Rental Income and Capital Gains form UK UAE Exempt from Pakistani Tax

The Appellate Tribunal Inland Revenue (ATIR), Islamabad, has ruled that under Pakistan’s tax treaties with the United Arab Emirates (UAE) and the United Kingdom (UK), rental income and capital gains derived from these countries by resident Pakistanis are not taxable in Pakistan. This decision resolves conflicting judgments on the matter and upholds the rights granted under international tax agreements.

The ruling comes in response to an appeal filed by a taxpayer who, as a resident of Pakistan, had declared exempt foreign income under the categories of rental income, capital gains, and bank profits in their tax return. The assessing officer issued a show-cause notice, asserting that foreign income of a resident individual is not exempt under Pakistan’s tax laws, but rather qualifies for a tax credit for taxes paid abroad.

Taxpayer’s Argument

The taxpayer argued that the respective tax treaties exclusively grant taxing rights to the country where the income originates. For example, under the treaty, income derived from immovable property or capital gains arising in the UAE or UK can only be taxed in those countries. This position was rejected by the assessing officer, who maintained that both states—the state where the income arises and the state of residency—have the right to tax the income under the treaties.

Tribunal’s Analysis

The ATIR, after reviewing the facts and principles of interpretation laid down by the Supreme Court in its 2023 ruling, disagreed with the assessing officer’s interpretation. It clarified that the phrase “may be taxed” in Articles 6.1 and 14.1 of the tax treaties is context-specific and grants taxing rights exclusively to the state where the income arises. The Tribunal emphasized that this interpretation aligns with Article 11.2 of the treaties, which explicitly uses the phrase “may also be taxed” to address other income categories, indicating a deliberate distinction in wording and intent.

The Tribunal noted that taxing the income in both countries would render the phrase “may also be taxed” redundant, which is contrary to the principles of treaty interpretation. Additionally, the Tribunal highlighted that the UAE does not levy taxes on rental income or capital gains, which further substantiates the exclusive taxing rights of the UAE under the treaty.

Conflicting Judgments and Precedence

The Tribunal also addressed a conflicting judgment issued in a similar case, which supported the taxation of rental income in Pakistan. It ruled that this judgment, being later in time, did not take into account earlier precedents and a clarification issued by the Federal Board of Revenue (FBR) Helpline. The ATIR reaffirmed the principle that decisions of a division bench are binding on other benches until reversed by a higher court. Thus, the earlier judgment favoring the taxpayer was upheld.

Expert Opinion

Tax consultant Shahid Jami commented on the broader implications of the ruling, pointing out flaws in the negotiation and implementation of tax treaties. According to Jami, officials negotiating treaties often prioritize agreements without fully considering Pakistan’s national interests. Consequently, when taxpayers claim exemptions based on these treaties, tax authorities face challenges reconciling treaty provisions with domestic tax laws.

Jami further explained that under these treaties, taxing rights for certain types of income, such as rental income and capital gains, are allocated to the UAE and UK. However, since the UAE does not currently impose taxes on these income categories, the income remains untaxed in either country. While this situation is difficult for tax authorities to accept, the Supreme Court’s principles confirm that the treaty provisions must prevail.

Implications

This ruling reinforces Pakistan’s adherence to its international tax obligations and establishes clarity on the taxation of foreign income. The decision also highlights the need for better negotiation and structuring of tax treaties to align with Pakistan’s economic and fiscal objectives.

With the investigation of such cases continuing, the ruling serves as a benchmark for interpreting treaty provisions and ensures that taxpayers’ rights under international agreements are upheld.