Understanding Implications of Section 7E – Deemed Income on Capital Assets

Welcome to our blog on the introduction of Section 7E i.e. Deemed Income on Capital Assets under the tax laws. The implementation of this new section has caused some controversy, as it is in the nature of a capital value tax, which is a provincial subject and some argue that the government should not have imposed it. Therefore, many taxpayers had also approached higher courts to challenge the imposition of deemed income, but the Sindh High Court (SHC) through its order late October 2022 rejected the petitions and allowed the Federal Board of Revenue (FBR) to levy and collect the tax. Since it is now applicable (although the matter is still sub-judice in other superior courts), it’s important to understand the implications of this section and how it may affect you as a taxpayer.

From Tax Year 2022 (July 01, 2021 till June 30, 2022) and onwards, a resident person who owns capital assets on the last day of the tax year (i.e. 30th June) with an aggregate fair market value above Rs. 25 million, is liable to pay tax on deemed income.

But what exactly is deemed income and fair market value?

The fair market value is the value notified by the Federal Board of Revenue (FBR) and deemed income is calculated as 5% of the fair market value. This deemed income is subject to a tax rate of 20%. For example, if a person owns a property with a fair market value of Rs. 27 million, the deemed income will be Rs. 1,350,000 (27 million x 5%) and the tax payable on deemed income will be Rs. 270,000 (1,350,000 x 20%), effectively 1% tax will be paid on fair market value (27 million x 1%).

However, there are certain exceptions where the tax on deemed income will not be applicable. These include:

1. Owning only one capital asset;
2. Self-owned business premises for business where the person is a Filer at any time during the year;
3. Self-owned agriculture land for agriculture activity (excludes farmhouses and land annexed to them);
4. Capital assets allotted to certain individuals such as Shaheeds or dependents of Shaheeds belonging to Pakistan Armed Forces, war wounded persons serving Pakistan Armed Forces, Federal and Provincial Government and more;
5. Income from any property which is chargeable to tax under the Ordinance and tax on the same has been paid;
6. Acquisition of capital asset on which advance tax u/s 236K has been paid during the tax year;
7. Where the FMV of the property or properties, in aggregate, excluding capital assets mentioned above does not exceed Rs. 25 million;
8. Capital assets owned by Provincial and Local Government; or
9. Capital assets owned for land development and construction by a development and local authority, builders and developers those are registered with Directorate General of Designated Non-Financial Businesses and Professions of Board (DNFBP).

It’s important to note that Capital Asset is defined as any kind of property held by a person, whether or not used for business. However, it does not include the following:

1. Any stock-in-trade, consumable stores or raw materials held for business purpose
2. Any shares, stocks or securities
3. Any property on which depreciation or amortization expense is allowed.
4. Any moveable asset not mentioned in a, b and c above.

Declaration for deemed income was required to be filed along with income tax return. However, till 30th September 2022, the fields for entering the required details were not available in FBR’s return filing portal (IRIS). Later, FBR clarified that the required fields had been included in IRIS for filing on or after Sep 30, 2022, but those taxpayers who had already filed the return till 30th September 2022 were required to file declaration of deemed income in a separate form under section 7E available in IRIS portal. It’s important to note that even if deemed income tax is not applicable on a person, they are still required to file its declaration. Every person is required to file a declaration whether the fair market value is below the prescribed limit or if the capital assets are excluded for the aforementioned reasons.

Following are various scenarios to explain the practical application of the law:

Scenario 1: A person owns a single property with a fair market value of Rs. 30 million. In this case, the deemed income would be Rs. 1.5 million (30 million x 5%) and the tax payable on deemed income would be Rs. 300,000 (1.5 million x 20%). However, as per Section 7E, owning only one capital asset is exempt from tax on deemed income. Therefore, this person would not have to pay any tax on deemed income.

Scenario 2: A person owns a commercial property used for business with a fair market value of Rs. 35 million and is a Filer at any time during the year. In this case, the deemed income would be Rs. 1.75 million (35 million x 5%) and the tax payable on deemed income would be Rs. 350,000 (1.75 million x 20%). However, as per Section 7E, self-owned business premises used for business where the person is a Filer at any time during the year are exempt from tax on deemed income. Therefore, this person would not have to pay any tax on deemed income.

Scenario 3: A person owns two properties, one with a fair market value of Rs. 20 million and the other with a fair market value of Rs. 28 million. In this case, the aggregate fair market value of both properties is Rs. 48 million. The deemed income would be Rs. 2.4 million (48 million x 5%) and the tax payable on deemed income would be Rs. 480,000 (2.4 million x 20%). However, asset with a FMV of Rs. 28 million can be treated as capital asset excluded for tax purposes, and the other property worth Rs. 20 million would also be excluded since its FMV does not exceed the threshold of Rs. 25 million.

Scenario 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. In this case, the aggregate fair market value of both properties is Rs. 58 million. The deemed income would be Rs. 2.9 million (58 million x 5%) and the tax payable on deemed income would be Rs. 580,000 (2.9 million x 20%). However, asset with a FMV of Rs. 30 million can be treated as capital asset excluded for tax purposes, and the other property worth Rs. 28 million would be taxed as deemed income amounting to Rs. 1.4 million (28 million x 5%) and the tax payable on deemed income would be Rs. 280,000 (1.4 million x 20%).

Scenario 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. In this case, the deemed income would be Rs. 1.5 million (30 million x 5%) and the tax payable on deemed income would be Rs. 300,000 (1.5 million x 20%). However, as per Section 7E, income from any property which is chargeable to tax under the Ordinance and the same has been paid is exempt from tax on deemed income. Therefore, this person would not have to pay any tax on deemed income.

To sum it up, the introduction of Deemed Income on Capital Assets can be a bit complicated to understand but it’s important to note that owning a property with an aggregate fair market value above Rs. 25 million will be liable for tax on deemed income, but there are certain exceptions through which you can avoid paying taxes. It’s always recommended to consult with a professional tax consultant for further assistance and to ensure compliance with the tax laws.