Pakistan is a resource constrained country. Meeting its current and development expenditures is problematic for the government. Rather than cutting its expenses, the government is continuously trying to enhance its revenues to bridge the ever-widening gulf between its expenditure and income. The major source of government income is the taxes it collects. Enhancing tax revenues through policy measures and improving tax administration has been the focus of successive governments. Several measures taken by the government also impact Pakistanis living permanently or temporarily abroad. These involve not only financial liability but also some compliance requirements. This article is aimed at apprising the Pakistanis living abroad about the impact of Pakistani Income Tax laws on them and how they can plan their investments in Pakistan so as to reduce their financial liabilities under the applicable laws and also avoid any adverse consequences for failing to discharge their legal obligations.
Firstly, it would be useful to understand the reasons and explanation for the application of Pakistanis living abroad, some of which may not be having Pakistani citizen ship or are dual nationals. According to principles of International Law, the authority of a sovereign state is confined within its territorial boundaries. Its laws are applicable only on its territory, the persons residing within its boundaries and events happening on its territory. Income tax Ordinance is a law of Pakistan. It can, therefore, apply only to persons residing in Pakistan or events occurring in Pakistan, and for the purposes of Income Tax, the relevant event is the receipt or arising of income in Pakistan.
A person may be either a tax resident in Pakistan or a non-resident, and residence is essentially the basis of taxation. What is additionally required for any sum to be subjected to income tax is its link with Pakistan. The two most important concepts for determination of tax liability are therefore residence and place of accrual or receipt of the income. Another important point to be realized is that tax residence according to Pakistani law has nothing to do with citizenship or nationality. An individual, irrespective of his nationality, who is in Pakistan for a period or periods aggregating to 183 days or more in a tax year (period between 1st July of one year and 30thJune of the next year) will be resident in Pakistan for that tax year. Therefore, the residential status may change from year to year, a person may be resident in one tax year and non-resident in the next, depending upon his period of stay in Pakistan.
The second element as mentioned above for determining the application of Pakistani income tax is the source of income. For the purposes of the present discussion, income can be derived either from within Pakistan or from abroad. In simple words the taxability of both types of income is explained as under-
(a) Income which is derived from sources in Pakistan, is taxable in the hands of all persons (both resident and non-resident).
(b) Income arising outside Pakistan is taxable in the hands of a resident but such income is not taxable in the hands of a non-resident.
It can also be said that the residents are obliged to pay tax under Pakistani Income Tax law on their global or world income. Whereas, the non-residents have to pay income tax to Pakistani government only on their income derived from within Pakistan or Pakistan source income. The non-resident Pakistanis are on the same principle required to pay tax on income derived from Pakistan in their respective countries of residence and non-declaration of Pakistan source income would be a violation of the respective tax law. It may appear from the above that the same income is being taxed twice; once in the country of source of income and secondly in the country of residence. However, to prevent this double taxation, elaborate rules are available in tax laws throughout the world. Pakistan has entered into bilateral Avoidance of Double Tax Agreements with more than 65 countries, and all these agreements attempt to ensure that the same income is not taxed twice. A detailed discussion of these tax treaties and the principles underlying them would become hyper technical and the taxpayers is not expected to acquire a detailed understanding of these. That is the job of tax consultants.
After understanding the above framework, we can come to the issue of overseas Pakistanis. In view of the psychological and social bonding with their roots in Pakistan, most overseas Pakistanis continue remitting funds to Pakistan not only to support their close relatives but also to make investments in Pakistan. Though investments in real estate is the preferred mode of investment yet investments can take multiple forms such as in bank accounts, stock markets, bonds, purchase of motorcars and even in running businesses. These investments are made with the aim of getting returns or income, as sometimes the returns are better than the return from corresponding investments in the countries of residence. For example, the interest rates in Pakistan have always been much higher than the developed countries which sometimes even have negative interest rates. As already explained non-residents are required to declare the incomes earned from Pakistan to the local tax authorities and pay the due taxes thereon. This can be done through a local agent.
In addition to avoiding penal consequences, there is another considerable advantage in becoming a return filer for the non-residents having income or investments in Pakistan. Over the years Pakistan has established an elaborate system of withholding taxes. A large number of economic transactions including sale and purchase of real estate, vehicle purchase and registration, payment of educational fee etc. are subject to withholding taxes which are adjustable against the tax liability computed at the time of filing of return. A person who files a return gets the credit and, in some cases, even refund of the withheld amount. Whereas, a person who doesn’t file the return loses any benefit of the withheld tax. Pakistan in the last decade has also introduced an innovative measure to incentivize filing of returns. The rate of withholding tax in most cases becomes double (and even three times for some transactions) if the person is not a return filer as compared to the person who has filed his return. This translates into a substantial additional burden for the non-filers.
As already mentioned, what should be a major concern for overseas Pakistanis is the withholding taxes on property transactions. Pakistan up to 2012 had exempted capital gains from real estate. In 2012 income tax at a reduced rate on capital gains from immovable property was imposed, at the same time a withholding tax to be collected from the seller of the property was introduced. This withholding tax was to be adjusted against the capital gain from sale of property at the time of filing of return. A few years later a withholding tax to be collected at the time of purchase of immovable property was also introduced. Both these withholding taxes are adjustable against the tax liability determined at the time of filing of return. Since the overseas Pakistanis are not likely to have multiple sources of income in Pakistan, the likelihood of their getting the withheld amount refunded to them far exceeds the chances of the resident Pakistanis getting the amounts refunded. Factoring in the double rate at which the withholding tax is to be collected from the non-filers, the cost of non-filing of income tax returns which overseas Pakistanis are bearing due to lack of adequate knowledge becomes exorbitant. We intend to write a separate article on taxation of property taxation, but for the overseas Pakistanis an interesting feature of the tax structure needs to be pointed out. Capital gain on sale of immovable property that was acquired more than six years ago is exempt, but the seller is obliged to pay withholding tax at the rate of 3% and 6% in the case of non-filers, on the entire sale consideration of the property sold, even if it was held for a period exceeding six years. The entire amount withheld would be refundable in such a situation, as no tax will be payable on the capital gains assuming that the non-resident seller has no other income tax payable against which the withheld tax can be adjusted. The non-filing of return and non-claiming of refund in such a situation would translate into a substantial cost.
Staying out of Pakistan’s tax system for overseas Pakistanis also depicts insufficient knowledge of the incentives offered by the government specifically designed for them. For instance, a concessional rate of tax has been prescribed for overseas Pakistanis on maintaining a Foreign Currency Value Account (FCVA) or a non-resident Pakistani Rupee Value Account (NRVA) on capital gains arising on the disposal of debt instruments and government securities and certificates. Similarly, complete exemption to income derived from a rupee account held with a bank in Pakistan by a non-resident Pakistani is available if the deposits in theses accounts are made from foreign exchange remitted into the account. There are several other concessions and exemptions that can be availed if they get professional advice.
In conclusion it needs to be emphasized that the overseas Pakistanis making investments in Pakistan or earning any income from within its geographical territories need to be aware of their obligations under Pakistani tax laws and to make compliance of these laws to save the hidden tax costs and to avoid needless complications.
