Paper F6 (PKN) Taxation (Pakistan) Monday 6 December Fundamentals Level Skills Module. The Association of Chartered Certified Accountants

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1 Fundamentals Level Skills Module Taxation (Pakistan) Monday 6 December 2010 Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FIVE questions are compulsory and MUST be attempted. Tax rates and allowances are on pages 2 3. Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall. Paper F6 (PKN) The Association of Chartered Certified Accountants

2 SUPPLEMENTARY INSTRUCTIONS 1. Calculations and workings need only be made to the nearest rupee. 2. All apportionments should be made to the nearest month except where exact number of days is given in the question. 3. All workings should be shown. TAX RATES AND ALLOWANCES The following tax rates and allowances for the tax year 2010 are to be used in answering all questions on this paper. A. Tax rates for salaried individuals where salary income exceeds 50% of taxable income Taxable income Rate of tax Up to Rs. 200,000* 0% Rs. 200,001 Rs. 250, % Rs. 250,001 Rs. 350, % Rs. 350,001 Rs. 400, % Rs. 400,001 Rs. 450, % Rs. 450,001 Rs. 550, % Rs. 550,001 Rs. 650, % Rs. 650,001 Rs. 750, % Rs. 750,001 Rs. 900, % Rs. 900,001 Rs. 1,050, % Rs. 1,050,001 Rs. 1,200, % Rs. 1,200,001 Rs. 1,450, % Rs. 1,450,001 Rs. 1,700, % Rs. 1,700,001 Rs. 1,950, % Rs. 1,950,001 Rs. 2,250, % Rs. 2,250,001 Rs. 2,850, % Rs. 2,850,001 Rs. 3,550, % Rs. 3,550,001 Rs. 4,550, % Rs. 4,550,001 Rs. 8,650, % Over Rs. 8,650, % * For a woman taxpayer, no tax is chargeable if taxable income does not exceed Rs. 260,000 B. Tax rates for non-salaried individuals and association of persons to whom the rates given in A are not applicable Taxable income Rate of tax Up to Rs. 100,000* 0% Rs. 100,001 Rs. 110, % Rs. 110,001 Rs. 125, % Rs. 125,001 Rs. 150, % Rs. 150,001 Rs. 175, % Rs. 175,001 Rs. 200, % Rs. 200,001 Rs. 300, % Rs. 300,001 Rs. 400, % Rs. 400,001 Rs. 500, % Rs. 500,001 Rs. 600, % Rs. 600,001 Rs. 800, % Rs. 800,001 Rs. 1,000, % Rs. 1,000,001 Rs. 1,300, % Over Rs. 1,300, % * For a woman taxpayer, no tax is chargeable if taxable income does not exceed Rs. 125,000 2

3 C. Internally Displaced Persons Tax (IDPT) For certain salaried individuals IDPT on bonus 30% D. Tax rates for companies Public/private company On taxable income 35% Minimum tax 0 5% of turnover E. Rates of deduction of tax at source Sale of goods 3 5% Services 6% Contracts 6% Commission or brokerage 10% Profit on debt 10% F. Tax rate for income from property (i) (ii) For individuals and association of persons Up to Rs. 150,000 0% Rs. 150,001 to Rs. 400,000 5% of the amount exceeding Rs. 150,000 Rs. 400,001 to Rs. 1,000,000 Rs. 12,500 plus 7 5% of the amount exceeding Rs. 400,000 Above Rs. 1,000,000 Rs. 57,500 plus 10% of the amount exceeding Rs. 1,000,000 For companies Up to Rs. 400,000 5% Rs. 400,001 to Rs. 1,000,000 Rs. 20,000 plus 7 5% of the amount exceeding Rs. 400,000 Above Rs. 1,000,000 Rs. 65,000 plus 10% of the amount exceeding Rs. 1,000,000 G. Other tax rates On dividends received from a company 10% H. Capital allowances Depreciation Rates Buildings (all types) 10% Furniture and fittings 15% Plant and machinery (not otherwise specified) 15% of the tax written down value Motor vehicles (all types) 15% Computer hardware 30%} Initial allowance 50% of cost I. Benchmark rate Interest free loan to employees 12% per annum 3 [P.T.O.

4 ALL FIVE questions are compulsory and MUST be attempted 1 Revolution Ltd ( the company ) is a company incorporated in Pakistan under the Companies Ordinance, 1984 and is listed on all stock exchanges of Pakistan. The company is engaged in selling environmentally friendly bio-technology products. The Chief Financial Officer (CFO) of the company has just produced the audited financial statement for the accounting period ended on 30 June 2010 depicting paid-up capital of Rs. 100 million, gross turnover of Rs. 50 million and net profit of Rs. 4 5 million. The tax manager of the company has also provided the following additional information: (1) The company purchased a secret formula for certain innovative products at a total cost of Rs. 1,500,000 from an Armenian citizen who was also resident in Armenia. Tax was duly deducted from this amount and deposited into the treasury. The amount was paid using a crossed demand draft. The formula does not have an ascertainable useful life and was used for 273 days during the accounting year ended on 30 June An estimated amount of Rs. 1,000,000 was charged to the profit and loss account for the use of the formula during the year. (2) A product was sold for Rs. 500,000 through a commission agent who retained his commission of Rs. 50,000 and remitted the balance of Rs. 450,000 to the company. The company has claimed the Rs. 50,000 as commission paid in its selling expenses. (3) Repairs and maintenance expenses included: (i) Rs. 200,000 spent on the replacement of worn out parts of a machine. (ii) Rs. 500,000 spent on enhancing the useful life of another machine by five years, as well as increasing its efficiency. (4) Rs. 4,000,000 was charged as accounting depreciation. The tax depreciation is yet to be computed but the following schedule of fixed assets has been prepared by the company s tax manager: Description of asset Tax written down Addition TWDV of Sale price value (TWDV) on assets of assets 1 July 2009 disposed disposed Rs. Rs. Rs. Rs. Buildings 5,000, Plant and machinery 4,000,000 2,000, , ,000 Computers 2,000, ,000 50,000 50,000 Vehicles 4,000,000 2,000, Furniture and fittings 2,000, ,000 50, ,000 Note: (i) All purchases were made by payment in cash. (ii) The addition to vehicles represents the purchase of a car for office use. (iii) The sale prices indicate the fair market value except for the computer, which was sold to an ex-employee. The computer would have fetched Rs. 100,000 in the open market. (5) The net profit includes a gain of Rs. 60,000 on the sale of fixed assets. (6) A trading liability of Rs. 500,000 was allowed as admissible expenditure on an accrual basis in the tax year 2003 but is still appearing as payable in the company s books. This amount has never been added back to taxable income in any previous tax year. (7) The net profit includes gross rent of Rs. 600,000 received from Mr Shakeel, a local trader, for the use of a warehouse. The following expenses relating to this warehouse were charged to the profit and loss account for the year ended 30 June Property tax paid Rs. 125,000 Repair allowance Rs. 120,000 No accounting depreciation has been claimed on this warehouse. The tax written down value of the buildings in (4) above does not include this warehouse. (8) The supplies of the company were mainly made to persons who are not registered under the Sales Tax Act,

5 (9) The company received share deposit money of Rs. 1,000,000 in cash from one of its shareholders. Complete particulars of the depositor along with his source of income are available in the records of the company. (10) An amount of Rs. 500,000 written off as a bad debt was charged as an expense. The details provided indicate that out of this amount: (i) Rs. 100,000 was on account of debtors who may default in future; (ii) Rs. 200,000 was on account of a loan which was given to an ex-director who has left the country for good. There are no chances of its recovery. (iii) Rs. 200,000 was on account of long-outstanding debts owed by many small trade debtors and written off as bad debts after exhausting all recovery measures. However, the measures did not include the filing of suits of recovery in a court of law as the company considered that this was not cost effective. (11) Miscellaneous expenses includes the write off of Benzene, a chemical used by the company as a raw material, with a cost of Rs. 200,000, because it could not be used after its expiry date. (12) The payment of utility bills during the year included a late payment surcharge of Rs. 100,000. (13) The company failed to deduct tax from a payment of Rs. 300,000 which was made to a supplier supplying chemicals under a contract for use in its laboratory. The amount was, however, paid using crossed cheques and fully verifiable. (14) The profit and loss account did not include the share of profit derived by the company from an association of persons (AOP). The taxable income of the AOP was Rs. 1,000,000 and the company s share of this profit was Rs. 440,000. The income of the AOP did not fall under the final tax regime (FTR). (a) Compute the taxable income of Revolution Ltd for the tax year 2010, giving brief explanations of your treatment of the items excluded from taxable income. (24 marks) (b) (c) Compute the total tax payable by Revolution Ltd, including under the final tax regime, assuming that neither the workers welfare fund nor quarterly advance income tax was payable by the company. (4 marks) State, giving reasons, at what rate Revolution Ltd should have deducted tax on the payment made to the contractor on account of his supply of chemicals (not being pharmaceuticals) for its laboratory. (2 marks) (30 marks) 5 [P.T.O.

6 2 (a) Mr Sannan, a Pakistani citizen born on 1 January 1974, had resided in Canada for ten years until 30 June On 1 July 2009 he returned to Pakistan and joined Hi-Tech (Pvt) Ltd (HPL), a company engaged in the production of bio-products. HPL paid him Rs. 2,500,000 as consideration for joining the company as an employee on 1 July However, HPL is entitled to recover 50% of this amount if Mr Sannan leaves the company before 30 June The annual emoluments received by Mr Sannan from HPL during the year ended 30 June 2010 were as follows: Basic salary Rs. 10,000,000 Medical allowance Rs. 500,000 Leave fare assistance Rs. 400,000 Other information relevant to Mr Sannan for the tax year 2010 is as follows: (1) An option to purchase 1,000 shares of HPL was given to him on 31 December 2009 at Rs. 20 per share when the break up value of the company was Rs. 100 per share. (2) HPL provided him with laptop, TV, and multi-media of the latest models for his use at home on 1 July The book value of these gadgets was Rs. 1,000,000 and 20% depreciation was charged by HPL. The gadgets are returnable to the company after five years. (3) The basic salary received of Rs. 10,000,000 does not include Rs. 500,000, given by HPL, in cash, on behalf of Mr Sannan as a donation to a hospital established by the government of Sindh. (4) HPL gave him a loan of Rs. 3,000,000 on 1 January 2010 for the purchase of a house. HPL charged him profit on this loan at the rate of 8% per annum. On the same date Mr Sannan also obtained a loan of Rs. 2,000,000 from a scheduled bank on which the bank charged him profit at the rate of 13% per annum. In addition, his uncle gave him a gift of Rs. 3,000,000 in cash for the purchase of the house. Mr Sannan purchased the house for Rs. 8,000,000 on 10 January The profit on the loans was duly paid to both the bank and the company up to 30 June (5) Salary of Rs. 500,000 was received by Mr Sannan in arrears from his ex-employer in Canada. (6) Rs. 1,000,000 was received by Mr Sannan on account of rent for his apartment in the USA. (7) Mr Sannan spent Rs. 300,000 on purchase of books and subscription of research magazines to keep his professional knowledge updated. (8) Mr Sannan paid Rs. 2,000,000 to head-hunter recruitment consultants in Pakistan to help him secure his employment with HPL. (9) Mr Sannan made a cash payment of Rs 500,000 on account of Zakat under the Zakat and Ushr Ordinance, (10) As per the terms of his employment, Mr Sannan was entitled to reimbursement of his medical and hospitalisation charges. Such reimbursement during the year ended 30 June 2010 was Rs. 50,000. (11) Mr Sannan received Rs. 100,000 as profit on his profit and loss sharing account maintained with the bank. The bank withheld Rs. 10,000 as tax from this amount. (12) Mr Sannan purchased the following shares on 25 March 2010: shares for Rs. 3,500,000 in Faisalabad Fabrics (Pvt) Ltd, as an original allottee; shares for Rs. 300,000 in Good Luck Ltd, a company quoted on the Lahore Stock Exchange (Guaranteed) Ltd, on the initial offer of the company s shares to the general public. (13) Mr Sannan contributed Rs. 700,000 to an approved pension fund under the Voluntary Pension System Rules, (14) Mr Sannan received a dividend of Rs. 1 per share on account of his holding of 350,000 shares in Faisalabad Fabrics (Pvt) Ltd. No tax was deducted by the company from this dividend on the understanding that Mr Sannan had bought the shares out of his foreign earnings. 6

7 Compute Mr Sannan s taxable income and total tax payable for the tax year 2010, assuming that no tax was withheld by his employer, Hi-Tech (Pvt) Ltd. Give brief reasons for the treatment of the items excluded from taxable income or for which no expense deduction is allowed. (20 marks) (b) On 15 October 2010, the Commissioner of Income Tax (Enforcement and Audit Division), having jurisdiction of Hi-Tech (Pvt) Ltd, issued the company with a show notice asking for various explanations regarding the non-deduction of tax and claiming additional tax from the company for the default period of 1 January 2010 to 15 October Assuming that Mr Sannan paid the tax (as computed in part (a)) on 30 September 2010, state the arguments that Hi-Tech (Pvt) Ltd (HPL) can use to respond to the following issues raised in the show notice: (i) Why the amount of tax that HPL failed to deduct from the salary paid to Mr Sannan during the year ended 30 June 2010 should not be recovered from the company. (ii) Why HPL may not be made liable to pay additional tax on the amount of tax not deducted for the period of default stated in the show notice. (iii) Why the amount of salary paid to Mr Sannan should not be treated as an inadmissible expense in computing HPL s taxable income. (3 marks) (c) State the tax implications, other than on account of a capital gain or loss, that would arise if the shares in Good Luck Ltd were sold by Mr Sannan on 25 September (2 marks) (25 marks) 7 [P.T.O.

8 3 (a) Mr Shahid, a resident in Pakistan, disposed of the following assets during the year ended 30 June 2010 in the manner indicated below: (1) 10 August 2009: Sold his personal car to his brother for Rs. 800,000. The fair market value of the car was Rs. 1,000,000 and it had been purchased by him on 10 June 2009 at total cost of Rs. 1,200,000. (2) 12 October 2009: Sold a statue of Buddha for Rs. 250,000. The statue had been gifted to him by his wife in 2003 when the market value of the statue was Rs. 150,000. His wife had purchased the statue for Rs. 100,000 from an antique shop on 10 July (3) 10 November 2009: Sold 5,000 shares in Innovation Ltd, a company quoted on the Lahore Stock Exchange but unquoted on all other stock exchanges of Pakistan, for Rs. 800,000. The shares had been received as a gift from his mother on 30 September 2008, on which date they were traded at Rs. 100 per share. (4) 1 January 2010: 4,000 shares in ABC Ltd, an unlisted company, were sold for Rs. 500,000. He had acquired these shares as under: 4 April ,000 shares costing Rs. 50,000 7 August ,000 shares costing Rs. 110,000 8 December for 3 rights issue was taken up fully, costing Rs. 40 per share; the company also issued bonus shares at the rate of 1 share for each 3 shares in issue before the rights issue. (5) 15 February 2010: An oil painting, which had been hanging in his drawing room, was sold for Rs. 550,000. The painting had been acquired on 1 January 2010 in exchange for an old car, which at that time had a market value of Rs. 200,000. (6) 20 February 2010: An antique vase purchased for Rs. 250,000 on 15 August 2001 was sold for Rs. 800,000 through an auctioneer who was paid Rs. 75,000 in cash as commission. Tax was deducted from the amount of commission paid and deposited with the Commissioner of Income Tax. (7) 21 February 2010: A silver necklace was sold for Rs. 100,000. The necklace had been purchased on 3 January 2003 for Rs. 250,000. (8) 1 March 2010: Sold his farmhouse for Rs. 5,000,000. The farmhouse had been purchased on 1 December 2009 for Rs. 4,000,000. (9) 15 April 2010: Sold 8,000 shares in KLM (Pvt) Ltd for Rs. 20 per share. He had purchased the shares on 30 June 2009 from his brother, Mr Akmal, for Rs. 10 per share. However, capital gains in the hands of Mr Akmal had been worked out by the taxation officer on the basis that the consideration received was Rs. 15 per share. (10) 15 July 2009: Received compensation from the government of Rs. 800,000 for plant purchased for Rs. 600,000 on 1 July The plant was for the manufacture of black polythene shopping bags but before it was installed, the government had introduced a law to ban such bags. On 20 August 2009 he purchased new plant capable for producing white bags for Rs. 900,000. Mr Shahid has unadjusted losses determined by the tax department for previous tax years as follows: Tax year Loss Rs. Income from business ,000 Income from other sources ,000 Capital loss on shares of: a company listed on Lahore Stock Exchange ,000 a private limited company ,000 Compute the taxable income of Mr Shahid under the head capital gains and the tax due thereon for the tax year Give reasons for your treatment of each item. (18 marks) 8

9 (b) Mr Shahid purchased 5,000 shares in Toy (Pvt) Ltd for Rs. 50 per share on 1 January These shares were still held by him on 30 June 2010 at which time the shares were being traded among shareholders of the company for Rs. 20 per share. There is no likelihood that the share price will resurge to Rs. 50 in the near future. Explain the treatment Mr Shahid s impending loss on the shares held in Toy (Pvt) Ltd, on 30 June 2010 under the Income Tax Ordinance, (2 marks) (20 marks) 9 [P.T.O.

10 4 (a) Mr Yousha is registered under the Sales Tax Act, 1990 as a manufacturer of taxable consumer goods [canned foods]. In the tax year 2010, all his goods were sold to companies registered under the Sales Tax Act, 1990 and the companies duly deducted tax at 3 5% on the payments made to Mr Yousha on account of these supplies. Mr Yousha s accountant thinks that he is entitled to a tax credit at 2 5% of the tax payable on account of these supplies in the tax year State, giving reasons, whether the opinion of Mr Yousha s accountant is correct, based on the Income Tax Ordinance, (4 marks) (b) Mr Subaiyal is confused about the difference between the two expressions total income and taxable income. Explain for the benefit of Mr Subaiyal the difference between the two expressions based on the Income Tax Ordinance, (3 marks) (c) Mr Waail, a resident of Pakistan, derived the amounts as under in the tax year 2010: (1) Rs. 1,000,000 from crops grown on his agricultural land situated in Canada. (2) Rs. 1,500,000 gross, received from the poultry farm he established in June 2009 in Rawalpindi. (3) Rs. 1,000,000 from the deposit of a prospective buyer of his flat, forfeited by Mr Waail when the buyer failed to fulfil the terms of the contract for the sale of the flat. State, giving reasons, whether the amounts received by Mr Waail will be taxable or exempt for the tax year 2010, based on the Income Tax Ordinance, Note: you should ignore the effect of any tax treaty provisions. (3 marks) (d) Modern Agricultural Farms Ltd is a public listed company that derives its total income from growing sugarcane on its own farms situated in Faisalabad. On 30 November 2009, the company paid a dividend to its shareholders, but no tax was deducted as the company derived its income from agriculture. State, giving reasons, whether the company can be treated as a defaulter for the non-deduction of tax from the dividend paid. (2 marks) (e) Mr Ukasha derived taxable income of Rs. 1,000,000 from his wholesale business of trading in pesticides in the tax year During the same tax year, as a member of an association of persons (AOP), he also received his share of the AOP s profit of Rs. 600,000. The AOP had already paid tax on all of its taxable income fully covered under the normal law. Compute the tax liability of Mr Ukasha for the tax year (3 marks) (15 marks) 10

11 5 For the purpose of this question, you should assume today s date is 4 July Zubair Enterprises Ltd (ZEL), a registered person under the Sales Tax Act, 1990, is engaged in the production of consumer goods. The company s business transactions for the month of June 2010 were: Rs. Rs. Sale of taxable goods to registered persons 20,000,000 Sale of taxable goods to unregistered persons 25,000,000 Less: Trade discount at 10% (2,500,000) 22,500,000 Exports of goods sold to Saudi Arabia 18,000,000 Payment for purchases of raw materials for manufacturing taxable local supplies 42,000,000 Payment for purchases of raw materials for manufacturing exports 16,000,000 The company s records further show that: (1) The figures for the sales of goods (including exports) are all stated exclusive of sales tax. (2) The rate of discount is in conformity with the normal business practice in the industry but was not shown on the tax invoices. (3) Goods with the value of Rs. 100,000 were given free of cost to the Chief Executive of the company in accordance with his terms of employment. (4) All payments were made inclusive of sales tax and paid through crossed cheques. (5) Payment on account of the purchase of a new machine for the manufacture of goods meant for export only, of Rs. 10,000,000 (inclusive of sales tax) was made during May The machine was used for the first time in June (6) Input tax of Rs. 100,000 pertaining to the raw materials purchased for the manufacture of taxable goods in November 2009 could not be claimed due to an oversight. (a) (b) Calculate the sales tax payable or refundable to Zubair Enterprises Ltd, for the month of June 2010, giving explanations for treatment of: the trade discount allowed to unregistered persons; the goods given to the Chief Executive; the input tax on the machinery purchased for the manufacture of goods meant for export only; and the input tax not claimed in the return for November (7 marks) Zubair Enterprises Ltd (ZEL) has made purchases of taxable goods from a registered person but suspects that the registered person has not paid the tax in respect of these supplies. State whether the amount of tax unpaid by the supplier can be recovered from ZEL, together with any actions that the company might take to mitigate any potential liability. (3 marks) (10 marks) End of Question Paper 11