Readers of KCO blogs are welcomed once again. After a gap of almost 2 months, Khilji & Co, Chartered Accountants are pleased to start the Blog Writing Campaign. This particular campaign which will continue during upcoming weeks will consists of fresh Blogs written by all KCO Team members.

This 1st blog is written by Mr. Sharif Uddin Khilji, FCA. Please read this blog and provide your valued comments and feed back.

Gratuity Fund & Provident Fund – Tax Deduction by banks


Income of Approved Provident Fund & Gratuity fund is not subject to taxation while clause 47B, Part IV, Second Schedule of ITO 2001 provides exemption from application of sections relating to withholding tax i.e. section 150, 151 & 233.

As per past practice, payers (say banks) did not use to deduct tax on payments (say interest) to such funds in view of statutory exemption under clause 47B and did not require the funds to produce exemption certificates. However, Sindh High Court through its decision reported as 2016 PTD 1204, decided that production of exemption certificate is necessary for the application of clause 47B and in the absence of exemption certificate, the banks are obliged to deduct income tax under section 151 of ITO 2001.

The Sindh High Court decision was followed by Peshawar High Court and Islamabad High Court however Lahore High Court gave a contrary decision and held that exemption certificate is not necessary.

Another aspect – section 161

I respect the decisions of both High Court and personally believe the decision of Lahore High Court should prevail however I propose to discuss another aspect in favor of the Funds which was apparently neither presented to the Courts by any of the Honorable Advocates nor taken into consideration in the final decision of the Court.

The provisions of section 161(1B) provide that principal amount of tax cannot be collected from the withholding agent if it has already been paid by the recipient. The Honorable High Court in a reported judgment (110 TAX 121) quoted the following text:

 Quote To declare a deductor, who failed to deduct the tax at source, as an assessee in default, the condition precedent is that the payee has also failed to pay tax directly. Unquote

The Honorable High Court further held in the same judgment:

Quote Another aspect of assessment under section 161 is the obligation of the department to establish that the deductible amount has not been paid in the meanwhile under section 161(1B). In order to establish this, an opportunity of hearing is required to be provided to the taxpayer (payee) i.e., E&P in this case. This complies with the requirement of Articles 4 and 10A of the Constitution and the jurisprudence settled by the superior courts (reliance for convenience is placed on Mst. Zahida Sattar and others v, Federation of Pakistan and others (PLD 2002 SC 408). The assessment order presented in Court during the proceedings, inter alia, fails to comply with this constitutional requirement. Unquote

In view of the above, it is evident that the provisions of section 161 are primarily to ensure deduction of tax at appropriate rate while in case a person fails to deduct tax but principal amount of tax is already paid by the recipient of amount then the payer (withholding agent) is only required to pay default surcharge.

In the case of subject approved funds, there is no principal tax liability because of exemption from income available in the law and if the bank fails to deduct tax on interest paid to such approved funds even then no default surcharge can be levied because effectively there was no default of principal amount due to statutory exemption. Accordingly, there is no case of FBR against banks for the principal amount or the default surcharge.

Sharif Uddin Khilji, FCA