The Federal Board of Revenue (FBR) has issued an updated version of the Income Tax Ordinance, 2001, which now includes amendments from the Finance Act, 2021. One of the notable updates is the detailed specification of Section 109A, which addresses the taxation of income from controlled foreign companies (CFCs) for resident taxpayers.
Key Provisions of Section 109A
Section 109A mandates that income from a controlled foreign company shall be included in the taxable income of a resident person for a tax year. A controlled foreign company (CFC) is defined as a non-resident company that meets certain criteria:
1. Ownership Threshold: A non-resident company is considered a CFC if more than 50% of its capital or voting rights are held, directly or indirectly, by one or more residents of Pakistan, or more than 40% is held by a single resident person.
2. Taxation Benchmark: The non-resident company must pay less than 60% of the tax on its income, after considering any foreign tax credits, compared to what would be payable under Pakistan’s tax laws.
3. Business Activity: The non-resident company does not derive active business income, which is defined as income primarily from business operations rather than passive sources such as dividends, interest, or capital gains.
4. Stock Exchange Listing: The shares of the non-resident company are not traded on a recognized stock exchange in its country of residence.
Determination of Active Business Income
For a company to be considered as deriving active business income, more than 80% of its income must come from business operations and not from passive sources like dividends, interest, property, capital gains, royalties, or annuity payments. Furthermore, it must principally derive income under the head “income from business” in its country of residence.
Income Attribution and Tax Calculation
The income of a CFC is determined as if it were a resident taxpayer in Pakistan, and is taxed at the rate specified in Division III of Part I of the First Schedule. The attributable income is calculated using the formula:
A×(B/100)A \times (B/100)A×(B/100)
where:
• AAA is the income of the CFC, and
• BBB is the percentage of capital or voting rights held by the resident person.
If the resident person’s share is less than 10%, or if the CFC’s income is less than 10 million Rupees, the attributable income is considered zero.
Currency Conversion
The income of a CFC, determined in its foreign currency, is converted into Rupees at the State Bank of Pakistan’s rate as of the last day of the tax year.
Avoidance of Double Taxation
Income taxed under Section 109A will not be taxed again when received in Pakistan by the resident taxpayer. Additionally, if a resident person pays tax on the CFC’s income and later receives dividends from the CFC, they are entitled to a tax credit for the foreign tax paid on those dividends.
Implications for Pakistani Residents
These provisions ensure that Pakistani residents cannot defer or avoid taxes by using controlled foreign companies. By including the income of CFCs in the taxable income of residents, the FBR aims to curb tax avoidance and ensure a fair tax system.
The updated Income Tax Ordinance, 2001, reflects Pakistan’s commitment to aligning with international tax standards and closing loopholes that could be exploited for tax evasion. The detailed regulations under Section 109A provide clarity for taxpayers and enforce a stringent regime for the taxation of foreign income.