SHC declares income tax on undistributed profits as unconstitutional

SHC declares income tax on undistributed profits as unconstitutional

KARACHI: Sindh High Court (SHC) on Friday declared levy of tax on undistributed profits under Section 5A of Income Tax Ordinance, 2001 as unconstitutional and set aside all the show cause notices and demand notices issued by the tax authorities under the section.

A division bench of the SHC ordered in Sapphire Textile Mills Limited vs Federation of Pakistan & Others: “insertion of Section 5A in the Income Tax Ordinance, 2001, including amendments theretho from time to time, does not fall within the parameters delineated per Article 73 of the constitution of Pakistan, 1973, hence, the provision impugned is found to be ultra vires of the constitution, and is hereby struck down.”

It ordered further that as a consequence, any show cause / demand notices or constituents thereof, seeking enforcement of Section 5A of the Income Tax Ordinance, 2001, are hereby set aside.

A large number of taxpayers filed petition before the higher court seeking relief against action initiated by Federal Board of Revenue (FBR).

The petitioners challenged the Section 5A of the Income Tax Ordinance, 2001, which was initially inserted in the Ordinance through Finance Act, 2015 and amended through Finance Act, 2017, ostensibly in order to induce certain public companies to distribute dividends among their shareholders.

In original form, as inserted through Finance Act, 2015, the tax was levied upon the reserves of a company. However, post Finance Act, 2017 the levy befell upon accounting profit before tax of a company.

The petitioners requested the court to declare the provision as unconstitutional. The plain reading of Section 5A suggests that it amounts to double taxation, as income received or taxed in the same hand ceases to be income.

It is submitted: “the regulation of companies is undertaken inter alia vide the Companies Act, 2017, being special in nature, and any attempt at such regulation by inserting penal provisions into the Ordinance routed through a money bill, was prima facie unmerited.”

Counsel for the respondents submitted: “5A did not amount to double taxation as it contemplated an independent levy.”

It was argued that 5A identified a class to be taxed, hence, could not be considered discriminatory.

It was concluded that the legislature had ample power to regulate economic behavior and 5A was merely one specie of exercise of such power.

The court observed that 5A of the Ordinance amounts to legislation, not contemplated in the Constitution to be undertaken vide a money bill. “In such a scenario no rationale has been articulated before us to justify the regulation of companies behavior, pertaining to dividends, to be effected vide a money bill, within the mandate of Article 73 of the Constitution, while abjuring the regular legislative process.

“Therefore, it is our deliberated view that section 5A of Income Tax Ordinance, 2001 cannot be sustained on the constitutional anvil; hence, could not be construed to have legal effect.”

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