Tax imposition on undistributed company profits declared illegal

KARACHI: The Sindh High Court (SHC) has struck down Section 5A of the Income Tax Ordinance 2001, including the amendments that relate to tax on undistributed profits of companies, declaring it ultra vires (beyond the powers) of the constitution.

Deciding the petitions of several companies that assailed the vires (powers) of Section 5A of the Income Tax Ordinance 2001, an SHC division bench headed by Justice Mohammad Junaid Ghaffar also set aside any show-cause or demand notices or constituents with regard to the enforcement of Section 5A of the ordinance.

The petitioners said that Section 5A was initially inserted in the ordinance vide the Finance Act 2015, and amended relevant to the present lis vide the Finance Act 2017 ostensibly in order to induce certain public companies to distribute dividends among their shareholders.

The petitioners’ counsel said that the impugned section amounts to double taxation, as income received or taxed in the same hand ceases to be income.

The counsel also said that the regulation of companies was undertaken through the Companies Act 2017 being special in nature, and any attempt at such regulation by inserting penal provisions into the ordinance, routed through a money bill, was prima facie (at first view) unmerited.

The federal law officers said that the impugned Section 5A did not amount to double taxation, as it contemplated an independent levy. It was argued that Section 5A identified a class to be taxed, so it could not be considered discriminatory.

It was concluded that the legislature had ample power to regulate economic behaviour and Section 5A was merely one species of exercise of such power.

The law officers said that the purpose of inserting Section 5A into the ordinance was to incentivise the distribution of profits by companies, and to keep companies compliant with the requirements of the company law.

They argued that the distribution of dividends was a mandatory requirement of the law and Section 5A of the ordinance was a supplemental provision thereto, while the levy was analogous to super tax, so it was valid in respect of the same income.

The court said that a tax is required to be a common burden for raising revenues for a general purpose, and Section 5A does not manifest itself to be a common burden for raising revenues for a general purpose at all, and instead seeks to target an additional levy on certain public companies with the objective to encourage or incentivise dividends.

The bench said that it has been established that Section 5A of the ordinance amounts to legislation not contemplated in the constitution to be undertaken vide a money bill.

The bench also said that in such a scenario, no rationale has been articulated before the court to justify the regulation of companies’ behaviour pertaining to dividends to be effected vide a money bill within the mandate of Article 73 of the constitution while abjuring the regular legislative process.

The court said that Section 5A of the Income Tax Ordinance 2001 cannot be sustained on the constitutional anvil and cannot be construed to have legal effect.

The bench declared that the insertion of Section 5A in the ordinance, including amendments thereto from time to time, does not fall within the parameters delineated per Article 73 of the constitution, and the provision impugned was found to be ultra vires of the constitution. The high court also set aside any show-cause or demand notices or constituents for the enforcement of Section 5A of the Income Tax Ordinance 2001.