The avoidance of double taxation treaties between Pakistan and foreign countries has long been a source of contention between tax officials and foreign companies and their agents in Pakistan. They continued by saying that the taxation authorities spare no time in issuing letters whenever they discover a taxpayer has neglected to withhold tax from payments made to their international counterparts. In a similar vein, the department does not consider requests from taxpayers seeking exemption from withholding tax deduction in relation to the consulting fee it pays to overseas corporations.
The sources claim that tax officers pursue foreign corporations and their representatives using the justification that they operate in Pakistan through a permanent establishment there. As a result, they are prohibited from transmitting any earnings they make in Pakistan without first deducting withholding taxes.
The foreign entities, on the other hand, argue that because they are not subject to tax and do not have a permanent establishment in Pakistan, they are not required to withhold tax on royalties. As a result, they do not challenge their case. Self-serving interpretations of the treaty by the two parties result in legal disputes that occasionally wind up being decided by higher appellate forums.
According to sources, it becomes a Herculean challenge for revenue officers to establish the fact of a permanent presence of a foreign firm in the majority of cases. Yet, they are adamant to maintain their position until the highest appeal forum rules against the department.
But, sources added that in some other situations, international businesses mix up payments for consulting services with profits made in Pakistan and seek sanctuary under an agreement to prevent double taxation. They rely on Article 7 of the treaty, which addresses business and stipulates that, unless a corporation has a permanent establishment in another contracting state, all commercial earnings made by an entity of a contracting state are subject to taxation in the state to which the company belongs.
But, when they concede in front of the adjudication forum that the tax being asked from them is in relation to the consulting services and not on any commercial earnings, their reliance on the aforementioned Article of the Treaty is rendered ineffective.
According to Article 12.2 of the treaty, fees for consulting services must be taxed in the contracting state from which they originate and in conformity with its legal framework.
It should be highlighted that Pakistan’s tax legislation provides incentives for the creation of authorised new businesses in order to draw money and promote investment for the growth of Pakistan’s economy and natural resources. Regarding the profits of such enterprises and the dividends paid out of those revenues, Pakistan offers specific tax breaks. More specifically, under Pakistani income tax law, a company that qualifies as a new enterprise may receive a tax exemption for a term of five years on earnings that do not exceed five percent of invested capital, as well as a tax exemption on dividends paid from such profits.