A division bench of the Appellate Tribunal Inland Revenue (ATIR) has delivered a significant ruling stating that under the tax treaties between Pakistan and the United Arab Emirates (UAE) as well as the United Kingdom, rental income and capital gains earned by Pakistani residents from these countries are exempt from taxation in Pakistan.
In its decision, the ATIR analyzed two earlier conflicting judgments but chose to follow the first ruling, which favored taxpayers. The tribunal established that the taxing rights over these types of income are allocated to the country where the income is generated rather than the country where the recipient resides.
The case involved a Pakistani taxpayer who, in his tax return, had declared his foreign income as exempt, which included rental income, capital gains, and bank profits. The assessing officer responded by issuing a show cause notice, asserting that, as a resident individual, the foreign income should not be exempt. Instead, the officer stated that a tax credit for any foreign taxes paid could be applied.
In response, the taxpayer argued that the respective tax treaties clearly assigned the right to tax to the country where the income arises. However, the assessing officer dismissed this explanation, claiming that the treaties granted taxing rights to both countries: where the income arises and where the recipient is a tax resident.
Given that the tax levied exceeded Rs20 million, the taxpayer filed an appeal directly with the ATIR. In its order, the ATIR referenced the principles of interpretation set forth by the Supreme Court in a recent judgment. The tribunal noted that the learned officer of income tax (OIR) had misinterpreted the phrase “may be taxed” in Articles 6.1 and 14.1 by isolating it from Article 11.2, which states that interest income “may also be taxed” in another contracting state. This distinction was crucial, as Articles 6 and 14, concerning income from immovable property and capital gains, do not include a similar stipulation.
The ATIR criticized the OIR’s misunderstanding, emphasizing that the phrase “may be taxed” should be understood in context. It clarified that this language was intended to address situations like the present case, where the UAE has not imposed taxes on the rental income since the treaty was executed.
The tribunal asserted that if “may be taxed” granted jurisdiction to both states, it would render the phrase “may also be taxed” in Article 11.2 redundant, which is an untenable interpretation.
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Furthermore, the ATIR rejected the OIR’s reliance on a later decision from another ATIR division bench, which had taken a different stance on rental income from properties in the UAE. The tribunal noted that the earlier decision had not been properly considered by the later bench, emphasizing that established principles dictate that one division bench must adhere to the precedent set by another unless overturned by a higher court.
Tax consultant Shahid Jami commented on the ruling, suggesting that during tax treaty negotiations, officials often prioritize signing agreements without fully considering Pakistan’s national interests or the practical implications. He explained that, according to the tax treaty, taxing rights for certain income types are assigned to the UAE, which has not imposed taxes on these incomes. However, he stressed that the treaty’s provisions should prevail, aligning with the principles laid out by the Supreme Court.
