Section 7E: Deemed Income on Capital Assets & Its Implications

Introduction section 7E:

Recently, the government implemented Section 7E, a controversial provision related to Deemed Income on Capital Assets under the tax laws. This new section, akin to a capital value tax, has raised concerns as some argue it falls under provincial jurisdiction, leading to challenges in higher courts. Nevertheless, the Sindh High Court (SHC) upheld the government’s right to levy and collect the tax through its order in late October 2022. With this section now in effect (though subject to ongoing judicial review in other superior courts), taxpayers must grasp its implications and how it may affect them.

Effective from Tax Year 2022 (July 01, 2021, to June 30, 2022) and onwards, resident individuals owning capital assets with an aggregate fair market value above Rs. 25 million on the last day of the tax year (30th June) are liable to pay tax on deemed income.

What is Deemed Income and Fair Market Value?

To understand this better, let’s clarify what deemed income and fair market value mean:

• Fair market value: This value is notified by the Federal Board of Revenue (FBR) and serves as the basis for calculating deemed income.
• Deemed income: It is calculated as 5% of the fair market value. The tax rate on deemed income is 20%. For instance, if a person owns a property with a fair market value of Rs. 27 million, the deemed income would be Rs. 1,350,000 (27 million x 5%). The tax payable on this deemed income would be Rs. 270,000 (1,350,000 x 20%), effectively resulting in a 1% tax on the fair market value (27 million x 1%).

Exceptions to Tax on Deemed Income

However, certain exceptions exist where the tax on deemed income does not apply. These exceptions include:

1. Owning only one capital asset.
2. Self-owned business premises used for business, provided the person is a Filer at any time during the year.
3. Self-owned agricultural land for agricultural activities, excluding farmhouses and annexed land.
4. Capital assets allotted to specific individuals, such as Shaheeds or their dependents belonging to Pakistan Armed Forces, war-wounded persons serving Pakistan Armed Forces, Federal and Provincial Government employees, and more.
5. Income from a property chargeable to tax under the Ordinance, where tax has been paid.
6. Acquisition of a capital asset on which advance tax u/s 236K has been paid during the tax year.
7. Aggregate fair market value of properties, excluding excluded capital assets mentioned above, does not exceed Rs. 25 million.
8. Capital assets owned by Provincial and Local Governments.
9. Capital assets owned for land development and construction by registered builders, developers, or development and local authorities.

It’s important to note that Capital Asset refers to any property held by an individual, irrespective of whether it is used for business. However, it does not include stock-in-trade, consumable stores or raw materials held for business purposes, shares, stocks, securities, or depreciable/amortizable assets.

Initial Challenges and Implementation

Initially, there were challenges with the declaration of deemed income, as the fields for entering the required details were not available in FBR’s return filing portal (IRIS) until 30th September 2022. Subsequently, FBR included the required fields in IRIS for filing on or after September 30, 2022. Taxpayers who had already filed their returns by that date were required to file the declaration of deemed income separately using the form available in the IRIS portal. This declaration is mandatory for all individuals, regardless of whether the fair market value is below the prescribed limit or if the capital assets fall under the exemptions mentioned earlier.

Practical Examples of the Application of the Law Section 7E

Let’s explore some practical examples to better grasp the application of the law:

1. Example 1: A single property with a fair market value of Rs. 30 million. Although the deemed income would be Rs. 1.5 million (30 million x 5%), owning only one capital asset is exempt from tax on deemed income, and thus no tax is payable.
2. Example 2: A person owns a commercial property utilized for business worth Rs. 35 million and is a Filer at any time during the year. The deemed income would be Rs. 1.75 million (35 million x 5%), but self-owned business premises used for business, where the person is a Filer, are exempt from tax on deemed income. Therefore, no tax is payable.
3. Example 3: A person owns two homes, one of which is worth Rs. 20 million and the other at Rs. 28 million. The aggregate fair market value is Rs. 48 million. The deemed income would be Rs. 2.4 million (48 million x 5%). However, the asset with an FMV of Rs. 28 million can be excluded from tax purposes. Furthermore, the other property worth Rs. 20 million is also excluded as its FMV does not exceed the Rs. 25 million threshold.
4. Example 4: A person owns two properties, one with a fair market value of Rs. 30 million and the other with a fair market value of Rs. 28 million. The aggregate fair market value is Rs. 58 million. The deemed income would be Rs. 2.9 million (58 million x 5%). In this case, the asset with an FMV of Rs. 30 million can be treated as a capital asset excluded from tax purposes. However, the property worth Rs. 28 million would be taxed as deemed income, amounting to Rs. 1.4 million (28 million x 5%), with a tax payable of Rs. 280,000 (1.4 million x 20%).
5. Example 5: A person owns a property with a fair market value of Rs. 30 million and has already paid tax on the income from this property. The deemed income would be Rs. 1.5 million (30 million x 5%), with a tax payable of Rs. 300,000 (1.5 million x 20%). However, income from properties already chargeable to tax under the Ordinance and on which tax has been paid are exempt from tax on deemed income. Therefore, no further tax is payable in this case.

Postponement of New Valuation Tables Release

The Federal Board of Revenue (FBR) has recently made two significant decisions pertaining to the real estate sector. First, the planned release of new valuation tables for immovable properties, scheduled for August 2023, has been postponed until next month. The FBR will collaborate with committees established in each city to determine the new values.

Introduction of Online Facility for Exemptions and Tax Payments

In another move, the FBR has decided to introduce an online facility within the updated “IRIS” system. This facility will allow all citizens to easily apply for an exemption or pay the one percent tax under section 7E on immovable properties. With this new system, taxpayers will no longer be required to visit the Commissioner of Inland Revenue (FBR), to address concerns about potential corruption.

The new online platform will significantly streamline the process for all citizens of Pakistan, whether they are filers or non-filers of income tax returns. Previously, filers seeking exemption from section 7E had to visit the concerned commissioner to obtain proof of exemption. However, the FBR’s online facility will enable them to get the exemption certificate conveniently and securely.

Conclusion

In conclusion, the introduction of Deemed Income on Capital Assets may seem complex, but it is crucial to remember that owning a property with an aggregate fair market value above Rs. 25 million makes one liable for tax on deemed income. Nevertheless, there are specific exceptions to help individuals avoid paying taxes under certain circumstances. For comprehensive understanding and compliance with tax laws, it is advisable to seek assistance from professional tax consultants.