Section 115(4) Final Tax Regime: When You Don't Need to File Returns in Pakistan

In Pakistan's complex tax landscape, understanding your obligations is paramount for every business owner and professional. While filing income tax returns is a standard requirement, the Income Tax Ordinance, 2001, offers specific provisions that can exempt certain taxpayers from this annual formality. One such crucial provision is found in Section 115(4), which outlines the conditions under which income is subject to a Final Tax Regime (FTR). This regime essentially means that the tax deducted or collected at source is the full and final discharge of the taxpayer's liability in respect of that income, thereby eliminating the need to file a return for such income. This article delves into the intricacies of Section 115(4), empowering you to identify if your business or income falls under this beneficial exemption and how to correctly navigate these provisions.

What is the Final Tax Regime (FTR)?

The Final Tax Regime (FTR) is a system where the tax collected or deducted at source by the payer from certain incomes is considered the full and final settlement of the recipient's tax liability concerning that specific income. In essence, once tax is withheld under an FTR provision, the recipient is absolved of the obligation to include that income in their regular income tax return and pay tax thereon. This simplifies compliance significantly for taxpayers whose incomes are exclusively covered by FTR provisions.

The rationale behind FTR is often to:

• Simplify tax administration for both the Federal Board of Revenue (FBR) and taxpayers.
• Ensure tax collection at an earlier stage, reducing the risk of evasion.
• Provide certainty to taxpayers regarding their tax liability on specific income streams.

Decoding Section 115(4) of the Income Tax Ordinance, 2001

Section 115 of the Income Tax Ordinance, 2001, deals with the "Return of income." Subsection (4) specifically carves out an exemption for individuals or persons whose entire income is derived from sources subject to a final tax.

The exact wording of Section 115(4) states:

"Notwithstanding anything contained in this Division, an individual or a company shall not be required to furnish a return of income for a tax year if the person's entire income for the year consists of – (a) any income chargeable to tax under the head 'Salaries' which is received by the person in Pakistan; (b) any income subject to a final tax under the provisions of this Ordinance; or (c) any combination of income referred to in clause (a) and (b)."

Let's break down the critical components of this provision:

Key Conditions for Exemption under Section 115(4)

For a taxpayer to be exempt from filing a return under Section 115(4), two primary conditions must be met:

1. Entire Income Consists of Specific Sources: The taxpayer's entire income for the tax year must exclusively comprise income falling under the categories mentioned in clauses (a) and (b) (or a combination thereof). If even a single rupee of income falls outside these categories and is taxable in the regular regime, the exemption under Section 115(4) will not apply.
2. Income Sources are FTR or Salaries: The allowed income sources are:
   • Income chargeable to tax under the head 'Salaries' received in Pakistan: This primarily applies to salaried individuals. If their only income is their salary and the tax has been correctly deducted by their employer (who is responsible for withholding tax on salaries), they are generally exempt from filing.
   • Income subject to a final tax under the provisions of this Ordinance: This is where the broader scope for businesses and other entities lies. Numerous sections of the Income Tax Ordinance, 2001, levy tax as final. Examples include withholding tax on certain services, dividends, interest, and specific business income streams.

Common Scenarios and Examples

To illustrate how Section 115(4) operates, let's consider some practical scenarios relevant to Pakistani businesses and individuals:

Scenario 1: The Salaried Individual

Mr. Ahmed is an employee earning a salary of PKR 1,200,000 per annum. His employer deducts withholding tax on salaries each month as per the applicable rates. Mr. Ahmed has no other source of income, such as rental income, business profits, or capital gains. In this case, his entire income consists of 'Salaries' received in Pakistan, and tax has been withheld. Therefore, Mr. Ahmed is exempt from filing an income tax return for that tax year under Section 115(4)(a).

Scenario 2: The Freelancer with Final Taxed Income

Ms. Zara is a freelance graphic designer. She receives payments from clients within Pakistan, and the clients deduct withholding tax at the applicable rate for professional services (often considered FTR for the recipient). Suppose Ms. Zara's total income for the year is PKR 800,000, and all of it has been subjected to withholding tax under an FTR provision (e.g., Section 153 of the Income Tax Ordinance, 2001, if applicable and treated as final). If this is her *only* source of income and the tax deducted is indeed final, she would not need to file a return.

Scenario 3: The Small Business Owner with FTR Income Only

"QuickFix Auto Services" is a sole proprietorship. Its entire revenue comes from services rendered to corporate clients, and the corporate clients are withholding tax at the applicable rate as per Section 153 (where the withholding is treated as final for the service provider). If the business owner's *total* income for the year is derived *solely* from these FTR-subjected services, and there are no other taxable incomes (like interest from bank deposits not subject to FTR, or rental income), then the business owner may be exempt from filing a return for that tax year under Section 115(4)(b).

Scenario 4: The Mixed Income Case (Exemptions NOT Applicable)

Mr. Bilal is a director in a private limited company. He receives a salary of PKR 1,000,000. Additionally, he earns rental income of PKR 300,000 from a property he owns. His salary income is subject to withholding tax. However, his rental income is not subject to a final tax. Therefore, Mr. Bilal's income does not *entirely* consist of salaries or FTR income. He must declare his salary and his rental income in his income tax return and pay tax accordingly. He is not exempt under Section 115(4).

Identifying Income Subject to Final Tax (FTR)

The critical element of Section 115(4) is the identification of income that is subject to a "final tax." The Income Tax Ordinance, 2001, contains numerous sections where tax is levied as final. Some common examples include:

• Dividends: Under Section 5 of the Third Schedule, dividends received by shareholders are subject to a final tax.
• Interest Income: Certain types of interest income (e.g., from bank accounts, government securities) are often subject to final withholding tax.
• Winnings from Lotteries, etc.: Under Section 162, income from prize winnings is subject to a final tax.
• Contract Payments and Payments for Goods/Services (under specific conditions): Section 153 and Section 154 deal with withholding tax on payments made by companies and other specified persons for goods, services, and contracts. While these are often treated as advance tax, there are specific scenarios and thresholds where the withholding can be considered final for the recipient, particularly for individuals and AOPs, depending on the nature of the service and the payer.
• Payments for Technical Services, Royalties, etc.: Various sections impose final taxes on such payments.

Important Note: It is crucial to verify whether the specific withholding tax provision applicable to your income explicitly states that the tax is "final." If the Ordinance states the tax is "advance tax" or "adjustable tax," then that income, even if withheld at source, is not considered FTR for the purpose of Section 115(4) and must be included in the return.

Common Pitfalls and How to Avoid Them

Navigating FTR provisions requires diligence. Here are some common mistakes and how to sidestep them:

1. Assuming All Withholding is Final: This is the most frequent error. Many taxpayers mistakenly believe that any tax withheld by a payer is automatically final. Always check the specific section of the Income Tax Ordinance, 2001, under which tax was withheld. If it's not explicitly stated as final, it's likely adjustable.
2. Omitting Non-FTR Income: If you have any income that is *not* subject to FTR (e.g., rental income, freelance income where tax was not withheld or treated as final, capital gains), you must file a return, even if you have substantial FTR income.
3. Incorrectly Calculating Total Income: Ensure you have a clear picture of all income sources and their tax treatment for the entire tax year.
4. Forgetting Carry-Forward Losses: If you have carried-forward losses from previous years, you typically need to file a return to claim these losses, even if your current year's income is fully covered by FTR.
5. Lack of Documentation: Maintain records of all FTR payments, including withholding certificates or statements from the payer. This is crucial for demonstrating compliance if queried by the FBR.

Pro Tip: Document Everything!

Always request a withholding tax certificate from the payer. This document serves as proof that tax has been deducted and remitted to the government. For businesses or individuals relying on FTR income, these certificates are vital evidence should the FBR seek clarification on return filing status.

Who Should Still File a Return?

You must file an income tax return if:

• Your income includes any source that is *not* subject to final tax (e.g., business income taxed under the normal regime, rental income, capital gains).
• You have incurred a loss in a tax year, which you intend to carry forward to future years.
• You are a taxpayer who has been specifically required to file a return by the FBR through a notice or notification.
• You are a resident person whose taxable income from sources other than salaries and FTR sources exceeds the taxable threshold.

Cost and Timeline Implications

For those eligible to claim exemption under Section 115(4), the primary benefit is the significant saving in time and resources that would otherwise be spent on preparing and filing tax returns. While there's no direct monetary cost saved by *not* filing (as the tax liability is already settled), the administrative burden reduction is substantial.

Timeline: The deadline for filing income tax returns in Pakistan is typically December 31st for individuals and companies. If you are exempt, you do not need to worry about this deadline.

Where to Seek Further Assistance

Navigating the intricacies of the Income Tax Ordinance, 2001, especially concerning final tax regimes and exemptions, can be complex. If you are unsure whether your income qualifies for an exemption under Section 115(4), or if you have mixed income sources, it is highly advisable to consult with a qualified tax professional or a firm specializing in corporate and tax law. Such professionals can provide tailored advice based on your specific circumstances and ensure you remain compliant with all FBR regulations.

At Javid Law Associates, we offer comprehensive corporate legal and tax advisory services designed to help businesses and individuals navigate Pakistan's tax laws effectively. Whether you need assistance with company registration Pakistan, understanding tax obligations, or ensuring compliance, our team is equipped to assist you.

Frequently Asked Questions (FAQs)

Q1: If my income is subject to withholding tax under Section 153, am I automatically exempt from filing a return?

A1: Not necessarily. Section 153 withholding is generally treated as adjustable tax, not final tax, for most income earners, especially businesses. Only in specific circumstances where the FBR or the Ordinance explicitly states it as a final tax for the recipient of income (e.g., for certain services rendered by individuals) would you be exempt under Section 115(4) based solely on Section 153 income. You must verify the final tax status.

Q2: Can I claim a refund if my FTR income results in excess tax being withheld?

A2: Generally, no. By definition, a final tax is considered the full and final discharge of liability. This means there is no provision for claiming a refund if more tax was withheld than theoretically due, as the tax is considered settled. However, if the payer made an error in withholding, they might need to rectify it.

Q3: What if I have salary income and also income from dividends? Am I exempt from filing?

A3: No. While salary income and dividend income are both subject to tax at source (salary as regular withholding and dividends as final tax), your income does not *entirely* consist of only one of these categories if you have both. Since dividends are specifically mentioned as FTR, and salary is also mentioned, a combination of only these two *could* exempt you if your salary tax was fully paid. However, the wording in the Ordinance implies that if you have salary *and* FTR income, you might still need to file if the FTR is for a different *type* of income not falling under 'Salaries'. The safest approach for individuals with both salary and dividend income is often to file a return to consolidate and ensure all aspects are covered, unless explicitly advised otherwise by a tax professional. Correction: Re-reading 115(4)(c) - "any combination of income referred to in clause (a) and (b)" suggests that a combination of salary income (a) and FTR income (b) *can* lead to exemption. Therefore, if your *entire* income comprises salary and FTR income, you would be exempt. The critical factor is ensuring there is no other taxable income outside these two categories.