Capital Gain and its Taxation.

Capital Gain is Taxation Income and is a separate head of Income. It is taxed not only in cases of Capital Gains on Immovable Properties (Real Estates, or Properties), but also on other Capital Assets.

Lets us have a simple introduction of Capital Gains and its taxation as a source of Income:

Capital Gains[1]

Heads of income

The section 11 of the Income Tax Ordinance, 2001 classify incomes under the following heads, namely:

(1)      Salary;

(1)      Income from Property;

(2)      Income from Business;

(3)      Capital Gains; and

(4)      Income from Other Sources.

Capital Gain is the fourth head of income.

Capital Gain on disposal of Capital Asset

Subject to this Ordinance, a gain arising on the disposal of a Capital Asset by a person in a Tax Year, other than a gain that is exempt from tax under this Ordinance, shall be chargeable to tax in that year under the head “Capital Gains”.

Computation of Capital Gain[2]

The gain arising on the disposal of a Capital Asset by a person shall be computed in accordance with the following formula, namely:

A – B

where:

‘A’is the consideration received by the person on disposal of the asset; and

‘B’is the cost of the asset.

Therefore,

Capital Gains	=	A	–	B
Capital Gains	=	consideration received on disposal of asset	–	cost of asset

Disposal of Capital asset after twelve months[3]

If a Capital Asset has been held by a person for more than one year, other than shares of public companies including the vouchers of Pakistan Telecommunication Corporation, modaraba certificates or any instrument of redeemable capital, the amount of any gain arising on disposal of the asset shall be computed in accordance with the following formula, namely:

A x ¾

where‘A’ is the amount of the gain determined as if the Capital Asset were sold before twelve months.

Therefore,

Capital Gains after 12 months	=	A	X
Capital Gains after 12 months	=	Capital Gains	X

Example

Mr. Jamal Joiya purchased a Capital Asset for Rs. 250,000 and sold it for Rs. 375,000. Calculate Capital Gain on disposal of the asset if: holding period is less than 1 year, and holding period is more than 1 year.

Solution

Case 1: Holding period less than 1 year.

Mr. Jamal Joiya
Tax Year : XXXX
Tax Year Ended : 30-06-XXXX
Residential Status : Resident
Computation of Capital Gains
Particulars	Rs.	Rs.
Capital Gains
Consideration received on disposal	375,000
Less: Cost of asset	250,000
Capital Gains for holding period:	125,000
(Less than 1 year)		125,000

Case 2: Holding period more than 1 year.

Mr. Jamal Joiya
Tax Year : XXXX
Tax Year Ended : 30-06-XXXX
Residential Status : Resident
Computation of Capital Gains
Particulars	Rs.	Rs.
Capital Gains
Consideration received on disposal	375,000
Less: Cost of asset	250,000
Capital Gains for holding period:
(Less than 1 year)	125,000
(More than 1 year)
Capital Gains for less than 1 year x 3/4 (Rs. 125,000 x ¾)		93,750

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[1] See Section 11

[2] See Section 37(2)

[3] See Section 37(3)

What is a Tax Year?

What is a Tax Year?

Focus on the word TAX YEAR in the basic sentence below:

For each Tax Year, the government imposes Income Tax at a specified rate on every Person who has Taxable Income.

The discussion below will develop an understanding of the word TAX YEAR.

Note the word "each" in our basic sentence:

Income Tax is imposed on every Person who has Taxable Income for eachTax Year.

The Income Tax is periodic in nature, and a person has to pay tax after a period of twelve months—a Tax Year. However, the meaning of Tax Year is not the same as the meaning of a year we use in our day-to-day conversation. A Tax Year not only has special meanings, but also has three types. The three types are:

1.       Normal Tax Year,

2.       Special Tax Year, and

3.       Transitional Tax Year.

Normal Tax Year

A Normal Tax Year is a period of twelve months which ends on 30^th June of the year in its name.

A Normal Tax Year of twelve months has six months from a year and another six months from the next year. For example, the Tax Year 2014 has six months from year 2013 and six months from year 2014. In the diagram, the Tax Year 2014 is shown. Note the following details to understand the definition of a Tax Year.

(1)      First six months of Tax Year 2014 fall in calendar year 2013;

(2)      Second six months of it fall in calendar year 2014;

(3)      It is a twelve months long period;

(4)      It starts from 1st July, 2013;

(5)      It ends at 30th June, 2014.

There are cases when a Normal Tax Year is not twelve months long. For example, Mr. Rashid Rao starts business on 1^st October, 2013. He will have a Tax Year 2014 which ends on 30^th June, 2014. Therefore, his Tax Year 2014 will be nine months long. The situation is shown in the diagram.

Most of the taxpayers have Normal Tax Years ending on 30^th June of a year.

Special Tax Year

Some particular businesses have specific business cycles which do not fit into the period of twelve months of a Tax Year. For example, a cotton season in Pakistan starts on 1^st of September of a year and ends on 30^th October next year. To match the business cycle of cotton season with the taxation cycle, the Federal Board of Revenue has specified that their Tax Year will commence on 1^st October and will end on 30^th September following. A Special Tax Year is denoted by the calendar year of the Normal Tax Year in which it’s ending date falls.

The FBR may specify a twelve months period that makes up a Special Tax Year for:

1.       a person,

2.       a class of persons, and

3.       a source of income.

Following are some of the notified Tax Years:

Type of business	Starting date	Ending date
Manufacturing of jute goods	1st July	30th June
Manufacturing of sugar	1st October	30th September
Manufacturing of cotton textiles	1st October	30th September
Export of rice	1st January	31st December
Ginning of cotton	1st September	31st August
Rice husking	1st  September	31st August
Oil mills	1st September	31st August
Manufacturing of shawls	1st April	31st March
Trading of shawls	1st April	31st March
Insurance	1st January	31st December
Banking	1st January	31st December

A Person can get his Tax Year changed from Normal Tax Year to a Special Tax Year or a Special Tax Year to a Normal Tax Year by applying to a Commissioner. The Commissioner has powers to makes such changes in Tax Years in cases of needs.

The Board has powers to permit a class of persons or a type of business to change their Tax Year from Normal Tax Year to a Special Tax Year. Similarly, the board also can make the reverse change i.e. the change of a Special Tax Year to Normal Tax Year devote notifies all such changes.

Transitional Tax Year

When Tax Year of any class of persons or a single person is changed as a result of an order by the Board or Commissioner of Income Tax, it results:in the emergence of a changing period which is known as "Transitional Tax Year" and is treated to be a separate Tax Year. It consists of the period between the end of last year before change and the start of the changed Tax Year.

What is a Head of Income?

What is a Head of Income?

The term head of Income is confusing for some people; however, it is not so difficult to understand its meaning. There is no difficult concept involved; just think in terms of equations below:

Head = Account

And

Head of Income = Account of Income

In Pakistan, there are five accounts of Income. Each account (head) denotes a separate type of Income. The five accounts or Heads of Income are:

(1)      Salary,

(2)      Income from property,

(3)      Income from Business,

(4)      Capital gains, and

(5)      Income from other sources.

The purpose of maintaining five heads of Income is obvious: we need these accounts or heads to manage and understand from where government is getting money. For example, we can easily compare Income Tax paid by the salaried persons and by business-persons.

What is Income Tax?

What is Income Tax?

Focus on the word INCOME TAX in the basic sentence below:

For each Tax Year, the government imposes Income Tax at a specified rate on every Person who has Taxable Income.

The discussion below will develop an understanding of the word INCOME TAX.

Income Tax is a Federal Tax which the Federal Government has imposed on Person with Taxable Income. 

In general, tax is a common burden payable by the citizen of Pakistan to make the Governance of the state financially possible. Income Tax is the tax imposed on the citizen of Pakistan in exercise of power of the Federal Government under item no. 47 of the Federal Legislative List, the constitution of Pakistan. The Income Tax is administered under the provision of Income Tax Ordinance, 2001. The Ordinance defines the word Tax as follows:

Tax[1] means any tax imposed under the income tax law. It also includes any penalty, investment tax, fee or other charge or any sum or amount leviable or payable under the Income Tax Ordinance, 2001.

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[1] See Section 63

What is Taxable Income?

What is Taxable Income?

Focus on the word TAXABLE INCOME in the basic sentence below:

For each Tax Year, the government imposes Income Tax at a specified rate on every Person who has Taxable Income.

The discussion below will develop an understanding of the word TAXABLE INCOME.

The Taxable Income is the Income of a person on which the person pays Income Tax; whereas, the Exempt Income is the Income of a person on which he has to pay no Tax. The Taxable Income becomes very important to understand because Income Tax is calculated on Taxable Income. The Taxable Income depends on the value of Total Income a person derives, and the value of Deductible Allowances.

Technically, the Taxable Income is defined as under:

The Taxable Income[1] of a person for a Tax Year is the Total Incomeunder all heads of Income of the person for the year reduced (but not below zero) by the total Deductible Allowances.

Taxable Income = Total Income – Deductible Allowances

In the equation, Total Income means:

The Total Income[2] of a person for a Tax Year is the sum of his

1.       Income under all heads of income; and

2.       Income exempt from tax.

Therefore,

Total Income = Income under all heads + Exempted Income

The Income Tax Ordinance, 2001 provides us classification of Income into five heads:[3]

(1)      Salary,

(2)      Income from property,

(3)      Income from Business,

(4)      Capital gains, and

(5)      Income from other sources.

Exempted Income is the Income on which a person has to pay no Income Tax. One example of exempted Income is Agricultural Income. A person deriving Agriculture Income does not pay Income Tax under the provision of Income Tax Ordinance, 2001.

The overall relationship between Total Income, Taxable Income, and Exempt Income is shown in the diagram below.

Example

Mr. Arslan Aslam has Total Incomeof Rs. 2,600,000. Deductible allowances in his case are valued at Rs. 720,000. What is his Taxable Income?

Solution

Mr Arslan Aslam
Tax Year : XXXX
Computation of Taxable Income
Particulars	Rs.
Total Income	2,600,000
Less: Deductible Allowances	720,000
Taxable Income	1,880,000

Another classification of Income is Pakistan-Source Income, and Foreign-Source Income. This classification is used to differentiate the Tax liability of Resident and Non-Resident Person. A Non-Resident Person has to pay Tax on both the Pakistan-Source Income and Foreign-Source Income. On the other hand, a Resident Person pays Tax on his Pakistan-Source Income only.

Pakistan-Source Income

The Pakistan-Source Income[4] includes the income which a person earns in Pakistan without regard to location of receiving the income.

[1]See Section 9

[2] See Section 10

[3] See Section 11

[4] See Section 2(40)

What is Income?

What is Income?

In the previous post, we have a basic sentence to understand the Income and Income Tax. Focus on the word Income in the basic sentence below:

For each Tax Year, the government imposes Income Tax at a specified rate on every Person who has Taxable Income.

The discussion below will develop an understanding of the word Income.

In common sense, Income is what a person earns, or make after paying all the expenses from the gross receipts. Technically, it has different meaning for Income Tax purposes. Income Tax Ordinance, 2001 defines Income[See 1 below] as under:

Income includes any amount chargeable to tax, any amount subject to collection or deduction of tax, any amount treated as income, and any loss of income. However,it does not include the amount representing the face value of any Bonus share or the amount of any Bonus by the company to the shareholders to increase capital.

Thus, the following amounts are income:

(1) Any amount chargeable to tax;

(2) Any amount subject to collection or deduction of tax;

(3) Any amount treated as income; and

(4) Any loss of income.

Keeping in view the other definition, following are income:

(1) The value of import is income because the collector of customs deducts Income Tax from it under the Income Tax Ordinance, 2001;

(2) Prizes and winnings are income because Income Tax is deducted at source from them; and

(3) Advanced tax paid by the owners of vehicles also falls in the definition of Income.

The law does not ignore the possibility of loss, and has included loss in the definition of Income.

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[1]See Section 2(29) of the Income Tax Ordinance 2001; simplified version of the definition

Understanding Income Tax

Understanding Income Tax

The word Income Tax has two parts: Income and Tax.

In order to have a professional level of knowledge about Income Tax, one has to understand following basic sentence and its underlying meaning in Income Tax Law – the Income Tax Ordinance, 2001.

"For each Tax Year, the government imposes Income Tax at a specified rate on every Person who has Taxable Income."

The sentence has words, which need explanation of their meanings as used in the Income Tax Ordinance, 2001. The words are Income,Taxable Income,Income Tax, Tax Year, Person, and the government.
In essence, defining these words will provide us with answers to the following basic questions:

(1) What is Income?

(2) What is Taxable Income?

(3) What is Income Tax?

(4) What is a Tax Year?

(5) Who is a Person?

(6) Who collects Income Tax?

(7) How much Income Tax is payable by a Person?

After knowing answers to these questions, you will have an overall understanding of Income Tax. Before going into details, a set of brief and non-technical answers are given below:

(1) What is Income?

Income is any amount on which Income Tax is chargeable, and it includes the amount, which the Income Tax Ordinance, 2001 treats as Income

(2) What is Taxable Income?

The Taxable Incomeis what a person gets after subtracting deductible allowances from the Total Income. The Income Tax is calculated on the Taxable Income, not the Income.

(3) What is Income Tax?

Income Tax is a tax imposed on person with Taxable Income by the Federal Government.Taxable Income is the basis of calculating Income Tax.

(4) What is a Tax Year?

The Tax Year is a period of twelve months for which income of a person is assessed. Normally, it starts on 1st July of a year and ends on the 30th June of the next year. It has three types: Normal Tax Year, Special Tax Year, and Transitional Tax Year.

(5) Who is a Person?

Commonly, a Person is an individual, but the concept of Person is wider in Income Tax; it includes Individuals, Association of Persons, Companies, and Governments, etc.

(6) Who collects Income Tax?

The Federal Governments collects the Tax through the Federal Board of Revenue. The Federal Board of Revenue runs the administration of the Income Tax department through the Chief Commissioners, the Commissioners, the Deputy Commissioners and other subordinate authorities, officers, and officials.

(7) How much Income Tax is payable by a Person?

The Tax Payable by the person depends on Income of the Person, the applicable rates of tax, and reliefs given to the Person under the Income Tax Ordinance, 2001.

Summary of basic questions and answers
Questions	Answers
What is Income?	(i) An amount chargeable to Income Tax (ii) An amount treated as Income under the Ordinance
What is Taxable Income?	The income on which tax is chargeable
What is Income Tax?	A federal tax on person with Taxable Income
What is a Tax Year?	A period of 12 months to assess income of a person
Who is a Person?	An individual, an AOP, a company, and a trust, etc.
Who collects Income Tax?	(i) The Federal Governments through the FBR (ii) Collecting and deducting agents
How much Income Tax is payable by a Person?	It depends on Income of the Person, the applicable rates of tax, and reliefs, credits and concessions.