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Law and the super tax: Part – I

Former member of parliament of the United Kingdom William Cobbett is famously known to have stated: “Nothing is so well calculated to produce a death-like torpor in the country as an extended system of taxation and a great national debt.”

When it comes to taxation; early and distant civilizations such as Egypt in the year 3000 BC, utilized taxes as a tool for governments to generate revenue and concomitantly used them as a form of a contract between citizens and the state. Over the period, spanning over the past two centuries, tax systems and tax policies have been structured efficiently by developing states, to yield better revenue along with providing quality public goods, services and protection to its citizens.

An article published by economist and professor Ander Jensen, in the American Economic Review, examined how the modern tax system emerged, over time, as a country experienced economic development. His research, extremely relevant, involved the construction of a micro-database, pertinent to household surveys, covering 100 countries at all levels of income. Using evidence from this new micro-database, Jensen established a set of stylized facts, which explain how intimately connected the expansion of the income tax base is to a country’s development, both across and within countries over the long run.

It is of vital importance to draw a distinction between develop(ed) and develop(ing) states, at this juncture, in relation to their structures of tax, so that an accurate analogy can be weaved between the two. Developed countries typically have a modern tax system with high capacity for collection and redistribution. The tax exemption threshold for a developed economy is typically at the bottom of the income distribution, like in the US, where approximately 90 per cent are required to pay income taxes. Meanwhile, in developing economies the threshold is closer to the top of the income distribution, like in India where approximately five per cent of those that are economically active are liable to pay income taxes.

Post-independence, Pakistan inherited the income tax law of India. The law was amended several times in the early years of the country’s inception, with the majority of the amendments increasing the tax rate and expanding the scope of the legislation. However, soon after, the Income Tax Ordinance 1979 was promulgated, which seemed to be a major overhaul of the tax system in Pakistan, introducing a number of new features, such as a progressive tax rate, a withholding tax system, and a self-assessment system.

The 1979 Income Tax Ordinance has been amended several times since its promulgation, with the most recent amendment being made in 2001. The current system of taxation is premised upon the Income Tax Ordinance, 2001 which is also deemed to be the primary legislation on taxation matters, with the Federal Board of Revenue administering the tax system.

The Finance Act, 2022 was promulgated on June 30, 2022. Section 5 of the Finance Act, 2022 relates to the amendments in the 2001 Income Tax Ordinance, while Section 5(3) of the same duly incorporates Section 4C in the ordinance, termed as “Super tax on high earning persons”. Section 4C states: “(1) A super tax shall be imposed for tax year 2022 and onwards at the rates specified in Division IIB of Part I of the First Schedule, on income of every person: Provided that this section shall not apply to a banking company for tax year 2022.”

It is imperative to expound here that income for the purposes of this specific section is defined, as under Clause (2) of 4C, to be the sum of the following: “(i) profit on debt, dividend, capital gains, brokerage and commission; (ii) taxable income (other than brought forward depreciation and brought forward business losses) under section 9 of the Ordinance, excluding amounts specified in clause (i); (iii) imputable income as defined in clause (28A) of section 2 excluding amounts specified in clause (i); and (iv) income computed, other than brought forward depreciation, brought forward amortization and brought forward business losses under Fourth, Fifth 1, [Seventh and Eighth] Schedules.”

Income, as applicable to the general provisions of the 2001 Income Tax Ordinance, is defined under Section 2 (29), as: ““income” includes any amount chargeable to tax under this ordinance, any amount subject to collection, [or deduction] of tax, under section 148, 4 [150, 152(1), 153, 154, 156, 156A, 233.”

Division IIB of the 2001 Income Tax Ordinance, titled Super Tax on high earning persons, lays out the rate of tax chargeable for tax year 2022 and 2023, respectively. Where income under 4C exceeded Rs150 million but was less than Rs200 million: the rate of tax was fixed at one per cent of the income, and so forth, with a cap at four per cent where the income exceeds Rs300 million.

In consideration of the foregoing, a proviso was annexed (the legality of which will be considered later on), which further augmented the realm of the provided super tax cap, from four per cent to 10 per cent where income exceeds Rs300 million (for tax year 2022), for persons engaged in specific industries (whether wholly or partially), inclusive of, but not limited to, persons engaged in the business of airlines, automobiles, beverages, cement, chemical, cigarette and tobacco, fertilizer, iron and steel, LNG terminal, oil marketing, oil refining, petroleum and gas exploration and so on.

Post amendment in the 2001 Income Tax Ordinance, through the Finance Act 2022, which eventually led to the inclusion of 4C (expressed to be effective on July 1, 2022), and the subsequent imposition of a super tax on the specialized cadre of taxpayers, numerous writ petitions under Article 199 of the constitution were preferred before the Islamabad High Court impugning the vires of 4C, and the notices from the Commissioner demanding super tax. Consequently, on July 20, 2023 a judgment authored by the Honorable Justice Sardar Ejaz Ishaq Khan in the case titled ‘M/s Fauji Fertilizer Company Limited & another v Federation of Pakistan & others’, declared 4C as ultra vires fundamental rights as enshrined under Articles 18, 23 and 24, read with Article 4 of the constitution.

The judgment made waves and stands not only as a testament to the wisdom of the judiciary but also as a resounding victory for the principles of fairness, equality, and human rights. It must be noted that rarely have we witnessed a judgment so meticulously crafted, so firmly rooted in the bedrock of legal precedent, and yet so boldly innovative in its approach.

The judgement rendered was appropriately divided into ‘common-grounds’ (concerning the majority of the petitioners), and ‘industry-specific’ grounds (concerning specific Petitioners such as the petroleum industry and benevolent funds). The first point addressed in the judgment was pertinent to the question regarding the powers vested in parliament to legislate retrospectively, in response to which a sound analogy was drawn between rights vested in the first place by some legislative act, or by grant of an exemption and rights naturally accorded to citizens. It was held that this principle of retrospective legislation had no application where a ‘natural’ right existed, which was not dependent on any beneficence of the legislature or the executive, that could be taken away, retrospectively.

It was held that: “The right of a citizen to earn and keep the fruits of its labor is an inherent natural and a fundamental right, that does not depend on any legislative or executive act. This right is only subject to such laws on taxation by which the citizen pays a part of his earnings to the State by way of tax. When that right is curtailed by any legislation, it can only be prospective and never retroactive for not being a right vested by legislation in the first place.”

To be continued

Khuzair Raheem, "Law and the super tax: Part – I," The News. 2023-08-16.
Keywords: Economics , Economic development , Economic review , Taxation , Revenue , Ander Jensen , India , Pakistan , LNG , IIB