FBR outlines how taxable business income and deductible expenses of Pakistani permanent establishments of non-resident persons will be determined.
The Federal Board of Revenue (FBR) has outlined the tax treatment of a permanent establishment (PE) in Pakistan belonging to a non-resident person for Tax Year 2027.
The FBR issued the Income Tax Ordinance, 2001, updated up to June 30, 2026, for Tax Year 2027, covering the period from July 1, 2026 to June 30, 2027.
Under Section 105, the FBR has prescribed principles for determining the income of a permanent establishment in Pakistan of a non-resident person chargeable to tax under the head “Income from Business”.
PE treated as separate entity
Section 105 requires the profit of a permanent establishment to be calculated as if it were a distinct and separate person carrying out the same or similar activities under the same or similar conditions.
The PE is also treated as dealing independently with the non-resident person of which it forms part.
This approach is used to determine the business income attributable to the Pakistani permanent establishment for tax purposes.
Deductions for business expenses
Subject to the provisions of the Income Tax Ordinance, deductions are allowed for expenses incurred for the business activities of the permanent establishment.
These can include executive and administrative expenses incurred either in Pakistan or elsewhere, provided the relevant conditions for deductibility are met.
However, Section 105 places restrictions on certain payments and internal dealings between a Pakistani PE and its head office or another permanent establishment of the same non-resident person.
Payments to head office may not be deductible
The restrictions cover royalties, fees or similar payments made for the use of tangible or intangible assets by the permanent establishment.
They also apply to compensation for services, including management services, performed for the permanent establishment.
Similarly, profit on debt relating to money lent to the permanent establishment is not deductible, except where the payment relates to a banking business.
The provision also excludes reimbursement of actual expenses incurred by the non-resident person towards third parties from the restricted internal payments.
Amounts charged by PE also restricted
Section 105 also provides that certain amounts charged by a permanent establishment to its head office or another permanent establishment of the same non-resident person are not taken into account when determining the PE’s income.
These include royalties, fees or similar payments for the use of tangible or intangible assets and compensation for services, including management services.
Profit on debt relating to money lent by the permanent establishment is also covered by the restriction, subject to the exception applicable to banking business.
Limit on head office expenditure
The FBR has placed a specific restriction on deductions relating to head office expenditure.
Under Section 105(2), a permanent establishment in Pakistan cannot claim a deduction for head office expenditure exceeding the amount that bears the same proportion to the PE’s turnover in Pakistan as the non-resident person’s total head office expenditure bears to its worldwide turnover.
The provision therefore links the allowable deduction to the proportion represented by the Pakistani permanent establishment’s turnover within the non-resident person’s overall business.
What constitutes head office expenditure?
Section 105(3) defines head office expenditure as executive or general administration expenditure incurred by the non-resident person outside Pakistan for the business purposes of its Pakistani permanent establishment.
The definition includes rent, local rates and taxes, excluding foreign income tax, as well as current repairs and insurance against risks of damage or destruction outside Pakistan.
It also covers salaries paid to employees working for the head office outside Pakistan and travelling expenses incurred by those employees.
Other expenditure prescribed under the relevant rules may also fall within the definition of head office expenditure.
Debt financing restrictions
The FBR has separately restricted deductions relating to debt used to finance the operations of a Pakistani permanent establishment.
Under Section 105(4), no deduction is allowed in calculating the business income of the PE for any profit paid or payable by the non-resident person on debt used to finance its operations.
Similarly, no deduction is allowed for any insurance premium paid or payable by the non-resident person in respect of such debt.
Tax framework for non-resident PEs
The provisions establish the framework for determining the taxable business income of permanent establishments belonging to non-resident persons in Pakistan.
The rules allow qualifying business expenses while restricting deductions arising from certain internal dealings with overseas head offices and related permanent establishments, as well as specified head office expenditure and debt-financing costs.
The provisions apply to the determination of taxable income for Tax Year 2027, covering the period from July 1, 2026 to June 30, 2027.