Method of accounting under income tax ordinance

Method of accounting under income tax ordinance

KARACHI: The intricacies of accounting methods for income tax purposes are elucidated in Sections 32, 33, and 34 of the Income Tax Ordinance, 2001, as outlined by the Federal Board of Revenue (FBR).

The updated ordinance, effective until June 30, 2021, incorporates amendments introduced through the Finance Act, 2021.

Section 32: Method of Accounting

1. Regular Method: A person’s income subject to taxation shall be computed in alignment with the method of accounting regularly employed by that individual.

2. Company Accounting: Companies are required to account for income chargeable to tax under the “Income from Business” category on an accrual basis. Other entities have the flexibility to account for such income on either a cash or accrual basis.

3. Board’s Discretion: The Board holds the authority to prescribe that certain classes of persons must account for income chargeable to tax under the “Income from Business” category on either a cash or accrual basis.

4. Change in Accounting Method: A person may apply in writing for a change in their accounting method. The Commissioner may approve such an application if convinced that the change is necessary to accurately reflect the person’s income chargeable to tax under the “Income from Business.”

5. Adjustments for Change: If a person’s method of accounting changes, adjustments must be made to items of income, deduction, or credit to ensure no omission or duplication of items.

Section 33: Cash-Basis Accounting

• Persons accounting for income chargeable to tax under the “Income from Business” on a cash basis recognize income when received and incur expenditure when paid.

Section 34: Accrual-Basis Accounting

1. Recognition of Income: Persons accounting for income under the “Income from Business” on an accrual basis recognize income when it becomes due to the person.

2. Recognition of Expenditure: Expenditure is recognized when it becomes payable by the person.

3. Due Amounts: An amount is considered due when the person becomes entitled to receive it, even if the discharge of the entitlement is postponed or if the amount is payable by instalments.

4. Payable Amounts: An amount is payable when all events determining liability have occurred, and the amount of liability can be determined with reasonable accuracy.

5. Unpaid Liabilities: If a person has been allowed a deduction for an expenditure but has not paid the liability within three years of the end of the tax year in which the deduction was allowed, the unpaid amount becomes chargeable to tax.

6. Benefit of Trading Liability: If a person has derived a benefit from a trading liability for which a deduction was allowed, the value of the benefit is chargeable to tax when received.

7. Deductions for Payments: When an unpaid liability becomes chargeable to tax, and the person subsequently pays the liability, a deduction is allowed for the amount paid in the tax year of payment.

Disclaimer: The provided text is for informational purposes only. While efforts have been made to present the correct version, is not responsible for any errors or omissions. The sections outlined aim to bring clarity to the method of accounting for income tax purposes in Pakistan.