In a major development, resident Pakistanis will not be required to pay tax on rental income and capital gains earned in the United Arab Emirates (UAE) and the United Kingdom (UK).
In this regard, the Appellate Tribunal Inland Revenue (ATIR) Lahore has issued a detailed judgment.
Under the tax treaties between Pakistan and the UAE and UK, rental income and capital gains derived from these countries by resident Pakistanis are not taxable in Pakistan.
The ATIR focused on two earlier conflicting judgments of the Tribunal, ultimately following the first one, which was in favor of the taxpayer. It held that, under the tax treaties, the taxing rights over these heads of income are granted to the country where the income arises, not to the country where the recipient of the income resides.
The taxpayer, a resident of Pakistan, had declared exempt foreign income in their tax return under the heads of rental income, capital gains, and bank profit. However, the assessing officer issued a show-cause notice, arguing that, as a resident individual, foreign income is not exempt. Instead, the taxpayer would be eligible for a tax credit for foreign taxes paid.
The taxpayer responded that, under the respective tax treaties, the right to tax is exclusively granted to the state where the income arises. However, the assessing officer rejected this explanation, asserting that the treaties grant taxing rights to both states: the state where the income arises and the state where the recipient is a tax resident.
Since the tax levied exceeded Rs. 20 million, the taxpayer filed an appeal directly with the ATIR. In its order, the ATIR, after reproducing the principles of interpretation laid down by the Supreme Court in the recent judgment reported as 2023 PTD 863, held as follows:
**“13. The aforesaid principles of the Supreme Court are to be considered in this case. The learned OIR, while interpreting the word ‘may’ used in Articles 6.1 and 14.1 in isolation, has not considered Article 11.2, where it is expressly mentioned that the interest income ‘may also be taxed’ in the other contracting state. Such a stipulation does not exist in Articles 6 or 14, which pertain to income from immovable property and capital gains, respectively.
The OIR erred in understanding the phrase ‘may be taxed’ used in Articles 6.1 and 14.1 of the Treaty by completely taking it out of context due to a lack of understanding of the principles of interpretation. A plain reading of the aforesaid Articles makes it clear that the words ‘may be taxed’ are used to address situations exactly like the case at hand, wherein the UAE had not levied tax on rental income when the treaty was executed or even to date.
The intention of the phrase is that, if at all, a taxpayer may be taxed in situations where the property from which income is derived is in one contracting state and the owner is a resident of another contracting state, it will be taxed in accordance with the laws of the state in which the property is situated. If the expression ‘may be taxed’ granted jurisdiction to both states to tax the same income, then the expression ‘may also be taxed’ used in Article 11.2 would become redundant, which cannot be justified.”**
The ATIR further stated:
**“16. The reliance of the DR on another order of the ATIR in ITA.No.1524/IB/2021 dated 07.11.2022 is not valid, wherein a different view was taken with reference to rental income from property situated in the UAE. This order is later in time, and the learned bench was not properly assisted regarding the earlier precedent in ITA.No.4299/LB/2022 dated 08.09.2022 and a clarification by the FBR Helpline.
It is an established principle that the decision of a division bench is binding on another division bench. In the case of the earlier precedent, the department’s reference application was pending before the Lahore High Court, and the principle of propriety and consistency warranted that the earlier precedent be followed until it is reversed by the High Court.”*
