Karachi, September 29, 2024 – The Federal Board of Revenue (FBR) has introduced new guidelines for the taxation of permanent establishments in Pakistan for the tax year 2024-25. These guidelines, extending the current regulations, govern the taxation of permanent establishments under Section 105 of the Income Tax Ordinance, 2001.
A permanent establishment (PE) refers to a fixed place of business through which a non-resident person carries out business in Pakistan. The taxation of such establishments is crucial for ensuring fair tax practices and compliance. According to the FBR, Section 105 outlines the principles to determine the taxable income of a permanent establishment in Pakistan.
The key points of these guidelines include the following:
Independent Entity Concept
The first principle laid out by the FBR is that a permanent establishment in Pakistan is treated as a distinct and separate entity. This means that even though the PE is part of a non-resident company, it is taxed as if it operates independently. Its profits are computed based on its activities in Pakistan, under the same or similar conditions as any local entity performing comparable functions.
Allowable Deductions
The FBR clarifies that deductions are allowed for expenses incurred by the PE for its business activities. This includes executive and administrative expenses, regardless of whether they are incurred in Pakistan or in another country. This provision ensures that PEs are only taxed on their net profits after considering legitimate business expenses.
However, certain payments made by the PE to its head office or other branches are not eligible for deductions. These include:
1. Royalties, fees, or similar payments for using tangible or intangible assets.
2. Compensation for services, such as management services, performed by the head office for the PE.
3. Interest on debt, except for loans connected to banking businesses.
This rule ensures that PEs do not artificially reduce their taxable income by transferring profits to their head offices or other branches through these types of payments.
Internal Charges
Similarly, when a PE charges its head office for services or assets, these amounts are not considered when calculating the PE’s taxable income. This rule is designed to prevent manipulation of profits by inflating internal charges between a PE and its head office.
Limit on Head Office Expenditures
The FBR has set a limit on the amount of head office expenditure that can be deducted by a PE in Pakistan. This limit is proportional to the PE’s turnover in Pakistan relative to the worldwide turnover of the non-resident company. The purpose of this rule is to ensure that head office expenses are allocated fairly and that PEs in Pakistan are not deducting an excessive share of their parent company’s costs.
Exclusions from Deductions
There are further restrictions on deductions for certain types of expenditures. For instance, no deduction is allowed for:
1. Interest on debt used to finance the operations of the PE.
2. Insurance premiums paid on such debt.
This prevents PEs from claiming deductions for financing costs that are not directly related to their business operations in Pakistan.
Definition of Head Office Expenditure
The FBR also defines what qualifies as “head office expenditure” for the purposes of calculating deductions. These include general administration costs incurred outside Pakistan, such as rent, taxes (excluding foreign income tax), salaries for head office employees, travel expenses, and other prescribed costs.
In conclusion, the FBR’s updated guidelines ensure transparency and fairness in the taxation of permanent establishments. By treating PEs as independent entities and restricting certain deductions, the FBR aims to prevent tax avoidance and ensure that non-resident companies pay their fair share of taxes on profits earned in Pakistan. These guidelines are vital for strengthening the tax system and ensuring compliance by multinational corporations operating in the country.
