Tax Practices

Definition of taxation
Revenue & Non-revenue objectives
Taxes as mean for development

Taxation is defined in many ways, common definition is as under:

It is the process by which the sovereign, through its law making body, raises revenues in
order to use it for expenses of government.

It is a means for the government in increasing its revenue under the authority of the law,
purposely used to promote welfare and protection of its citizenry.

It is the collection of the share of individual and organizational income by a government

under the authority of the law.

Taxes are primary revenue yielding tools of the Government of modern ages. The government
levies taxes in order to achieve following objectives:

For collection of revenue to run and administer the Government;

To use as a tool for implementation of its policies; and

For fair distribution of wealth.

Aside from purely financing government operational expenditures, taxation is also utilized as a tool
to carry out the national objective of social and economic development.

To strengthen anaemic enterprises by granting them tax exemptions or other conditions or

incentives for growth;

To protect local industries against foreign competition by increasing local import taxes;
As a bargaining tool in trade negotiations with other countries;

To counter the effects of inflation or depression;

To reduce inequalities in the distribution of wealth;

To promote science and invention, finance educational activities or maintain and improve
the efficiency of local forces;

To implement laws which eliminate discrimination among various elements in the

markets/businesses.

To discourage certain undesirable sectors and activities.

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 Chapter 1: System of taxation in Pakistan

Tax Law Objective

Tax Law Objective

Taxes are one of the main sources for development. This is not because revenue collected by the
state is used on developmental projects. Rather, taxes can be used in many different ways for
development of the country. Some examples are as under:
The Government can declare some areas as free zone, industrial zone, and economic zone
and provide tax incentives to such areas. Such incentives could attract
businessman/industrialist who may opt to establish business concerns/industrial units that
would bring employment, opportunities and overall prosperity in these under developed
areas.
Taxing the rich at higher rates while taxing the low income groups at lower tax rates.
Imposition of high custom duty rates on luxury items. This promotes local manufacturing
industry.
Tax credits on charitable donations to promote welfare activities.
Tax exemptions to charity organisation/educational institutions to promote these activities.
Exemption of tax to Agriculture sector to promote agriculture.

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Tax Practices

Basics of tax laws

following canons of Taxation:

Equality
Tax payments should be proportional to income and applied equally to all concerned areas
Certainty
Tax liabilities should be clear and certain
Convenience of payment
Taxes should be collected at a time and in a manner convenient for taxpayer
Economy of collection
Taxes should not be expensive to collect and should not discourage business.

Following are some broad principles for levy of taxes:

The Benefit Principle
This principle holds that the individuals should be taxed in proportion to the benefits they
receive from the governments and that taxes should be paid by those people who receive
the direct benefit of government programs and projects out of the taxes paid.
The Ability-to-Pay Principle
This principle holds that taxes should relate with the person
that is, those with greater income or wealth who can afford to pay should be taxed. Similarly,
even rate of tax could increase with higher income.
The Equal-Distribution Principle
Income, wealth and transaction may be taxed at a fixed percentage; that is, people who earn
more and spend more should pay more taxes, but not pay a higher rate of tax.

Proportional tax/Flat Tax

A tax system that requires the same percentage of income from all taxpayers regardless of
their earnings. A proportional tax applies the same tax rate across low, middle and high-
income taxpayers. The proportional tax is in contrast to a progressive tax, where taxpayers
with higher incomes pay higher tax rates than taxpayers with lower incomes. A proportional
tax is also called a flat tax.
Regressive tax
A tax that takes a -
high-income. A regressive tax is generally a tax that is applied uniformly. This means that it
hits lower-income individuals harder.

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 Chapter 1: System of taxation in Pakistan

Progressive tax
A tax that takes a larger percentage from high-income earners than it does from low-income
earners. In other words, the more one earns, the more tax he would have to pay. The tax

more than a poor man.

Following are major characteristics of a taxation system:

Tax is an enforced contribution
Tax payment is not voluntary in nature and the imposition is not dependent upon the will of
the person taxed.
Tax is generally payable in cash (bank)
This means that payment by cheques, promissory notes, or in kind is not accepted.
Tax is proportionate in character
Payment of taxes should be based on the ability to pay principle; higher income of the tax
payer, the bigger amount of the tax paid.
Tax is levied (to impose; collect) on income, transactions or property
There are taxes that are imposed or levied on acts, rights or privileges.
Tax is levied by the state which has jurisdiction over the person or property
As a general rule, only persons, properties, acts, right or transaction within the jurisdiction
of the taxing state are subjects for taxation.
Tax is levied by the law making body of the state
This means that law must be enacted first by the Parliament in Pakistan.
Tax is levied for public purposes
Taxes are imposed to support the government in implementation of projects and programs.

Fiscal adequacy

The sources of revenue taken as a whole should be sufficient to meet the expenditures of
the government, regardless of business, export taxes, trade balances and problems of
economic adjustments. Revenues should be capable of expanding or contracting annually
in response to variations in public expenditures.

Equality or Theoretical Justice

Taxes levied must be based upon the ability of the citizen to pay.

Administrative Feasibility

In a successful tax system, tax should be clear and plain to taxpayers, capable of
enforcement by the adequate and well-trained public officials, convenient as to the time and
manner of payment and not unduly burdensome to discourage business activity.

Consistency or Compatibility with Economic Goals

Tax laws should be consistent with economic goals or programs of the government which
pertain to basic services intended for the masses.

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Tax Practices

Brief overview of different direct and indirect taxes

Federal taxes in Pakistan like most of the taxation systems in the world are classified into two broad
categories, viz., direct and indirect taxes. A broad description regarding the nature of administration
of these taxes is explained below:

Direct taxes primarily comprise of Income Tax. In the Income Tax Ordinance, 2001, tax is levied
generally on the net income of a taxpayer earned during a tax year computed by applying the
specified tax rates as applicable to respective taxpayer.
For the purpose of the charge of tax and the computation of total income, all income is classified
under the following heads:
Salary
Income from property
Income from business
Capital gains; and
Income from other sources

Capital value tax on different transaction such as transfer of immoveable property, transfer of rights
etc.

Following are the indirect taxes under the Pakistani Taxation System.

Goods imported and exported from Pakistan are liable to rates of customs duties as prescribed in
Pakistan Customs Tariff. Customs duties in the form of import duties and export duties constitute
a major part of the total tax receipts. The rate structure of customs duty is determined by a large
number of socio-economic factors. However, the general scheme envisages higher rates on luxury
items as well as on less essential goods. The import tariff has been given an industrial bias by
keeping the duties on industrial plants and machinery and raw material lower than those on
consumer goods.

Federal Excise duties are levied on a limited number of goods produced or manufactured, and
services provided or rendered in Pakistan. On most of the items Federal Excise duty is charged on
the basis of value or retail price. Some items are, however, chargeable to duty on the basis of
weight or quantity. Classification of goods is done in accordance with the Harmonized Commodity
Description and Coding system which is being used all over the world. All exports are liable to Zero
per cent Federal Excise Duty.

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 Chapter 1: System of taxation in Pakistan

Sales tax is levied at various stages of economic activity @ 17 per cent on:
All goods imported into Pakistan, payable by the importers
All supplies made in Pakistan by a registered person in the course of furtherance of any
business carried on by him
There is an in-built system of input tax adjustment and a registered person can make adjustment
of tax paid at earlier stages against the tax payable by him on his supplies. Thus, the tax paid at
any stage does not exceed 17% of the total sales price of the supplies.

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Tax Practices

History of tax laws in Pakistan

In Pakistan, Federal Government is empowered to levy and collect tax on the income of a person.
The history of modern income taxation dates back to the year 1860. The British Empire introduced
first formal Income Tax Act of 1860 in an effort to end the budgetary deficit faced due to the war of
independence of 1857. The tax was not intended to be permanent and was repealed in 1865.
The Income Tax Act of 1886 was a general income tax that had been imposed on traders by some
of the provinces. This Act of 1886 was a great improvement on earlier enactments. Its basic

is almost the same as in the Income Tax Ordinance 2001. This Act continued in force for 32 years.
The 1918 Act consolidated a number of wartime amendments. A graduated super tax on income
over Rs.50,000 and on the undistributed profits of the corporation and other entities was introduced
by the Super Tax Act of 1917 and continued in force through modifications by the Super Tax Act
of 1920. The Income Tax Act and the Super Tax Act were later on consolidated in another act i.e.
the Income Tax Act of 1922, which remained in force in Pakistan till 30th June 1979; when the new
law was promulgated i.e. the Income Tax Ordinance, 1979 with effect from 1st July 1979.
Income Tax Ordinance 1979 was amended through innumerable presidential ordinances, annual
finance acts/ordinances and statutory regulatory orders (SROs) and most of its lacunas were
removed over a long period of time. However, after approximately 23 years of its existence when
substantive amendments and judicial pronouncements made it a universally understandable and
acceptable piece of legislation for everybody, a new ordinance (i.e.) Income Tax Ordinance, 2001
was promulgated on 13th September 2001.

© Emile Woolf International 8 The Institute of Chartered Accountants of Pakistan