Chapter 1: Basic Concepts of Taxation
CHAPTER 1
BASIC CONCEPTS OF TAXATION
1. DEFINITION OF TAXATION AND OBJECTIVES OF TAXATION LAWS
Definition of tax
Tax is defined as follows:
1. Taxation is collection of share of individual and organization’s income by Government under authority of
law.
2. Taxation is used by Government for increasing revenue under authority of law to promote welfare and
protection for its citizens.
Non-revenue objectives of taxation
The main purpose of taxation is to collect revenue for the Government. The Government levies tax to achieve
following objectives.
1. To collect revenue to run and administer Government.
2. Tax is a tool for implanting its policies.
3. Tax is used for fair distribution of wealth.
In addition to finance Government expenses, tax is used as a tool to carry out national objective of social and
economic development as follows:
1. Government can encourage the production of certain goods by introducing exemptions.
2. By charging high tax rates on imports the Government can encourage local purchase.
3. Taxes can be used to reduce inequalities in distribution of wealth.
4. Tax prevents wealth being concentrated in a few hands of the rich.
5. Through tax Government can encounter the effect of inflation and depression
6. To promote science and invention, education systems, health care systems, energy system and military defense.
7. It can be used to discourage investment abroad.
8. Tax can be used as a bargaining tool in trade negotiation with other countries.
9. Tax laws can be used for documentation of economy(Any amount transferred otherwise than banking channel
will be deemed as income)
10. Government can discourage use of harmful goods by levying heavy rates of tax on certain sectors.
11. Tax can be used to discourage certain undesirable sectors and activities.
12. Government can encourage research & developments by introducing tax credits.
Question Explain the objectives of following tax laws?
Solution
Tax Law
Tax on salary income
Money transferred not through banking channel is
considered as income
Tax on moveable assets of taxpayers
Higher taxes on import of luxury goods
Allowing research as an expense
Making exports exempt from tax
Tax credit on Donations to approved institutions
Tax credit on investments
Tax exemptions to software exports
Note: Students should memorize it.
1
Objective
Revenue Collection
Documentation of economy
Fair distribution of wealth
Reduction in imports of unnecessary goods
Promotion of research
Promotion of Exports
To promote culture of payment of donation to only
organized and regulated institutions
Promote investments in listed companies
Promote software Industry
Chapter 1: Basic Concepts of Taxation
2. BASIC CONCEPTS
Basics of tax laws
Adam Smith’s in his famous book “Wealth of Nations” has elaborated following canons of taxation:
Equality
Tax payments should be proportional to income.
Certainty
Tax payable should be clear and certain to taxpayer.
Convenience of payment
Tax should be collected from taxpayer at a convenient time.
Economy of collection
Taxes should not be expensive to collect.
2.1 Tax as means for development
Tax is a main source of development. Tax helps in the development of country as follows:
1. Tax incentives for agro based projects promote agriculture.
2. Charities can be encouraged by providing tax credits on them.
3. Imposing high custom duties on import of luxury items will encourage local manufacturing.
4. Taxing rich at higher rate and low income group at lower rate.
5. Government can mark areas as tax free zones, industrial zone and economic zone to provide tax incentives to
such areas. It will encourage business concerns to establish business units that will bring employment
opportunities.
6. Investment in new shares can be encouraged through introducing tax credits.
7. Investment in new plant and machinery can be encouraged through introduction of tax credits.
2.2 Kinds of taxes/Structure of taxes
Proportional tax/ Flat tax
It is a tax where the rate of tax is fixed. A fixed rate is applied on person's income whether the income is high or
low. Under this system people who earn more are not charged at a higher percentage as compared to progressive tax.
Progressive tax
It is a tax in which the tax rate increases as the income base increases. A progressive tax takes a larger amount of
tax from the high-income group as compared to low-income group. This tax proportionately equal to a person’s
status in the society.
Regressive tax
It is a tax where tax rate decreases as the amount of income increases. The higher income group pays less in taxes
than the lower income group. Regressive taxes impose greater tax burden on the poor.
2.3 Principles for levy of tax
Following are the principles for levy of tax.
The Benefit Principle
This principle says that taxes should be based on the benefits received. It means that those who receive the greatest
benefits from Government projects should pay the most taxes. The benefit principle is commonly used for highways,
libraries, etc.
The Ability-to-Pay principle
The tax should be based on ability to pay. It means that a person who is earning more income should pay more tax.
Progressive tax rates are an example of it.
The Equal Distribution Principle
It says that incomes and transactions should be taxed at a fixed rate. Therefore, people who are earning more income
shall pay more tax but not at higher rate.
2.4 Characteristics of tax laws
Following are some of the characteristics of a taxation system:
1. Administration and compliance costs should be low.
2. It should be understandable to the taxpayer.
3. The burden of taxes should be distributed in proportion to the ability of the tax-payer, i.e., it should be
progressive in character.
4. The tax should be payable in cash. It means that payment through cheques should not be accepted.
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Chapter 1: Basic Concepts of Taxation
5.
6.
7.
8.
9.
It should be mandatory in nature and payment should not be voluntary in nature.
Taxes should be collected at a convenient time for tax payers.
Tax should be imposed by state which has the jurisdiction over the person to recover i.e. it should be imposed
by Parliament in Pakistan.
It is levied for public purpose i.e. taxes are imposed to support Government to implement projects.
Taxes should be charged on incomes, transactions or property.
2.5 The principles of a sound tax system
1. Fiscal adequacy
The sources of revenue should be sufficient to meet expenses of government. Revenues of Government
should be capable of expanding or contracting annually in response to variations in public expenditures.
2. Equality or Theoretical Justice
Taxes charged must be based upon the ability of the citizen to pay.
3. Administrative Feasibility
Tax laws should be clear and plain to taxpayers. Capable and well-trained public officers should enforce it.
Time of payment should be convenient.
4. Consistency or Compatibility with Economic Goals
Tax laws should be consistent with economic goals of the government. The goal of Government is to
provide basic services for general public.
3. TYPES OF TAXES IN PAKISTAN
Federal taxes in Pakistan are classified into 2 broad categories:
1. Direct taxes
2. Indirect taxes
Direct Taxes
Income Tax
Income tax is imposed for each tax year, at specified rates on every person who has taxable income for the year.
Taxable income for charge of tax is divided under the following heads:
a) Salary;
b) Income from Property;
c) Income from Business;
d) Capital Gains; and
e) Income from Other Sources.
Capital Value Tax
Capital value tax on different transaction such as transfer of immoveable property, transfer of rights etc.
Indirect Taxes
Sales Tax
Sales tax is charged and paid at the rate of 17% of the value of-a)
taxable supplies made by a registered person in the course of any taxable activity carried on by him; and
b)
goods imported into Pakistan.
For determining tax liability input paid at the time of purchase or import is deducted from output tax charged on
sales.
Customs Duty
Customs Act in Pakistan specifies import and export duties on certain goods. A major portion of Government’s
revenue is collected through this tax. The rate of custom duty is determined by socio-economic factors. Under this
Act high rate is applied on luxury items as well as less essential goods. The import tariff on industrial plant and
machinery is lower than that of consumer goods.
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Chapter 1: Basic Concepts of Taxation
Federal Excise Duty
Under Federal Excise Act tax is charged at specified rate on:
 Goods produced or manufactured in Pakistan
 Goods imported in Pakistan
 Services provided in Pakistan
The base on which tax is charged may be value or retail price or weight. Classification of goods is done as per
Harmonized Commodity Description and Coding system. All exports are charged to tax at the rate of zero percent.
4. HISTORY OF TAX LAWS IN PAKISTAN
In Pakistan Federal Government has the right to collect tax on the income of a person.
The history of modern tax came from year 1860. Before the partition, income tax was introduced for the first time in
1860. The British Empire first introduced the Income Tax Act 1860 to fulfill the deficit faced due to war of
independence of 1857. The tax was repealed in 1865.
Thereafter Income Tax Act of 1886 was introduced and it was imposed on traders by some of provinces. Its basic
scheme survives till today. It introduced the definition of agricultural income and it was made exempt from tax and
the exemption is applicable till now.
After the World War, the Government required more funds. So in 1916 for the first time progressive rates of tax
were introduced. Government thought that flat rates of taxes are not justified and the amount of the tax levied should
depend upon the income of the earner. For collecting additional resources, a Super Tax was levied in 1917.
The most comprehensive tax introduced was Income Tax 1922 in which income tax and super tax were
consolidated. Its salient features were:
 Rates to be decided every year through Finance Act.
 In certain cases tax withholding was made mandatory.
 Re-opening of assessment was allowed.
After independence, the Government of Pakistan adopted this Act.
Till 1979, lot of amendments took place in Income Tax Act, 1922. Resultantly, the Act became a complicated law.
Keeping in view the difficulties, the Government promulgated a new income tax law namely "The Income Tax
Ordinance, 1979". This law was amended through number of finance acts and after 23 years of its existence, a new
law was promulgated termed as “Income Tax Ordinance, 2001. The fundamental change introduced was the
introduction of a regime of Universal Self-Assessment Scheme.
This law has also been amended through number of finance acts and changes are still going on.
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Chapter 1: Basic Concepts of Taxation
ICAP PAST PAPER QUESTIONS
Question-1
The primary objective of a taxation system is to collect revenue. You are required to list the other objectives (nonrevenue) which a taxation system can achieve.
(10)
(Q.7 September 2014)
Question-2
State any five ways through which taxes can be used for development of the country.
Question-3
Briefly explain any three indirect taxes applicable in Pakistan.
(05)
(Q.9 March 2015)
(05)
(Q.10 March 2015)
Question -4
Besides financing government operational expenditures, taxation is also utilized as a tool to carry out the national
objective of social and economic development. List any five non-revenue objectives of taxation.
(05)
(Q.7 (b) March 2016)
Question -5
Taxes are primary revenue yielding tools of the Government of modem ages. You are required to state any three
non-revenue objectives which the Government achieves by imposing taxation.
(03)
(Q.5 March 2018)
Question -6
(a)
Briefly explain indirect taxes applicable in Pakistan.
(04)
(b)
State one objective of tax laws in each of the following cases:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
High tax rate on high income
Higher taxes on import of luxury goods
Tax credit on donations to approved institutions
Tax credit on investments
Creation of tax free zones
Tax on income of individuals and companies
Tax on transactions not made through normal banking channel
Zero rating under the Sales Tax Act, 1990
Question-7
(a)
Briefly discuss three broad principles for levy of taxes.
(b)
Briefly explain any three indirect taxes applicable in Pakistan.
(06)
(Q.7 September 2018)
(04)
(05)
(Q.8 September 2019)
Question-8
Taxes are primary revenue yielding tools of the Government of modern ages. State any five ways by which taxes
can be used for the development of the country.
(05)
(Q.8(a) March 2021)
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Chapter 1: Basic Concepts of Taxation
ICAP PAST PAPER SOLUTIONS
Answer-1
Non-revenue objectives of taxation
Though the main purpose of taxation is to collect revenue for the Government, but in addition the Government has
certain non-revenue objectives which are listed below:
1. Government can encourage the production of certain goods by introducing exemptions.
2. By charging high tax rates on imports the Government can encourage local purchase.
3. Taxes can be used to reduce inequalities in distribution of wealth.
4. Tax prevents wealth being concentrated in a few hands of the rich.
5. Through tax Government can encounter the effect of inflation and depression
6. To promote science and invention, education systems, since and invention, health care systems, energy system
and military defense.
7. It can be used to discourage investment abroad.
8. Tax can be used as a bargaining tool in trade negotiation with other countries.
9. Tax laws can be used for documentation of economy(Any amount transferred otherwise than banking
channel will be deemed as income)
10. Government can discourage use of harmful goods by levying heavy rates of tax on certain sectors.
11. Tax can be used to discourage certain undesirable sectors and activities.
12. Government can encourage research & developments by introducing tax credits.
Answer-2
Tax as means for development
Tax helps in the development of economy as follows:
1. Tax incentives for agro based projects promote agriculture.
2. Charities can be encouraged by providing tax credits on them.
3. Imposing high custom duties on import of luxury items will encourage local manufacturing.
4. Taxing rich at higher rate and low income group at lower rate.
5. Government can mark areas as tax free zones, industrial zone and economic zone to provide tax incentives to
such areas. It will encourage business man to establish business units that will bring employment opportunities.
6. Investment in new shares can be encouraged through introducing tax credits.
7. Investment in new plant and machinery can be encouraged through introduction of tax credits.
Answer-3
Indirect Taxes
Sales Tax Act, 1990
Sales tax is charged and paid at the rate of 17% of the value of-c)
taxable supplies made by a registered person in the course or furtherance of any taxable activity carried on
by him; and
d)
goods imported into Pakistan.
For determining tax liability input paid at the time of purchase or import is deducted from output tax charged on
sales.
Customs Act, 1990
Customs Act in Pakistan specifies certain import and export duties on goods. A major portion of Government’s
revenue is collected through this tax. The rate of custom duty is determined by socio-economic factors. Under this
Act high, rate is applied on luxury items as compared to others. The import tariff on industrial plant and machinery
is lower than that of consumer goods.
Federal Excise Act, 1990
Under Federal Excise Act tax is charged at specified rate on:
 Goods produced or manufactured in Pakistan
 Goods imported in Pakistan
 Services provided in Pakistan
The base on which tax is charged may be value or retail price or weight. Classification of goods is done as per
Harmonized Commodity Description and Coding system. All exports are charged to tax at the rate of zero percent.
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Chapter 1: Basic Concepts of Taxation
Answer-4
Refer Answer-1
Answer-5
Refer Answer-1
Answer-6
a)
Indirect Taxes
Sales Tax Act,1990
Sales tax is charged and paid at the rate of 17% of the value of-a)
taxable supplies made by a registered person in the course of any taxable activity
carried on by him; and
b)
goods imported into Pakistan.
For determining tax liability input paid at the time of purchase or import is deducted from output
tax charged on sales.
Customs Act,1990
Customs Act in Pakistan specifies import and export duties on certain goods. A major portion of
Government’s revenue is collected through this tax. The rate of custom duty is determined by
socio-economic factors. Under this Act high rate is applied on luxury items as well as less essential
goods. The import tariff on industrial plant and machinery is lower than that of consumer goods.
Federal Excise Act, 1990
Under Federal Excise Act tax is charged at specified rate on:
 Goods produced or manufactured in Pakistan
 Goods imported in Pakistan
 Services provided in Pakistan
The base on which tax is charged may be value or retail price or weight. Classification of goods is
done as per Harmonized Commodity Description and Coding system. All exports are charged to tax at
the rate of zero percent.
b)
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
To reduce inequalities in distribution of wealth.
Reduction in imports of unnecessary goods.
To promote culture of payment of donations to only organized and regulated institutions.
To promote investments in listed companies.
To encourage business concerns to establish business units that will bring employment opportunities.
To generate revenue.
Documentation of economy
Promotion of exports.
Answer-7
(a)
Refer Heading 2.3 of Chapter.
(b)
Refer Heading 3 of Chapter and only write down indirect taxes.
Answer-8
Refer Answer-2
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