Domestic law: ATIR SB upholds tax treaty supremacy on PE definition

ISLAMABAD: A special bench of the Appellate Tribunal Inland Revenue has reaffirmed the supremacy of provisions of avoidance of double taxation treaties over domestic tax law and held, amongst other things, that in case of a conflict between the definition of a Permanent Establishment in the Income Tax Ordinance 2001 [2001 Ordinance] law and a double tax avoidance treaty, the definition cemented in the tax treaty shall prevail. The Tribunal further held that the payments made to the foreign Company by the taxpayer were in the nature of royalty and not fee for technical services, and that payment on account of reimbursement of expenses did not attract withholding tax obligations under the 2001 Ordinance. The ATIR’s decision reaffirms the primacy of provisions of double tax avoidance treaties over domestic law, and settles an important principle that reimbursement of expense does not constitute income in the hands of the recipient and hence will not trigger withholding obligations. The decision further emphasizes the application of substance over form doctrine in determining the nature of payments, and underscores the requirement that tax authorities must base disallowances on cogent evidence rather than general assertions. READ ALSO: ‘Subversion’ of tax treaties? The cross appeals arose out of an assessment order passed under section 122(5) of the Income Tax Ordinance, 2001 for Tax Year 2011, whereby a substantial tax demand was raised against the taxpayer. The assessment order was partly set aside by the Commissioner (Appeals), leading both the taxpayer and the FBR to file cross appeals before the Appellate Tribunal Inland Revenue (“Tribunal”). The dispute primarily concerned the characterization and taxability of certain cross-border payments, applicability of withholding tax provisions, and the allow ability of various expenses claimed by the taxpayer. The taxpayer was represented by renowned chartered accountant and former minister of state, Ashfaq Tola along with Barrister M. Asad Ashfaq Tola and M. Amayed Ashfaq Tola, LLM International Tax Laws. A central issue before the Tribunal was whether payments made by the taxpayer (a branch of a multi-national company) to a company in the United States constituted royalty or fee for technical services. The FBR argued that the payments were in the nature of technical services, thereby attracting withholding tax under section 152, and that failure to deduct such tax warranted disallowance under section 21(c) of the Income Tax Ordinance 2001. It was further argued that certain arrangements, including equipment rentals and ERP-related payments, gave rise to a permanent establishment in Pakistan, making such payments taxable in Pakistan. The FBR also supported various disallowances on the basis of inadequate documentation and alleged non-compliance with withholding provisions, and contended that certain head office expenditures, particularly those relating to research and development, fell outside the permissible scope of section 105. The counsel for the taxpayer, on the other hand, contended that the payments in question were in substance royalty payments for the use of intangibles, as also clearly evidenced by the underlying agreement. It was argued that under Article VIII of the Pakistan–USA Double Taxation Treaty, such royalty payments, in the absence of a permanent establishment of the foreign recipient Company in Pakistan, were not taxable in Pakistan, and therefore no withholding obligation arose. The taxpayer further submitted that the FBR had failed to establish the existence of any permanent establishment and had incorrectly relied on domestic law definitions in disregard of treaty provisions. With respect to expense disallowances, it was contended that several payments represented reimbursement of expenses which lacked the characteristics of income, hence the taxpayer was under no obligation to withholding tax, and that the tax authorities had conducted fishing and roving inquiries without identifying specific defects. It was also argued that head office expenditures, including research and development costs, were allowable under section 105 as they were incurred for the benefit of the Pakistan operations. Upon consideration of the record, the Tribunal held that the payments made to the foreign Company by the taxpayer were in the nature of royalty and not fee for technical services. In arriving at this conclusion, the Tribunal applied the principle that substance must prevail over form, observing that the agreement clearly provided for the use of intellectual property and other intangibles. It was further held that, in terms of the applicable treaty provisions, such royalty payments were not taxable in Pakistan in the absence of a permanent establishment of the foreign entity, and the FBR had failed to discharge its burden of proving the existence of such a permanent establishment. Consequently, it was held that no obligation to withhold tax under section 152 arose, and the disallowance under section 21(c) was not sustainable. The FBR’s appeal was therefore dismissed. In relation to the taxpayer’s appeal, the Tribunal found that the disallowances made by the tax authorities were largely based on presumptions and inadequate examination of the material placed on record. It was observed that payments characterized as reimbursements did not constitute income in the hands of the recipient and therefore did not trigger withholding tax obligations. The Tribunal further noted that the tax authorities had failed to identify specific discrepancies despite the taxpayer having provided substantial documentation, and had instead engaged in impermissible fishing inquiries. Disallowances relating to repairs, transportation, and third-party expenses were accordingly set aside. With respect to head office expenditures, the Tribunal held that the statutory definition of head office expenditure under section 105 is inclusive in nature and must be interpreted broadly, and that research and development expenses incurred for the benefit of the Pakistan branch were allowable. The Tribunal also rejected the FBR’s contention that the taxpayer constituted a permanent establishment of the foreign entity, particularly in light of the restrictive definition under the applicable treaty. In view of the foregoing, the Tribunal upheld the relief granted by the Commissioner (Appeals) in favour of the taxpayer and further allowed the taxpayer’s appeal by deleting the remaining disallowances. Copyright Business Recorder, 2026

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