Tax avoidance and tax evasion are often conflated, one is a legal right and the other is a punishable offense. Here’s how to legitimately minimize your tax liability in Pakistan without getting into the realm of criminality.
Tax Avoidance vs. Tax Evasion
Tax avoidance means arranging your affairs to claim legitimate deductions, credits, exemptions and allowances provided for by the Income Tax Ordinance; tax evasion means hiding income and falsifying records to claim deductions and exemptions which you are not entitled to and is punishable under Section 192 for the Federal Board of Revenue’s enforcement provisions. Everything below is the former.
Legit Deductions, Allowances and Credits
- Zakat paid under the Zakat and Ushr Ordinance is fully deductible from taxable income, provided it is deducted at source or remitted with a valid Zakat receipt
- Approved donations (donations to organizations on FBR’s approved charity list) qualify for a tax credit, which is a more generous form of a deduction – research the current list before donating if tax planning is part of your motivation
- Contributions to approved pension funds (Voluntary Pension Scheme) qualify for a tax credit under Section 63, the amount of which is dependent on your age and income
- Investments in Sukuk, shares and insurance schemes may still qualify for tax credits under Section 62/62A depending on the current Finance Act’s provisions; these are subject to periodic revision so always confirm against the current year’s provisions before assuming a credit applies
Structural Decisions That Legitimately Minimize Tax
Aside from straightforward deductions and allowances, certain structures legitimately reduce your tax bill based on your effective tax rate:
- Small Company status – a private limited company that qualifies as a Small Company according to the SECP’s criteria has a lower corporate tax rate than an ordinary private limited company; see our company types guide for the difference
- Income and expense timing – deferring the recognition of income or accelerating the recognition of expenses within a fiscal year, within the bounds of accrual accounting practices, is completely legitimate tax planning and is not considered tax evasion
- Filer status – becoming a filer is not a “tax avoidance strategy”, but it substantially reduces the withholding tax rate you have to pay on almost every category of transaction
Where the Line Is Drawn
The distinction between tax avoidance and tax evasion made by the FBR and the courts usually turns on whether the transaction has a genuine commercial purpose or is a contrivance which is designed solely to avoid tax with no commercial rationale. In practice, any restructuring which is solely designed to circumvent the tax system and has no commercial rationale behind it can be recharacterized by the FBR as tax evasion under the general anti-avoidance provisions even if every step is technically legitimate.
FAQ
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Is tax avoidance illegal in Pakistan?
No; tax avoidance means using legitimate deductions, credits and exemptions to minimize your tax liability while tax evasion (withholding income and falsifying records) is illegal.
Can the FBR challenge a legitimate tax-saving structure?
Yes, if the structure has no commercial rationale other than to reduce tax liability, the FBR can recharacterize it as tax evasion even if every component of it is otherwise legal.
Does filing as a filer count as a tax avoidance strategy?
It’s not really a “strategy”; it’s a baseline requirement but becoming a filer substantially reduces the withholding tax rate you have to pay on almost any category of transaction, which is often the single biggest legal tax saving available.
