TAX ON FOREIGN SOURCE INCOME OF RESIDENT PAKISTANIS
[DISCLAIMER] THIS IS FOR GENERAL GUIDANCE ONLY AND NOT A LEGAL, EXPERT, PROFESSIONAL OR ACTIONABLE ADVICE. PLEASE CONSULT A PROPER TAX LAWYER / CONSULTANT FOR CORRECT AND ACCURATE APPLICABILITY OF LAW ON CASE TO CASE BASIS. THIS ARTICLE WAS LAST UPDATED ON 09-JULY-2019
Many of our members are having questions related to the Foreign Source Income of Resident Pakistanis, and most of the people here are informing them that it is exempt under section 111 (4)(a) of the Income Tax Ordinance. Therefore, I think that it is very important that we look at what law states,
The Income Tax Ordinance 2001, (ITO or ITO 2001) specifically addresses Foreign Source Income of Resident Pakistanis (FSIRP) in Chapter VII Part II Section 102 to Section 104.
Chapter VII Part 1 Section 101 of the ITO defines Foreign Source Income as :
“An amount shall be foreign-source income to the extent to which it is not Pakistan-source income.”
Section 102 States :
- Foreign source salary of resident individuals.— (1) Any foreignsource salary received by a resident individual shall be exempt from tax if theindividual has paid foreign income tax in respect of the salary.
(2) A resident individual shall be treated as having paid foreign incometax in respect of foreign-source salary if tax has been withheld from the salary bythe individual’s employer and paid to the revenue authority of the foreign countryin which the employment was exercised.
Section 103 States :
- Foreign tax credit.— (1) Where a resident taxpayer derives foreign source income chargeable to tax under this Ordinance in respect of which the taxpayer has paid foreign income tax, the taxpayer shall be allowed a tax credit of an amount equal to the lesser of –
(a) the foreign income tax paid; or
(b) the Pakistan tax payable in respect of the income.
(2) For the purposes of clause (b) of sub-section (1), the Pakistan tax payable in respect of foreign source income derived by a taxpayer in a tax year shall be computed by applying the average rate of Pakistan income tax applicable to the taxpayer for the year against the taxpayer’s net foreign-source income for the year.
(3) Where, in a tax year, a taxpayer has foreign income under more than one head of income, this section shall apply separately to each head of income.
(4) For the purposes of sub-section (3), income derived by a taxpayer from carrying on a speculation business shall be treated as a separate head of income.
(5) The tax credit allowed under this section shall be applied in accordance with sub-section (3) of section 4.
(6) Any tax credit or part of a tax credit allowed under this section for a tax year that is not credited under sub-section (3) of section 4 shall not be refunded, carried back to the preceding tax year, or carried forward to the following tax year.
(7) A credit shall be allowed under this section only if the foreign income tax is paid within two years after the end of the tax year in which the foreign income to which the tax relates was derived by the resident taxpayer.
(8) In this section,— “average rate of Pakistan income tax” in relation to a taxpayer for a tax year, means the percentage that the Pakistani income tax (before allowance of the tax credit under this section) is of the taxable income of the taxpayer for the year; “foreign income tax” includes a foreign withholding tax; and “net foreign-source income” in relation to a taxpayer for a tax year, means the total foreign-source income of the taxpayer charged to tax in the year, as reduced by any deductions allowed to the taxpayer under this Ordinance for the year that –
(a) relate exclusively to the derivation of the foreign-source income; and
(b) are reasonably related to the derivation of foreign-source income in accordance with sub-section (1) of section 67 and any rules made for the purposes of that section.
Section 104 is about the losses and deductible expenses, I am leaving that for another discussion.
From the above interpretation, it is very clear that Foreign Source Income of the Resident Pakistanis is Taxable. In order to avoid double taxation, you will have to pay tax as per Pakistani Laws less any amount paid as Foreign Income Tax.
Why Normally People Say it is Exempt and Application of Section 111?
Mostly, people say that it is exempt, which is due to the reason, that ITO states, any “unexplained income and assets” related to foreign remittance can not be added to the taxable income of the taxpayer.
I would like to draw attention of my readers, towards the fact that “exemptions” are specifically mentioned in the Second Schedule to the ITO. Second Schedule no where mentions “Foreign Remittances” as exempt.
Let us read section 111.
- Unexplained income or assets. — (1) Where —
(a) any amount is credited in a person’s books of account;
(b) a person has made any investment or is the owner of any money or valuable article;
(c) a person has incurred any expenditure; or
[(d) any person has concealed income or furnished inaccurate particulars of income including —
(i) the suppression of any production, sales or any amount chargeable to tax; or
(ii) the suppression of any item of receipt liable to tax in whole or in part,]
and the person offers no explanation about the nature and source of the amount credited or the investment, money, valuable article, or funds from which the expenditure was made [suppression of any production, sales, any amount chargeable to tax and of any item of receipt liable to tax] or the explanation offered by the person is not, in the Commissioner’s opinion, satisfactory, the amount credited, value of the investment, money, value of the article, or amount of expenditure [suppressed amount of production, sales or any amount chargeable to tax or of any item of receipt liable to tax] shall be included in the person’s income chargeable to tax under head “Income from 6 [Other Sources”] to the extent it is not adequately explained[:]
Basically, section 111 deals with unexplained Income and Assets and empowers the Commissioner to add the “unexplained income or assets to the taxable income of the persons.
However, Subsection 4 of the section 111, defines certain “unexplained assets and income” which can not be added to the “taxable income”, which includes, “unexplained foreign remittances”.
So, the crux is, if foreign remittances are “unexplained” they can not be added to your taxable income.
Other Relevant Treatments
Another way to be tax efficient, is to treat your FRSI as an export receipt. Exports are generally taxed at a Full and Final Rate of 1% of the export Value (Section 154).
However, Second Schedule, Entry 133, exempts the Exports of IT services from tax upto year 2025,
How to Treat your Free Lancing for Better Tax Management.
- EXPORT RECEIPTS
- EXPORT OF IT SERVICES.
Please remember to comply with Provincial Tax Laws as well.