Understanding Business Expenses and Deductions under the Income Tax Ordinance 2001 in Pakistan

Starting and running a business in Pakistan involves navigating a complex array of tax regulations, including understanding which expenses are deductible. This guide simplifies the key rules and limitations around deductibles, empowering you to optimize your tax planning and minimize your tax burden.

Start-up Expenses:

  • Expenses incurred before business commencement to generate taxable income are deductible over five years.

Interest Expense:

  • Deductible only if required withholding tax is deducted and deposited with the government.

Bad Debts:

  • Deductible if previously included in taxable income, written off in financial statements, and demonstrably irrecoverable.

Charitable Contributions:

  • Refer to the “Charitable donations credit” section for applicable deductions.

Fines and Penalties:

  • Only non-tax-related fines and penalties are deductible.

Taxes:

  • Income tax is not deductible, but sales and excise taxes incurred by the business are.

Other Significant Items:

  • Scientific research expenses in Pakistan are deductible.
  • Foreign currency loan exchange gains/losses for asset acquisition adjust the asset’s depreciation cost.
  • Lease rentals to specific entities are deductible, excluding financial charges (added back to taxable income).
  • Passenger vehicle lease rentals (non-transport) deduction cap raised to PKR 7.5 million.
  • Expenditure on sales to unregistered persons exceeding PKR 100 million per person may be partially disallowed.
  • Non-compliance with fiscal electronic device requirements can penalize 8% of total deductions.

Net Operating Losses:

  • Losses can be carried forward and offset against profits of the next six years in the same business.

Other Loss-Related Rules:

  • Group relief loss utilization is restricted if holding company ownership falls below specific thresholds.
  • Business losses from company mergers can be carried forward for six years under specific conditions.

Payments to Foreign Affiliates:

  • Deductible head office expenses are limited proportionally to the ratio of Pakistan turnover to global turnover. However, tax treaties with specific countries may override this rule.

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