Pakistan is a country that attracts a significant amount of foreign investment and remittance flows. As a result, there are many residents in Pakistan who have foreign-source income. The tax treatment of such income is governed by the Income Tax Ordinance, 2001. In this article, we will discuss the tax treatment of foreign source income for Pakistani residents and how they can benefit from it.
Exemption from Taxation
Under the Income Tax Ordinance, 2001, any foreign-source salary received by a resident individual shall be exempt from tax if the individual has paid foreign income tax in respect of the salary. This means that if an individual has paid tax on their foreign-source income in the country where they earned it, they will not have to pay tax on that income again in Pakistan.
Qualifying for Foreign Income Tax Payment
To be treated as having paid foreign income tax, the individual must have had tax withheld from their salary by their employer and paid to the revenue authority of the foreign country where the employment was exercised. This ensures that the foreign income tax has actually been paid and that the individual is not trying to avoid paying taxes in either country.
If a resident taxpayer derives foreign source income chargeable to tax under this ordinance, and they have paid foreign income tax on that income, they shall be allowed a tax credit. The tax credit is equal to the lesser of the foreign income tax paid or the Pakistan tax payable in respect of the income. This means that the individual will not have to pay tax twice on the same income, and the tax credit ensures that they are not double-taxed.
Computation of Pakistan Tax Payable
The Pakistan tax payable in respect of foreign source income derived by a taxpayer in a tax year is 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. This ensures that the individual is only paying tax on their net income after deducting any allowable expenses related to the derivation of foreign-source income.
Separate Head of Income
If a taxpayer has foreign income under more than one head of income in a tax year, this section applies separately to each head of income. Income derived from carrying on a speculation business is treated as a separate head of income for this purpose.
Utilization of Tax Credit
The tax credit allowed under this section shall be applied in accordance with sub-section (3) of section 4. 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. This means that any unused tax credit cannot be carried forward or back and must be used in the current tax year.
Time Limit for Payment of Foreign Income Tax
The foreign income tax must be 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. This ensures that the tax credit is only allowed for taxes that have actually been paid and not for future taxes that may or may not be paid.
The deductible expenditures incurred by a person in deriving foreign-source income chargeable to tax under a head of income shall be deductible only against that income. If the total deductible expenditures exceed the total foreign-source income for a tax year chargeable to tax under a head of income, the excess will be carried forward to the following tax year and set off against the foreign source income chargeable to tax under that head in that year. This allows individuals to deduct any expenses related to the derivation of foreign-source income.
To sum up, residents in Pakistan who earn foreign-source income can benefit from favorable tax treatment as long as they have paid foreign income tax on that income. This ensures that they are not subject to double taxation and that they are only taxed on their net income after allowable expenses. The tax credit provided under the Income Tax Ordinance, 2001 is a valuable benefit for individuals with foreign-source income, as it ensures that they are not taxed twice on the same income. By taking advantage of these provisions, individuals can optimize their tax liabilities and maximize their earnings from foreign investments and remittances.