5 Taxation of Individuals from taxation management

Taxation management

1. TAXATION OF PERSONS

2. TAXATION OF PERSONS The Income Tax Ordinance, 2001 outlines provisions for taxation based on specific categories of individuals and entities. This chapter discusses the taxation principles applied to different persons. 2

3. Taxation of Individuals To determine taxable income and liability, individuals are broadly classified into: Salaried Individuals – Those whose salary income constitutes more than 75% of their taxable income for the year. Non-Salaried Individuals – All other individuals who do not fall under the salaried category. While the method for computing taxable income is similar for both categories, their applicable tax rates differ. 3

4. Taxation of an Individual [86] Except as specified under special cases, each individual shall be charged to tax separately. The taxable income, tax liability, or amount of refund shall be determined for each individual who shall be liable for the same. 4

5. Taxation of a Deceased Individual [87] The tax liability of a deceased person is computed as if they were still alive. However, the responsibility for payment shifts to the legal representative , who is liable only for the amount received or held on behalf of the deceased. The deceased's estate must first cover any outstanding tax liabilities. Any pending tax proceedings against the deceased will continue against their legal representative. Legal representatives are responsible for managing the deceased’s estate and fulfilling tax obligations accordingly. Legal Representative – A person who, in law, represents the estate of a deceased person. Any person to whom the estate of a deceased person passes upon their death or who intermeddles with such an estate is also treated as a legal representative. [87(4)] 5

6. Individual as Member of an AOP [88] Where an individual is a member of an Association of Persons (AOP), their tax liability shall be determined by considering the nature of their other incomes, if any. If there is no other taxable income for the tax year, the person shall not be required to pay income tax on their share from the AOP. However, if the person has other taxable incomes, then their share from the AOP shall be included in their total income for rate purposes only. 6

7. INCOME OF MINOR CHILD [91] Business Income Business income of a minor child shall be clubbed with the income of the parent whose taxable income for the tax year is greater. However, if the child has invested income from inheritance, their income shall be taxed separately. Non-Business Income A minor child shall be taxed separately for their income under any head, except for Income from Business . 7

8. TAXATION OF ASSOCIATION OF PERSONS AND ITS MEMBERS [92 & 88] An AOP is taxed separately from its members and treated as an independent taxable entity. Key taxation principles for AOPs include: AOPs must pay tax on their chargeable income. If an AOP has paid tax on its income, any amount received by a member out of its income shall be exempt from tax Standard return filing procedures (u/s 114, 118, 119) apply to AOPs. The AOP is entitled to set off and carry forward its losses as per normal procedure. However, its members cannot set off their respective share of AOP losses. 8

9. If a member’s income from AOP is exempt and they have no other income, they are not required to file a tax return. However, if they have other sources of taxable income, their AOP share is considered for rate calculation. In this case, the following steps should be followed [88]: i ) Compute taxable income (including share from AOP). ii) Compute tax on taxable income as per rates specified in the First Schedule. iii) Divide the tax amount by the taxable income (including AOP share) to get the average tax rate. iv) Apply the average tax rate to actually taxable income (excluding AOP share) to determine the tax liability. If an AOP’s income is tax-exempt, its members are not taxed on their share of the exempt income. 9

10. Compute the tax liability of Mr. Hammad who has the following sources of income: Taxable business income Rs. 2,400,000 Share of income from AOP (Exempt in the hands of its members) 600,000 Total income (for rate purposes 3,000,000 Tax as per tax table 465,000 Less: Rebate in respect of exempt income : Tax on taxable income × Exempt income 465000 * 600000 (93,000) Taxable Income 3000000 Tax liability for actually taxable income 372,000 10

11. Companies as Members of an AOP When an AOP has at least one company as a member: The company’s share in the AOP’s income is excluded from the total AOP income. The company is taxed separately at the applicable corporate rate. 11

12. Example Neelum Limited, a manufacturing company, has a taxable income of Rs. 5,000,000. It is also a 50% member of Sharda Associates (AOP), which has taxable income of Rs. 2,600,000. Taxable Income and Tax Liability of Sharda Associates: Total taxable income Rs. 2,600,000 Less: Neelum Limited’s share (50% of Rs. 2,600,000) 1,300,000 Remaining taxable income 1,300,000 Tax liability: On Rs. 1,200,000 @ 20% 75,000 On remaining Rs. 100,000 @ 20% 20,000 Total tax 95,000 12

13. Taxable Income and Tax Liability of Neelum Limited: Own business income 5,000,000 Add: Share from AOP 1,300,000 Total taxable income 6,300,000 Tax liability at 29% 1,827,000 A company’s share from an AOP is taxable at its applicable corporate rate. However, the AOP itself is taxed on its residual income separately. 13

14. TAXATION OF FOREIGN-SOURCE INCOME OF RESIDENTS As a general principle, the residents are liable to tax for their total income whether it is a Pakistan-source income or a foreign-source income. However, there are some specific provisions for taxation of foreign-source incomes of residents. Foreign-Source Salary Income [102] A foreign-source salary income of a resident individual will be exempt from tax if he has paid foreign income tax in respect of such income. Payment of foreign tax means that the employer has deducted the tax at source and deposited the same to the revenue authority of the country in which employment was exercised. 14

15. MAXIMUM TAX ON COTTON GINNERS Maximum tax payable by cotton ginners on their income and profits shall be 1% of their turnover from cotton lint, cotton seed, cotton seed oil, and cotton seed cake. Tax so payable shall be final tax in respect of their cotton ginning and oil milling activities only. 15

16. TAX ON WOMAN ENTERPRISES Tax payable by 'woman enterprise' on profit and gains from business shall be reduced by 25%. A 'Woman Enterprise' refers to a startup established on or after 01-07-2021 as a sole proprietorship owned by a woman, an AOP (Association of Persons) whose members are women, or a company where 100% shareholding is held or owned by women. 16

17. Taxation of Companies [94] A company is a separate legal entity distinct from its members (shareholders). Therefore, the tax liability of a company and its shareholders is determined separately , and each member is liable for their respective tax obligations. A company’s income is taxed based on the following principles: Taxable income (excluding dividend income) is calculated and taxed as per normal procedure. Under the Normal Tax Regime (NTR), the applicable tax rate is applied to the taxable income of the company. Dividend income received by the company is treated as a separate block of income and taxed by applying rates specified in Division-III, Part-I of the First Schedule to the gross dividend amount. This income is taxed under Final Tax Regime (FTR). 17

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