ISLAMABAD: Federal Board of Revenue (FBR) on Tuesday explained treatment of tax on foreign controlled entity by a resident Pakistani.
The FBR issued Circular No. 13/2019 for explaining the Section 109A of Income Tax Ordinance, 2001.
The FBR said that a new section 109A had been introduced through Finance Act, 2018, which is effective from July 01, 2018. “Return for tax year 2019 will be the first year when provision of this section will become applicable.”
This section states the taxable income of resident person shall include income attributable to a “Controlled Foreign Company.”
The FBR said that in ordinary sense, income of a foreign company owned by a Pakistani resident is taxable in Pakistan only when such income is received from the non-resident entity.
Section 109A(1) of the Ordinance is a deeming provision which essentially creates legal fiction resulting in following exceptions:
(a) Corporate veil is pierced and income of a company is deemed to be the income of controlling entity; and
(b) income is taxed in the year it is earned not when it is actually received. This is the consequence of the first action because when corporate veil is pierced the income becomes taxable when earned.
Explaining the CFC, the FBR said that in order determine that a foreign company is a controlled foreign company either of the two conditions regarding control of the resident over foreign company has to be fulfilled:
(i) more than fifty percent of the capital or voting rights of the non-resident company are held, directly or indirectly, by one or more persons resident in Pakistan; or
(ii) more than forty percent of the capital of the voting rights of the non-resident company are held, directly or indirectly, by a single resident person in Pakistan.
However, a foreign entity which fulfills either of the above condition, cannot be treated as a CFC if:
(i) the shares of the company are traded on any stock exchange recognized by law of the country or jurisdiction of which the non-resident company is resident for tax purpose;
(ii) the non-resident company derives active business income as defined under Sub-Section (3) of Section 109A; and
(iii) tax paid, after taking into account any foreign tax credits available to the non-resident company, on the income derived or accrued, during a foreign tax year, by the non-resident company to any tax authority outside Pakistan is less than sixty percent of the tax payable on the said income under the Ordinance.
The FBR further explained the concept of active business income: It said that ‘Active Income’ for the purpose of exclusion from CFC regime requires simultaneous fulfillment of two conditions:
(i) cumulative income from dividend, interest, property, capital gains, royalty, annuity payment, supply of goods or services to an associate, sale or licensing of intangibles and management, holding or investment in securities and financial assets is less than 20 percent of the total income of the said company; and
(ii) principal source of the company is under the head ‘income from business’ in the country or jurisdiction of which it is a resident.
The FBR said that the term ‘direct control’ refers to direct ownership of capital or voting right in the foreign entity. However, the term ‘indirect control’ is very wide in its connotation. “It includes indirect control by a company through subsidiary companies in which the resident person holds capital or voting rights but also includes other companies in which the resident person exercises control through ownership of capital or voting rights.”
Regarding ‘attributable income’ under Section 109A(1) of the Ordinance the FBR said that it is in the hand of resident person. The taxable income is income generated by a controlled company that should have been taxed ‘when earned’ instead of ‘when distributed.’
The attributable income of the resident person shall be determined by comparing the percentage of control (whether direct or indirect) held by the said person over the CFC.
Certain other exclusion have also been prescribed by law which are:
(i) Income of a controlled foreign company shall be treated as zero, if it is less than ten million rupees.
(ii) If direct/indirect capital or voting right held by the resident person is less than 10 percent in the foreign entity.