HISTORY OF TAX LAWS IN PAKISTAN AND ITS TYPES.

HISTORY OF TAX LAWS IN PAKISTAN

In undivided India (now Pakistan, Bangladesh, and India), income tax was first introduced in 1860 through the Income Tax Act, 1860, mirroring the UK’s system. This Act was effective from July 31, 1860, until its repeal on August 1, 1865. Notably, it taxed agricultural income exceeding Rs.600 per annum. In Pakistan, the Federal Government can levy taxes on individual income, excluding provincial taxes.

Subsequently, some provinces enacted a general income tax for traders via the Income Tax Act of 1886, which significantly improved upon previous laws and introduced a definition of “agricultural income” akin to that in the Income Tax Ordinance of 2001. This Act remained in effect for 32 years until 1918.The 1918 Act consolidated wartime amendments and introduced a graduated super tax on incomes over Rs.50,000 and undistributed corporate profits through the Super Tax Act of 1917, which was modified by the Super Tax Act of 1920. These were later merged into the Income Tax Act of 1922.After gaining independence on August 14, 1947, Pakistan adopted the Income Tax Act of 1922, which remained in force for 57 years until 1979.

Due to implementation challenges, the Income Tax Ordinance was introduced in 1979. Reforms continued with the National Tax Reforms Commission in 1985 recommending a replacement by the Income Tax Ordinance of 2001, which was enacted on September 13, 2001, and became effective from July 1, 2002. The Federal Board of Revenue (FBR) asserts that this new Ordinance is clear, practical, and aligns with global standards for taxing income earned from July 1, 2002, onward.

The tabular presentation of laws in Pakistan is as under:

SR.	Name of prevailing Law	Remarks
1.	Income tax Act, 1860	Repealed in 1865
2.	Income tax Act, 1886	Effective till 1917
3.	Income tax Act, 1918 including Super Tax Act, 1917	Enforced till 1920
4.	Income tax Act, 1922 (Merged Income Tax Act, 1918 with Super Tax Act, 1917)	Effective till 30-06-1979
5.	Income tax Ordinance, 1979	Effective till 30-06-2002
6.	Income tax Ordinance, 2001	Enforced from 01-07-2002

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

S.no.	Name of prevailing Law	Remarks
1.	Income tax Ordinance, 2001	All income is classified under the following five heads: · Income from salary · Income from property · Income from business · Capital gains; and · Income from other sources
2.	Capital Value Tax	CVT on different transaction such as transfer of motor vehicles, immoveable property, transfer of rights and acquisition of shares of listed Companies etc.

INDIRECT TAXES

Following are the indirect Taxes under the Pakistani Taxation System

S.no.	Name of prevailing Law	Remarks
1.	Sales Tax Act, 1990	Sales tax is a value added tax system. Being as indirect tax collectable from whole supply chain i.e. importers, manufacturers, wholesalers (including dealers and distributors) and retailers with certain exceptions. Therefore, the sales tax is a multi-stage tax payable at standard rate of 18% u/s (3) of the Sales tax Act, 1990 on: · Goods imported into Pakistan; · All taxable supplies by a registered person in respect of any taxable activity carried on by him; VAT is a percentage tax levied on the price each registered person charges for goods or taxable services rendered by him. VAT normally utilizes as system of tax credit (being as input tax adjustment) to place the ultimate and read burden on tax on the final consumer and to relieve the intermediaries from any tax burden except the final consumer. Further there are also the concepts of minimum tax and Final tax under the sales tax Act on specific persons or class of persons or sectors as the case may be.
2.	Federal Excise Act, 2005	Federal Excise duties (FED’s) are leviable on a limited number of goods produced or manufactured, and services provided or rendered in Pakistan. On most of the items FED 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 0% FED.
3.	Customs Act, 1969	Goods imported and exported from Pakistan are liable to Customs duties as prescribed through code or otherwise 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

Taxation Principles & Strategies

1. Adam Smith’s Canons of Taxation in the Book “Wealth of Nations”

• Equality: Taxes proportional to income, applied uniformly.
• Certainty: Clear, predictable tax obligations.
• Convenience: Collection aligned with taxpayer’s capacity (e.g., post-harvest).
• Economy: Minimal administrative costs; no business deterrence.

2. Tax Levy Principles

• Benefit Principle: Tax based on benefits received (e.g., road users fund infrastructure).
• Ability-to-Pay: Higher earners taxed more (e.g., 30% rate on high income).
• Equal-Distribution: Fixed tax rates; higher absolute payments from wealthier individuals.

3. Tax Structures

• Proportional: Fixed rate (e.g., 10% on Rs 100k → Rs 10k; 10% on Rs 150k → Rs 15k).
• Regressive: Higher % on lower income (e.g., 15% on Rs 100k vs. 10% on Rs 200k).
• Progressive: Higher % on higher income (e.g., 20% on Rs 300k vs. 10% on Rs 100k).

4. Tax Management Strategies

• Evasion: Illegal underreporting (e.g., hiding income).
• Avoidance: Exploiting loopholes (e.g., offshore accounts). it is called Tax Avoidance and is an offence.
• Planning: Legal minimization (e.g., deductions, rebates)

Example

Explain which type of Tax strategy is being employed by following persons and what its legal consequences are:

Tax Law	Objective
Mr. X, has earned of Rs. 5 (M), however, he kept its cash in his bank and hide that from Tax authorities. He paid all its related expenses from cash	Tax avoidance, Criminal Act, He cannot buy any asset or settle liabilities declare this income
Mr. Y, earned income of Rs. 6(M), however, he declared only so much of income which is verifiable from the banks i.e. 4(M), remaining amount he has hidden in a separate bank account	Tax evasion, Criminal Act, understatement is similar to Tax avoidance
Mr. Z, has earned Rs. 7(M), however, he recorded expenses incurred against such receipts, and accordingly, he offered the remaining income of Rs 3(M) for Taxes. He paid salary to his brother to the extent it remain taxable below the tax rate of 10%. In such way that he get reduction in tax rate.	Tax planning, it is legally permissible and appreciable Act.

Taxes which can be imposed by the Federation (Federal Govt.)

• Taxes on income other than agricultural income;
• Taxes on corporations.
• Taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed, except sales tax on services.
• Taxes on the capital value of the assets, not including taxes on immovable property.
• Taxes on mineral oil, natural gas and minerals for use in generation of nuclear energy.
• Taxes and duties on the production capacity of any plant, machinery, undertaking establishment or installation in lieu of any one or more of them.
• Terminal taxes on goods or passengers carried by railway, sea or air; taxes on their fares and freights.

Taxes which can be imposed by the Provinces (Provincial Govt.)

Accordingly, various types of taxes are introduced by the Provinces are as under:

• Agriculture income Tax
• Sales Tax on services
• Marriage Halls
• Taxes on transfer of immoveable property
• Professional Tax
• Tax on luxury Houses
• Tax on registration of luxury Vehicles etc.
• Property tax

Provinces rates of Taxes.

1. Sindh Sales tax on services: 15%
2. Punjab Sales tax on services: 16%
3. Balochistan Sales tax on services: 15%
4. Khyber Pakhtunkhwa (KPK) Sales tax on services: 15%
5. Islamabad Capital Territory (Tax on Services): 15%

In budget 2024-25 some shares and allocation of Provinces.

What is Income Tax:

Income tax is a direct tax imposed on the income earned by individuals, businesses, and other entities. The amount of tax is determined based on taxable income, which is calculated after accounting for allowable deductions, exemptions, and credits. In essence, income tax is levied according to the principle of “ability to pay,” meaning that individuals or entities with higher incomes generally pay more in taxes.

Income Tax Liabilities:

Income tax liabilities refer to the total amount of income tax that an individual or entity is legally required to pay to the government for a specific tax period. This liability is calculated after applying the relevant tax rates to the taxable income and considering all applicable deductions and credits. In accounting terms, it represents the obligation recorded on the balance sheet until the tax is paid.

• Calculation:
  Compute taxable income and apply the appropriate tax rates.
• Deductions & Credits:
  Use allowable deductions and credits to reduce taxable income and lower tax liability.
• Compliance:
  Report and pay taxes by deadlines to avoid penalties and interest.
• Impact on Cash Flow:
  Proper management of tax liabilities is key for effective financial planning.

What is GST (General Sales Tax) in Pakistan

The General Sales Tax (GST) is an indirect tax levied on the supply of goods and services in Pakistan. Administered by the Federal Board of Revenue (FBR), GST plays a crucial role in the country’s taxation framework. Businesses operating in Pakistan must comply with GST regulations to avoid penalties and ensure smooth operations.

Sales Tax Liabilities

The following sectors require Sales Tax Registration and Monthly Return Filing:

•     Manufacturing
•     Import
•     Services
•     Distribution, Wholesale & Retail stage.

The Sales Tax had previously been applied to manufacturing & import, and it has now been extended to the remaining sectors. It applies to goods produced and imported into Pakistan with the exception of the computers, software, poultry feed, medicines, and unprocessed agricultural produce of Pakistan, as well as items listed in Section 6 of the Sales Tax Act, 1990.

Core Principles of Sales Tax in Pakistan

1. Definition and Scope
   • Sales tax is charged at 18%on taxable supplies made by registered persons during the course of business activities. This includes goods produced, imported, or sold domestically.
   • Key Mechanism:
     • Output Tax: Charged on sales.
     • Input Tax: Paid on purchases/imports.
     • Net Tax Payable: Output tax minus input tax (paid to the government).

Example:

• A manufacturer sells goods worth Rs. 1,000 to a distributor.
  • Output Tax: Rs. 180 (18% of 1,000).
• The distributor pays Rs. 153 as input tax on purchases.
  • Net Tax Payable: Rs. 180 – Rs. 153 = Rs. 27.

Key Situations for Levying Sales Tax

1. Standard Levy [Section 3(1)]

• 18% Tax: Applies to all taxable supplies by registered businesses and imports.
• Taxable Activity: Supplies must relate to business operations (e.g., manufacturing, trading).
• Case Law: PTCL 2007 CL 565 (Supreme Court)clarified that taxable supplies include goods indirectly linked to business growth (e.g., equipment purchases).

2. Further Tax [Section 3(1A)]

• Additional 4%: Levied on sales to unregistered or inactive taxpayers.
• Exclusions:
  • Domestic electricity/agricultural gas.
  • Retail sales to end consumers.
  • Items in the Third/Fifth Schedules (e.g., fertilizers, steel).

Example:

Goods	Value	ST @18%	Further Tax @4%	Total
TV	1,000	180	40	1,220

Compliance Checklist for Businesses

1. Registration: Ensure GST registration with FBR.
2. Invoicing: Use FBR-compliant invoices with NTN/STRN.
3. Record-Keeping: Maintain records for 6 years(mandatory under Income Tax Ordinance 2001).
4. Timely Filing: Submit returns by the 15th of each month.
5. Reconciliations: Regularly match input/output tax to avoid discrepancies.