Division of Expenditures & Deductions for Multiple Sources of Income

Apportioning expenditures, deductions, and allowances under Rule 13 of the Income Tax Rules is a systematic process that ensures fair distribution of costs across various income classes. This guide elaborates on the rule’s application and methodology as per the law, emphasizing clarity and compliance.

Applicability of Rules

Rule 13 applies specifically to Section 67 of the Income Tax Ordinance, which governs the apportionment of expenditures, deductions, and allowances incurred for multiple purposes. The rule ensures that such expenses are distributed appropriately among different classes of income.

1. Allocation for Specific Income Classes

Expenditures incurred for a particular class of income should be directly allocated to that income class. For instance, expenses related solely to “Income from Property” must be fully attributed to that head.

2. Allocation of Common Expenditures

When expenditures are common and cannot be attributed to a specific income class, a formula-based approach is used for apportionment:

Formula:

• A x B / C

Where:

• A: Total common expenditure incurred.
• B: Total gross receipts (without deduction of expenses) for a specific class of income.
• C: Total gross receipts (without deduction of expenses) and net gains for all classes of income.

3. Allocation of Brokerage, Commission, and Similar Income

When apportioning brokerage, commission, and other related income, the formula considers gross profit for calculating components B and C.

Factors to Consider in Allocation

1. Nature and Source of Income
   Allocations should reasonably reflect the nature of the income, ensuring that the expenses correspond to the efforts and activities required to generate that income.
2. Selling Expenses
   Particular attention is given to selling expenses, which are directly attributable to specific income classes based on their contribution to revenue generation.

Certification Requirements

• Audited Books of Accounts:
  A certificate from a Chartered Accountant (CA) or a Cost and Management Accountant (CMA) is required, stating the basis of allocation. This certificate is generally accepted unless significant discrepancies (beyond ±10%) are identified.
• Unaudited Books of Accounts:
  For businesses not requiring audited accounts, a reasonable basis of allocation must be adopted and approved by the Commissioner. However, variations beyond ±10% may warrant additional scrutiny.

Classification of Income Classes

Rule 13 categorizes income into distinct “classes of income” for allocation purposes. These include:

1. Salary
   • Pakistan-source income.
   • Foreign-source income.
2. Income from Property
   • Pakistan-source income.
   • Foreign-source income.
3. Income from Business
   • Pakistan-source income (excluding Section 19).
   • Foreign-source income (excluding Section 19).
4. Speculation Business
   • Pakistan-source income.
   • Foreign-source income.
5. Capital Gains
   • Pakistan-source income.
   • Foreign-source income.
6. Income from Other Sources
   • Pakistan-source income.
   • Foreign-source income.
7. Exempt Income

Definition of Common Expenditures

Common expenditures refer to costs that cannot be clearly attributed to a specific class of income. Examples include general administrative costs, office utilities, and salaries for non-revenue-specific roles.

1. Documentation and Certification
   Maintain clear records of all allocations, supported by a CA or CMA certification when applicable.
2. Reasonableness and Fairness
   The basis for allocation should be reasonable and reflective of the actual effort or expense incurred in earning each class of income.
3. Variance Thresholds
   Be mindful of the ±10% threshold for variances. Significant deviations may lead to further inquiries or adjustments by tax authorities.
4. Exclusion of Non-Business Advances
   Financial expenses related to non-business advances or loans should be excluded from the allocation process.

Explanation of Terms

• Gross Receipts: Net-off receipts or turnover, excluding sales tax or Electronic Fund Transfer (EFD) paid.
• Common Expenditures: General administrative expenses not attributable to a specific income class.

Understanding and implementing Rules ensures fair and compliant apportionment of expenses across various income classes. By following the prescribed methodology, businesses can achieve accurate tax computations and reduce the risk of disputes with tax authorities. Proper documentation and adherence to reasonable allocation principles are key to successful implementation.