Clarifying the Taxation of Foreign Income

Rule 15 – Foreign Income Tax:

Rule 15 serves as a cornerstone for the taxation of foreign income by residents. It lays out the following crucial provisions:

Applicability: Rule 15 applies to sections 102 and 103 of the Income Tax Ordinance, which offer relief from international double taxation.

Foreign Income Tax: The rule defines a foreign levy as a foreign income tax if two conditions are met. First, the levy must be a tax, and second, it should be substantially equivalent to the income tax imposed by the Income Tax Ordinance.

Defining Tax: A foreign levy is considered a tax if it requires a compulsory payment under the authority of the foreign country to levy taxes. However, penalties, fines, interest, or similar obligations are not classified as taxes under this chapter.

Specific Economic Benefit: The rule makes a distinction by stating that a foreign levy is not considered a tax if the person subject to the levy receives an economic benefit from the foreign country in exchange for the payment.

Substantial Equivalence: For a foreign tax to be substantially equivalent to the income tax imposed under the Ordinance, certain conditions must be met, including the computation of the taxable amount and the treatment of dividend or interest income earned from foreign sources.

Examples of Equivalent Taxes: The rule provides examples of foreign taxes that are substantially equivalent to the income tax imposed under the Ordinance, such as withholding tax on dividends and tax on wages by withholding.

Rule 16 – Foreign Tax Credit:

Rule 16 complements the provisions of Rule 15 by addressing the foreign tax credit, which is a critical aspect for residents dealing with foreign income:

Application for Foreign Tax Credit: Residents who wish to claim a foreign tax credit for a tax year are required to submit an application for the credit along with their income tax return for that year.

Form Requirements: The application for a foreign tax credit should follow the specified form as outlined in Part I of the First Schedule to the Income Tax Rules, 2002.

Supporting Documentation: Taxpayers must submit certain documents with their application, including a declaration by the payer of income tax (if tax was deducted at source) and a certified copy of the receipt from the foreign tax authority for the deducted tax.

Secondary Evidence: In cases where a resident taxpayer cannot obtain evidence of tax deduction as required, the Commissioner may accept secondary evidence as determined by him.

These rules play a pivotal role in providing clarity and guidance to residents of Pakistan who earn income from foreign sources. Understanding the criteria for determining foreign income taxation and the procedures for claiming foreign tax credits is essential for individuals and businesses engaged in international financial activities.

As always, it’s important to stay up-to-date with the latest tax regulations and consult with tax professionals when dealing with foreign income to ensure compliance with the law and to optimize tax planning strategies.

For your reference, the original

CHAPTER – IV TAXATION OF FOREIGN-SOURCE INCOME OF RESIDENTS Income Tax Rules 2002