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Basic concept of taxation

1.    What is a tax year?

2.    What is taxable income and how it is computed?

3.    Who is person?

What is a tax year?

 

There are three kinds of tax years

1-Normal tax year

2- Special tax year

3- Transitional tax year

Normal tax year

In Pakistan, the normal tax year, often referred to as the “fiscal year” or “financial year,” runs from July 1st to June 30th. Therefore, when taxpayers in Pakistan prepare their annual tax returns, they report income and deductions based on this 12-month period.

Special tax year

A “special tax year” can refer to a fiscal or tax year that doesn’t follow the standard or normal 12-month period set by the country’s taxation authority. It’s often applicable to businesses rather than individual taxpayers and might be used in certain circumstances, like when a business is started or closed and doesn’t operate for a full standard tax year.

Transitional tax year

In some tax jurisdictions, including Pakistan, entities or individuals might not always follow the normal tax year (July 1 to June 30 in Pakistan’s case). Instead, they may use a “special tax year” or an “alternate tax year” under specific circumstances. This is often true for companies or organizations with unique operating cycles or for those that are incorporated or start operations partway through the regular fiscal year.

What is Taxable Income?

“Taxable income” refers to the amount of income that is subject to tax, after all allowable deductions, credits, and exemptions have been subtracted from the total income. The exact computation method can vary significantly between countries and individual circumstances, but generally follows a few common steps:

General Steps to Compute Taxable Income:

Determine Total Income:

Include all sources of income such as wages, salaries, bonuses, and any other income like rent, dividends, or profits from investments.

Adjust for Allowable Deductions:

Subtract any allowable deductions. These can include certain expenses, such as mortgage interest, educational expenses, or contributions to retirement accounts, depending on jurisdiction-specific tax laws.

Include Additional Income:

Add any other applicable sources of income, like social security benefits, interest, or earnings from a side business.

Apply Credits and Exemptions:

Subtract any tax credits or exemptions for which you are eligible. Tax credits might be available for certain types of investments, educational expenses, or energy improvements.

Subtract Prepayments and Withholdings:

Deduct any taxes already paid during the year through withholding or estimated tax payments.

Computation in a Specific Context (e.g., Pakistan):

In the context of Pakistan, the following approach is commonly used to compute taxable income, though it’s essential to refer to the most recent and relevant tax laws and guidelines from the Federal Board of Revenue (FBR) due to potential changes:

Income Accumulation:

Aggregate income from all the sources: salary, business income, income from property, capital gains, and other sources.

Deduct Allowable Expenses:

Deduct allowable expenses and deductions, such as specific deductions available on certain types of income like donations, investments, or education expenses.

Account for Losses:

Adjust for any losses carried forward from prior years if applicable, such as business losses or capital losses.

Compute Taxable Income:

Calculate the net taxable income by subtracting the total of deductions and allowances from the total income.

Apply Tax Rates:

Use the applicable tax rates (as per the tax slabs and rules defined by the FBR) on the net taxable income to calculate the tax liability.

Deduct Tax Credits:

Deduct any available tax credits or rebates, and account for any taxes already paid or withheld during the fiscal year.

Determine Tax Liability:

The resultant figure is the tax liability for the year, which could either be a payable amount or a refund, depending on taxes previously paid.

This process can be complex and subject to specific rules and regulations. Remember that tax laws and applicable rates can change, so always refer to the most recent tax codes or a tax professional when preparing a tax return.

Who is person?

In the context of taxation, the term “person” is typically defined in a broad sense and it can include various entities subject to tax. The precise definition can vary from one jurisdiction to another, but generally, “person” might encompass:

Individuals:

This refers to natural persons, such as yourself or any other individual taxpayer.

Corporations:

This includes businesses or other entities that are treated as separate taxable entities.

Partnerships:

This includes entities where two or more persons engage in a business venture and share profits, losses, and responsibilities.

Trusts and Estates:

These are entities where assets are held on behalf of beneficiaries or are in the process of being settled due to a person’s death.

Limited Liability Companies (LLCs) and Other Business Entities:

Depending on the jurisdiction, other types of business entities may also be treated as a “person” for tax purposes.

Government Organizations and Non-Profit Entities:

Sometimes, local government organizations or non-profit entities might be considered a “person” in tax contexts.

Associations:

This might include clubs, organizations, or bodies of persons, whether incorporated or not, depending on the local tax regulations.

Each of these “persons” may be subject to different rules and regulations regarding taxation depending on the jurisdiction. Tax laws often establish different tax rates, obligations, exemptions, and incentives based on the type of “person” and the activities in which they are engaged. Always refer to the specific tax legislation of the jurisdiction in question for detailed and applicable definitions and rules.

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