Raw Materials Purchased from Un-regd Person and Used Exclusively in Taxable Supplies

Q: What are the provisions of Sales Tax Law in case raw material is purchased from un-registered person and is exclusively used in taxable supplies?

Ans: If raw material is purchased from an un-registered person, input tax (if any) is not admissible, but output tax is to be charged and paid on such supplies regardless of the fact  whether the supplies are made to a registered person or to a non-registered person.

With respect to the fact that a certain amount of raw materials purchased from unregistered person is wholly used in taxable supplies, it must be noted that this fact does not have any effect on the computation and it cannot be used to reduce the input tax credit.

The ‘purchase/sale ratio’ has been invented and used by some to limit the input tax paid on purchases from registered persons. There is no such ratio in the Sales Tax Act, 1990, or Sales Tax Rules, 2006, and the restriction on input tax in such a way in not intended by the law maker. (I must say it’s a smart idea, though, but without any legal basis.)

The whole concept has been derived from Rule 25 of the Sales Tax Rules, 2006, which relates to allocation/proration of input tax. The said rule says:

-         Input tax paid on raw materials relating wholly to taxable supplies is wholly admissible.

-         Input tax paid on raw materials relating wholly to exempt supplies is not admissible.

-         Input tax paid on raw materials relating to both taxable supplies and exempt supplies (called ‘residual input tax’) is to be apportioned according to the following formula.

Residual input tax credit on taxable supplies

=

Value      of    Taxable    supplies           (Value of Taxable + Exempt Supplies)

×

Residual input tax

Here, the gross value of taxable supplies for the month is to be taken for denominator and numerator (as computation is done on monthly basis) and not the value reduced by any ‘purchase/sale ratio’.

Note that ICAP has examined this point at least twice in Spring 2011 and Autumn 2009 and in its suggested answers has not used any ‘ratio’ to reduce the input tax credit. ICAP suggested answer is correct and in accordance with law and rules of sale tax.

To sum up:

-         Input tax (if any) on purchases from unregistered person is not allowable.

-         Output tax is chargeable on supplies made to registered person, as well as un-registered person.

-         If it is given that a specified amount of raw material is purchased from unregistered person and is used exclusively in taxable supplies, ignore it and don’t use any formula not provided in the law/rules to reduce the input tax credit.

-         Input tax paid on raw materials relating wholly o taxable supplies is wholly admissible as adjustment.

-         Input tax paid on raw material relating to wholly exempt supplies is not admissible.

-         Input tax paid on raw materials relating to both taxable supplies and exempt supplies (called ‘residual input tax’) is to be apportioned according to the aforesaid formula.

Interest-free Loan Used in Property Producing Taxable Income

Q: What is the tax treatment of concessionary/interest-free loan which is used by the employee in acquiring an asset or property producing income chargeable to tax? (Section 13(8) of ITO-2001)

Ans: If concessionary/interest-free loan acquired by employee from employer is used by him in acquiring an asset or property which produces income chargeable to tax under ITO-2001, following provions shall apply:

(1) An amount equal to the bench mark rate in case of interest-free loan and difference of the bench mark rate and the interest charged by employer in case of concessionary loan, shall be charged to tax under the head Salary in accordance with Section 13(7).

(2) The amount of profit on loan equal to the bench mark rate shall be DEEMED to have been PAID by the employee to employer.

(3) Although the employee may not have actually paid any amount to employer on account of the profit on loan, but an amount equal to the bench mark rate is assumed to have been paid to the employer owing to the reason that DEDUCTION for profit on loan equal to the benchmark rate may be allowed to employee under the head in which income arising from the asset/property is charged to tax.

Example: Mr. A is an employee at XYZ Ltd. He has received interest free loan at Rs. 800,000 from his employer and has purchased a car from that loan. The car, being used in rent-a-car, produces income from business at Rs. 350,000. Bechmark rate is 13%.

Solution:

Amount chargeable under Salary   800,000 x 13% = 104,000

Amount chargeable under IFB    350,000
Deduction for profit on loan        104,000
Income under IFB                       246,000

Note: In case the property purchased from loan is land or building and rental income is generated from the said property, then there will be no benefit of the aforesaid provision of law to the employee as no deduction is allowed under Income from Property.      

Gain on Disposal of Immovable Property

Q: An immovable property is sold for Rs. 20 (m). The cost of the said property was Rs. 10 (m). Accumulaed Depreciation is Rs. 1(m). What will be the tax gain?

Ans:

Consideration Recieved   10
WDV (10-1=9)                 09
Tax Gain                          01

According to Section 22(14) if consideration recieved on disposal of an immovable property exceeds the cost of the property, the consideration recieved is to be taken equal to the cost. Due to this provision of law, gain shall always be equal to the depreciation deduction claimed by the taxpayer, the maount of gain over and above the claimed deprecation will not be charged to tax. This provision is designed only to re-coup the amount of depreciation deductions claimed by the taxpayer.

Rent in Kind

Q: If rent for a building is recieved in kind by the owner, will it be taxable under Income from Property?
Ans: Yes, it will taxable at fair market value under the head Income from Property, except when the building is Agricultural Building, in which case rent will be exempt u/s 41 of the ITO-2001.

Sales Tax as Deduction in Computation of Income Tax

Q: Is Sales Tax allowed as Deduction under Income Tax Law?
Ans: No, Sales Tax is not normally allowed as deduction in the computation of Income Tax liabiliy of a person, for the reason that it is not borne by the person but rather is passed on to others i.e. the final  consumers. However, sales tax shall be allowed as deductible expense when it has been borne by the person and not passed on to any other person and is incurred wholly and exclusively for the purpose of businss.

Commissioner Vs. Collector

Q: What is the difference between Commissioner and Collector?
Ans: Both are Grade-20 officers of  the Federal Board of Revenue, but each belonging to a different department of the FBR.  The Commissioner is an officer of Inland Revenue Service (IRS) and is responsible for enforcement of the Income Tax Ordinance, 2001, and Sales Tax Act 1990. The Collector is an officer of Customs Department and is and authority only under Customs Act, 1969. Previously, the Collector was responsible for enforecement of Sale Tax as well, but the said function/task is now performed by the Commossioner. Hence, any reference to 'Collector' in the Sales Tax Act 1990 and Sales Tax Rules 2006 should be read as 'Commissionr'.

Input Tax is Adjustable Even When Paid on Goods Used in Supply to Non-registered Persons

Q: Is Input Tax ajustable if it is paid on purchase of goods that are used in supply to non-registered person?
Ans: Yes, Input Tax will be adjustable in this case for the reason that the supply of goods to a non-registered person is also a taxable supply and Output Tax is required to be charged/paid on the said supplies. Input Tax is not allowed adjustment when it is paid on goods used or to be used in supply other than taxable supply i.e. exempt supply.

Royalties & Fee for Technical Services of Non-Resident - Exceptions to FTR

Q: Tax imposed at the rate of 15% on every Non-Resident Person who recieves Pakistan-sourece royalty or Fee for Technical Services (FTS) is considered to be a final tax on the amount in respect of which the tax is imposed. Identify the exeptions to the above rule, as referred to in the Income Tax Ordinance, 2001. (ICAP Module-C, Spring 2010)

Ans: The exceptions are: (i) royalty is earned by NR from a property or right which is connected with the PE of the NR in Pakistan. (ii) FTS is earned by NR where services giving rise to the FTS are rendered by PE of the NR in Pakistan, & (iii) Royalty or FTS is exempt from tax. (Ref: Sec 6(3) of ITO-2001)

Amendments Not to Apply to September 2011 Attempt

As per ICAP policy, amendments in Income Tax & Sales Tax Laws made vide Finance Act 2011 (Budget 2011-12) are not applicable to CA Module C Exam to be held in September 2011.

Tax Credit against Profit on Debt to Employee

Q: Is tax credit for 'profit on debt' u/s 64 of the ITO-2001 allowed to an employee who has used concessional loan from employer in construcion/acquisition of new house?

Ans. Tax credit on profit on debt u/s 64 is allowed against a profit on debt paid by a person to any of the persons listed in sub-section (1) of sec 64 i.e. Scheduled Bank, NBFC, Govt, Local Govt, Public Listed Co., or any statutory body.

An employee shall be allowed a tax credit aginst profit on debt deemed to have been paid u/s 13(8) of ITO-2001 by him to his employer if the employer is among any of the persons listed in Sec.64(1). In case the person is employee of any other person e.g. individual, tax credit u/s 64 shall not be allowed.

Business Losses

Q1: Is inter-head setting off allowed for broght forward normal business losses?

Ans. Brought fwd normal business loss is not allowed inter head setting off. Normal business loss for the current year is allowed setting of from income under any other head. Current loss not being able to be set of is carried forward to the next tax year, and is set of only from income under the head Income from Business. [Reference S.57(1)]

Q2: Which of the two following broght fwd loss is set of first: depreciation loss or normal business loss.

Ans. According to Sec. 57(4), depreciation loss is set of first by adding it in the depreciation deductions for the the year, and thereafter b/f normal business loss is set of from net income.

Meaning of Construction Materials Supplied by Govt

Q: What does this phrase mean: " payment made by the Govt to a contractor for construction material supplied to the contractor by such Govt." [Used in Section 153(5)(ba)]

Ans. In construction contracts given by a Govt to contractors, the Govt sometimes makes part payment in the form of contruction materials. For example a contract amounting to Rs. 30 (m) is awarded by Govt to a private contractor for construction of a road. Out of this amount Rs. 25 (m) are given in cash, whereas construction material worth Rs. 5 (m) is given to the contractor. In such situations tax is not required to be deducted u/s 153 from the contract amount representing the contruction materials [i.e. Rs. 5 (m) in this example]. Thus, tax is be deducted at 6% of Rs. 25 (m) only.

Purchases from and Supplies to Un-registered Person (Sales Tax)

Q: What are the implications of purchases made from and supplies made to unregistered person under the Sales Tax Act, 1990?

Ans. No input tax credit is allowed on purchases made from unregistered person, whereas out put tax is charged on supplies made to unregistered person.

What is Separate Block of Income

Q: What is Separate Block of Income? Explain with examples.

Ans. The method of computation of taxable income and tax thereon is to first compute the income under each head of income by deducting 'deductions allowed', if any, from 'amount chargeable' under the head. Incomes under all five heads are then added up to get 'total income', from which are reduced 'deductible allowances'. The resulting amount is called 'taxable income'. Tax rates given in the first schedule to ITO-2001 are then applied to the whole amount of the taxable income to determine the tax liability of the person for the year.

However, there are few exceptions to this method of computation of tax liability. There are some incomes which are treated separately as a 'separate block of income'. These types of income are given below:

(1) incomes subject to final tax (FTR) are not included in any head and are to be treated separately.

Example: Dividend recieved by an individual amounting to Rs. 200,000 from which tax has been deducted at sources at Rs. 20,000.

(2) certain incomes are subject to lower tax rates than are normally applicable, such as income from property, capital gains, and golden handshake amount etc. Though such incomes are taken into account while computing taxable income but are subtracted from it at the time of application of tax rates.

Example:

Income from Business..................................800,000
Income from Property....................................400,000
Total income................................................1,200,000
L:Deductible Allowance.................................50,000
Taxable Income...........................................1,150,000
L:Income from Property.................................400,000
Taxable Income ( for Normal rates).................750,000
Income from Property ( for Reduced rates)....... 400,000

Advance Tax

Q: List down various types of incomes which are not taken into consideration while calculating advance tax?

Ans:

1. Dividends (S.5)

2. Certain payments to non-residents (S.6)

3. Shipping and air transport income of a non-resident person (S.7)

4. Income from Property

5. Salary

6. Income that is subject to deduction/ collection of tax under Division II or Division III, or Chapter XII and which is subject to final taxation.


A taxpayer deriving income exclusively from one or more of these sources is not required to pay advance tax. In case a person derives incomes subject of advance tax and incomes not subject to advance tax, the person is required to pay advance tax only in relation to incomes that are subject to advance tax.

[See Para 22.1.2 of 'Taxation in Pakistan' or Sec. 147(1) of the ITO-2001]

Meaning of 'Securitization"

Q: What is the meaning of ''securitization"?

Ans. It means sale of accounts recievables by any person (called 'originator') to Special Purpose Vehicle (SPV) which then collects those recievables from the debtors. Note that only a public limited company, a trust or a company controlled or managed by Fed/Provincial Government can function as SPV after getting registered with the SECP.

(Concept of securitization is relevant for Sec. 28(1)(b) and Sec. 153(5) (d) of the ITO-2001)