THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN

Final Examinations Summer 2009

June 4, 2009

ADVANCED TAXATION (MARKS 100)

(3 hours)

Q.1 Joy Limited is incorporated with a paid up capital of Rs. 500 million under the Companies
Ordinance, 1984. Deep Sea Inc. USA (DSI) and Shallow Waters Inc. USA (SWI) hold 50%
shares each. Green Sea Group is the parent company of both the DSI and SWI. Joy Limited is
following a special tax year i.e. January-December.

On 30th April 2009, Joy Limited has an outstanding loan balance of Rs. 300 million payable to
DSI with interest payable @10% per annum. This loan is repayable in equal annual
installments of Rs. 50 million each, at the end of each year.

To finance a new project of Joy Limited, DSI is considering to provide another long term loan
of Rs. 5.0 billion carrying interest @ 10% per annum. 25% of the loan is expected to be
disbursed in the current year ending December 31, 2009 while the remaining 75% of the loan
would be received by Joy Limited in December, 2010. The new loan would be repayable in
twenty equal annual installments of Rs. 250 million each, with the first installment falling due
in July 2012.

As on December 31, 2008, Joy Limited had a balance of Rs. 500 million in its retained
earnings account. The profits forecast for three years is as under:

Tax Years 2010 2011 2012

-------- Rs. in billions -------
Profit 0.7 0.85 1.0

(a) Explain thin capitalization rule in the light of the provisions of Income Tax Ordinance,
2001. (04)

(b) If Joy Limited acquires the above long term loan from DSI, compute the following in
respect of each tax year:
(i) Amount of foreign debt
(ii) Foreign equity of Joy Limited
(iii) Admissible / inadmissible interest expense (12)

(c) What would be the implication of thin capitalization rule, if Joy Limited acquires a new
loan from another foreign company not related to the Green Sea Group? (03)

Q.2 ABC Limited has incurred losses for the past few years. The Board of Directors of the
company wants to surrender its assessed losses in favour of its holding company, Triangle
Limited. In view of the provisions of Income Tax Ordinance, 2001 you are required to state
the following:

(a) the conditions which must be fulfilled before Triangle Limited can adjust the losses
surrendered by ABC Limited against its income under the head “income from business”. (04)
(b) the limitations, if any, on the types of losses which can be surrendered and also the
period beyond which such losses can not be surrendered. What would be the treatment
of such losses if it remains unadjusted within the specified time period? (03)
 (2)

Q.3 Mr. and Mrs. Vakeel, both lawyers of high repute, established their own law firm on July 01,
2008 with the name and style of Vakeel Associates. The firm is primarily engaged in
providing services for both civil and criminal law suits and is equally managed by Mr. and
Mrs. Vakeel. The profit and loss account of the firm, for the first year of their operations, is as
follows:

----- Rupees -----

Gross receipt 25,750,000
Less: Salaries 10,000,000
Rental for office premises 1,200,000
Accounting depreciation 1,000,000
Purchase of technical books 750,000
Subscription fees 250,000
Other expenses 1,300,000 14,500,000
Income for the year 11,250,000

Following further information is available from the firms record:

(i) Mr. and Mrs. Vakeel have an equal share of profits and losses in the firm.
(ii) During the year, the firm was engaged on a retainership basis by various corporate
clients. Gross receipts from such clients amounted to Rs. 10,000,000. Tax at the rate
of 6% of the gross receipts was deducted from payments to the firm by such clients.
Tax so deducted was charged to ‘other expenses’.
(iii) Thomas Associates, a law firm based in UAE, appointed Vakeel Associates under an
agreement to technically assist them in defending a particular law suit in Dubai. The
sum agreed for the services amounted to Rs. 2,500,000. Mr. Vakeel stayed in Dubai
for over a month, for the purpose of this assignment. The fee was transferred to the
firm’s Bank account in Pakistan. No tax was deducted either by Thomas Associates
or the bank transferring the amount from such payment.
(iv) The firm also provided advisory services in Pakistan to different law firms situated
outside Pakistan. An amount equal to Rs. 5,000,000 was received from such services
in foreign currency through normal banking channel. The bank collected tax at the
rate of 1% from the gross receipts. The tax deducted from the proceeds was charged
to ‘other expenses’.
(v) No tax has been deducted on any other receipts of the firm.
(vi) Salary expenses include an amount of Rs. 100,000 each paid to Mr. and Mrs. Vakeel
every month.
(vii) Bonus amounting to Rs. 1,000,000 was paid to the employees of the firm (other than
Mr. and Mrs. Vakeel). No tax was deducted from such payments.
(viii) The office premises are owned by Mrs. Vakeel and rent was paid to her without
deducting any tax from such payments.
(ix) Subscription fee was paid in cash to Pakistan Bar Council without withholding any
tax from such payment.
(x) During the year some structural improvements were made to the office premises at
the cost of Rs. 500,000. This amount was also charged to ‘other expenses’.
(xi) Following details are available in respect of the firm’s assets:

Depreciation
Cost of
charged to
Category of assets acquisition
accounts
----- Rupees ----
Furniture and fittings 2,000,000 200,000
PCs and Laptops 1,600,000 320,000
Motor vehicle (provided to Mr. & Mrs. Vakeel) 2,400,000 480,000
 (3)

(xii) In 2006, Mr. Fazil the father of Mrs. Vakeel gave her 1,000 shares of Fortune Inc.
USA, a company listed on New York Stock Exchange, by way of a gift. Mr. Fazil had
purchased those shares in 2003 at a cost of USD 10 per share, when he was working
in the USA. The dollar rupee parity at the time of purchase was USD 1 = PKR 58.
The fair market value of the shares at the time of transfer to Mrs. Vakeel was USD 25
(USD 1 = PKR 60). Mrs. Vakeel disposed off the shares during the year at a price of
USD 60 per share. She also paid USD 1,000 in taxes in the USA, in respect of such
receipts. The dollar rupee parity on the date of disposal was USD 1 = PKR 80.

Required:
In the light of the provisions of Income Tax Ordinance, 2001, compute the taxable income
and tax liability of the following for the tax year 2009:
(a) Vakeel Associates. (14)
(b) Mrs. Vakeel. (08)

Show all necessary calculations and give brief reasons, wherever necessary, in support of your
treatment of each item.
Note:-
(i) Rate chart is available on the last page
(ii) Section references are not required

Q.4 (a) Explain the conditions under which no gain or loss shall be taken to arise on the
disposal of an asset, under the provisions of the Income Tax Ordinance, 2001. (06)

(b) When an asset is disposed of in a non-arms length transaction, how would you
determine the consideration:
(i) received by a seller; and
(ii) paid by a buyer. (03)

Q.5 Mr. Hijrat has informed you that he would be permanently migrating to USA with his family
on July 10, 2009 and has no intention of returning to Pakistan. He is seeking your advice as to
his obligations, if any, under the Income Tax Ordinance, 2001 in this regard. (04)

Q.6 Narrate the provisions of Sales Tax Act, 1990 relating to the following:
(a) extra tax. (04)
(b) due date of payment of sales tax. (03)

Q.7 (a) Describe input tax and output tax as defined in the Sales Tax Act, 1990. (05)

(b) Mr. Insaf, the executive director of Super Tech (Pvt.) Ltd, a company engaged in the
manufacture and sale of electronic goods, has reviewed the sales tax return for the
month of May 2009, in place of its director finance, who is currently on leave. During
the review he noticed that certain input tax has not been claimed by the company. He
does not accept the view point of the chief accountant and is of the opinion that all
input tax paid by the company should be available for adjustment. You are required to
clarify the following matters in the light of Sales Tax Act, 1990.

(i) The conditions that need to be satisfied for the adjustment of input tax against the
output tax liability and the remedy available to the company if it fails to adjust
the input tax in the period in which it is paid. (07)
(ii) Identify the circumstances in which input tax is not allowed to be adjusted
against the output tax liability. (04)
 (4)

Q.8 Fragrance (Pvt.) Limited (FPL), buys perfumes from a local supplier, which are directly used
in the production of toiletries. FPL wants to adjust the duty of excise paid on perfumes from
the amount of duty on its finished products. Explain the necessary conditions required to be
fulfilled for the adjustment of such duty, under the Federal Excise Act, 2005. (04)

Q.9 In the light of the Federal Excise Act, 2005 you are required to explain the following:

(a) the persons who are responsible to pay the duty of excise. (04)
(b) the requirements related to the issuance of invoices. (05)
(c) meaning of the term “franchise”. (03)

RATES OF TAX
Division I
Rates of Tax for Individuals and Association of Persons
Rate of
S. No. Taxable Income
Tax
(1) (2) (3)
1. Where the taxable income does not exceed Rs. 100,000 0.00%
2. Where the taxable income exceeds Rs. 100,000 but does not exceed Rs. 110,000 0.50%
3. Where the taxable income exceeds Rs. 110,000 but does not exceed Rs. 125,000 1.00%
4. Where the taxable income exceeds Rs. 125,000 but does not exceed Rs. 150,000 2.00%
5. Where the taxable income exceeds Rs. 150,000 but does not exceed Rs. 175,000 3.00%
6. Where the taxable income exceeds Rs. 175,000 but does not exceed Rs. 200,000 4.00%
7. Where the taxable income exceeds Rs. 200,000 but does not exceed Rs. 300,000 5.00%
8. Where the taxable income exceeds Rs. 300,000 but does not exceed Rs. 400,000 7.50%
9. Where the taxable income exceeds Rs. 400,000 but does not exceed Rs. 500,000 10.00%
10 Where the taxable income exceeds Rs. 500,000 but does not exceed Rs. 600,000 12.50%
11. Where the taxable income exceeds Rs. 600,000 but does not exceed Rs. 800,000 15.00%
12. Where the taxable income exceeds Rs. 800,000 but does not exceed Rs. 1,000,000 17.50%
13. Where the taxable income exceeds Rs. 1,000,000 but does not exceed Rs. 1,300,000 21.00%
14. Where the taxable income exceeds Rs. 1,300,000 25.00%

Division VI
Income from property

S. No. Gross amount of rent Rate of tax

1. Where the gross amount of rent does not Nil
exceed Rs. 150,000.
2. Where the gross amount of rent exceeds 5 percent of the gross amount exceeding
Rs. 150,000 but does not exceed Rs. 400,000. Rs. 150,000.
3. Where the gross amount of rent exceeds Rs. 12,500 plus 10 percent of the gross amount
Rs. 400,000 but does not exceed Rs. 1,000,000. exceeding Rs. 400,000.
4. Where the gross amount of rent exceeds Rs. 72,500 plus 15 percent of the gross amount
Rs. 1,000,000. exceeding Rs. 1,000,000.

RATES OF NORMAL DEPRECIATION

I. Building (all types). 10%

II. Furniture (including fittings) and machinery and plant (not otherwise specified),
motor vehicles (all types), ships, technical or professional books. 15%
III. Computer hardware including printer, monitor and allied items (machinery and
equipment used in manufacture of I.T. products), aircrafts and aero engines. 30%

(THE END)