were held by Noman for more than one year, only

Rs. 75,000, being 75% of the gain of Rs. 100,000 is chargeable to tax.

Note (5) A gain on the disposal of shares in a company which is a ‘public company’ for tax purposes isexempt from tax up to the tax year ending on 30 June 2007 (clause 110 of Part 1 of the SecondSchedule). Highlands Ltd is a ‘public company’ for tax purposes, since 50% of its shares are heldby a company incorporated in Saudi Arabia (foreign company) which is wholly owned by theKingdom of Saudi Arabia (foreign government) [s.2(47)(ab)]. Therefore, the gain of Rs. 40,000 onthe disposal of the shares is exempt from tax.

Note (6) Gain on the sale of jewellery

A gain or loss under the head ‘Capital gains’ can only arise on the disposal of a ‘capital asset’.Movable assets held for personal use (with certain exceptions) are excluded from the definition ofa ‘capital asset’ and therefore, any gain or loss on the disposal of such movable assets (which arenot in the list of the exceptions) is outside the ambit of capital gains. One of the exceptions to theabove is jewellery. Any jewellery even if held for personal use is treated as a ‘capital asset’ and anygain on its disposal is chargeable to tax as income from capital gains [s.37(5)(d)].

For assets acquired by gift (there is no cost of acquisition for the person acquiring the asset), theFMV of that asset, on the date of its acquisition by the donee is treated as the cost of the asset[s.37(4A)]. The jewellery gifted to Noman on 1 January 2006 was valued by a reputed firm ofjewellers to be worth Rs. 900,000, which can be taken to be the FMV of the jewellery at the timeof its acquisition by Noman. Rs. 900,000 is accordingly treated as the cost of the jewellery.

RupeesSale consideration of the jewellery 1,200,000Cost being the FMV of the jewellery on 1 January 2006 900,000

—————Gain on sale 300,000

——————————

75% of the gain of Rs. 300,000 is chargeable to tax since the jewellery was held by Noman for more than a year [s.37(3)] 225,000

——————————

Note (7) A payment of zakat under the Zakat and Ushr Ordinance, 1980 is a deductible allowance fromtotal income [s.9 and s.60].

4 (1) The following issues raised by the Commissioner are not in accordance with the provisions of the tax statute:

(i) Minimum taxThe concept of minimum tax shall apply only to a resident company [s.113(1)]. As JasminePharmaceuticals Company (JPC) is a partnership firm, its tax status is that of an association of personsand therefore, the provisions relating to minimum tax payable are not applicable to JPC. 2

(ii) Contribution to the unrecognised provident fundA contribution to a recognised provident fund is an allowable deduction. A contribution made to anunrecognised provident fund is also deductible provided the employer has made effective arrangementsto ensure that tax would be deducted from any payments made by the fund in respect of which therecipient is chargeable to tax under the head ‘Salary’ [s.21(f)].

As JPC has made the aforesaid effective arrangements for deduction of tax from any payments made bythe fund to an employee which is chargeable to tax as the employee’s salary income, the contribution ofRs. 400,000 made to the fund is a deductible expenditure. 3

(iii) Eid-Milan partyThe expenditure of Rs. 75,600 is in the nature of an amenity provided to the employees motivated onthe grounds of commercial expediency, since maintaining cordial and friendly relations with employeesis an integral part of the profit earning process of any business. Expenditure incurred on the grounds ofcommercial expediency and in order to indirectly facilitate the carrying on of the business, is expenditureincurred wholly and exclusively for the purposes of the business and is a deductible expenditure. 2

(iv) Damages paidThe Rs. 500,000 paid to the sole distributor as damages due to the failure to deliver supplies within thetime stipulated in the contract, is an expense connected and incidental to the carrying on of the businessof JPC. That the delay in the delivery of the goods was due to the negligence of JPC’s despatchdepartment is not relevant. The expenditure incurred is wholly and exclusively for the purpose of thebusiness and is a deductible expenditure. 2

23



Marks(2) The following issues raised by the Commissioner are in accordance with the provisions of the tax statute:

(i) Travelling expenses The expenditure of Rs. 1,530,000 incurred solely to secure the purchase of a mixing machine, is capitalexpenditure and is not deductible. Rs. 1,530,000 should be added to the cost of the mixing machine fortax purposes. 2

(ii) Donation The donation of Rs. 1,000,000 paid to a hospital run by the Federal Government is not a deductibleexpenditure. JPC is however entitled to a tax credit [s.61(I)(b) and (2)]. 2

(iii) Salary paid to Mr A.Any salary paid by an association of persons (AOP) to a member of the AOP is not a deductibleexpenditure [s.21(j)]. A partnership firm has the tax status of an AOP and is assessed to tax as an AOP.Mr A, being a partner in JPC, is thus a member of the AOP and therefore, the salary paid to him is nota deductible expenditure. 2

—–15—–

5 Mr MiskeenRupees

(a) Calculation of input taxSales tax on:– purchases of raw materials from registered persons [Rs. 2,500,000 × 15/115] 326,087 1·0– purchases of packing materials from unregistered persons ((b)(i)) – 1·0

—————Admissible amount of input tax for June 2007 326,087

——————————

Calculation of output taxSales tax on:– supply of goods to registered persons [Rs. 1,890,000 × 15%] 283,500 0·5– supply of goods to unregistered persons [Rs. 2,150,000 × 15%] ((b)(ii)) 322,500 1·0– supply of goods at a trade discount of 35% [Rs. 650,000 × 15%] ((b)(iii)) 97,500 1·0

—————Admissible amount of output tax for June 2007 703,500

——————————

Sales tax payable for June 2007Output tax 703,500Input tax 326,087

—————377,413 0·5

————— ––––—————5

—––

(b) (i) As unregistered persons do not charge sales tax and issue tax invoices the question of claiming input taxdoes not arise. 1

—–

(ii) As Miskeen is a registered person for sales tax purposes he is required to charge sales tax on makingtaxable supplies, irrespective of the fact that the supply has been made to an unregistered person. 1

—–

(iii) In the case of trade discounts the ‘value of supplies’ for the purpose of the levy of sales tax shall be thediscounted price excluding the amount of tax, provided that the tax invoice shows the discounted priceand the related tax and the discount allowed is in conformity with normal business practice.

In respect of the sale of the old model toasters, the discounted price and related tax has been shown onthe tax invoices. However, since the trade discount of 35% is not in conformity with normal businesspractice, the consideration of Rs. 422,800 received by Miskeen for the sale of the old model toasters, isnot the ‘value of supplies’. Rs. 650,000, which would have been received had the toasters been sold attheir normal price, is considered as the ‘value of supplies’ on which sales tax must be charged, leviedand paid. 3

—–—–10—–

24





ALL FIVE questions are compulsory and MUST be attempted.Tax rates and allowances are on pages 3–4.




Pape

r F6

(PK

N)

Taxation(Pakistan)

Monday 2 June 2008




This is a blank page.The question paper begins on page 3.

2






A. Tax rates for individualswhere salary income exceeds 50% of taxable income for the tax year 2008.

Taxable income Rate of taxUp to Rs. 150,000* 0%Rs. 150,001 – Rs. 200,000 0.25%Rs. 200,001 – Rs. 250,000 0.50%Rs. 250,001 – Rs. 300,000 0.75%Rs. 300,001 – Rs. 350,000 1.50%Rs. 350,001 – Rs. 400,000 2.50%Rs. 400,001 – Rs. 500,000 3.50%Rs. 500,001 – Rs. 600,000 4.50%Rs. 600,001 – Rs. 700,000 6.00%Rs. 700,001 – Rs. 850,000 7.50%Rs. 850,001 – Rs. 950,000 9.00%Rs. 950,001 – Rs. 1,050,000 10.00%Rs. 1,050,001 – Rs. 1,200,000 11.00%Rs. 1,200,001 – Rs. 1,500,000 12.50%Rs. 1,500,001 – Rs. 1,700,000 14.00%Rs. 1,700,001 – Rs. 2,000,000 15.00%Rs. 2,000,001 – Rs. 3,150,000 16.00%Rs. 3,150,001 – Rs. 3,700,000 17.50%Rs. 3,700,001 – Rs. 4,450,000 18.50%Rs. 4,450,001 – Rs. 8,400,000 19.00%Rs. 8,400,001 and over 20.00%


B. Tax rates for individualsto whom the rates given in A are not applicable.

Taxable income Rate of taxUp to Rs. 100,000 0%Rs. 100,000 – Rs. 110,000 0.50%Rs. 110,001 – Rs. 125,000 1.00%Rs. 125,001 – Rs. 150,000 2.00%Rs. 150,001 – Rs. 175,000 3.00%Rs. 175,001 – Rs. 200,000 4.00%Rs. 200,001 – Rs. 300,000 5.00%Rs. 300,001 – Rs. 400,000 7.50%Rs. 400,001 – Rs. 500,000 10.00%Rs. 500,001 – Rs. 600,000 12.50%Rs. 600,001 – Rs. 800,000 15.00%Rs. 800,001 – Rs. 1,000,000 17.50%Rs. 1,000,001 – Rs. 1,300,000 21.00%Rs. 1,300,001 and over 25.00%

3 [P.T.O.



C. Tax rates for companiesTax year Public company Private company Small company2008 35% 35% 20%

D. Rates of advance collection or deduction of taxFor the rendering of or providing of services 6% of the gross amount payable

E. Other tax ratesOn dividends received from a company 10% of the gross amount of the dividend

On income from property 5% of the rent chargeable to tax

F. Capital allowancesDepreciationBuildings (all types) 10% Furniture and fittings 15% Plant and machinery (not otherwise specified) 15% of the tax written down valueMotor vehicles (all types) 15% Computer hardware 30%


G. Pre-commencement expenditureRate of amortisation of pre-commencement expenditure 20% (straight-line basis)

4




1 PQR (Pakistan) Ltd (PQR), incorporated on 1 January 2007, commenced its business operations on 1 March 2007.PQR is a public company under the Companies Ordinance, 1984. The company was granted permission by thecommissioner to use a twelve-month period ending 31 December as its tax year. The company applied for listing onthe Lahore Stock Exchange and its shares were traded on that exchange for the first time on 31 December 2007. Thecompany remained listed on that exchange until 1 July 2008 on which date the company was delisted on theexchange.

PQR is an industrial undertaking engaged in the business of manufacturing pharmaceuticals and its summarisedaccounts for the period from 1 January 2007 to 31 December 2007 are as follows:

Notes Rupees RupeesSales 98,000,000Cost of sales 1 (69,500,000)Gross profit ––––––––––– 28,500,000

Less: Administration expenses 2 6,900,000Less: Selling and distribution expenses 3 4,750,000Less: Financial charges 4 2,250,000Less: Provision for bad debts 5 300,000Less: Income tax 6 1,100,000 15,300,000

–––––––––– –––––––––––13,200,000

Other income 7 1,650,000–––––––––––

Net profit 14,850,000–––––––––––

The following additional information is provided:

(1) Cost of sales includes: Rupees

(i) Accounting depreciation. 5,948,000

(ii) The first instalment of lease rent paid to an approved leasing company for the lease of a liquid filling plant which is being used by PQR for its business. The ownership of the plant is to be transferred to PQR on payment of the sixth andfinal instalment. 300,000

(iii) Depreciation on the leased liquid filling plant used by PQR in its business. 165,000

(iv) Payment to the Workers’ Welfare Fund under the Workers’ Welfare Fund Ordinance, 1971. 195,000

(v) Donation to a charitable hospital established by a private trust. 300,000

(2) Administration expenses include: Rupees

(i) Accounting depreciation. 1,650,000

(ii) Tax collected by the Collector of Customs:– On the import of raw materials for the company’s own use. 965,000– On imported injections in finished form, for sale. 837,000

(iii) Legal expenses:– For an amendment in the memorandum and articles of association to

incorporate changes required by the corporate law authority. 100,000– For increasing the share capital of the company. 625,000

5 [P.T.O.



(3) Selling and distribution expenses include a penalty of Rs. 650,000 paid to a customer in settlement of a claim for damages under a clause of a contract for the supply of a batch of influenza vaccines. Laboratory tests and in-house investigations revealed that the vaccines exceeded the accepted level of impurities specified in the contract and that this was due to the negligence of employees of PQR’s production department.

(4) Financial charges include reimbursement to the promoters of the company for expenditure incurred in taking legal advice on certain matters raised by the company law authorities at the time of the incorporation of PQR of Rs. 600,000.

(5) The movement in the provision for bad debts comprises: Rupees Rupees30 June 2007 Provision made (5% of debtors) 300,00030 July 2007 Loan given to an employee written off 10,000

Trading debts written off 90,000Excess provision written back 100,000 (200,000)

–––––––– –––––––––31 December 2007 Balance carried forward 100,000

–––––––––

(6) Income tax represents a payment in discharge of a demand raised by the commissioner on completion of the tax audit for the tax year 2006.

(7) Other income includes: Rupees

(i) Share of profit received from an association of persons (AOP) in which PQR is a member. 550,000The AOP was in the business of manufacturing spare parts. No tax was deducted from the payments received for the sale of goods as the payers were not prescribed persons who are required to deduct tax.The taxable income of the AOP was Rs. 1,500,000 and the tax assessed and paid by the AOP was Rs. 375,000.

(ii) Excess provision for bad debts written back (as per (5) above) 100,000

(iii) Net income on the sale of imported injections 67,000The net income has been adjusted for tax purposes including the apportionment of common expenses and allowances allocated to the sale of the imported injections.

(8) During the period from 1 January 2007 to 28 February 2007 PQR incurred expenses on the construction of prototypes and trial production activities aggregating Rs. 3,000,000, which has been debited to the preliminary expenses account and is shown as an asset in the balance sheet as on 31 December 2007.

(9) Advance tax paid for the tax year 2008 on 15 December 2007 was Rs. 900,000.

(10)Assets purchased during the tax year and shown as fixed assets in the balance sheet as on 31 December 2007 were:

Fixed assets RupeesPlant and machinery 17,500,000Buildings 15,700,000Motor cars 12,900,000Furniture 18,750,000Computers 20,900,000

(i) All the above assets are new assets except for the following which have been used previously in Pakistan:– second-hand plant costing Rs. 10,000,000 – a factory building costing Rs. 11,700,000

6



(ii) The amount for computers of Rs. 20,900,000 is made up as follows:Rupees

Computer hardware 10,900,000Computer software 10,000,000

––––––––––20,900,000––––––––––

The computer software was acquired on 1 November 2007, but was not used by PQR in its businesschargeable to tax before 1 February 2008. The normal useful life of the software is estimated to be fiveyears.

Required:

(a) Briefly state with reasons:

(i) whether or not PQR (Pakistan) Ltd is a public company for tax purposes; and (2 marks)

(ii) whether you consider PQR (Pakistan) Ltd to be a resident company or a non-resident company.(1 mark)

(b) Compute the taxable income of PQR (Pakistan) Ltd for the relevant tax year under the appropriate heads ofincome, giving clear reasons/explanations for the inclusion in or exclusion from the computation of taxableincome of each of the items listed above.

Note: the reasons/explanations for the items not listed in the computation of taxable income should be shownseparately. Specific marks are allocated for this part of the requirement.

(23 marks)

(c) Calculate the tax payable by/refundable to PQR (Pakistan) Ltd for the relevant tax year. (4 marks)

(30 marks)

7 [P.T.O.



2 For the purpose of this question you should assume that today’s date is 15 August 2008.

The following information is provided by Mr Qureshi.

(1) Qureshi, a citizen of Pakistan, retired from the services of XYZ Private Ltd (XYZ) on 29 June 2007. On retirement,Qureshi was eligible to receive the following from XYZ:

(i) A monthly pension of Rs. 20,000 payable from 1 July 2007.

(ii) Rs. 100,000 in lieu of unavailed privileged leave.

(iii) Rs. 350,000 as a gratuity. The gratuity payable was under a gratuity scheme of XYZ, which is applicableto all the company’s employees. The gratuity scheme has been approved by the then Central Board ofRevenue.

The pension is deposited at the end of each month into Qureshi’s bank account. The amounts for the leave pay(leave encashment) and gratuity were paid by XYZ to Qureshi on 5 July 2007. No taxes were deducted by XYZfrom the above payments.

(2) Qureshi commenced employment with Superior Steel Ltd (SSL) on 1 July 2007 as the factory accountant. Inaccordance with the terms of his employment the following remuneration and benefits were received by Qureshifor the year ended 30 June 2008:

(i) A basic monthly salary of Rs. 200,000.

(ii) Monthly allowances of Rs. 20,000 for housing and Rs. 30,000 each for utilities and medical treatment.

(iii) A company maintained motor car for his business and private use.

(iv) Reimbursement of all medical treatment or hospitalisation charges for Qureshi and his wife.

(v) Two months notice in writing on either side in case of cessation of employment.

(3) As a policy matter of SSL, which is applicable to all employees, the basic salary for the month is deposited intoeach employee’s bank account on the first working day of the following month. The monthly allowances are tobe collected by the employees from the cashier on the last working day of each month.

(4) (i) In order to provide the benefit of a car to Qureshi, a new Toyota Saloon was taken on lease by SSL on 1 August 2007 from an approved leasing company, for an annual lease rental of Rs. 400,000 payable forfour years. If the car had been purchased outright by SSL, the cash price would have been Rs. 1,200,000.

(ii) For the year ended 30 June 2008, SSL paid Rs. 210,000 as hospitalisation charges for the treatment ofQureshi’s wife.

(iii) SSL made a one time payment of Rs. 500,000 to Qureshi on his agreement to give six months notice ofcessation of employment instead of the two months notice agreed to in the original terms of employment.

(iv) During the month of June 2008, Qureshi was on vacation. On resuming his duties on 7 July 2008, hecollected his monthly allowances from the cashier for the month of June 2008.

(v) Tax deducted at source by SSL from Qureshi’s salary income for the relevant tax year was Rs. 767,000.

(5) (i) On 1 July 2007, Qureshi rented an apartment owned by SSL, located in a building adjoining the SSL’sfactory premises. The apartment had recently been vacated by a tenant. The tenant, who had no connectionwith SSL, had paid a monthly rent of Rs. 15,000. A deduction of Rs. 10,000 per month is being made bySSL from the basic salary of Qureshi as rent for the use of the apartment.

(ii) Due to the constantly fluctuating power supply, SSL agreed to supply electricity to the apartment rented byQureshi from the factory generator. The electricity units consumed during the year ended 30 June 2008 asper the meter installed in the apartment, if purchased from an independent power company, would havecost Rs. 123,800.

8



(6) Qureshi is the owner of a piece of land in Sadar.On 1 September 2007, Qureshi entered into a contract with Mr Govind for the sale of the land for Rs. 20,000,000. Under the terms of the sale contract, Govind paid Rs. 300,000 as a deposit and the balanceof Rs. 19,700,000 was payable at the latest by 1 October 2007, failing which the deposit would stand forfeited.Govind failed to pay the balance amount of Rs. 19,700,000 and the deposit of Rs. 300,000 was forfeited.

On 1 October 2007, Qureshi rented the land to Govind on a monthly rental of Rs. 250,000. Govind paid therent in advance up to 30 June 2008. On 1 October 2007 Govind also paid Qureshi a refundable deposit of Rs. 3,000,000 which was not adjustable against the rent payable.

(7) After seeking permission from SSL, Qureshi commenced his own part-time business, under the name of Taxhelp,of preparing returns of income of salaried individuals for the year ended 30 June 2007 which were to befurnished to the tax authorities by 30 September 2007. The permission granted by SSL was on the understandingthat on working days Qureshi could devote his time to the business only after 7 pm and that his business shouldnot interfere with his official duties as the factory accountant.

Qureshi closed the first accounts of Taxhelp for the period ended 30 June 2008. The summarised income andexpenditure account for that period is as follows:

Rupees RupeesReceiptsFees received (net of tax) from Rose Pakistan Ltd (RPL) for preparing the tax returns of all the employees of RPL – category 1 282,000Fees received from other individuals – category 2 100,000 382,000

––––––––

ExpenditureSalaries to part-time employees working exclusively on the RPL assignment (155,600)Expenditure common to both categories 1 and 2Salaries to part-time employees 64,000Stationery, computer hire and conveyance of staff 24,432 (88,432)

–––––––– ––––––––Surplus of receipts over expenditure 137,968

––––––––

The above expenditure is only for the business of Taxhelp and is not allocable to any other head of income.

(8) Other information submitted by Qureshi.

(i) On 13 June 2008, Qureshi donated Rs. 150,000 to an educational institution established in Karachi by theFederal Government.

(ii) Qureshi received a dividend of Rs. 45,000 (net of tax) from a private company on 10 January 2008.

(iii) Qureshi paid Rs. 15,000 as zakat under the Zakat and Ushr Ordinance, 1980 in the year ended 30 June2008.

Required:

(a) Compute the taxable income of Mr Qureshi for the relevant tax year under the appropriate heads of income,giving clear reasons/explanations for the inclusion in or exclusion from the computation of taxable income ofeach of the items listed above.

Note: the reasons/explanations for the items not listed in the computation of taxable income should be shownseparately. Specific marks are allocated for this part of the requirement.

(20 marks)

(b) Calculate the tax payable by/refundable to Mr Qureshi for the relevant tax year. (5 marks)

(25 marks)

9 [P.T.O.



3 For the purpose of this question, you should assume that today’s date is 15 August 2008.

Mr Tausif is preparing his return of income for the tax year 2008 and furnishes you with the following information forhis accounting year ended 30 June 2008.

(1) He has been a member of the Karachi Stock Exchange since 2 January 2006. He is self-employed and is thesole proprietor of Tausif Associates, which is engaged in the business of stocks and shares and finance brokers.Due to his indifferent health, he has been in the process of winding up the business of Tausif Associates since 1 January 2007 and since that date he has not transacted any business for his clients. The transactions in thebooks of Tausif Associates for the year ended 30 June 2008 are as follows:

(i) Disposal of shares on 7 January 2008 held as stock-in-trade in the books of Tausif Associates.

– Gain of Rs. 143,000 on the sale of shares in Ebu Ltd, a listed company on the Karachi Stock Exchange.

– Gain of Rs. 360,000 on the sale of shares in Aromatic Coffee (Pakistan) Ltd (ACL) a companyincorporated under the Companies Ordinance, 1984. ACL is not listed on any stock exchange inPakistan. 50% of the shares in ACL are held by Aromatic Coffee Kenya which is owned by theGovernment of Kenya.

– Loss of Rs. 180,400 on the sale of shares in Alibaba Ltd, a company whose shares are listed on theLahore Stock Exchange.

– The shares in Ebu Ltd, ACL and Alibaba Ltd were all purchased on 16 January 2006.

(ii) Membership rights in the Karachi Stock Exchange (KSE)On 14 February 2008, Tausif gave up his membership rights in the KSE and transferred his one share inKarachi Stock Exchange (Guarantee) Ltd (KSEGL) to Billimoria Pakistan Ltd along with a room occupied byhim in the KSE building, for a total consideration of Rs. 50,000,000. Tausif had acquired the one share inKSEGL on 31 December 2005 for Rs. 35,000,000 but had not paid anything at the time of occupying theroom in the KSE.

(2) As a past employee of Safe Bank Inc (SBI), Tausif had participated in the SBI Employee Share Scheme (Scheme).The details of his participation in the Scheme are as follows:

(i) Tausif was given the right to acquire 1,500 shares in SBI at the exercise price of US$10 per share.

(ii) On 16 July 2003, Tausif acquired 1,000 shares in SBI on making payment of the exercise price of US$10per share.

(iii) The price quoted on the New York Stock Exchange on 16 July 2003 was US$15 per share.

(iv) Under the terms of the Scheme, 50% of the shares acquired were subject to a restriction on the transfer ofthe shares. An employee only had the free right to dispose of the said 50% of the shares after a holdingperiod of three years.

(v) On 15 July 2006 (the date when Tausif had the free right to transfer the shares), the price of one share inSBI on the New York Stock Exchange was US$20.

On 7 January 2008, Tausif sold the unutilised right to purchase 500 shares for Rs. 200,000. On the same day,Tausif also disposed of the 1,000 shares in SBI as under:

(i) 200 shares were sold to Mr Khalid Maqbool, an ex-employee of the Pakistan branch of SBI, for Rs. 300,000.

(ii) 500 shares were gifted to his wife Nilufer who is a citizen of Pakistan. Nilufer left Pakistan to reside in NewYork on 29 December 2007 and has been living in New York since then.

(iii) 300 shares were gifted to his daughter Nasreen who is a citizen of Pakistan and living with her mother inNew York. Nasreen left Pakistan on 1 August 2007 and has been living in New York since then. Nasreenis the manager of the visa section of the Government of Pakistan in New York and is an employee of theFederal Government.

10



(3) Disposal of other assets

(i) As a founder member of Cuppa Tea (Private) Ltd (CTP), Tausif purchased 70,000 shares in CTP at Rs. 10per share in the year 2004. He sold these shares in CTP on 7 January 2008 for Rs. 400,000.

(ii) On the death of Tausif’s father in the year 2004, Tausif had inherited two oil paintings. The two paintings,‘A’ and ‘B’, were valued by an expert art dealer at the time of his father’s death at Rs. 1,700,000 and Rs. 100,000 respectively. On 11 June 2008 Tausif sold painting ‘A’ for Rs. 1,448,000 and painting ‘B’ forRs. 1,000,000. The paintings had been retained by Tausif for his own use in the intervening period.

(4) Tausif has also furnished you with the following information:

(i) In the accounting year ended 30 June 2008, Tausif paid Rs. 9,000 as zakat under the Zakat and UshrOrdinance, 1980.

(ii) On 16 June 2008 Tausif invested Rs. 100,000 in the purchase of new shares offered to the public byNewCo Ltd, a public company listed on the Islamabad Stock Exchange. Tausif is an original allottee of theshares.

The rate of exchange is to be taken as US$1 = Rs. 60 at all relevant dates.

Required:

(a) Compute the taxable income of Mr Tausif under the appropriate heads of income for the relevant tax year,giving clear reasons/explanations for the inclusion in or exclusion from the computation of taxable income ofeach of the items listed above.

Note: the reasons/explanations for the items not included in the computation of taxable income should beshown separately. Specific marks are allocated for this part of the requirement.

(17 marks)

(b) Calculate the tax payable by or refundable to Mr Tausif for the relevant tax year. (3 marks)

(20 marks)

11 [P.T.O.



4 Sunflowers Oil Pakistan Ltd (SOPL) is in the business of manufacturing edible oils. The company was incorporatedon 1 January 2007 and was allowed by the commissioner to use a twelve-month period ending on 31 Decembereach year as its tax year. The company’s first accounts were made up to 31 December 2007.

(1) You were invited to a meeting on 3 September 2007 when the following issues relating to the income tax returnof income for the tax year 2008 were discussed with the Finance Director of SOPL.

(i) Advance taxThe company has not paid any instalments towards advance tax for the tax year 2008.

(ii) Machinery Supplies plc (MS)SOPL had entered into a contract with MS on 1 February 2007 (MS contract) for the purchase of a newseed crushing plant to be shipped from the London docks at the latest by 31 May 2007. The MS contractprovided that, if for any reason, SOPL failed to open a letter of credit for the sale value of the plant in favourof MS by 1 March 2007 the contract would stand terminated and SOPL would have to pay a penalty of Rs. 1,500,000 for breach of the terms of the contract. Within a week of entering into the contract with MS,SOPL were able to acquire a locally manufactured seed crushing plant. The MS contract was terminated andSOPL paid Rs. 1,500,000 to MS as the penalty for breach of the contract.

The decision to terminate the contract was in the interest of the business, since with the locallymanufactured seed crushing plant the production target for the year 2007 could be achieved therebymaximising the profitability of the company. This was possible because the locally manufactured seedcrushing plant could be commissioned for use immediately as against a waiting period of three to fourmonths before the imported plant could be commissioned for use.

(iii) Forward contract for the purchase of raw materials SOPL entered into a forward contract for the purchase of raw materials used in its business of manufacturingedible oils to guard against loss through price fluctuations. On the date of maturity of the forward contract,SOPL did not take delivery of the raw materials but the contract was settled by a payment of Rs. 950,000.

(iv) Repairs SOPL purchased a labelling machine with the full knowledge that the machine was in an imperfect conditionand was in need of repairs to render it serviceable. Rs. 790,000 was expended on repairs to bring themachine into a serviceable condition.

(v) Trade markOn 1 January 2007 SOPL made a one time payment of Rs. 1,000,000 to EFG Ltd to acquire a valuabletrade mark. The use of the trade mark in the business has substantially improved the image of SOPL’sproducts and this advantage is expected to accrue for a fairly long time.

(2) The Finance Director’s contentions in respect of each of the above transactions are as under:

(i) Advance taxThere is no obligation on the company to pay advance tax for the tax year 2008 since under the relevantprovisions of the Income Tax Ordinance, 2001 (Ordinance) only a taxpayer whose income was charged totax for the latest tax year is liable to pay advance tax. SOPL’s first return of income is for the tax year 2008which is due to be furnished to the commissioner on or before 30 September 2008 therefore, the issue ofSOPL’s income being charged to tax for any year prior to the tax year 2008 does not arise.

(ii) Machinery Supplies plc (MS)Under the Ordinance any fine or penalty is not an allowable deduction. As the payment of Rs. 1,500,000to MS was due to a breach of the terms of the contract between SOPL and MS, the payment is in the natureof a penalty and therefore, is not a deductible expenditure.

(iii) Forward contractThe forward contract for the purchase of raw materials was settled otherwise than by taking actual deliveryof the raw materials. This transaction would be construed to be a speculative business and treated as distinctand separate from any other business of SOPL. Therefore, the Rs. 950,000 paid to settle the forwardcontract is a loss incurred in a speculative business and is not a deductible expenditure in computing incomefrom SOPL’s business.

12



(iv) Repairs The Rs. 790,000 was expended solely for repairing the labelling machine. The expenditure was incurredwholly and exclusively for the purposes of business and therefore, is a deductible expenditure.

(v) Trade markAs the acquisition of the trade mark for Rs. 1,000,000 has resulted in an advantage of an enduring nature,the expenditure is capital in nature and therefore, is not claimable as a deductible expenditure.

Required:

State, giving reasons, whether or not you agree with each of the five contentions of the Finance Director. If youare not in agreement with any of the contentions of the Finance Director, explain the correct treatment to beadopted under the provisions of the Income Tax Ordinance, 2001.

Note: the allocation of marks is 3 marks for each item. (15 marks)

5 (a) Mr Danny is registered under the Sales Tax Act, 1990 as a manufacturer of flavoured tea. He informs you thatthe Association of Tea Manufacturers has approached the then Central Board of Revenue about reducing the rateof sales tax from 15% to 12% on the sale of locally produced tea. He furnishes you with the following informationfor the month of October 2007:

RupeesSale of flavoured tea from 1 October 2007 to 15 October 2007 4,580,000Sale of flavoured tea from 16 October 2007 to 31 October 2007 8,779,000Purchase of raw material on 3 October 2007 – paid by crossed cheque 2,635,000Purchase of spares and supplies on 15 October 2007 – paid in cash 168,500Payment of courier service charges on 9 October 2007 – paid by crossed cheque 1,703,333Purchase of raw materials on 21 October 2007 – paid by crossed cheque 9,470,000

Notes:(1) All payments for purchases are stated inclusive of sales tax at the rate applicable at the relevant date.

(2) The figures for the sales and courier services are stated exclusive of sales tax.

(3) All purchases made during the period 1 October 2007 to 15 October 2007 were consumed/utilised inproducing the goods sold during the said period.

Required:

Assuming the rate of sales tax was reduced from 15% to 12% effective from 16 October 2007:

(i) State the manner in which the sales tax return for the month of October 2007 would need to befurnished. (3 marks)

(ii) Calculate the sales tax payable by Mr Danny for the month of October 2007. (5 marks)

(b) Under the Sales Tax Act, 1990, a person who is required to maintain any records or documents, shall retain suchrecords and documents for a prescribed period of time.

Required:

State the period for which a person is required to retain records and documents under the Sales Tax Act,1990. (2 marks)

(10 marks)


13



Answers



17

Fundamentals Level – Skills Module, Paper F6 (PKN) June 2008 Answers and Taxation (Pakistan) Marking Scheme

Marks1 (a) (i) A public company for Pakistan tax purposes, inter alia, means a company whose shares were traded on

a registered stock exchange in Pakistan at any time in the tax year and which remained listed on that exchange at the end of that year.

The tax year of PQR (Pakistan) Ltd (PQR) is the twelve month period ended on 31 December 2007 (tax year 2008). PQR is a public company for Pakistan tax purposes since its shares were traded on the Lahore Stock Exchange for the first time on 31 December 2007 and PQR remained listed on that exchange at the end of its tax year [s.2(47)(b)]. 2

(ii) PQR is a resident company since the company is incorporated under the Companies Ordinance, 1984 [s.83(a)]. 1

–––3

–––

(b) PQR (Pakistan) LtdAccounting year ended 31 December 2007

Tax year 2008

Computation of taxable income Rupees RupeesIncome from businessAccounting profit 14,850,000Add: Accounting depreciation (Note 1) 7,598,000 0·5Add: Depreciation on the leased asset (Note 2) 165,000 0·5Add: Payment to Workers’ Welfare Fund (Note 3) 195,000 0·5Add: Donation (Note 4) 300,000 1·0Add: Tax collected by the Collector of Customs on:Add: – import of raw materials for own use (Note 5) 965,000 1·0Add: – imported injections in finished form (Note 6) 837,000 1·0Add: Legal expenses (Note 7) 625,000 1·0Add: Payment to the promoters of the company (Note 8) 600,000 1·0Add: Provision for bad debts (Note 9) 300,000 0·5Add: Income tax paid (Note 10) 1,100,000 0·5

–––––––––– 12,685,000–––––––––––27,535,000

Less: Net income on the sale of imported injections (Note 11) 67,000 1·0Less: Trading debts written off (Note 12) 90,000 0·5Less: Provision for bad debs written back (Note 13) 100,000 1·0Less: Amortisation of pre-commencement expenditure (Note 14) 600,000 2·0Less: Initial allowance (Note 15) 11,200,000 2·0Less: Depreciation (Note 16) 8,315,000 2·5

–––––––––– 20,372,000–––––––––––

Total income 7,163,000Less: Allowance for Workers’ Welfare Fund (Note 3) 195,000 0·5

–––––––––––Taxable income 6,968,000

–––––––––––

The relevant notes for the explanations of the treatment of items included in the computation of taxable income and tax payable will be considered in allocating marks against each item.

In addition to the above, specific marks will be awarded for the explanations of the treatment of items not included in the computation of taxable income (1 mark for each item) as follows: 6·0

–––23–––



18

MarksItems not included in the computation of taxable income

(1) Lease rent paid to an approved leasing company for the lease of a liquid filling plant used by PQR (Pakistan) Ltd (PQR) for its business is a deductible charge [s.28(b)] and therefore no adjustment is required in the computation of taxable income.

(2) Legal expenses incurred for an amendment in the memorandum and articles of association of PQR to bring it in accord with the company law requirements is revenue expenditure and is deductible.

(3) Rs. 650,000 paid to a customer in settlement of a claim of damages arising out of a contract for the supply of influenza vaccines which were not in accordance with the standard agreed to in the contract for sale is an expenditure in the ordinary course of carrying on the business and is therefore a deductible expenditure. The payment of Rs. 650,000 is not a fine or a penalty for the violation of any law, rule or regulation.

(4) Rs. 10,000 representing a loan to an employee written off against the provision for bad debts is not a deductible charge since it is not the business of the company to advance loans.

(5) The share of profit of Rs. 550,000 received from the association of persons (AOP) has correctly been included in the profit and loss account under the account head of other income [s.88A(1)] and therefore no adjustment is required in the computation of taxable income. However as the AOP has already paid tax on its income, PQR is allowed a tax credit against its tax payable.

(6) The Rs. 10,000,000 cost of the computer software is an intangible for tax purposes and has a normaluseful life of more than one year. An amortisation deduction is allowed in respect of such an intangiblebut only if it is used in the tax year in deriving income from business chargeable to tax. As the computersoftware was not used by PQR in its business in the year ended 31 December 2007, there can be nodeduction in that year.

(c) Computation of tax payable Rupees Rupees

Tax on taxable income of Rs. 6,968,000 at 35% 2,438,800 0·5Tax credit on tax paid by the AOP (Note A) (137,500) 2·0

––––––––––2,301,300

Tax collected by the Collector of Customs 965,000 1·0Advance tax paid 900,000 0·5

––––––––– (1,865,000)––––––––––

Tax payable 436,300––––––––––

–––4

–––30–––

Note (A) Tax credit on the tax paid by the AOP: RupeesShare of profit received from the AOP (A) 550,000Taxable income of the AOP (B) 1,500,000Tax assessed on the AOP (C) 375,000A/B x C550,000/1,500,000 x 375,000 137,500

–––––––––

Notes referred to in the computation of taxable income.

Note (1) Accounting depreciation of Rs. 7,598,000 (Rs. 5,948,000 included in cost of sales and Rs. 1,650,000 in administration expenses) is not a deductible charge for tax purposes. Depreciation calculated at the rates prescribed in the Third Schedule is a deductible charge.

Note (2) Depreciation is allowed only to the owner of an asset. The charge for depreciation of Rs. 165,000 of the leased liquid filling plant is not deductible since the plant had not been transferred by the approved lessor to PQR (lessee).

Note (3) The payment of Rs. 195,000 to the Workers’ Welfare Fund is not deductible in computing the total income but is an allowable deduction from the total income to arrive at the taxable income.

Note (4) The donation of Rs. 300,000 to the charitable hospital established under a private trust is not a deductible charge. Tax credit under the provisions of s.61(1)(b) is also not admissible on the amount paid since the hospital is not one that is established or run by the Federal Government or a Provincial Government or a local authority.



19

MarksNote (5) The tax of Rs. 965,000 collected by the Collector of Customs on the import of raw materials for

the company’s own use is not a deductible expenditure. Rs. 965,000 is allowable as a tax credit in computing the tax due on the taxable income of PQR.

Note (6) The tax of Rs. 837,000 collected by the Collector of Customs on the import of injections in finished form is not deductible. Rs. 837,000 is the final tax on the income from the sale of the injections [s.148(7)].

Note (7) Legal expenses for increasing the share capital of a company are not deductible. The expenditure is capital in nature and is not an expenditure incurred wholly and exclusively for the purposes of the business.

Note (8) The payment of Rs. 600,000 to the promoters of PQR relates to the period prior to incorporation of the company – in fact it is an expense relating to the formation of the company and is therefore capital expenditure and is not deductible.

Note (9) The provision for bad debts of Rs. 300,000 made on 30 June 2007 is not for specific debts (being 5% of outstanding debtors) and is therefore not a deductible charge.

Note (10) Any tax paid that is levied on profits or gains is not deductible [s.21(I)].

Note (11) The net income (adjusted for tax purposes) on the sale of the imported injections in finished form is not to be included in the total income since the tax collected by the Collector of Customs at the import stage is the final tax on the income from the sale of the imported injections.

Note (12) Trading debts amounting to Rs. 90,000 written off against the provision for bad debts are taken as a deductible charge on the assumption that the debts were previously included in PQR’s business income and PQR has reasonable grounds for believing that the debts are now irrecoverable.

Note (13) The excess provision of Rs. 100,000 written back to the provision for bad debts and credited to other income in the profit and loss account is not chargeable to tax since the provision of Rs. 300,000 for bad debts has not been allowed as a deductible charge.

Note (14) The expenditure of Rs. 3,000,000 incurred by PQR during the period 1 January 2007 (date of incorporation of the company) to 28 February 2007 (the last day prior to commencement of business) on the construction of prototypes and trial production activities is treated as pre-commencement expenditure for tax purposes. Such expenditure is allowed to be amortised for tax purposes over five years in equal proportions (20% per year).

RupeesTotal expenditure on pre-commencement expenditure 3,000,000

––––––––––Amortisation at 20% which amount is allowed as a tax deduction 600,000

––––––––––

Note (15) Initial allowance.

Plant and Building Computers Total initial machinery allowance

Rs. Rs. Rs. Rs.Total cost shown under fixed assets 17,500,000 15,700,000 20,900,000 –Cost of plant previously used in Pakistan (10,000,000) – – –Cost of building previously used in Pakistan – (11,700,000) – –Cost of software wrongly capitalised as a fixed asset (see note below) – – (10,000,000) –

–––––––––– –––––––––– –––––––––––Eligible for initial allowance 7,500,000 4,000,000 10,900,000 –

–––––––––– –––––––––– –––––––––––Initial allowance at 50% 3,750,000 2,000,000 5,450,000 11,200,000

–––––––––– –––––––––– ––––––––––– –––––––––––

Note: Rs. 10,000,000, being the cost of the computer software, has been included as a fixed asset in the balance sheet erroneously as computer software is considered to be an intangible for tax purposes.



MarksNote (16) Depreciation

Plant and Buildings Computer Motor Furnitue Totalmachinery hardware vehicles depreciation


Cost 17,500,000 15,700,000 10,900,000 12,900,000 8,750,000Initial allowance 13,750,000 12,000,000 15,450,000 – –

––––––––––– ––––––––––– –––––––––– ––––––––––– ––––––––––Written down value 13,750,000 13,700,000 15,450,000 12,900,000 8,750,000

––––––––––– ––––––––––– –––––––––– ––––––––––– ––––––––––Depreciation 12,062,500 11,370,000 1,635,000 11,935,000 1,312,500 8,315,000

––––––––––– ––––––––––– –––––––––– ––––––––––– –––––––––– ––––––––––

2 Mr QureshiAccounting year ended 30 June 2008

Tax year 2008

(a) Computation of taxable income Rupees RupeesSalary From XYZ Private LtdPension Rs. 240,000 (Rs. 20,000 x 12 months) – exempt from tax (Note 1A) – 1·0Payment in lieu of unavailed leave (Note 1B) 100,000 1·0Gratuity (Note 1C) 150,000 1·5

From Superior Steel Ltd.Basic salary – Rs. 200,000 x 11 months (Note 2) 2,200,000 1·0Allowances (Note 3)– Housing – Rs. 20,000 x 12 months (Note 3A) 240,000 0·5– Utilities – Rs. 30,000 x 12 months (Note 3A) 360,000 0·5– Medical – Rs. 30,000 x 12 months (Note 3B) 360,000 1·0Benefit of company maintained car (Note 4) 55,000 1·5Benefit of free hospitalisation – Rs. 210,000 – exempt from tax (Note 5) – 0·5Consideration for agreement to a change in the terms of employment (Note 6) 500,000 1·0Concessional rent for use of company’s apartment (Note 7) 60,000 1·0Free electricity (Note 8) 123,800 1·0

–––––––––4,148,800

Income from property (Note 9) 2,550,000 2·0Income from business (Note 10) 77,892 3·0


––––––––––Taxable income 6,761,692

––––––––––

The relevant notes for the explanation of the treatment of items included in the computation of taxable income and tax payable will be considered in allocating marks against each item.

In addition to the above, specific marks will be awarded for the explanations of the treatment of items not included in the computation of taxable income (1 mark for each item) as follows. 3·0

–––20–––

Items not included in the computation of income and tax payable

(1) Sadar landAn amount received by an owner of a building which is not adjustable against the rent payable by the tenant is treated as rent chargeable to tax in the tax year in which it is received and the following nine years in equal proportions. However, there is no provision for treating such non-adjustable amounts received by an owner of land as rent chargeable to tax. Consequently the Rs. 3,000,000 received by Qureshi as a refundable deposit from Govind, which is not adjustable against the rent payable, is not income chargeable to tax and has therefore not been included in the computation of taxable income.

20



21

Marks(2) Dividend

Dividend income received by an individual is taxed at the rate of 10% on the gross amount of the dividend irrespective of the status of the company paying the dividend. The Rs. 45,000 received by Qureshi as dividend is after deduction of tax at 10% [s.150]. Rs. 5,000, being the tax deducted at source (10% of Rs. 50,000), is the final tax and the amount of dividend income is not chargeableto tax under any head of income in computing the taxable income of Qureshi (s.5).

(3) Income from the rendering of servicesRose Pakistan Ltd (RPL) being a company is a prescribed person for the purpose of deduction of tax under s.153(9) from payments made, inter alia, for the rendering of or providing of services. Rs. 18,000, being the tax deducted at the rate of 6% of the gross fees of Rs. 300,000, is the final tax of Qureshi on the income arising from the services rendered to RPL [s.153(1) and (6)]. Such income is not chargeable to tax under any head of income and no deduction is allowable for any expenditure incurred in deriving the income [s.169(1) and (2)]. The income derived from the services rendered to RPL is therefore not included in the computation of taxable income.

(b) Computation of tax payableRupees

Taxable income 6,761,692Less: Income from property considered separately 2,550,000 1·0

––––––––––4,211,692––––––––––

Tax on Rs. 4,211,692 at 18.5% 779,163 0·5Tax on property income of 2,550,000 at 5% (Note 9) 127,500 1·0

––––––––––906,663

Tax credit on donation (Note 11) 20,113 2·0––––––––––

886,550Tax deducted at source on salary income 767,000 0·5

––––––––––Tax payable 119,550

–––––––––– ––––5

––––25

––––

Notes referred to in the computation of income and tax payable

Note (1A) All income included under the head ‘salary’ is chargeable to tax when the income is received by an employee [s.12(1)]. A person is treated as having received an amount, inter alia, when the amount, benefit or perquisite is actually received by the person [s.69(a)]. Furthermore any amount or perquisite paid, inter alia, by a past employer is treated as received by an employee from an employment and is treated as salary [s.12(5)(b)].

The Rs. 240,000 (Rs. 20,000 x 12) received by Qureshi from XYZ Private Ltd (XYZ) as his pension for the twelve months from July 2007 to June 2008 is his salary income for the tax year 2008. However, the Rs. 240,000 is exempt from tax since Qureshi is a citizen of Pakistan, the pension received is from his former employer (XYZ) and he does not continue to work for XYZ or any associate of XYZ (clause 8 of Part I of the Second Schedule).

Note (1B) Payment in lieu of unavailed leave amounting to Rs. 100,000, though relating to Qureshi’s past employment with XYZ and paid by XYZ, is his salary income [s.12(2)(a)] and is chargeable to tax in the tax year 2008 since it was paid to Qureshi on 5 July 2007 (accounting year ended 30 June 2008 – tax year 2008).

Note (1C) The Rs. 350,000 received as a gratuity from XYZ was paid to Qureshi on 5 July 2007. The amount is his salary income [s.12(2)(a)] and is chargeable to tax in the tax year 2008. However, an amount not exceeding Rs. 200,000 is exempt under the provisions of clause (13)(iii) of Part I of the Second Schedule since the amount received as a gratuity is received under the XYZ gratuity scheme which is applicable to all the employees of XYZ and the scheme has been approved by the then Central Board of Revenue for the purpose of the said clause (13)(iii).

RupeesGratuity received from XYZ 350,000Exempt from tax 200,000

––––––––Chargeable to tax as salary 150,000

––––––––



22

MarksNote (2) As the basic salary, in accordance with the employment policy of Superior Steel Ltd (SSL),

is payable on the first working day of the following month, the salary for June 2008 was credited in Qureshi’s bank account in July 2008. As salary is taxed on the receipts basis, the salary for 11 months (July 2007 to May 2008) is taxable in the tax year 2008. The salary for June 2008 will be taxable in the tax year 2009.

Note (3) A person is treated as having received an amount, benefit or perquisite if it is made available to the person [s.69(c)]. As per SSL’s policy, Qureshi should have collected the allowances for housing, utilities and medical on the last working day of June 2008. The allowances were thus made available to Qureshi in June 2008 and are therefore treated as having been received by him in June 2008 despite the fact that the allowances were actually collected by him on 7 July 2008.

Note (3A) The allowances for housing and utilities are taxable.

Note (3B) A medical allowance up to 10% of the basic salary of an employee is exempt from tax if free medical treatment or hospitalisation or reimbursement of such expenses is not provided for in the terms of employment (clause 139(b) of Part I of the Second Schedule). Qureshi is allowed a reimbursement of all medical or hospitalisation charges under the terms of his employment, therefore, the medical allowance of Rs. 360,000 is taxable.

Note (4) As the motor car taken on lease by SSL on 1 August 2007 is used by Qureshi partly for personal and partly for official use, the taxable benefit is calculated at 5% of the fair market value of the vehicle at the commencement of the lease. The aggregate amount of Rs. 1,600,000 payable by SSL over the lease period is not the FMV of the vehicle on 1 August 2007. Rs. 1,200,000 being the cash price of the vehicle on 1 August 2007 is the FMV of the vehicle on that date.

RupeesAnnual benefit – 5% of Rs. 1,200,000 60,000

–––––––For 11 months (from1 August 2007 to 30 June 2008) 55,000

–––––––

Note (5) The Rs. 210,000 paid by SSL for the hospitalisation charges for the treatment of Mrs Qureshi is exempt from tax as this benefit is in accordance with the terms of employment of Qureshi. It is assumed that the national tax number of the hospital is available and SSL has certified and attested the hospital bill [clause 139(a) of Part I of the Second Schedule].

Note (6) An amount received as consideration by an employee for his agreement to a change to his terms of employment is considered as salary chargeable to tax [s.12(2)(e)(ii)]. Therefore, theRs. 500,000 received by Qureshi on his agreement to give six months notice of his intention to cease employment as against the period of two months in the original terms of employment, is income chargeable to tax as salary.

Note (7) Qureshi pays a monthly rent of Rs. 10,000 for an apartment which is owned by SSL. The previous tenant who had recently vacated the apartment was paying a monthly rent of Rs. 15,000. As the previous tenant was not connected in any way to SSL, the monthly rent of Rs. 15,000 is considered as the fair market rent of the apartment. The difference of Rs. 5,000 a month is a benefit of employment. Rs. 60,000 (Rs. 5,000 x 12 months) is thus chargeable to tax as salary.

Note (8) Rs. 123,800 would have been the cost of the electricity if the electricity units consumed were purchased from an independent power company. Since the electricity was supplied free of cost to Qureshi the Rs. 123,800 is a benefit of employment chargeable to tax as salary.

Note (9) Income from property.Rupees

Consideration received for the use of land at Rs. 250,000 per month (Rs. 250,000 x 9) 2,250,000Forfeited deposit paid under a contract for the sale of land 1,300,000

––––––––––Rent chargeable to tax 2,550,000

––––––––––

Rent received or receivable by the owner of land or buildings for a tax year is chargeable to tax in that year. Rent includes any amount received or receivable as consideration for the use of land and includes any forfeited deposit paid under a contract for the sale of the land [s.15(1) and (2)]. Income from property is taxed at the rate of 5 per cent of the gross amount of rent chargeable to tax [s.15(6) read with Division VI of Part I of the First Schedule]. The tax payable on the income from property is Rs. 127,500 (5% of Rs. 2,550,000).



23

MarksNote (10) Income from business

The tax of Rs. 18,000 deducted by Rose Pakistan Ltd (RPL) is the final tax on the gross fees of Rs. 300,000 for the services rendered to RPL by Taxhelp. The Rs. 300,000 is therefore not included in the computation of income from business [item (3) in the list of items not included in the computation of income and tax payable]. No tax has been deducted from Rs. 100,000 being the fees received from individuals, since individuals are not prescribed persons required to deduct tax from payments for services rendered.

The income chargeable to tax under the head income from business is computed as under:

RupeesFees received 100,000Deductible expenditure – Note (10A) 122,108

–––––––177,892–––––––

Note (10A) The common expenditure amounting to Rs. 88,432 incurred in deriving income from the assignment relating to RPL and from the work done for individuals is allocable to the fees received from individuals in the proportion that the said fees bear to the total gross fees received.

RupeesCommon expenditure incurred in deriving income from the RPL assignment and from individuals (A) 188,432Fees received from individuals (B) 100,000Total gross fees received (Rs. 300,000 from RPL and Rs. 100,000 from individuals) (C) 400,000A x B/C88,432 x 100,000/400,000 122,108

––––––––

1 Note (11) The donation of Rs. 150,000 to an educational institution established in Karachi by the Federal Government is entitled to a tax credit [s.61(b)]. Tax credit is allowed at the average rate of tax (before allowance of any tax credit) on the lower of the amount of the donation or 30% of the taxable income of the individual [s.61(2)]

RupeesTax on taxable income before tax credit (A) 1,906,663Taxable income for the year (B) 6,761,692The lesser of Rs. 150,000 (donation) or Rs. 2,028,507 (30% of taxable income) (C) 1,150,000A/B x C906,663/6,761,692 x 150,000 1,120,113

––––––––



24

Marks3 Mr Tausif


(a) Computation of taxable income Rupees RupeesSalary Sale of rights under an employee share scheme (Note 1) 200,000 1·0

Capital gainsShares held as stock-in-trade in the books of Tausif Associates.– Gain of Rs. 143,000 on the disposal of shares in Ebu Ltd –

exempt from tax (Note 2) – 0·5– Gain of Rs. 360,000 on the disposal of shares in Aromatic

Coffee (Pakistan) Ltd – exempt from tax (Note 2) – 1·0

One share in Karachi Stock Exchange (Guarantee) Ltd.– Gain of Rs. 15,000,000 on the disposal of the one share –

exempt from tax (Note 3) – 1·5

Shares acquired in Safe Bank Inc under an employee share scheme – Gain on the sale of 200 shares (Note 4) 67,500 3·5– Gain on the transfer of 500 shares to Nilufer (Note 5) 168,750 3·0

Loss on the sale of shares in Cuppa Tea (Private) Ltd (Note 6) (300,000) 1·0

Movable assets held for own use– Gain on the sale of painting ‘B’ – (Note 7) 675,000 1·5

–––––––––611,250

–––––––––Total income 811,250Zakat paid (9,000) 0·5

–––––––––Taxable income 802,250

–––––––––

The relevant notes will be considered in allocating marks against each item included in the computation of taxable income.

In addition specific marks will be awarded for the explanation of the treatment of items not included in the computation of taxable income [1 mark each for items (1) and (2) and 11/2 marks for item (3)] as follows:

3·5–––17–––

Items not included in the computation of taxable income(1) No loss is deductible in computing income under the head capital gains on the disposal of a capital

asset where a gain on the disposal of such asset is not chargeable to tax [s.38(2)]. As Alibaba Ltd is a company whose shares are listed on the Lahore Stock Exchange, any gain on the disposal of its shares is exempt from tax [clause (110) of Part I of the Second Schedule] and consequently the loss of Rs. 180,400 on the disposal of the shares in Alibaba Ltd is not deductible.

(2) Under the non-recognition rules, no gain or loss is taken to arise on the disposal of an asset, inter alia, by reason of a gift of the asset provided the person acquiring the asset is not a non-resident at the time of the acquisition of the asset [s.79(1)(c) and (2)].

As Nasreen is an employee of the Federal Government of Pakistan posted abroad since 1 August 2007, she was a resident individual (for Pakistan tax purposes) in the tax year 2008 when 300 shares in Safe Bank Inc were transferred to her on 7 January 2008. Since the shares were gifted to Nasreen by Tausif and Nasreen was not a non-resident when she acquired the shares, no gain or loss on the disposal of the 300 shares is taken to have arisen. Therefore, this transaction is not included in the computation of taxable income.

(3) Income under the head capital gains can only arise on the disposal of a capital asset. Moveable assets held for personal use are excluded from the definition of capital assets with certain exceptions. There are certain moveable assets which despite being held for personal use, are treated as capital assets and the gain on the disposal of such assets is chargeable to tax under the head capital gains but no loss is recognised on the disposal of such assets.



MarksOne of the exceptions when a moveable asset held for personal use is treated as a capital asset is a painting. Though a gain on disposal of a painting is chargeable to tax as capital gains, any loss on the disposal of a painting is not recognised and is not deductible [s.38(5)(a)]. The loss of Rs. 252,000 [cost as valued by the expert art dealer Rs. 1,700,000 less sale proceeds Rs. 1,448,000] suffered on the disposal of painting ‘A’ is not recognised as a loss and is not deductible and has therefore not been included in the computation of taxable income.

(b) Computation of tax payable RupeesTax on taxable income of Rs. 802,250 at 17·5% 140,394 0·5Less: Tax credit on the purchase of shares (Note 8) 114,039 2·5

––––––––Tax payable 126,355

–––––––– ––––3

––––20

––––


Note (1) Gain on the sale of rights under an employee share scheme.Any gain made on the disposal of a right or option to acquire shares under an employee share scheme is chargeable to tax as salary income [s.14(5)]. As Tausif has not paid any consideration for the grant of the rights, Rs. 200,000 is chargeable to tax as salary income.

Note (2) Gain on the sale of shares held as stock-in-trade.Stock-in-trade representing stocks and shares is considered to be a capital asset [s.37(5)(a)] and therefore the shares in Ebu Ltd and Aromatic Coffee (Pakistan) Ltd (ACL) are the capital assets of Tausif. Any income, inter alia, from the sale of shares listed on a stock exchange in Pakistan or from the sale of shares of a public company (for Pakistan tax purposes), is exempt from tax up to the tax year ending on 30 June 2008 [clause (110) of Part 1 of the Second Schedule)].

As the shares in Ebu Ltd are listed on the Karachi Stock Exchange, the gain of Rs. 143,000 on the disposal of the shares in Ebu Ltd is exempt from tax. ACL is a public company since 50% of its shares are held by a foreign company (Aromatic Coffee Kenya) which company is owned by a foreign government (Government of Kenya) [s.2(47)(ab)]. Accordingly the gain of Rs. 360,000 on the disposal of the shares in ACL is exempt from tax.

Note (3) Gain on the sale of one share in Karachi Stock Exchange (Guarantee) Ltd. The income derived from the transfer of the membership rights in a stock exchange in Pakistan along with a room in the stock exchange building is exempt from tax provided the transferor is an individual, the transferee is a company and the transfer is effected between 1 July 2005 and 30 June 2008 [clause (133A) of Part I of the Second Schedule]. The gain of Rs. 15,000,000 [Rs. 50,000,000 sale proceeds of the one share in Karachi Stock Exchange (Guarantee) Ltd less Rs. 35,000,000 cost of the share] is exempt from tax since the transferor of the share (Tausif) is an individual, the transferee (Billimoria Pakistan Ltd) is a company and the transfer was effected prior to 30 June 2008.

Note (4) Gain on the sale of 200 shares in Safe Bank Inc (SBI) acquired under an employee share scheme.

Rupees RupeesConsideration received 300,000Cost of the sharesAmount paid for 200 shares at US$10 per share 120,000Amount chargeable to tax under the head salary – Rs. 450 per share – Note (4A) – (Rs. 450 x 200)

[Cost of one share is Rs. 1,050 (210,000 / 200)] 90,000 210,000–––––––– ––––––––

90,000––––––––

75% of the gain of Rs. 90,000 is chargeable to tax as capital gains since the shares were held for more than one year 67,500

––––––––

25



MarksNote (4A) Amount chargeable to tax under the head salary

Rupees– 500 shares in SBI which were not subject to a restriction on the transfer of

the shares. The shares were acquired by Tausif on 16 July 2003 at the exerciseprice of US$10 per share when the fair market value (FMV) of one share (price quoted on the stock exchange) was US$15. The difference of US$5 per share [US$2,500 i.e. Rs. 150,000 (US$1 = Rs. 60)] is chargeable to tax under the head salary and would have been taxed in the tax year 2004. 150,000

– 500 shares in SBI which were subject to a restriction on the transfer of the shares. These 500 shares were also acquired by Tausif on 16 July 2003 at S$10 per share. As the shares were subject to a restriction on their transfer, the amount chargeable to tax is the FMV of the share (US$20 per share) on 15 July 2006 (the end of the holding period of 3 years) as reduced by the amount paid for the shares (US$10 per share). The difference of US$10 per share [US$5,000 i.e. Rs. 300,000 (US$1 = Rs. 60)] is chargeable to tax under the head salary and would have been charged to tax in the tax year 2007. 300,000

––––––––Total amount chargeable to tax as the salary income of Tausif in the tax years 2004 and 2007. 450,000

________The amount chargeable to tax in respect of one share is (Rs. 450,000/1,000). 450

––––––––

Note (5) Gain on the transfer of 500 shares in SBI to Nilufer No gain or loss is taken to arise on the disposal of an asset, inter alia, by reason of a gift if the person receiving the asset is not a non-resident [non-recognition rule s.79]. This provision is not applicable to the gift of 500 shares in SBI made to his wife Nilufer on 7 January 2008. She was a non-resident at the time of receiving the shares. Nilufer was a non-resident in the tax year 2008 since she was neither present in Pakistan for 183 days in the tax year 2008 (having left Pakistan on 29 December 2007) nor was she an employee of the Federal or Provincial government posted abroad in the tax year 2008.

When a capital asset is disposed of, inter alia, by reason of a gift, the fair market value (FMV) of the asset on the date of the gift is treated as the consideration received [s.77(1)]. On 7 January 2008 (the date of the gift of 500 shares in SBI to Nilufer), Tausif had sold 200 shares in SBI for Rs. 300,000 (Note 4) i.e. at the rate of Rs. 1,500 per share. The said Rs. 1,500 is treated as the FMV of one share in SBI on the date of the gift to Nilufer.

RupeesConsideration received for 500 shares (Rs. 1500 x 500) 750,000Cost of 500 shares in SBI [(Rs. 1050 per share as determined in Note (4)] 525,000

––––––––Gain 225,000

––––––––75% of the gain of Rs. 225,000 is chargeable to tax as capital gains since the shares were held for more than one year 168,750

––––––––

Note (6) Loss on the sale of shares in Cuppa Tea (Private) Ltd.Rupees

Cost of 70,000 shares 700,000Consideration received on the sale of 70,000 shares 400,000

––––––––Capital loss 300,000

––––––––

26



MarksNote (7) Gain on the sale of painting ‘B’

Though the painting was held by Tausif for his own use, a painting is considered to be a capital asset and any gain on the disposal of a painting is chargeable to tax as capital gains, but no loss is recognised on the disposal of a painting s.38(5)(a)].

Where a capital asset becomes the property of a person, inter alia, by inheritance, the fair market value of the asset on the date of its acquisition is treated as the cost of the asset. Since the painting was valued at Rs. 100,000 by an art expert at the time of the death of Tausif’s father, Rs. 100,000 is treated as the cost of the painting.

RupeesSale proceeds 1,000,000Cost 100,000

–––––––––900,000

–––––––––75% of Rs. 900,000 is chargeable to tax as capital gains since the paintingwas held for more than one year 675,000

––––––––––

Note (8) A person (other than a company) is entitled to a tax credit for a tax year on the cost of acquiring in that year, new shares offered to the public by a public company listed on a stock exchange in Pakistan, provided the person is the original allottee of the shares [s.62(1)].

Tausif is eligible for a tax credit on the investment in shares since he is an individual and is the original allottee of new shares issued by NewCo Ltd a public company listed on the Islamabad Stock Exchange.

The amount on which the tax credit is to be calculated is the lowest of (a) the cost of acquiring the shares, (b) 10% of the person’s taxable income or (c) Rs. 300,000. Since both the cost of acquiring the shares (Rs. 100,000) and Rs. 300,000 are more than 10% of taxable income (Rs. 80,225), the tax credit is calculated on Rs. 80,225 [s.62(2)].

RupeesThe tax credit allowable is calculated as under:Tax assessed before allowance of tax credit (A) 140,394Taxable income for the year (B) 802,250Amount of investment on which tax credit is to be calculated (C) 80,225

A/B x C140,394/802,250 x 80,225 14,039

––––––––––

27



Marks4 The Finance Director of Sunflower Oil Pakistan Ltd (SOPL) should be advised on the following lines:

(1) Advance tax

Up to the tax year 2007, only a taxpayer whose income was charged to tax for the latest tax year was required to pay advance tax in four quarterly instalments computed on the basis of the last assessed income. The Finance Act, 2007 enacted on 1 July 2007, inserted a new provision whereby advance tax is now payable by every company even if it has not been charged to tax previously or there has been no previous assessment. Such companies are required to estimate the amount of advance tax payable on the basis of the estimated quarterly accounting profit and paythe amount so determined after taking into account the minimum tax payable and any adjustment for tax already paid [s.147(6A)].

As the accounting year of SOPL is from 1 January 2007 to 31 December 2007 and the above change in the law was enacted on 1 July 2007, SOPL was not required to pay advance tax for the first two quarters ended 31 March 2007 and 30 June 2007 respectively. However, advance tax computed on the estimated quarterly accounting profit is payable for the two quarters ended 30 September 2007 and 31 December 2007 on or before 15 September 2007 and 15 December 2007 respectively. 3

(2) Machinery Supplies plc (MS)Fees and penalties which are not deductible under the Income Tax Ordinance, 2001 are those which are paid or payable by a taxpayer for the violation of any law, rule or regulation [s.21(g)]. The Rs. 1,500,000 paid by SOPL was in the nature of compensation for a breach of the contract with MS and the payment, though termed a penalty in the contract document, is in fact not a fine or penalty for the violation of any law, rule or regulation . The payment was the price paid for the termination of the contract which was regarded as detrimental to the profitable conduct of the company’s business. Any expenditure incurred to terminate a disadvantageous contract is revenue expenditure and is deductible. 3

(3) Forward contractThe forward contract entered into by SOPL for the purchase of raw materials used in its business of manufacturing edible oils is in the nature of a hedging contract which was entered into to guard against loss from future price fluctuations. Such contracts have specifically been excluded from the definition of speculative business [s.19(2)]. Therefore, the Rs. 950,000 paid to settle the forward contract is an expenditure incurred in the normal course of business and is a deductible expenditure. 3

(4) Repairs An expenditure in the nature of repairs to an asset used for the purpose of the business would normally be a deductible expenditure provided the repairs do not change the identity of the asset. Any expenditure which substantially changes the identity of an asset or which adds value to an asset is capital expenditure.At the time of the purchase of the labelling machine, SOPL was fully aware that the machine was in an imperfect condition and that further expenditure in the nature of repairs had to be incurred to bring the machine up to a proper standard before it could be used for the business. The expenditure of Rs. 790,000 has thus added value to the machine – it is in fact a part of the cost of acquiring the machine and is capital expenditure and is not deductible. 3

(5) Trade markA trade mark is considered to be an intangible for tax purposes. The cost incurred by a taxpayer in acquiring or developing a trade mark is not allowed as a deductible charge but an amortisation deduction is allowable provided the intangible is used by the taxpayer in deriving income from business chargeable to tax. The expenditure is allowed to be amortised over the normal useful life (NUL) of the intangible, proportionate to the number of days the intangible is used in a tax year for the purpose of the business. An intangible with a NUL of more than 10 years is to be treated as if it has a NUL of 10 years.

The Rs. 1,000,000 expended by SOPL in acquiring the trade mark is the cost of an intangible acquired by SOPL. As the advantage from the use of the trade mark is expected to accrue for a number of years, the NUL for the purpose of working the allowable amortisation deduction should be taken at 10 years. SOPL should claim the amortisation deduction in the return of income for the tax year 2008 and in the subsequent tax years the trade mark is used in the business. The total amortisation deduction allowable should not exceed Rs. 1,000,000 which is the cost of acquiring the trade mark. 3

––––15

––––

28



Marks5 (a) Mr Danny

(i) When there is a change in the rate of sales tax during a tax period, a separate return for each portion of the tax period is required to be furnished. Thus, two returns will have to be furnished for the month of October 2007 – a return for the period 1 October 2007 to 15 October 2007 and a separate return for the period from 16 October 2007 to 31 October 2007 3

––––

(ii) Sales tax at the rate of 15% Rupees RupeesOutput taxSale of taxable goods (Rs. 4,580,000 x 15%) 687,000 0·5Input taxPurchase of raw materials (Rs. 2,635,000 x 15/115) 343,696 1·0Purchase of spare parts and supplies – Rs. 168,500 paid in cash so not admissable – 1·0Payment to courier company (Rs. 1,703,333 x 15%) 255,500 0·5

––––––––599,196––––––––

Sales tax payable 87,804––––––––

Sales tax at the rate of 12%Output taxSale of taxable goods (Rs. 8,779,000x 12%) 1,053,480 0·5Input taxPurchase of raw materials (Rs. 9,470,000 x 12/112) 1,014,643 1·0

––––––––––Sales tax payable 38,837

––––––––––Sales tax payable for the month of October 2007 (87,804 + 38,837) 126,641 0·5

–––––––––– ––––5

––––

(b) A person is required to retain the records and documents for a period of five years after the end of the tax period to which such records or documents relate. 2

––––10

––––

29





ALL FIVE questions are compulsory and MUST be attempted.Tax rates and allowances are on pages 2–3.




Pape

r F6

(PK

N)

Taxation(Pakistan)

Monday 1 December 2008







A. Tax rates for individualswhere salary income exceeds 50% of taxable income for the tax year 2008.

Taxable income Rate of taxUp to Rs. 150,000* 0%Rs. 150,001 – Rs. 200,000 0·25%Rs. 200,001 – Rs. 250,000 0·50%Rs. 250,001 – Rs. 300,000 0·75%Rs. 300,001 – Rs. 350,000 1·50%Rs. 350,001 – Rs. 400,000 2·50%Rs. 400,001 – Rs. 500,000 3·50%Rs. 500,001 – Rs. 600,000 4·50%Rs. 600,001 – Rs. 700,000 6·00%Rs. 700,001 – Rs. 850,000 7·50%Rs. 850,001 – Rs. 950,000 9·00%Rs. 950,001 – Rs. 1,050,000 10·00%Rs. 1,050,001 – Rs. 1,200,000 11·00%Rs. 1,200,001 – Rs. 1,500,000 12·50%Rs. 1,500,001 – Rs. 1,700,000 14·00%Rs. 1,700,001 – Rs. 2,000,000 15·00%Rs. 2,000,001 – Rs. 3,150,000 16·00%Rs. 3,150,001 – Rs. 3,700,000 17·50%Rs. 3,700,001 – Rs. 4,450,000 18·50%Rs. 4,450,001 – Rs. 8,400,000 19·00%Rs. 8,400,001 and over 20·00%


B. Tax rates for individualsto whom the rates given in A are not applicable.

Taxable income Rate of taxUp to Rs. 100,000 0%Rs. 100,001 – Rs. 110,000 0·50%Rs. 110,001 – Rs. 125,000 1·00%Rs. 125,001 – Rs. 150,000 2·00%Rs. 150,001 – Rs. 175,000 3·00%Rs. 175,001 – Rs. 200,000 4·00%Rs. 200,001 – Rs. 300,000 5·00%Rs. 300,001 – Rs. 400,000 7·50%Rs. 400,001 – Rs. 500,000 10·00%Rs. 500,001 – Rs. 600,000 12·50%Rs. 600,001 – Rs. 800,000 15·00%Rs. 800,001 – Rs. 1,000,000 17·50%Rs. 1,000,001 – Rs. 1,300,000 21·00%Rs. 1,300,001 and over 25·00%

2



C. Tax rates for companiesTax year Public company Private company Small company2008 35% 35% 20%

D. Rates of advance collection or deduction of taxCollection of advance tax by the Collector of Customs on the importof goods 5% of the value of the goods

E. Other tax ratesOn dividends received from a company 10% of the gross amount of the dividend

On income from property 5% of the rent chargeable to tax

F. Capital allowancesDepreciationBuildings (all types) 10% Furniture and fittings 15%Plant and machinery (not otherwise specified) 15% of the tax written down valueMotor vehicles (all types) 15%Computer hardware 30%

}Initial allowance 50% of cost

G. Benchmark rateFor determining the value of the perquisite on loans given to employees, the benchmark rate for the tax year 2008 is10% per annum of the loan amount.

3 [P.T.O.




1 Woodcrafts Pakistan Limited (WPL) is an industrial undertaking engaged in the business of manufacturing furnitureusing Swedish technology and designs. The following information is available for the accounting year ended 30 June2008:

(1) WPL is a public company under the Companies Ordinance, 1984. 50% of its shares are held by SwedecraftsCompany Inc (SCI), a company incorporated in Sweden. The Government of Sweden owns 51% of the sharesin SCI. WPL is not listed on any stock exchange in Pakistan.

(2) WPL held 100% of the share capital in Stylecrafts (Private) Limited (Stylecrafts) on 1 July 2007. Stylecrafts isan industrial undertaking and is not engaged in the business of trading.

(3) WPL’s accounting profit for the year ended 30 June 2008, after the transfer of Rs. 3,000,000 to dividendequalisation reserve account, was Rs. 9,000,000.

(4) Deductions charged in the accounts include: Rupees

(i) Accounting depreciation. 750,000

(ii) Donation to Poor Patients Hospital established inKarachi by the Provincial Government of Sindh. 600,000

(iii) Air fare for the production manager’s business visit to Sweden,paid in cash. 250,000

(iv) Payment to a management consultant in the matter of increasingthe company’s share capital. 49,000

(v) Payment to the Karachi Port Trust (KPT) being charges for not liftingimported goods from the docks within the time stipulated in theKPT rules. 50,000

(vi) Legal costs incurred for the purpose of standing as a surety for thedue performance of a supply contract entered into by Stylecrafts,a subsidiary company of WPL, with the Ministry of Industries,Government of Pakistan. 220,000

(5) Income shown in the accounts include: Rupees

(i) Accounting profit on the sale of a motor car. 388,000

(ii) Damages recovered against WPL’s claim for loss of trading profits,from a supplier who failed to deliver a consignment of teak woodwithin the time stipulated in the supply contract. 1,000,000

(iii) Unclaimed wages which had become time-barred.Out of the Rs. 650,000, Rs. 491,628 had been chargedto tax by the Commissioner under the head ‘Income for business’in the prior years as the amount had remained unpaid forthree years from the end of the year the deduction was allowed. 650,000

(6) Fixed assets

(i) The tax written down values of the company’s assets on 1 July 2007 were:

RupeesPlant and machinery 19,500,000Buildings 9,660,000Motor cars 5,090,000Furniture 2,400,000Computers hardware 3,800,000

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(ii) During the year a motor car was sold for Rs. 900,000. The cost of the motor car was Rs. 1,500,000 butits cost was restricted to Rs. 1,000,000 for the purposes of claiming tax depreciation. The tax written downvalue of the car at the time of its sale was Rs. 510,000.

(iii) On 1 December 2007, the following assets were purchased:– one new motor car for Rs. 2,000,000– ten new personal computers for Rs. 760,000

(iv) During the year Rs. 10,800,000 was expended on the construction of a residential building for workers.The Rs. 10,800,000 included Rs. 2,000,000 for the cost of land. The workers occupied the building on 1 May 2008.

(7) Other information

(i) Rs. 11,950,000 was expended on the in-house development of a computer software for designingstandardised office furniture. The software was used for the first time by WPL in its business chargeable totax on 1 January 2008. Considering the fast changing trends in furniture design it was not possible toestimate the normal working life of the software. It was however decided by the management that theRs. 11,950,000 should be treated as deferred revenue expenditure and written off equally over five years.Accordingly Rs. 2,390,000 (1/5 of Rs. 11,950,000) has been charged to cost of sales for the year ended30 June 2008.

(ii) Sundry creditors include Rs. 700,000 being a provision made on 30 June 2008 for gratuities payable toemployees on their retirement under a gratuity scheme approved by the then Central Board of Revenue. TheRs. 700,000 has been charged as an expense under the account head of salaries and wages.

(iii) On 3 November 2007, WPL sold 26% out of its 100% shareholding in Stylecrafts (subsidiary company) fora gain of Rs. 180,000. The shares sold had been held for more than one year.

(iv) Stylecrafts furnished its return of income for the tax year 2008 to the tax department under the selfassessment scheme, on 1 December 2008, declaring a tax loss of Rs. 875,000 for its accounting yearended 30 June 2008. The Chief Financial Officer of WPL wants Stylecrafts to surrender this loss of Rs. 875,000 in favour of WPL, so that WPL can set off the Rs. 875,000 against its taxable income for thetax year 2008.

(v) Advance tax paid by WPL for the tax year 2008 in quarterly instalments was Rs. 1,120,000.

Required:

(a) State, giving reasons, whether or not Woodcrafts Pakistan Limited is a public company for tax purposes.(2 marks)

(b) Compute the taxable income of Woodcrafts Pakistan Limited for the tax year 2008 under the appropriateheads of income, giving clear reasons/explanations for the inclusion or exclusion in the computation of taxableincome of each of the items listed.

Note: the reasons/explanations for the items not listed in the computation of taxable income should be shownseparately from the other reasons/explanations. (25 marks)

(c) Calculate the tax payable by or refundable to Woodcrafts Pakistan Limited for the tax year 2008.(3 marks)

(30 marks)



2 The following information is provided to you by Mr Abdullah

(1) Abdullah is a citizen of Pakistan and until 30 June 2007, he was an employee of the Karachi branch of ABCInc, a company incorporated in the United States. On 28 June 2007, Abdullah opted for early retirement undera voluntary retirement scheme floated by ABC Inc. His resignation was accepted on the same day and ABC Inc.,gave instructions to their bank to transfer, before 30 June 2007, Rs. 1,850,000 into the bank account ofAbdullah. The Rs. 1,850,000 is made up of the following:

Rupees– Salary for the month of June 2007 300,000– Gratuity under a gratuity scheme of ABC Inc. The scheme was not approved by

the Federal Board of Revenue and was applicable only to the employees in themanagement cadre. 750,000

– Compensation for redundancy of employment 800,000—————1,850,000——————————

The Rs. 1,850,000 was credited to Abdullah’s bank account on Monday 2 July 2007 as 30 June 2007 was abank holiday.

On retirement Abdullah was also entitled to a monthly pension of Rs. 20,000 payable on the first working dayof each month commencing from the month of July 2007.

(2) On 30 June 2007, Rs. 100,000 was payable by Abdullah to ABC Inc against a loan taken by him. On 16 July2007 Abdullah informed ABC Inc that Rs. 70,000 was due to him as salary in lieu of unused privileged leave.He required ABC Inc to apply the Rs. 70,000 toward part-repayment of the loan. ABC Inc did not pay the Rs. 70,000 to Abdullah but on 16 July 2007 applied the Rs. 70,000 against the outstanding loan amount of Rs. 100,000. On 30 June 2008, the balance amount of Rs. 30,000 outstanding against the loan, was waivedby ABC Inc.

(3) On 2 July 2007, Abdullah imported 5,000 units of pressure cookers. The entire consignment was sold to KitchenAppliances, a sole proprietorship concern. Abdullah wound up this activity of imports on 30 September 2007after making a nominal profit of Rs. 7,500. The summarised profit and loss account for that period is asfollows:

Rupees RupeesSales 10,000,000Cost of sales – Cost of the 5,000 units 8,850,000– Tax collected by the collector of customs on the value of the imported goods 442,500– Damages paid to Kitchen Appliances against a claim for defective cookers 700,000 9,992,500

————— ——–———Net profit 7,500

——–—————–———

(4) On 1 August 2007, when Abdullah was no longer an employee of ABC Inc, he was allowed to participate in theABC Employee Share Scheme (Scheme). The custodian of the Scheme granted Abdullah the right to acquire1,000 shares in ABC Inc at the exercise price of US$ 10 per share. There was no payment to be made for theright to acquire the shares. The price of the shares in ABC Inc quoted on the New York Stock Exchange on1 August 2007 was US$ 12 per share and the value of one right on that date was estimated by the custodianto be US $2.

(5) On 1 August 2007, Abdullah was offered employment as the finance manager of PQR Ltd Karachi. As aninducement for Abdullah’s agreement to enter into an employment relationship commencing from 1 September 2007, PQR Ltd proposed to give Abdullah a loan of Rs. 1,000,000 free of profit. On Abdullah’sagreement to the proposal, he received the Rs. 1,000,000 from PQR Ltd on 1 August 2007 at which timeAbdullah was not an employee of PQR Ltd. The loan was repayable in 10 equal yearly instalments but Abdullahrepaid the full amount of the loan on 30 April 2008.

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(6) Abdullah commenced employment with PQR Ltd on 1 September 2007. His terms of employment provided forthe following:


(ii) Monthly cash allowances of:– 25% of basic salary each for utilities and medical;– 45% of basic salary for housing.

(iii) One return business class air-fare for Abdullah’s personal travel to London in a year.

(iv) A company maintained motor car for his business and private use.

(v) Abdullah is not entitled to free medical treatment or hospitalisation or to the reimbursement of such charges.

(7) Other information submitted by Abdullah

(i) Abdullah accepted the benefit of the return air passage to London on 2 April 2008 which cost PQR LtdRs. 217,500.

(ii) In order to provide the benefit of a company maintained motor car to Abdullah, a new motor car waspurchased by PQR Ltd on 1 October 2007, for Rs. 1,500,000.

(iii) Abdullah received a special monthly allowance of Rs. 20,000 from PQR Ltd to meet entertainment expenseswholly and necessarily to be incurred in the performance of his duties as a finance manager.

(iv) Tax deducted at source by PQR Ltd from Abdullah’s salary for the relevant tax year was Rs. 1,100,000.

(v) On 1 June 2008 Abdullah resigned from PQR Ltd and left Pakistan for Dubai on the same day and remainedin Dubai until 30 June 2008. He commenced employment with Lotus Associates, Dubai on 1 June 2008at a consolidated salary of US$ 10,000 per month. He was also provided with residential accommodationwhich cost Lotus Associates US$ 4,000 per month.

(vi) On 1 May 2008 Abdullah disposed of the right to purchase the 1,000 shares in ABC Inc for Rs. 215,000.

(vii) On 1 May 2008, by a notice in writing to the Commissioner, Abdullah had elected to be taxed on the amountof the compensation for redundancy received from ABC Inc at the average rate of tax paid by him on histotal income for the preceding three tax years. This tax rate worked out at 15%.

(viii) Abdullah is the owner of a building in the Defence Housing Society. On 1 September 2007, he rented thebuilding to Mr X for Rs. 76,000 a month, which amount includes Rs. 10,000 for providing a security guardfor the building. The following expenses were incurred by Abdullah on the building:

RupeesRepairs and renovation 20,000Ground rent 3,000Insurance 6,000

———–29,000———–———–

Abdullah paid Rs. 5,000 a month as salary to the security guard.

(ix) Abdullah rented a factory building in the Korangi Industrial Estate on 1 July 2006 and paid three years rentin advance at the rate of Rs. 650,000 per annum. On 1 July 2007, Mr Bee wanted to sub-lease the buildingfrom Abdullah at an annual rental of Rs. 2,000,000. As an inducement for Abdullah’s agreement to enterinto a sub-lease arrangement for two years, Bee proposed to pay Abdullah a deposit of Rs. 3,000,000 whichwould not be adjustable against the rent. On Abdullah’s agreement to the proposal, Bee paid Abdullah on2 July 2007:– Rs. 4,000,000 as rent in advance for two years; and– Rs. 3,000,000 as a deposit which was not adjustable against the rent.

(x) On 2 July 2007 Abdullah invested Rs. 500,000 in the purchase of new shares in Classic Cars Ltd, a publiccompany listed on the Lahore Stock Exchange. Classic Cars Ltd had offered the new shares to the publicand Abdullah was an original allottee of the shares.

7 [P.T.O.



Required

(a) Compute the taxable income of Mr Abdullah under the appropriate heads of income for the tax year 2008,giving clear reasons/explanations for the inclusion or exclusion in the computation of taxable income for eachof the items listed.

Note: the reasons/explanations for the items not included in the computation of income should be shownseparately from the other reasons/explanations. (20 marks)

(b) Calculate the tax payable by or refundable to Mr Abdullah for the tax year 2008. (5 marks)

(25 marks)

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This is a blank page.Question 3 begins on page 10.

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3 (a) Medico Pakistan Ltd (MPL) is a company incorporated in Pakistan under the Companies Ordinance, 1984 andis engaged in the business of manufacturing pharmaceuticals. 49% of the shares in MPL are owned by Chin Inc(CI), a company incorporated in a country which has no tax treaty with Pakistan for the avoidance of doubletaxation. CI’s only income in Pakistan is from the dividends received from MPL. On 30 June 2008, CI disposedof its 49% share holding in MPL to a tax resident of the United Kingdom (UK). The sale transaction wascompleted in the UK and the sale consideration was also received by CI in the UK. The sale of the shares in MPLresulted in a gain of US$ 75,000 to CI.

CI is of the view that the US$ 75,000 is not chargeable to tax in Pakistan since the entire transaction of the salewas completed outside Pakistan and the sale consideration was also received outside Pakistan.

Required:

State, giving reasons, whether or not the view of Chin Inc is correct. (3 marks)

(b) Mr Prospector (P), a non-resident for Pakistan tax purposes, holds 50% of the shares in Black Gold Inc (BGI), acompany incorporated in a country which has no tax treaty with Pakistan for the avoidance of double taxation.BGI is a non-resident company for Pakistan tax purposes. BGI entered into an agreement with the Governmentof Pakistan (GOP) under which BGI was given the right to explore for and exploit crude oil and natural gas in anarea of Pakistan. This right to explore for and exploit crude oil and gas is the principal asset of BGI in Pakistan.The profit and loss share in the venture of exploration and production of oil and gas was 51% to GOP and 49%to BGI. BGI commenced operations in Pakistan as a branch on 1 January 2007.

On 30 June 2008, P disposed of his entire share holding in BGI to Mr Q, a tax resident of the United Kingdom(UK). The sale transaction was completed in the UK and the sale consideration was also received by P in theUK. The sale of the shares in BGI resulted in a gain of US$ 2,500,000 to P.

P is of the view that since he was a non-resident in the tax year 2008 and the gain of US$ 2,500,000 arosefrom the sale of the shares in BGI, which is a non-resident company for Pakistan tax purposes, the US$ 2,500,000 is not chargeable to tax in Pakistan.

Required:

State, giving reasons, whether or not the view of Mr Prospector is correct. (3 marks)

(c) The following information is furnished to you by Mr Vakil, the executor to the estate of the late Mrs Moneybags(M). (1) M died on 1 June 2008

(2) On the basis of M’s return of income for the tax year 2007 (accounting year ended 30 June 2007) furnishedto the tax department under the self-assessment scheme, the position of M’s unadjusted losses was asfollows:– Rs. 768,640 loss for the tax year 2007 on account of forward trading in raw cotton on the cotton

exchange. The forward contract was settled otherwise than by actual delivery of cotton. – Rs. 560,650 capital loss sustained under the head ‘Capital gains’ which is made up as follows:

Accounting year ended on: Rupees30 June 2002 215,65030 June 2001 345,000

————560,650————————

(3) At the time of M’s death, she was survived by her three children whose details are as follows:

(i) Ginnie, her daughter, is an author. She left Pakistan for London on 30 December 2007 and has beenliving in London since then.

(ii) Peechu, her son, is an artist living in Paris. During the year ended 30 June 2008, he came to Pakistanfor the Eid holidays on 21 March 2008 for a week.

(iii) Roshi, her daughter, has always been resident in Pakistan.

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(4) On 20 June 2008, Mr Vakil, in accordance with the last will and testament of M, transferred the followingassets of M to the beneficiaries:

(i) To Roshi:– 1,000 shares in Zee (Private) Ltd which M had acquired on 2 July 2007 for Rs. 20,000.– A residential house in Shaheen Housing Society, which had been inherited by M in 1970 and was

then valued at Rs. 11,500,000.

(ii) To Ginnie:– The rupee equivalent of US$ 40,000 which was kept by M in a safe deposit vault. The

US$ 40,000 was converted into Pakistan rupees through an authorised dealer in foreign exchangeat the rate of US$ 1 = Rs.64. The US$ 40,000 had been purchased by M in 1985 for Rs. 800,000.

– Rs. 3,419,017 being the credit balance in M’s bank account.

(iii) To Peechu:– A rare Chinese manuscript of the Sung Dynasty which had been purchased by M in 1950 for

Rs. 7,000,000. The manuscript was considered by M to be her own personal asset.– 10,000 shares in Moneybags Investment Ltd (MIL). The shares were inherited by M from her

father who, as the founder member of MIL, had acquired the shares for Rs. 10 per share. Thebreak-up value of one share in MIL on 20 June 2008, as determined by a firm of CharteredAccountants, was Rs. 120.

– An original painting of the early Italian period, which had been purchased by M in 1945 for Rs. 7,500,000. The painting was considered by M to be her own personal asset.

(5) Other information (i) J B Boots Associates, a firm of surveyors and valuers was appointed by Mr Vakil to determine the fair

market value, as on 20 June 2008, of the Chinese manuscript, the painting of the Italian period, theresidential house and the 1,000 shares in Zee (Private) Ltd.

J B Boots reported that:– the Chinese manuscript was valued at Rs. 1,000,000. The condition of the manuscript had

deteriorated due to careless storage; – the painting was valued at Rs. 25,000,000;– the residential house was valued at Rs. 30,000,000; and – the break-up value of one share in Zee (Private) Ltd was Rs. 5.

(ii) M had retired from the employment of Exotic Sea Foods Inc (ESF) on 31 December 2006. M washospitalised for a month prior to her death. Despite M’s terms of employment not providing for anymedical benefits after retirement, the hospital bill of Rs. 1,174,300 was paid by ESF directly to thehospital on 28 May 2008.

(iii) On 1 May 2008, M had donated Rs. 2,000,000 to a hospital in Karachi run by the FederalGovernment.

Required:

(i) Compute the taxable income of the late Mrs Moneybags under the appropriate heads of income for thetax year 2008, giving clear reasons/explanations for the inclusion or exclusion in the computation oftaxable income of each of the items listed.

Note: the reasons/explanations for the items not included in the computation of income should be shownseparately from the other reasons/explanations. (12 marks)

(ii) Calculate the tax payable by or refundable to Mrs Moneybags for the tax year 2008. (2 marks)

(20 marks)

11 [P.T.O.



4 Mr Chaiwalla, a resident for Pakistan tax purposes, is engaged in the business of operating a number of café’s inKarachi under the name of Doodpati Chai. The assessment of Chaiwalla for the tax year 2007 (accounting year ended 30 June 2007) was selected for audit under section 177 of the Income Tax Ordinance, 2001.

(1) On completion of the audit the Commissioner issued a notice to Chaiwalla requiring him to give reasons, withinseven days of the receipt of the notice, why the assessment for the tax year 2007 should not be amended to:

(i) Disallow Rs. 150,000 paid to Doodpati Inc Bahamas, for the use of the brand name ‘Doodpati’, since notax was deducted from the amount remitted to Doodpati Inc.

(ii) Disallow Rs. 50,000 paid to Mr Consultant for suggesting cost-cutting measures in the café’s, since no taxwas deducted from the amount paid to Mr Consultant.

(iii) Treat Rs. 40,000 received from Ali Canteen Stores Lahore as income chargeable to tax. The Rs. 40,000received had been credited to Chaiwalla’s capital account.

(iv) Treat Rs. 36,000 received from Orchids Farms Ltd as income chargeable to tax. The Rs. 36,000 receivedhad been credited to Chaiwalla’s capital account.

(v) Disallow Rs. 7,500 salary paid in cash to Mr A, a temporary worker employed for the month of May 2007.

(2) Chaiwalla is not in agreement with the Commissioner’s proposal to amend the assessment. As required in thenotice issued by the Commissioner, Chaiwalla has submitted his objections to the proposed amendments inwriting together with the following reasons and explanations:

(i) Payment of Rs. 150,000 to Doodpati Inc on account of royaltyNo tax was required to be deducted from the payment of Rs. 150,000 made to Doodpati Inc (DI) since: – DI had no permanent establishment in Pakistan in the tax year 2007 and consequently the royalty

income of DI is not chargeable to tax in Pakistan; and– DI is a company incorporated in the Bahamas where no income tax is payable.

(ii) Payment of Rs. 50,000 to Mr ConsultantThe Rs. 50,000 was a payment by way of an advance and therefore tax was not deducted from thepayment. The total amount payable to Mr Consultant for the assignment is Rs. 120,000 and when thebalance amount of Rs. 70,000 is paid, tax would be deducted at the prescribed rate on the total amount ofRs. 120,000.

(iii) Rs. 40,000 received from Ali Canteen Stores LahoreThe amount received from Ali Canteen Stores Lahore relates to the business of a coffee house previously runby Chaiwalla in Lahore. The coffee house business ceased to exist on 31 December 2002. As on31 December 2002, Ali Canteen Stores Lahore owed Chaiwalla Rs. 40,000 in respect of the sale of coffeebeans. The Rs. 40,000 had not been recognised as the taxable income of Chaiwalla, since the system ofaccounting was on the cash basis.

The receipt of Rs. 40,000 is a capital receipt and is not chargeable to tax since:– it is not a profit or gain of a business carried on by Chaiwalla at any time during the tax year 2007;– it is not traceable to any source of income in the tax year 2007; and – the receipt relates to the coffee house business which had ceased business on 31 December 2002 i.e.

before the commencement of the tax year 2007.

(iv) Rs. 36,000 received from Orchids Farms LtdThis amount represents a dividend received from Orchids Farms Ltd (OFL). OFL’s income is derived whollyfrom agriculture and is therefore exempt from tax. The dividend of Rs. 36,000 being paid from an exemptincome is therefore not chargeable to tax.

(v) Salary of Rs. 7,500 paid in cashRs. 7,500 was paid in cash to A, a temporary worker, as A did not have a bank account.

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Required:

State giving reasons, whether or not in each case, the amendments proposed by the Commissioner is or is not inaccordance with the provisions of the tax statute.

Note: the allocation of marks is as follows: issues (i), (ii) and (iv), 3 marks each; issue (iii) 4 marks and issue (v) 2 marks.

(15 marks)

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5 (a) Barq Ro (Pakistan) Ltd (BRPL), a registered person under the Sales Tax Act, 1990, is engaged in the manufactureand sale of insulated cables. BRPL’s financial year is the year ended on 30 June annually. The management ofBRPL decided to start a new unit for the manufacture of underground cables that would require specialisedmachinery. The machinery was purchased on 1 May 2008 and the new unit commenced production on 4 May2008.

The business transactions of BRPL for the month of May 2008 were as follows:

RupeesPayment for purchase of raw materials 7,448,850Payment for advertisements 7,850,000Payment for the purchase of machinery for the new unit 5,395,500Sale of taxable goods in Pakistan 6,535,000Export of cables to Tanzania 5,790,000

Notes:(1) All payments are stated inclusive of sales tax. (2) The figures for the sale of taxable goods and export are stated exclusive of sales tax.

Required:

Calculate the sales tax payable by or refundable to Barq Ro (Pakistan) Ltd for the month of May 2008 giving clear explanations for the treatment accorded to the following items in determining theamount of input tax on:

– the purchase of raw materials and advertisements; and– the purchase of machinery for the new manufacturing unit. (7 marks)

(b) Mr Yousha, a registered person under the Sales Tax Act, 1990, is carrying on business in the name of YoushaAssociates. Yousha is informed by his chief accountant that a credit note has to be issued to a debtor in respectof an invoice issued on 30 June 2008. The chief accountant intends to issue the credit note in the month ofJanuary 2009.

Required:

State, giving reasons, whether or not you are in agreement with the chief accountant’s proposal to issue thecredit note in the month of January 2009. (3 marks)

(10 marks)


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Answers



17

Fundamentals Level – Skills Module, Paper F6 (PKN) December 2008 Answers and Taxation (Pakistan) Marking Scheme

Marks1 (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 company owned by a foreign government [s.2(47)(ab)]. 50% of the sharesin Woodcrafts Pakistan Limited (WPL) are held by Swedecrafts Company Inc (SCI) which is a foreign company, 2but SCI is not wholly owned by a foreign government. Therefore WPL is not a public company for Pakistan tax —purposes.

(b) Woodcrafts Pakistan LtdAccounting year ended 30 June 2008

Tax year 2008

Computation of taxable income Rupees RupeesIncome from businessAccounting profit 9,000,000Add: Transfer to dividend equalisation reserve (Note 1) 3,000,000 1

Accounting depreciation (Note 2) 750,000 0·5Donation to Poor Patients Hospital (Note 3) 600,000 1Consultancy charges for proposed increase in theshare capital (Note 4) 49,000 1Legal costs (Note 5) 220,000 1Provision for gratuity (Note 6) 700,000 1Tax profit on the sale of motor car (Note 7) 90,000 2Accounting amortisation of software (Note 8) 2,390,000 1

—————– 7,799,000—————–16,799,000

Less: Accounting profit on the sale of motor car (Note 7) 388,000 1Amortisation of an intangible (Note 8) 594,235 2Unclaimed wages previously taxed (Note 9) 491,628 1·5Initial allowance (Note 10) 4,780,000 1·5Depreciation (Note 11) 6,932,000 4·5

—————– 13,185,863—————–

3,613,137Capital gains Gain on the disposal of shares (Note 12) 135,000 1

—————–Taxable income 3,748,137

—————–—————–

The relevant notes for the explanations of the treatment of items included in the computation of taxableincome and tax payable will be considered in allocating marks against each item.

In addition to the above, specific marks will be awarded for the explanations of the treatment of items notincluded in the computation of taxable income [1 mark each for items (i), (ii) and (iii) and 2 marks for item 5(iv)] as follows: —–

25–—

Items not included in the computation of taxable income.

(i) Any expenditure for a transaction paid or payable under a single head of account aggregating in excessof Rs. 50,000 made other than by a crossed bank cheque or a crossed bank draft is not deductible withcertain exceptions. One of the exceptions is any expenditure on account of a travel fare [s.21(l)(b)(iii)].The Rs. 250,000 for air fare paid in cash is deductible and has therefore not been included in thecomputation of taxable income.

(ii) Rs. 50,000 paid to the Karachi Port Trust for not lifting the imported goods from the docks within theprescribed time, is an expenditure incurred wholly and exclusively for the purposes of business and istherefore a deductible expenditure. The payment is not a fine or penalty for the violation of any law, ruleor regulation.

(iii) Rs. 1,000,000 received as damages from a supplier of raw materials, under the terms of the supplycontract, was for the loss of trading profits suffered by Woodcrafts Pakistan Limited (WPL). The receiptof Rs. 1,000,000 is in the ordinary course of business and is therefore the taxable income of WPL.



18

Marks(iv) The provisions of group relief (s.59B), inter alia, state that a subsidiary company can surrender its

assessed tax loss (excluding capital loss) for the tax year in favour of its holding company providedcertain conditions are fulfilled. One of the conditions is that where none of the companies in the groupis a listed company on a registered stock exchange in Pakistan, the holding company should own atleast 75% of the share capital of the subsidiary company surrendering the loss.

Neither WPL or Stylecrafts (Private) Limited (Stylecrafts) is a listed company and after the disposal byWPL of 26% of its holding in Stylecrafts, WPL did not hold the minimum requirement of 75% of theshare capital of Stylecrafts. Therefore, Stylecrafts cannot surrender its tax loss of Rs. 875,000 to WPLand consequently the Rs. 875,000 cannot be set off by WPL against its taxable income for the taxyear 2008.

(c) Computation of tax payableRupees

Tax on taxable income of Rs. 3,748,137 at 35% 1,311,848 0·5Tax credit on donation of Rs. 600,000 (Note A) (196,777) 2

—————1,115,071

Advance tax paid (1,120,000) 0·5—————

Tax refundable 4,929——————————

—––3

——30

——

Note (A) As the donation of Rs. 600,000 is to a hospital established in Pakistan by the Provincial Government of Sindh, Woodcrafts Pakistan Limited is entitled to a tax credit [s.61(1)(b)]. The tax credit is allowed at the average rate of tax (before allowance of tax credit) on the lower of the amount of the donation or 15% of the taxable income of the company [s.61(2)].

RupeesTax on taxable income before tax credit (A) 1,311,848Taxable income for the year (B) 3,748,137The lesser of Rs. 600,000 (donation) orRs. 562,220 (15% of taxable income) (C) 562,220

————–A/B x C1,311,848 / 3,748,137 x 562,220 196,777

————–Notes referred to in the computation of taxable income.

Note (1) The transfer of Rs. 3,000,000 to dividend equalisation reserve account is an appropriation ofprofit. Therefore the Rs. 3,000,000 is not deductible.

Note (2) Accounting depreciation is not a deductible charge. Tax depreciation and initial allowances aredeductible at the rates prescribed in the Third Schedule.

Note (3) The donation to the Poor Patients Hospital is not a deductible charge, but WPL is entitled to a taxcredit under a prescribed formula [s.61(1)(b) and (2)].

Note (4) The expenditure relating to the proposed increase in the share capital is capital in nature.Therefore, the Rs. 49,000 is not deductible expenditure.

Note (5) Legal costs of Rs. 220,000, incurred by WPL for standing as a surety for the due performance ofa supply contract undertaken by Stylecrafts (Private) Limited (a subsidiary of WPL), is notdeductible since it is not expenditure incurred for the purposes of WPL’s business. A subsidiarycompany is a separate legal entity from its parent. Therefore, WPL as the parent company, cannotbe allowed a deduction for the Rs. 220,000.

Note (6) The provision of Rs. 700,000 made on 30 June 2008 is not for an ascertained liability and istherefore not a deductible charge.

Note (7) The accounting profit or loss on the disposal of a depreciable asset is ignored for tax purposes.Therefore, the accounting profit of Rs. 388,000 on the sale of the motor car is not taxableincome.

For the purposes of computing the taxable income, it is the tax profit or loss that is chargeable totax or allowed as a deduction. The tax profit or loss on the disposal of a depreciable asset is thedifference between the consideration received and the tax written down value of the asset.



19

MarksAs the cost of the motor car was restricted for claiming tax depreciation, the consideration receivedon its disposal is to be adjusted as follows:

RupeesSale consideration received (A) 900,000Restricted cost for depreciation purposes (B) 1,000,000Actual cost (C) 1,500,000A x B/C900,000 x (1,000,000/1,500,000) 600,000Rs. 600,000 is to be treated as the sale considerationfor calculating the tax profit or loss on the disposal ofthe motor car Sale consideration 600,000Tax written down value 510,000

—–———Tax profit on the disposal of the motor car 90,000

—–————–———

Note (8) Rs. 11,950,000 expended on the in-house development of computer software is considered tobe an intangible for tax purposes (s.24). There is no concept of deferred revenue expenditure fortax purposes. Therefore, the Rs. 2,390,000 (1/5 of Rs. 11,950,000) charged to cost of sales isnot a deductible charge.

For tax purposes, the cost incurred in acquiring or developing an intangible is allowed to beamortised over the normal useful life (NUL) of the intangible, proportionate to the number of daysthe intangible is used in the tax year in deriving income chargeable to tax. If the NUL of anintangible cannot be ascertained, the intangible is treated as having a NUL of 10 years.

RupeesCost of the computer software 11,950,000

——–———Normal useful life of the software in whole years 10 years

——–———Amortisation for one whole year 1,195,000

——–———Amortisation for 182 days (1 January 2008 to30 June 2008) in a year of 366 days(1,195,000 x 182/366) 594,235

——–———

Note (9) For accounting purposes Rs. 650,000 representing time barred unclaimed wages has beentreated as income. Rs. 491,628 out of the Rs. 650,000 had been charged to tax by thecommissioner as business income in prior years. Therefore the Rs. 491,628 is not incomechargeable to tax in the tax year 2008.

Note (10) Initial allowance

Computer InitialBuilding hardware allowance

Rs. Rs. Rs.Cost of workers’ residential building 10,800,000Less: Cost of land (Note) (2,000,000)

—————8,800,000—————

Initial allowance at 50% 4,400,000Cost of computers 760,000

—————Initial allowance at 50% 380,000

—————4,780,000——————————

Note: Initial allowance and depreciation is allowed on immovable property excluding the cost of land.



Note (11) Depreciation

Plant and Computer MotorRate of machinery Buildings hardware vehicles Furniture Totaldepreciation 15% 10% 30% 15% 15%

Rs. Rs. Rs. Rs. Rs. Rs.Writtendown value 19,500,000 9,660,000 3,800,000 5,090,000 2,400,000Disposal — — — 510,000

––––––––––– –––––––––– –––––––––– –––––––––– ––––––––––19,500,000 9,660,000 3,800,000 4,580,000 2,400,000––––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Depreciation 2,925,000 966,000 1,140,000 687,000 360,000 6,078,000––––––––––– –––––––––– –––––––––– –––––––––– ––––––––––

Additions 8,800,000 760,000 2,000,000Initial allowance (4,400,000) (380,000) *

–––––––––– –––––––––– ––––––––––Written down value 4,400,000 380,000 2,000,000

–––––––––– –––––––––– ––––––––––Depreciation 440,000 114,000 300,000 854,000

–––––––––– –––––––––– –––––––––– ––––––––––6,932,000––––––––––––––––––––

* Any road transport vehicle not plying for hire is not eligible for initial allowance.

Note (12) 75% of the capital gain of Rs. 180,000 on the disposal of the shares in Stylecrafts (Private) Limited is chargeableto tax, since the shares were held for more than one year. Therefore, Rs. 135,000 (75% of 180,000) is chargeableto tax under the head ‘capital gains’.

20



21

Marks2 Mr Abdullah


(a) Computation of taxable income Rupees RupeesSalaryFrom ABC Inc.

Salary for June 2007 (Note 1) 300,000 0·5Gratuity (Note 1A) 675,000 1Compensation for redundancy of employment (Note 1B) 800,000 1Encashment of unused leave pay (Note 2) 70,000 1Waiver of loan (Note 3) 30,000 0·5Pension – Rs. 240,000 exempt from tax (Note 4) — 0·5Employee share scheme – sale of rights (Note 5) 215,000 1

From PQR (Pakistan) Ltd.Basic salary – Rs. 300,000 x 9 (Note 6) 2,700,000 0·5Cash allowances: – utilities – 25% of Rs. 2,700,000 (Note 6A) 675,000 0·5– housing – 45% of Rs. 2,700,000 (Note 6A) 1,215,000 0·5– medical (Note 6B) 405,000 1Benefit of profit free loan (Note 7) 75,000 1Passage for travel abroad (Note 8) 217,500 0·5Benefit of company maintained car (Note 9) 50,000 1Special allowance (Note 10) 180,000 1

From Lotus Associates Dubai – exempt from tax (Note 11) — 2————— 7,607,500

Income from property (Note 12) 660,000 1

Income from other sources:Security guard connected with the renting of building (Note 12) 50,000 0·5Sub-lease of land (Note 13) 1,350,000 1

————— 1,400,000—————

Taxable income 9,667,500——————————

The relevant notes for the explanations of the treatment of items included in the computation of taxableincome and tax payable will be considered in allocating marks against each item.

In addition to the above, specific marks will be awarded for the explanations of the treatment of items notincluded in the computation of taxable income [1 mark each for items (1) and (2) and 2 marks for 4item (3)] as follows: –——

20–——

Items not included in the computation of taxable income

(1) The tax collected by the collector of customs amounting to Rs. 442,500 (5% of the value of theimported pressure cookers) is the final tax on the income arising out of the import of the pressurecookers [s.148(7)]. Therefore, the actual profit of Rs. 7,500 is not chargeable to tax under any head ofincome [s.169(2)(a)].

(2) The value of a right or option to acquire shares in an employee share scheme granted to an employee,is not chargeable to tax [s.14(1)]. Therefore, the value of one right on the date of the grant at US$ 2 isnot chargeable to tax.

(3) An amount received by an owner of a building from a tenant which is not adjustable against the rentpayable is considered as rent chargeable to tax in 10 equal instalments under the head ‘Income fromproperty’. However, there is no provision for treating a non-adjustable amount received by a tenant of abuilding as income chargeable to tax. As Abdullah is not the owner of the building which he has sub-leased to Mr Bee, the Rs. 3,000,000 received from Mr Bee, which is not adjustable against the rentpayable, is not income chargeable to tax.



22

Marks(b) Computation of tax payable Rupees Rupees

Taxable income 9,667,500Less: Income to be taxed separately: Less: – compensation for redundancy of employment 800,000 0·5Less: – ‘income from property’ 660,000 0·5

———— (1,460,000)—————8,207,500—————

Tax on balance of Rs. 8,207,500 at 19% 1,559,425 0·5Tax on Rs. 800,000 (compensation for redundancy) at 15% (Note 1B) 120,000 0·5Tax on Rs. 660,000 (income from property) at 5% (Note 12) 33,000 0·5

—————1,712,425

Tax credit on purchase of shares (Note 14) (53,140) 2Tax deducted at source by PQR Ltd from salary income (1,100,000) 0·5

—————Tax payable 559,285

—————————— –––––5

——–25

——–——–


Note (1) An amount or perquisite is treated as received by an employee from the exercise of employmentregardless of whether the amount is paid or provided by a past or future employer [s.12(5)(b)].All income included under the head ‘salary’ is chargeable to tax on a receipt basis [s.12(1)].

On 30 June 2007 (Abdullah’s tax year 2007) ABC Inc was required to pay Abdullah anaggregate amount of Rs. 1,850,000 being Rs. 300,000 for salary for June 2007, Rs. 750,000 for gratuity (Note 1A) and Rs. 800,000 for compensation for redundancy ofemployment (Note IB). The Rs. 1,850,000 was transferred to Abdullah’s bank account on 2 July 2007 and was therefore actually received by Abdullah in his accounting year ended 30 June 2008 [s.69(a)]. The amounts received from ABC Inc (past employer) for salary,gratuity and compensation for redundancy, are therefore chargeable to tax in the tax year 2008.

Note (1A) As the gratuity received by Abdullah was neither from an approved gratuity fund nor under anapproved gratuity scheme of ABC Inc applicable to all employees, the amount of the gratuityexempt from tax is 50% of the amount received or Rs. 75,000 whichever is the lower. [Clause13(iv) of Part I of the Second Schedule].

Rupees

Gratuity 750,000Exempt from tax – Rs. 75,000 is lower than 50% of the gratuity (75,000)

————Chargeable to tax as salary 675,000

————————

Note (1B) Rs. 800,000 received as compensation for redundancy by Abdullah under the voluntaryretirement scheme of ABC Inc is considered to be a profit in lieu of or in addition to salary andis chargeable to tax as salary [s.12(2)(e)(iii)]. Abdullah has opted to have the Rs. 800,000taxed as a separate block of income at the average rate of tax on his total income for thepreceding three tax years [s.12(6)]. Tax on the Rs. 800,000 is calculated separately at 15%being the average rate of tax of Abdullah for the preceding three years.

Note (2) A person shall be treated as having received an amount, benefit, or perquisite if, inter alia, theamount is applied on behalf of the person, at the instructions of the person [s.69(b)]. Abdullahis treated as having received the Rs. 70,000 due to him for unused leave pay as the Rs. 70,000, at his instructions, was applied by ABC Inc toward the part-repayment of theoutstanding loan amount of Rs. 100,000.

Note (3) The waiver of an obligation of an employee to repay an amount owing by the employee to theemployer is a perquisite chargeable to tax [s.13(9)]. The waiver by ABC Inc of the loan balanceof Rs. 30,000 payable by Abdullah to ABC Inc, is a perquisite provided by ABC Inc to Abdullahand is therefore chargeable to tax as salary income.



23

MarksNote (4) The monthly pension received by Abdullah is exempt from tax since Abdullah is a citizen of

Pakistan, the pension received is from a former employer (ABC Inc) and Abdullah does notcontinue to work for ABC Inc or any associate of ABC Inc [clause 8 of Part I of the SecondSchedule].

Note (5) A gain on the disposal of a right or option entitling the holder to acquire shares under anemployee share scheme is chargeable to tax to an employee under the head ‘salary’ [s.14(5)].As no payment was required to be made by Abdullah when he was granted the right to acquire1,000 shares in ABC Inc, the consideration of Rs. 215,000 received on the disposal of theright is his gain which is chargeable to tax as salary income.

Note (6) Abdullah’s period of service with PQR Ltd was for nine months – from 1 September 2007 to31 May 2008. Therefore the basic salary and cash allowances have been calculated for ninemonths.

Note (6A) The cash allowances for utilities and housing are both fully taxable.

Note (6B) As Abdullah’s terms of employment provide that he is not entitled to any free medical treatmentor hospitalisation or the reimbursement of medical or hospitalisation charges, any medicalallowance received by him not exceeding 10% of his basic salary is exempt from tax [clause 139(b) of Part I of the Second Schedule).

RupeesMedical allowance (25% of 2,700,000) 675,000Exempt from tax (10% of 2,700,000) (270,000)

————Chargeable to tax 405,000

————

Note (7) The loan of Rs. 1,000,000 given by PQR Ltd to Abdullah on 1 August 2007, on which noprofit was payable by Abdullah, is a perquisite provided by PQR Ltd to Abdullah. The value ofthe perquisite chargeable to tax is the profit on the loan of Rs. 1,000,000 computed at thebenchmark rate of 10% per annum [s.13(7)]. (The benchmark rate for the tax year 2008 isgiven in the preamble to the examination paper). As the loan was repaid on 30 April 2008, theprofit is to be computed for nine months. The profit chargeable to tax is Rs. 75,000 (10% ofRs. 1,000,000 x 9/12).

Note (8) The air-fare of Rs. 217,500 paid by PQR Ltd for Abdullah’s personal travel to London is aperquisite and is chargeable to tax as the salary income of Abdullah.

Note (9) As the motor car purchased for Rs. 1,500,000 on 1 October 2007 is used by Abdullah partlyfor private and partly for official use, the taxable benefit of the perquisite is 5% of the cost ofthe car proportionate to the number of months the car was available for Abdullah’s use. AsAbdullah resigned from the employment of PQR Ltd on 1 June 2008, the car was used by himfor eight months.

RupeesAnnual benefit – 5% of Rs. 1,500,000 75,000

———–For eight months (from 1 October 2007 to 31 May 2008) 50,000

———–

Note (10) Any special allowance or benefit or other perquisite specifically granted to meet expenseswholly and necessarily incurred in the performance of the duties of an office are exempt fromtax except an allowance for entertainment or conveyance [clause 39 of Part I of the SecondSchedule]. The special allowance of Rs. 180,000 (Rs. 20,000 x 9 months) received byAbdullah, to meet entertainment expenses to be incurred in the performance of his duties, istherefore chargeable to tax.

Note (11) If a citizen of Pakistan leaves Pakistan during a tax year and remains abroad during that taxyear, any salary income earned by the individual outside Pakistan is exempt from tax [s.51(2)].Abdullah is a resident for Pakistan tax purposes in the tax year 2008 and normally his foreign-source salary for the tax year 2008 would be chargeable to tax in Pakistan. However,since Abdullah left Pakistan for Dubai on 1 June 2008 (tax year 2008) and remained in Dubaitill 30 June 2008 (the end of the tax year 2008), the salary income earned in Dubai from hisemployment with Lotus Associates is exempt from tax.

Note (12) Rent received or receivable by the owner of land or a building is chargeable to tax under thehead ‘Income from property’ [s.15(1)]. However, where the rent includes any amount for theprovision of amenities, utilities or other services connected with the renting of a building, suchamount is chargeable to tax under the head ‘Income from other sources’ [s.15(3A)].



24

MarksRupees

Rent received from Mr X for 10 months at Rs. 76,000 per month 760,000Less: Amount included in the rent for the services of a security guardLess: for 10 months at Rs. 10,000 per month 100,000

————Rent chargeable to tax 660,000

————————

Rs. 660,000 is chargeable to tax as ‘Income from property’. The 660,000 is the gross amountof the rent which is chargeable to tax at the rate of 5% [s.15(6) read with Division VI of Part Iof the First Schedule]. As the gross rent is chargeable to tax, no deductions are allowable incomputing the income from property.

The Rs. 100,000 included in the rent received for providing the services of a security guard ischargeable to tax under the head ‘Income from other sources’ [s.39(1)(fa)]. Permissibledeductions in computing the income under this head include any expenditure paid in derivingthe income other than expenditure of a capital nature [s.40(1)]. The income chargeable to taxfor the provision of the security guard is Rs. 50,000 [Rs. 100,000 less Rs. 50,000(Rs. 5,000 x 10 months) salary paid to the guard].

Note (13) The income earned from the sub-leasing of the Korangi building taken on rent by Abdullah ischargeable to tax under the head ‘Income from other services’ [s.39(1)(e)]. Rs. 650,000 rentpaid by Abdullah for the building is deductible being expenditure (which is not of a capitalnature) paid in deriving the income chargeable to tax [s.40(1)]. Therefore, the incomechargeable to tax from the sub-lease of the Korangi building to Mr Bee is Rs. 1,350,000 (Rs. 2,000,000 rent received from Bee less Rs. 650,000 rent paid for the building).

Note (14) Abdullah is eligible to a tax credit on the investment of Rs. 500,000 on the purchase of newshares in Classic Cars Ltd since Classic Cars Ltd is a public company listed on a stockexchange in Pakistan, the new shares were offered to the public and Abdullah is an originalallottee of the shares [s.62(1)].

The credit is to be calculated on the lower of (a) the cost of acquiring the shares (b) 10% ofthe person’s taxable income for the year or (c) Rs. 300,000 [s.62(2)]. Since both the cost ofacquiring the shares (Rs. 500,000) and 10% of taxable income (Rs. 966,750) are more thanRs. 300,000, the tax credit is calculated on Rs. 300,000 only as against Rs. 500,000invested in the purchase of the shares.

RupeesTax assessed before allowance of tax credit (A) 1,712,425Taxable income for the tax year (B) 9,667,500Amount of investment on which tax credit is to be calculated (C) 300,000A/B x C1,712,425/9,667,500 x 300,000 53,140

—————

3 (a) The income of a non-resident person, under any head of income, is computed by taking into account onlyamounts that are Pakistan-source income [s.11(6)]. Chin Inc being a non-resident is chargeable to tax onlyon income which is Pakistan-source income.

Any gain arising on the disposal of shares in a resident company shall be Pakistan-source income[s.101(13)]. Medico Pakistan Ltd (MPL) is a resident company since it is incorporated under theCompanies Ordinance, 1984 [s.83(a)]. Chin Inc made a gain of US$ 75,000 on the disposal of itsshareholding in MPL (a resident company). Therefore the US$ 75,000 is the Pakistan-source income ofChin Inc. The view of Chin Inc that because the transaction of the sale was completed outsidePakistan and the sale consideration was also received outside Pakistan, the US$ 75,000 is not chargeable 3to tax in Pakistan is erroneous. ——

(b) Any gain from the alienation, inter alia, of any share in a company, the assets of which consist wholly orprincipally, directly or indirectly of immovable property in Pakistan or from any other interest in or overimmovable property including a right to explore for or exploit natural resources in Pakistan shall bePakistan-source income [s.101(10)].

Mr Prospector (P), being a non-resident for Pakistan tax purposes in the tax year 2008, is chargeable totax only on income which is Pakistan-source income [s.11(6)]. The gain of US$ 2,500,000 has arisenfrom the disposal by P of his shares in Black Gold Inc (BGI), a non-resident company engaged in theexploration and production of crude oil and gas in Pakistan. Since the principal asset of BGI in Pakistan is



Marksthe right to explore for and exploit crude oil and gas (natural resources) in Pakistan, the gain ofUS$ 2,500,000 made by P on the disposal of his shares in BGI is his Pakistan-source income and is 3chargeable to tax in Pakistan. Therefore, P’s view is erroneous. ——

(c) (i) Mrs Moneybags (deceased)Accounting year ended 30 June 2008

Tax year 2008

Computation of taxable income Rupees RupeesSalaryFrom Exotic Seafoods Inc– Benefit of free medical treatment (Note 1) 1,174,300 1Capital gainsOn the transmission of assets on the death of Mrs Moneybags– Gain on conversion of US$ 40,000 into rupees (Note 2) 1,320,000 1·5– Gain on 10,000 shares in Moneybags Investment Ltd (Note 2A) 825,000 1– Gain on the painting (Note 2B) 13,125,000 1·5

—————–15,270,000

Set off of capital loss brought forward (Note 3) (215,650) 1—————– 15,054,350

—————–Taxable income 16,228,650

—————–

The relevant notes for the explanation of the treatment of items included in the computation of taxableincome and tax payable will be considered in allocating marks against each item.

In addition to the above, specific marks will be awarded for the explanation of the treatment of itemsnot included in the computation of taxable income (1 mark for each item) 6

——12

——

Items not included in the computation of taxable income.

(1) The unadjusted loss of Rs. 768,640 sustained in the tax year 2007 is a loss from speculativebusiness, as the loss arose from a forward contract for the purchase of cotton which was settledotherwise than by actual delivery of the commodity [s.19(2)]. An unadjusted loss fromspeculative business can be carried forward for six years immediately succeeding the tax year inwhich the loss was sustained [s.58]. Normally the speculation loss of Rs. 768,640 could havebeen carried forward up to the tax year 2013 (six years immediately succeeding the tax year2007 in which the loss was sustained), but as Mrs Moneybags (M) died on 1 June 2008, theloss of Rs. 768,640 lapsed on that date, since only the person who has sustained any loss cancarry forward the loss.

(2) A capital loss cannot be carried forward to more than six years immediately succeeding the taxyear in which the loss was incurred. The brought forward loss of Rs. 345,000 sustained in theaccounting year ended 30 June 2001 lapsed on 30 June 2007 (tax year 2007) and is thereforenot available to be set off against the capital gains of the tax year 2008. The Rs. 345,000 waserroneously shown as an unadjusted loss in the return of income for the tax year 2007.

(3) The transmission of an asset by succession or under a will is treated as a disposal of the asset bythe deceased at the time the asset is transmitted [s.75(2)]. Under the non-recognition rules, nogain or loss is taken to have arisen on the disposal of an asset, inter alia, on the transmission ofthe asset to a beneficiary on the death of a person, provided the person acquiring the asset is nota non-resident person at the time of the acquisition [s.79(1)(b) and s.79(2)].

No gain or loss is taken to have arisen on the transmission of the 1,000 shares in Zee (Private)Ltd to Roshi on the death of M, as Roshi was not a non-resident person at the time of heracquisition of the 1,000 shares. Therefore, the transaction of the transmission of the shares is notincluded in the computation of taxable income.

(4) A gain or loss under the head ‘capital gains’ can only arise on the disposal of a capital asset. Acapital asset has been defined to mean property of any kind whether or not connected with abusiness but does not, inter alia, include any immovable property [s.37(5)(c)]. Therefore thequestion of computing any gain or loss on the transmission of the residential house in theShaheen Housing Society does not arise.

25



Marks(5) There can be no gain or loss on the transfer of cash from one person to another. Therefore, the

transmission of the amount of Rs. 3,419,017 to Ginnie has no impact on the computation oftaxable income.

(6) Moveable assets held for personal use (with certain exceptions) are excluded from the definitionof a capital asset and are therefore outside the ambit of capital gains. The exceptions include arare manuscript. Any gain on the disposal of a rare manuscript is income chargeable to tax ascapital gains, but any loss on the disposal of a rare manuscript is not recognised as a capital loss[(s.37(5)(d) and s.38(5)(c)]. Consequently the loss of Rs. 6,000,000 (cost of the manuscriptRs. 7,000,000 less Rs. 1,000,000 the fair market value of the manuscript on the date of itstransmission to Peechu) is not recognised as a loss and is therefore not included in thecomputation of taxable income.

(ii) Computation of tax payable RupeesTax on taxable income of Rs. 16,228,650 at 25% 4,057,163 0·5Less: Tax credit on donation (Note 4) (500,000) 1·5

—————Tax payable 3,557,163

————— ——2

——20

——


Note (1) An amount or perquisite is treated as received by an employee from an employmentregardless of whether the amount or perquisite is paid or provided by a past or prospectiveemployer [s.12(5)(b)].

A perquisite includes any amount paid by an employer to discharge an obligation of anemployee to another person [s.13(10)]. The Rs. 1,174,300 paid by Exotic Sea Foods Inc(ESF) (past employer) to the hospital for the medical treatment of Mrs Moneybags (M) is aperquisite provided by ESF to M and is therefore chargeable to tax under the head ‘salary’.

Note (2) The transmission of assets under the will of M is treated as a disposal of the assets by M atthe time the asset is transmitted [s.75(2)].

The non-recognition rule [s.79] referred to in item (3) of the ‘items not included in thecomputation of taxable income’, under which no gain or loss is taken to have arisen on thedisposal of an asset, inter alia, on the transmission of the asset to a beneficiary on thedeath of a person, is not applicable on the transmission of the Rs. 2,560,000 [the rupeeequivalent of the US$ 40,000 at the exchange rate of US$ 1 = Rs. 64] to Ginnie, sinceGinnie at the time of receiving the Rs. 2,560,000 was a non-resident person for Pakistantax purposes. She was a non-resident person since she was neither present in Pakistan fora period of 183 days or more [s.82(a)] nor was she an employee of the Federal orProvincial Government posted abroad in the tax year 2008 [s.82(b)].

Foreign exchange held as an investment is a capital asset and when it is converted intorupees it is considered as a disposal of the capital asset. As the US$ 40,000 has been heldby M since the time of its purchase in 1985, the US$ 40,000 is a capital asset. Theconversion of the US$ 40,000 into rupees resulted in a capital gain of Rs. 1,760,000,which is made as follows:

RupeesConsideration received on conversion of the US$ 40,000 –US$ 64 = Rs. 1 2,560,000Cost of the US$ 40,000 – purchase price 800,000

—————Gain 1,760,000

—————

As the US$ 40,000 was held by M for more than one year,75% of the gain is chargeable to tax (75% of Rs. 1,760,000) 1,320,000

—————

26



MarksNote (2A) The non-recognition rule [s.79] is not applicable to the transmission of the following assets

to Peechu on the death of M, since Peechu was a non-resident person at the time hereceived the assets.– the 10,000 shares in Moneybags Investment Ltd (MIL)– the Italian period painting (Note 2B)

The transmission of the 10,000 shares in MIL to Peechu, considered as a disposal of theshares, resulted in a capital gain of Rs. 1,100,000 to M, which is calculated as follows:

Rupees

Consideration received – Rs. 120, the break-up value of one share in MIL on 20 June 2008, as determined by a firm of CharteredAccountants, is treated to be the fair market value (FMV) of 1,200,000one share in MIL. (10,000 x 120)Cost – Rs. 10 per share (10,000 x 10) 100,000

—————Gain 1,100,000

—————

As the shares in MIL were held by M for over one year,75% of the gain is chargeable to tax (75% of 1,100,000) 825,000

—————

Note (2B) Moveable assets (with certain exceptions) held for personal use are excluded from thedefinition of a capital asset. The exceptions include a painting, sculpture, drawing or otherworks of art. The Italian period painting is therefore considered to be a capital asset and itstransmission to Peechu resulted in a capital gain of Rs. 17,500,000 which is calculated asfollows:

RupeesConsideration received – the FMV of the painting on20 June 2008 as determined by the valuer 25,000,000Cost of the painting 7,500,000

–—————Gain 17,500,000

–—————As the painting was held by M for more than one year, 75%of the gain is chargeable to tax (75% of 17,500,000) 13,125,000

–—————

Note (3) An unadjusted capital loss under the head ‘Capital gains’ can be carried forward for sixyears immediately succeeding the tax year in which the loss was sustained to be set-offonly against the profits under the head ‘Capital gains’. Therefore, the unadjusted loss of Rs.215,650 sustained in the year ended 30 June 2002 is set off against the profits for theyear ended 30 June 2008 (tax year 2008).

Note (4) The donation of Rs. 2,000,000 to a hospital in Pakistan run by the Federal Government isentitled to a tax credit [s.61(1)]. The tax credit is allowed at the average rate of tax (beforeallowance of any tax credit) on the lower of the amount of the donation or 30% of thetaxable income of the individual [s.61(2)].

RupeesTax on taxable income before tax credit (A) 4,057,163Taxable income for the year (B) 16,228,650The lesser of Rs. 2,000,000 (donation) orRs. 4,868,595 (30% of taxable income) (C) 2,000,000A/B x C4,057,163/16,228,650 x 2,000,000 500,000

–—————

27



Marks4 (1) The following issues raised by the Commissioner are in accordance with the provisions of the tax statute.

(i) Payment of Rs. 150,000 to Doodpati Inc on account of royalty

Doodpati Inc (DI) is a non-resident company and its Pakistan-source income is chargeable to tax inPakistan. The right to use a trademark or a brand name falls within the definition of royalty[s.2(54)(a)].The payment of Rs. 150,000 to DI for royalty is a Pakistan-source income of the non-resident DI, since payment has been made by a resident (Mr Chaiwalla) for the right to use thebrand name ‘Doodpati’, and the brand ‘Doodpati’ has not been used by Chaiwalla for any business carriedon by him outside Pakistan through a permanent establishment [s.101(8)]. The Rs. 150,000 3received by DI is therefore chargeable to tax. As no tax was deducted from the Rs. 150,000 remittedto DI, the Rs. 150,000 is not a deductible charge [s.21(c)].

(ii) Rs. 40,000 received from Ali Canteen Stores LahoreWhere income has been derived by a person in a tax year, inter alia, from any business that hasceased before the commencement of that year and that income would have been taxable had therebeen no cessation, then the provisions of the tax statute apply to that income as if the business hadnot ceased at the time the income was derived [s.72].

Under the provision of s.72, the business of the coffee house is treated as having been carried on byChaiwalla in the tax year 2007 as the Rs. 40,000 was received by Mr Chaiwalla in the tax year 2007.Therefore, the Rs. 40,000, though relating to the coffee house business that had ceased, is considered 4to be income chargeable to tax in the tax year 2007.

(iii) Rs. 36,000 received from Orchids Farms LtdThe exemption from tax of any income, in the absence of a specific provision to the contrary, is limitedto the original recipient of the exempt income and does not extend to any person receiving anypayment out of that income [s.55].

The income of Orchids Farms Ltd (OFL) being wholly agricultural income is exempt from tax. As thebenefit of the exempt income of OFL cannot extend to any other person receiving any payment out ofthe exempt income, the Rs. 36,000 received by Chaiwalla as dividend from OFL is therefore chargeable 3to tax.

(2) The following issues raised by the Commissioner are not in accordance with the provisions of the taxstatute.

(i) Payment of Rs. 50,000 to Mr ConsultantOnly a ‘prescribed person’ making a payment in full or part including a payment by way of advance toa resident, inter alia, for the rendering of or providing of services, is required to deduct tax [s.153(1)(b)].A ‘prescribed person’ does not include an individual. Therefore, Chaiwalla assessed as an individual, 3was not required to deduct tax from the payment of Rs. 50,000.

(ii) Salary of Rs. 7,500 paid in cash Any salary paid exceeding Rs. 10,000 per month other than by a crossed cheque or direct transfer offunds to the employee’s bank account, is not allowed as a deductible charge [s.21(m)]. Rs. 7,500paid as salary for the month of May 2007 to the temporary worker A in cash is less than Rs. 10,000. 2Therefore, the Rs. 7,500 is deductible expenditure.

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Marks5 (a) Barq Ro (Pakistan) Limited

RupeesOutput tax On the sale of taxable goods (Rs. 6,535,000 x 15%) 980,250 0·5On export of cables to Tanzania (zero rated) — 1

–————980,250

–————Input tax On payment for purchases of raw materials and advertisements (Note 1) 882,225 2·5On payment for machinery of the new unit (Note 2) 58,647 2·5

–————940,872

–————Tax payable for the month of May 2008Output tax 980,250Input tax 940,872

–————39,378 0·5

–———— ——–————7

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Note (1) A registered person is not allowed to adjust input tax for a tax period in excess of 90% of theoutput tax for that tax period (s.8B of the Sales Tax Act, 1990)

RupeesInput taxOn payment for purchase of raw materials (Rs. 7,448,850 x 15/115) 971,589On payment for advertisements (Rs. 850,000 x 15/115) 110,870

—————1,082,459—————

Restricted to 90% of output tax for May 2008 (90% of Rs. 980,250) 882,225——————————

The balance of Rs. 200,234 would be allowed as input tax for the month of August 2008 i.e.the second month following the end of the financial year ending on 30 June 2008, subject to thefulfilment of certain conditions.

Note (2) The input tax on Rs. 5,395,500 paid for the acquisition of the machinery of the new unit isallowed to be adjusted in 12 equal monthly instalments after the start of production of the newunit (first proviso to section 8B)

RupeesInput tax on payment for machinery of the new unit5,395,500 x 15/115 703,761Input tax allowable in 12 monthly instalments ————(Rs. 703,761/12 = 58,647). The first instalment is allowedas input tax for May 2008 58,647

————————

(b) A credit note can be issued within 180 days of the date of the relevant supply. As the supply was madeon 30 June 2008, the 180 days would expire on 27 December 2008. Therefore the credit note cannotbe issued by Yousha Associates in the month of January 2009 unless the Collector, at the request ofYousha Associates, extends the period for the submission of the credit note. The Collector has beenempowered to extend the period of 180 days by a further 180 days at the request of the supplierin writing giving reasons for the desired extension in time. 3

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