As the new forms of incomes emerged, Pakistan had to adopt a new set of recommendations given by the then Central Board of Revenue[i] in the form of Income Tax Ordinance, 1979. The promulgation of this Ordinance widened the tax net and expanded the tax base.
Similar need for revision was felt 21 years later when Income Tax Ordinance, 2001 was introduced which is still in operation subject to annual amendments through Finance Bill. Under the present structure of income taxation, incomes are classified into: (a) salary, (b) income from property, (c) income from business, (d) capital gains, and (e) income from other sources. The salary category encompasses: (a) wages and remuneration, including any fringe benefits in money terms such as leave pay, commission, and gratuity/work condition supplements. Deduction is allowed if salary constitutes more than 50 percent of a person’s overall earnings. Zakat is deducted from the tax base. Zakat is a mandatory tax on all Muslim citizens if they had any earnings during the year. It is charged at 2.5 percent on income (and specified asset holdings). See Zakat and Ushr Ordinance, 1980. Agricultural incomes have been exempt from taxation. This exemption is also applicable to any rent from agricultural land. However, more recently this type of exemption has become a controversial issue and has been debated on various occasions in the lower and upper houses of parliament. Apart from the income tax there are four other types of direct taxes namely: wealth tax, capital value tax, worker’s welfare fund, and corporate assets tax. The main income tax parameters have been derived from the Income Tax Ordinance, 2001. There are three different income categories general income, salaried income and agriculture income, each having five different bands where incomes are being taxed according to the prescribed schedule.
The income to be taxed is computed as below:[ii]
TY = Y – Z – WPF – WWF
Where TY is the taxable income, Y is total income from all heads of income, Z is the Zakat payment by an individual, WPF is the amount paid towards
workers participation fund under Companies Profit (Workers’ Participation)
Act, 1968. WWF is the amount paid to Workers’ Welfare Fund under the
Workers’ Welfare Fund Ordinance, 1971.
In this paper, we will mainly analyze the personal income taxation as the other forms of direct taxation are harder to simulate and at times lead to excessive use of assumptions. Furthermore the other four types of direct taxes yielded Rs. 7,123 million in the year 2000-01, which was 5.7 percent of the total collection from direct taxes (CBR Yearbook 2000-01).[iii] In the 2002 tax system, allowance is kept at Rs. 80,000 with progressive rates applied until Rs. 700,000 after which the highest (slab) rate of 35 per cent is applied.
As explained earlier agricultural incomes in Pakistan are exempt from taxes. However if a person’s agriculture income exceeds Rs. 80,000 and the person also has non-agriculture income then the tax rate will only apply to non-agricultural income of a taxpayer. A special tax credit of 50 per cent of the tax payable is allowed to an individual if: (a) his age is 65 years or more on the first day of the relevant tax year, and (b) his taxable income is up to Rs. 300,000.[iv] Other miscellaneous tax credits allowed by the government in the Ordinance include; foreign tax credit, tax credit for donations, tax credit for investment in shares, tax credit for payments towards retirement annuity scheme, and tax credit for mark-up on loans for house. A low tax base, failure to curb evasion and delay in bringing new forms of incomes in the tax net, has resulted in an inelastic tax structure. These issues although were part of the overall objectives of Income Tax Ordinance, however, revenue collections have not been able to keep pace with the growth milieu. The income tax to GDP ratio remained stagnant between the years 2000 to 2006. However, during this time Pakistan witnessed one of the highest GDP growth rates in its history (reaching up to 9% percent in 2005). Between 2001 and 2005 the economic growth rate averaged 5.1 percent, however the income tax to GDP ratio remained under 3.5 percent. The share of income tax in total direct taxes and overall federal tax receipts also declined from 95.8 to 93.2 percent and 33.8 to 29.4 percent respectively. Now a day various changes has been made in Clause [1A] of Part-III of Second Schedule in the Income Tax Ordinance.
[i] Now called: Federal Board of Revenue (FBR).
[ii] This definition is in line with the one given in Income Tax Ordinance, 2001-02, Central
Board of Revenue, Islamabad.
[iii] http://www.fbr.gov.pk/YearBook/2000-01/default.htm.
[iv] Clause [1A] of Part-III of Second Schedule in the Income Tax Ordinance.
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