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Section 7E: Constitutional validity

Taxing immoveable property and taxing income arising from immoveable property are two different concepts. The former is the burden on immovable property whereas the latter is the burden on the owner of the property—Syed Arshad Ali J, Latif Hakeem v Federation of Pakistan & Others

In the referred backdrop, the imposition of tax on 5% of the fair market value of the capital asset on the basis that any capital asset which a resident person might hold is treated to be deriving income is confiscatory in nature, hence is in violation or derogation of Article 23 of the Constitution—Aamer Farooq, Chief Justice, Islamabad High Court in Waheed Ashraf v Federation of Pakistan, etc.

Entry 50 was the subject matter of discussion in a number of appeals before a Division Bench of which one of us (Shahid Karim, J.) was a member and it was held that tax on capital value of immovable property was beyond the legislative competence of the Parliament and was within the power of the Provincial Assemblies to legislate upon—Commissioner of Inland Revenue v Muhammad Osman Gul [ICA No.35908 of 2023]

The Elahi Cotton case (it is the most misunderstood and misapplied judgement) makes absolutely clear that any item to be taxed should rationally be capable of being considered as the “income” of a citizen”— Taxing what is not ‘income’—I, Business Recorder, December 11, 2020

The conflicting judgements by high courts of the country in writs challenging section 7E of the Income Tax Ordinance, 2001 [“the Ordinance”], inserted retrospectively with effect from tax year 2022, by the Finance Act, 2022,have raised some fundamental issues relating to its validity under the Constitution of Islamic Republic of Pakistan [“the Constitution”] as well real import of amendment made in Entry 50, Part I of Federal Legislative List (FLL) of the Fourth Schedule by Constitution (Eighteenth Amendment) Act, 2010 [“18th Amendment”].

The Sindh High Court (SHC) was the first to hold section 7E of the Ordinance as intra vires of the Constitution—see detailed judgement at its website. A critical analysis of this judgement is contained in Legal fiction, Section 7E & Constitution, Business Recorder, December 2, 2022—its extended/detailed/updated version is also available at:https://www.linkedin.com/pulse/legal-fiction-section-7e-constitution-dr-ikramul-haq/.

After Division Bench’s judgement of SHC came an admirable verdict (curative) by Justice Shahid Jamil Khan of the Lahore High Court (LHC), an illustrious jurist, who resigned on February 2, 2024 after serving for 10 years. He later characterised his decision to resign as a “rebellion against a system held hostage by vested interests”.

The single judge judgement of LHC was later disapproved in the intra-court appeal by a Division Bench endorsing the view of the Sindh High Court that through legal fiction anything not income (even by any stretch of imagination) can still be brought to income taxation under Entry 47, Part I of FLL, Fourth Schedule to the Constitution. Needless to say that this view is not based on correct appreciation of the supreme law of the land as elaborated in https://www.linkedin.com/pulse/legal-fiction-section-7e-constitution-dr-ikramul-haq/.

The judgement of single judge of LHC, curative part aside, clearly and unambiguously holds: There is a difference between taxes on immoveable property and tax on income arising from immoveable property. Burden of income tax, including capital gain tax is on person who receives the income. Whereas burden of taxes on immoveable property is on the property and goes with the property if not taxed before the sale or transfer.

The Peshawar High Court (PHC), in its judgement, while endorsing the reasoning of single judge of LHC for striking down section 7E, aptly observed:

We concur with the finding of the Hon’ble Lahore High Court, but we do not deem it appropriate to read down the impugned legislation in the manner because it is for the Parliament to re-enact the law as suggested by the Hon’ble Lahore High Court.

The Chief Justice of Islamabad High Court (IHC), while disposing the writs challenging constitutionality of section 7E of the Ordinance, upheld its legislative mandate under Entry 47, Part I of the FLL, Fourth Schedule to the Constitution. However, he declared it ultra vires of the Constitution adjudging it “confiscatory in nature, hence is in violation or derogation of Article 23 of the Constitution”.

The judgement of single judge of LHC brilliantly traces the history of taxes on immovable property and makes the following noteworthy observations to highlight the real import and scope of amendment made in Entry 50, Part I of FLL, Fourth Schedule to the Constitution by the 18th Amendment:

In Pakistan, estate tax was charged under Estate Duty Act 1950, which was repealed in 1979, without any debate or deliberation. It was within competence of Federation under Entry 46 “Estate Duty on property” along with Entry 45 “Duties in respect of succession to property”. Both the entries, imposing tax on immoveable property, are repealed by 18th Amendment along with the amendment in Entry 50, where after the phrase “taxes on immoveable property” is excluding “taxes” on immovable property and not the immovable property itself from capital assets, value of which is to be taxed under Entry 50. Omission of Entries 46 & 45 along with amendment in Entry 50, collectively shows that all taxes, burden of which is on the immoveable property are excluded from competence of the Federation.

The conflicting judgements of high courts, elaborated above, have thrown the ball in the Supreme Court of Pakistan to authentically settle the issue. A three-member bench of the Supreme Court seized the matter and heard it for three days on day to day basis which was not as per the Supreme Court (Practice & Procedure) Act, 2023. Later, on the pointation that since the matter involved interpretation of the Constitution, it could not be heard by less than a five-member bench under section 4 of the Supreme Court (Practice & Procedure) Act, 2023, constituted a larger bench to hear the matter on April 25, 2024.

A holistic reading of the section 7E of the Ordinance shows that in pith and substance it is a tax on the “fair market value” (FMV)—as defined in section 68 of the Ordinance—of the immovable property situated in Pakistan, held on the last day of a tax year by a resident person. It imposes tax of 20% on “deemed income” [an amount equal to 5% of FMV, if in aggregate, value is Rs 25 million or more].

There is absolutely no doubt that section 7E represents capital value tax on immovable property and not tax on any income derived from it. There is no nexus of “an amount equal to five percent of the FMV of “capital assets” [read immovable property] with the expression “income” as used in Entry 47, Part I of FFL, Fourth Schedule to the Constitution even in its widest possible scope/import. Such a tax cannot even be imposed by the Parliament (Majlis-e-Shoora) under Entry 50, Part I of the FLL read with Article 77 and 142(a) of the Constitution after the 18th Amendment.

Under Entry 50 of the FLL, the Parliament can only resort to “taxes on the capital value of the assets, not including taxes on immovable property”. Since in pith and substance, section 7 of the Ordinance levies tax on immovable property treating five percent of its FMV as deemed income, it falls outside the legislative competence of the Parliament as the right to impose any kind of tax on immovable property exclusively vests with provincial assemblies under Article 142(c) of the Constitution as elaborated both by the single judge of LHC and PHC.

It is an established law that entries contained in the Fourth Schedule to the Constitution are mutually exclusive and for one taxable event two entries cannot be invoked—Pakistan International Freight Forwarding Association v Province of Sindh & Another 2017 PTD 1 followed in Pakistan Mobile Communication Ltd & 2 Others v Federation of Pakistan & Others (2022) 125 TAX 401 (H.C. Kar.).

The Punjab Assembly correctly read Entry 50 of Federal Legislative List and levied tax on gain of immovable property through section 9 of the Punjab Finance Act 2013—see detailed discussion in Constitutionality of CGT on immovable property, Business Recorder, July 15, 2011,‘Tax on gain of immovable property: Who is violating Constitution?’ Business Recorder, March 14, 2014, ‘Taxing capital gains’, Business Recorder, June 30, 2017 and ‘Services’ and immovable property income taxation: constitutional violation, Business Recorder, December 4, 2020.

LHC Division Bench in ICA No.35908 of 2023 followed SHC which held section 7E intra vires of the Constitution intra alia on the ground: “Legal fictions create an artificial state of affairs by a mandate of the legislature. They compel everybody concerned including the courts to believe the existence of an artificial state of facts contrary to the real state of facts. When a fiction is created by law, it is not open to anybody to plead or argue that the artificial state of facts created by law is not true, barring the only possible course if at all available is to question the constitutionality of the fiction”.

The Division Benches of LHC and SHC in their respective judgements failed to appreciate that the issue is relating to import and scope of the term “income” vis-à-vis misconception prevailing that National Assembly can declare anything “income” through the Finance Act, passed as Money Bill every year, in terms of Articles 73(2), 77 and142(a) read with Entry 47 or 52, Part I, FFL, Fourth Schedule to the Constitution discussed in detail in ‘Taxing what is not ‘income’—I’ and ‘Taxing what is not ‘income’—II’ [Business Recorder, December 11 and 13, 2020] is ignored—perhaps not presented.

The contents of the above article and the following dicta laid down in the Elahi Cotton Mills Ltd. and others v. Federation of Pakistan through Secretary Finance, Islamabad [(1997) 76 TAX 5 (S.C.Pak)] have been ignored by legislators while enacting section 7E of the Ordinance, and due to lack of assistance, the honourable Division Benches of LHC and SHC also decided otherwise:

* Legal fictions are limited for a definite purpose that cannot be extended beyond the purpose for which they are created.

* If one is to read Entry 47, Part I of the Fourth Schedule to the Constitution of Pakistan (1973) in isolation without referring to Entry 52, it can be argued that Entry 47 does not admit the imposition of presumptive tax as the expression “taxes on income” employed therein should be understood as to mean the working out of the same on the basis of computation as provided in the various provisions of the Ordinance.

* Presumptive tax is in fact akin to capacity tax i.e., capacity to earn. In this view of the matter, one will have to read Entry 47 in conjunction with Entry 52 which provides tax and duties on production capacity of any plant, machinery, undertaking, establishment or installation in lieu of the taxes or duties specified in Entries 44, 47, 48 and 49 or in lieu of any one or more of them. “If we were to construe Entry 52 of the Legislative List keeping in view the expression “in lieu of”, it becomes evident that the Legislature has the option whereby instead of invoking Entry 47 for imposing taxes on income, it can impose the same under Entry 52 on the basis of capacity to earn in lieu of Entry 47, but it cannot adopt both the methods in respect of one particular tax. Since under sections 80C and 80CC the imposition of presumptive tax is in substitution of the normal method of levy and recovery of the income-tax, the same is in consonance with Entry 52’.

* While interpreting an entry in a Legislative List it should be given widest possible meaning, “does not mean that Parliament can choose to tax as income which, in no rational sense, can be regarded as a citizen’s income”.

[Above is not verbatim reproduction of parts of the judgement, except where quotation marks are provided]

In para 31 (xii) of the Elahi Cotton case, the Supreme Court held: “That what is not “income” under the Income Tax Act cannot be made “income” by a Finance Act. An exemption granted by the Income Tax Act can be withdrawn by the Finance Act or the efficacy of that exemption may be reduced by the imposition of a new charge, of course, subject to Constitutional limitations”. This is a binding command of Supreme Court under Article 189 of the Constitution and no court or authority, except Supreme Court can revisit it.

In Shahid Pervaiz v Ejaz Ahmad and others 2017 SCMR 206, 14-member bench of Supreme Court held: “….where the Supreme Court deliberately and with the intention of settling the law, pronounces upon a question of law, such pronouncement is the law declared by the Supreme Court within the meaning of Article 189 and is binding on all the Courts of Pakistan. It cannot be treated as mere obiter dictum. Even obiter dictum of the Supreme Court, due to high place which the Court holds in the hierarchy in the country enjoy a highly respected position as if it contains a definite expression of the Court’s view on a legal principle, or the meaning of law”.

Needless to say that under Article 189 of the Constitution “any decision of the Supreme Court shall, to the extent that it decides a question of law or is based upon or enunciates a principle of law, be binding on all other courts in Pakistan” and enforceable for all forums including the Parliament. All the institutions are bound to follow the supreme law of the land and orders of the Supreme Court. The Legislature has violated the both by inserting section 7E, which is not “income” at all but tax on immovable property, for which exclusive legislative competence vests with the provinces in the wake of the 18th Amendment effective from April 19, 2010.

Dr Ikramul Haq, "Section 7E: Constitutional validity," Business recorder. 2024-04-19.
Keywords: Social sciences , Tax policy , Finance Act , Financial institution , Supreme court , Shahid Pervaiz , Syed Arshad Ali , Pakistan , SCMR , PTD

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