SOHAIL SARFRAZ

ISLAMABAD: There are many Pakistani residents who own properties in offshore jurisdictions, such as the United Arab Emirates (UAE), through entities incorporated in the UAE, and these will now be treated as Controlled Foreign Companies (CFCs).

Explaining the concept of Controlled Foreign Company (CFC) introduced in Pakistan through Finance Act 2018, tax expert Ashfaq Tola said that the CFC is a corporate entity that is registered and conducts business in a different jurisdiction or country other than the residency of the controlling owners. The objective of introduction of this new concept is to prevent erosion of domestic tax collections due to avoidance or deferment by home companies on income earned from overseas businesses carried out through offshore subsidiaries or affiliates.

A CFC charge under Pakistani Tax Law will be imposed on non-active business income only. The active business criterion has been specified in the definitions under the Finance Bill 2018. Therefore, the basic purpose is to charge tax on income other than active business to avoid tax avoidance on their incomes like dividend, royalty, etc, which will now be taxed.

As per Pakistani law, the income of a CFC will be taxed when it is earned only, thereby avoiding any tax liability when the same is received in Pakistan.

Before introducing the concept of a CFC, the income of such companies was not taxed in Pakistan if the same was retained and not repatriated to Pakistan. However, now the income of such foreign CFCs will be taxed even prior to distribution of the same, he said.

The news letter of Tola Associates said that as Pakistanis have ownerships and transactions of companies/partnership and trusts held outside Pakistan in the form of (i) Pakistani residents holding shares in Pakistani listed entities through nonresident enterprises which will now be treated as CFC, (ii) there are many Pakistani residents who own properties in offshore jurisdictions, like the UAE, through entities incorporated in UAE, which will now be treated as CFC, (iii) There are many trading and other non-resident companies owned by residents that supply goods to Pakistani enterprises, which will now be treated as CFC, etc.

About the role of the Organization for Economic Cooperation and Development (“OECD”), Ashfaq Tola said that international tax issues have never been higher on the political agenda than they are today. The increase in globalization has enhanced the variety of markets in which business can be done, causing strain on international tax rules. Weakness in taxation laws creates opportunities for Base Erosion and Profit Shifting (“BEPS”).

In response to the challenges of BEPS through CFCs, the OECD and G20 countries deliberated on this issue and set some actions or rules for the regulations of CFC. These rules only provide for minimum standards. Moreover, they are designed to ensure that jurisdictions that choose to implement them will have rules to effectively prevent taxpayers from shifting income to foreign subsidiaries.

Ashfaq Tola stated the concept of a CFC in Pakistani law has been introduced for the first time through the Finance Act 2018. The Parliament has done this by introducing Section 109A into the Income Tax Ordinance 2001 (“ITO”) through enactment of the Finance Act 2018. It is pertinent to note that the concept of a CFC did not exist in the Pakistani law before the enactment of the Finance Act 2018.

Furthermore, by virtue of the Finance Act 2018, now the income of a non-resident company should be included in taxable income of a resident person for a tax year.

As per Section 83 of the ITO 2001, a company shall be resident for a tax year if it is incorporated or formed by or under any law in force in Pakistan; control and management of the affairs of the company is situated wholly in Pakistan at any time in the year or it is a provincial government or local government in Pakistan and requirements for a company to be a CFC.

CFC means a non-resident company, if more than 50% 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, more than 40% of the capital or voting rights of the non- resident company are held, directly or indirectly, by a single resident person in Pakistan.

Tax paid in respect of income derived or accrued in a foreign tax year is less than 60% of tax payable on the said income under this Ordinance. A non-resident company does not derive “active business income.”

However, there are some exceptions where the amount of the attributable income is exempted from being allocated to a resident person, and these are as follows: If the capital or voting rights of the resident person is less than 10 %; and/or income of a controlled foreign company is less than 10 million rupees.

Since, the attributable income is taxed when it is earned or distributed by the CFC and not when it is received in Pakistan, the question of getting taxed twice on the attributable income does not arise.

The rates of tax charged are the same as for dividend income as per Division III, Part I of First Schedule which are 15% for filers and 20% for non-filers.

In India, the concept of a CFC was proposed in the Finance Bill 2010. However, it was never enacted into law, and currently under the Indian Jurisprudence, a 40% tax liability is charged on the global income of a company whose place of effective management is in India.

Under Pakistani tax law, a CFC charge would be imposed irrespective of whether it is set up in a high or a low tax jurisdiction. In order to give relief to the person who holds less than 10% of CFC capital or voting rights in a non-resident company, their income is not attributed to taxable income of the persons.

Ashfaq Tola added that now a resident of Pakistan can and will be taxed on their income from such non-resident companies unlike prior to enactment of Finance Act 2018 when there was no such concept of a tax on CFCs. The CFC has not been designed to increase the tax base. The main purpose of introducing this concept is to protect revenue. This may help further the documentation of the economy reducing administrative and compliance burdens on the government of Pakistan, the tax expert added.