In an increasingly globalized economy, many Pakistani residents earn income from sources outside Pakistan — such as foreign employment, dividends, interest, royalties, or business operations abroad. To prevent double taxation of such income, Section 103 of the Income Tax Ordinance, 2001 provides a foreign tax credit mechanism.
This section ensures that income taxed both abroad and in Pakistan is equitably adjusted, allowing taxpayers to claim credit for foreign taxes paid against their Pakistani tax liability on the same income.
Legal Text Section 103: Foreign Tax Credit
“Where a resident taxpayer derives foreign source income chargeable to tax under this Ordinance in respect of which the taxpayer has paid foreign income tax, the taxpayer shall be allowed a tax credit of an amount equal to the lesser of:
(a) the foreign income tax paid; or
(b) the Pakistan tax payable in respect of the income.”
1. Purpose and Objective of Section 103
The main objective is to eliminate double taxation by allowing a resident taxpayer to offset foreign income tax already paid abroad against tax payable in Pakistan on the same income.
It ensures fairness, encourages cross-border economic participation, and aligns Pakistan’s tax system with international norms.
2. Eligibility Criteria
A foreign tax credit is available when:
The taxpayer is a resident of Pakistan.
The income in question is foreign-source and chargeable to tax in Pakistan.
The taxpayer has actually paid foreign income tax on that income.
The foreign tax is paid within two years after the end of the tax year in which the income was derived.
3. Extent of Tax Credit — Limitation Rule
The amount of foreign tax credit allowed is the lesser of:
The foreign income tax paid, or
The Pakistan tax payable on that foreign income.
This ensures that credit is not claimed in excess of what would have been payable in Pakistan.
4. Calculation of Pakistan Tax on Foreign Income
Under Section 103(2), the Pakistani tax on foreign-source income is calculated using the average tax rate of the taxpayer for that year, applied to their net foreign income.
Formula:
ForeignTaxCredit=Lesserof(ForeignTaxPaid,AveragePakistaniTax×ForeignIncome)Foreign Tax Credit = Lesser of (Foreign Tax Paid, Average Pakistani Tax × Foreign Income)
5. Separate Application to Each Head of Income
Where a taxpayer has multiple categories of foreign income (e.g., salary, business income, dividends), Section 103(3) requires separate computation of tax credit for each head of income.
Even income from speculation business is treated as a distinct category under sub-section (4).
6. Non-Refundable and Non-Carry Forward Rule
Any unutilized foreign tax credit:
Cannot be refunded,
Cannot be carried back to prior years, and
Cannot be carried forward to future years.
It is usable only in the year in which the income is earned.
7. Application and Adjustment
The credit is applied in accordance with Section 4(3) of the Ordinance, ensuring systematic adjustment of credits against taxable income and minimizing duplicative taxation.
8. Practical Example
Mr. Bilal, a resident of Pakistan, earns foreign dividends of PKR 1,000,000 and pays foreign tax @15% (PKR 150,000).
In Pakistan, his average tax rate on total income is 10%.
Pakistantaxonforeignincome=1,000,000×10%=100,000Pakistan tax on foreign income = 1,000,000 × 10\% = 100,000
Since Pakistan tax (100,000) is less than foreign tax (150,000), credit allowed = PKR 100,000.
Thus, Mr. Bilal pays no further tax on that foreign income in Pakistan.
9. Documentation Required for Claiming Foreign Tax Credit
To claim the credit, the taxpayer must maintain:
Foreign tax payment receipts;
Certificates of tax deduction or payment issued by the foreign authority;
Proof of income remittance or accrual;
Tax computation sheet reflecting foreign income separately;
Proof that foreign tax was paid within two years.
10. Time Limit for Claiming Credit
Under sub-section (7), the credit is available only if foreign tax is paid within two years from the end of the relevant tax year. Late payments beyond this period disqualify the claim.
11. Common Sources of Foreign Income Eligible for Credit
Foreign employment or consultancy income
Dividends from overseas companies
Interest or royalty income from foreign payers
Foreign business or branch profits
Capital gains from sale of foreign assets
12. Importance of Section 103 in International Taxation
This section forms Pakistan’s domestic basis for unilateral relief against double taxation, complementing bilateral tax treaties (DTAs) signed with many countries.
Section 103 of the Income Tax Ordinance, 2001 provides a fair mechanism for residents earning abroad to avoid double taxation.
It aligns Pakistan’s tax law with global standards and encourages overseas investment, foreign employment, and cross-border business.
At Tanweer Habib & Co., we specialize in international tax compliance, assisting clients in properly computing, documenting, and claiming foreign tax credits to ensure full legal compliance and tax efficiency.
FAQs on Section 103 Foreign Tax Credit
1. What is Section 103 of the Income Tax Ordinance, 2001?
It allows Pakistani residents to claim a credit for income tax paid abroad on foreign-source income also taxed in Pakistan.
2. Who is eligible for the foreign tax credit?
Only resident taxpayers earning foreign-source income that is chargeable to tax in Pakistan.
3. What is the limit of credit allowed?
The credit is limited to the lower of foreign tax paid or Pakistan tax payable on that income.
4. How is Pakistan tax on foreign income computed?
By applying the average Pakistani income tax rate to the net foreign-source income for that year.
5. Can foreign tax credit be claimed by non-residents?
No, it is available only to resident taxpayers.
6. Can the credit be carried forward?
No, unused credit cannot be carried forward or refunded.
7. Can the credit be applied to minimum or final tax?
Yes, it can offset tax payable under the Ordinance, including minimum and final tax.
8. Is the credit applicable to all foreign income?
Yes, for all foreign-source income chargeable to tax in Pakistan, such as salary, dividends, royalties, or business income.
9. What happens if foreign tax is paid after two years?
The credit is disallowed if the tax is paid after two years from the end of the tax year in which income was derived.
10. Can credit be claimed for foreign withholding taxes?
Yes, if the withholding constitutes foreign income tax and proof of payment is available.
11. Does this apply to tax paid in multiple countries?
Yes, but the calculation must be done separately for each head of income and for each country.
12. Is the credit automatic or must it be claimed?
It must be specifically claimed in the annual income tax return and supported by documents.
13. How does this interact with double taxation treaties (DTAs)?
Section 103 provides unilateral relief; DTAs provide treaty-based relief — the taxpayer may claim the one that is more beneficial.
14. Is the credit available for taxes other than income tax?
No, only foreign income taxes qualify — not sales tax, VAT, or social security contributions.
15. Can companies also claim this credit?
Yes, both individuals and corporate taxpayers can claim foreign tax credit.
16. What proof is required from foreign authorities?
Tax payment receipts, deduction certificates, or official confirmation from the foreign tax department.
17. Does the credit apply to branch profits remitted to Pakistan?
Yes, if the profits are foreign-source and taxed abroad.
18. What if the taxpayer earns foreign losses?
No credit is available if there is no foreign tax payable or if foreign income results in a loss.
19. What if the foreign income is exempt under a treaty?
Then no credit is allowed since no foreign tax was legally required or paid.
20. How can Tanweer Habib & Co. assist?
We help clients compute, verify, and document foreign tax credits, reconcile with FBR filings, and ensure compliance with international tax standards.
