Plugging loopholes: amendments to Income Tax Ordinance proposed

BUSINESS RECORDER

SOHAIL SARFRAZ
ISLAMABAD (January 20 2008): The Federal Board of Revenue (FBR) has detected serious flaws in the exemptions granted for foreign remittances under section 111 of the Income Tax Ordinance 2001, analysing measures to control revenue loss and loophole in the tax collection system.

Sources told Business Recorder on Saturday that the income tax department had conducted a study on the "section-111 unexplained income/assets" to propose amendments to the Income Tax Ordinance, 2001.

The department has found that the anti-tax avoidance measure under section 111 is almost a replica of section 13 of the repealed Income Tax Ordinance, 1979, which is reproduction of the old law. All the sub-sections of the section 111 have some loopholes, which needs amendment to the Ordinance, 2001.

It is an important provision dealing with the unexplained assets and income tax to check black economy in Pakistan. Under the said section, the income tax department is not empowered to demand the source of the foreign investment.

The study has pointed out that the concept of unexplained income or assets defined in Section 111 cannot be said to be a new provision. The identical provisions were available in Section 4 of the Income Tax Act 1922 and Section 13 of the repealed Ordinance, 1979.

A comparison of Income Tax Ordinance, 1979, and new Ordinance, 2001 confirmed that all new provisions of the Ordinance, 2001 already existed in the old law. The identical provisions relating to unexplained investment/expenditure, valuation of assets, valuation of open plots, discovery of unexplained amount of investment, valuable articles or expenditure, etc were available in both the repealed and existing Ordinances without change.

According to the report, a departure from Section 13 of the repealed Ordinance, has been made for any amount being foreign exchange, brought into Pakistan through normal banking channels, encashed in rupees from a scheduled bank and a certificate was also obtained from that bank. This amount will not be subject to addition under this section of the Ordinance.

As a result of this, a free-hand is being given to anyone, who is in a position to transmit untaxed earnings (through Hawala) abroad, bring it in Pakistan through the said process and enjoy its benefits without paying a single rupee as tax or penalty.

Explaining Section 111, the analysis said that the concept behind such provisions are to bring into account under the chargeability of such incomes, that either have no source or a taxpayer fails to explain its sources or the assets are recorded below transactional value actually transacted. In this way, it is the taxation of income, which is either consciously or by fiction concealed/avoided from the tax authorities. The section 111 has been drafted to cater to this situation.

Under clause (a) (b) (c) of sub section (1), the legislature intends to check the source of any amount credited in the person's books of accounts, any investment made by persons being owner of the money or valuable article or a person's expenditure.

The main emphasis is on the source of the amounts referred above and in case the person offers no explanation or a satisfactory explanation about the nature and source, such amount should be included in the person's income chargeable to tax under the head "income from other sources" to the extent it is not adequately explained, report said.

With the universal acceptance of all returns under section 120, the provisions of this section will be applicable at the time of audit of cases by the Commissioner or proceedings u/s 122(1) of the Income Tax Ordinance 2001, whereas in the repealed Ordinance, section 13 could be invoked during proceedings of cases under normal law.

This means that any addition under this section can take place subsequent to its discovery by the commissioner, who after giving the taxpayer an opportunity of being heard can proceed with the addition, if the explanation offered by the taxpayer is not, in his opinion, satisfactory, it said.

Under the repealed Ordinance, 1979, the concept of year of discovery was to make addition in the year preceding to the year of discovery. Prior to amendment by the Finance Act, 2004, in sub-section (2), in respect of any unexplained cash credit in books of accounts, investment or expenditure the relevant period for additions was in the tax year in which discovery is made by the commissioner.

So, if discovery was made in respect of unexplained investment in tax year 2005 relating to tax year 2004, addition could only be made in tax year 2005 when return would he received. This had created a difficult situation for the department.

The amendment has shifted the period for the purpose of addition to "tax year immediately preceding the financial year in which discovery is made by the commissioner". In other words, now addition will be made in tax year 2004, if such discovery is made in tax year 2005. Under this section addition can only be made for the last five completed years.

It would have been more logical to amend the law to provide that addition be made in tax year/assessment year to which such cash credit in books of accounts investment or expenditure, etc relates, as now action u/s 111(1) can only be taken for preceding five tax years or assessment years.

The analysis further highlighted that under sub section (3), the commissioner has given powers to examine the declared cost of any investment, valuable article or declared amount of expenditure, which is less than reasonable cost, the difference is to be added in the income chargeable to tax under the head "income from other sources" in the tax year immediately preceding the financial year in which it was discovered. This is almost identical to Section 13 (1)(d) read with 13(2) of the repealed Income Tax Ordinance.

For valuation of assets for the purposes of this section, Rule 228 has been framed, however, in sub-section (4), the immunity in respect of foreign exchange remitted from outside Pakistan through normal banking channel has been reaffirmed.

It has been further provided that no addition can he made under sub-section (1) of Section 111 for a period beyond the preceding five tax years or assessment years.

Previously this was specified in Circular No 8 of 2003, which has now been made part of the statutory law to dispel any fear in the minds of the taxpayers regarding addition for unexplained sources being made in the year of discovery regardless of the limitation of time.