Federal govt loses key tax case
Perhaps for the first time, the federal government has lost a crucial case before the Federal Constitutional Court (FCC), which has declared Section 7E of the Income Tax Ordinance, 2001, ultra vires the Constitution.
In a short order announced by a two-member FCC bench headed by Chief Justice Aminuddin Khan, the court struck down the controversial provision and set aside all proceedings initiated under it by tax authorities, while allowing taxpayers' appeals and dismissing petitions filed by the Federal Board of Revenue (FBR) and Commissioner Inland Revenue (CIR).
"We are persuaded to hold that Section 7E of the Income Tax Ordinance, 2001, is ultra vires the Constitution, and is accordingly struck down, being void ab initio," the short order ruled.
For the reasons to be recorded separately, the order further ruled, all the civil petitions filed by the taxpayers against the judgments of the Sindh High Court (SHC) and the Lahore High Court (LHC) are converted into appeals and allowed while civil petitions filed by the FBR against the judgments of the Peshawar High Court (PHC) and the Balochistan High Court (BHC) are dismissed.
"The transferred cases are disposed of accordingly. Consequently, all actions, proceedings, and notices initiated or taken by the FBR/C.I.R under Section 7E are declared to be without lawful authority and are hereby set aside."
Section 7E was introduced through the Finance Act, 2022, for tax year 2023 and provided for taxation on deemed or notional income arising from ownership of certain immovable properties, subject to specified exemptions relating to personal residences, agricultural land, and other exempt categories recognised under the statutory framework.
The insertion of Section 7E into the Income Tax Ordinance, 2001, through the Finance Act, 2022, was challenged before all provincial high courts, including the Islamabad High Court, on constitutional grounds.
"The Peshawar High Court and the High Court of Balochistan declared the provision to be ultra vires the constitution and struck it down. The Islamabad High Court, while not invalidating the provision in its entirety, read it down and declared subsection (2) thereof to be ultra vires the Constitution," the order noted.
The court further observed that intra-court appeals against the Islamabad High Court's ruling were pending before a division bench of the IHC, while two writ petitions had also remained pending and were later requisitioned under Article 175E(5) of the Constitution before being transferred to the FCC.
The order further narrated that a single judge of the LHC had allowed writ petitions challenging the provision, but the judgment was later reversed by a division bench in intra-court appeals. The SHC had similarly dismissed constitutional petitions filed against the law.
"Consequently, the taxpayers assailed the judgments of the Lahore High Court and the High Court of Sindh, whereas the federal government/Federal Board of Revenue/Commissioner Inland Revenue challenged the judgments rendered by the Peshawar, Balochistan, and Islamabad High Courts," the order stated while outlining the litigation history.
Commenting on the verdict, advocate Zainab Janjua said Section 7E represented an attempt by the federal legislature to expand its authority beyond constitutional limits.
"The constitution very clearly ousts taxation on immovable properties from the purview of federal legislature," she said, adding that Section 7E, through the creation of a legal fiction of deemed income, indirectly sought to achieve what the Constitution did not permit directly.
Zainab Janjua further argued that the provision was discriminatory in application.
"Often times we see that in order to meet its tax targets, the government's tax initiatives are targeted towards those classes who are already within the tax net as opposed to bringing those within the tax net who have been evading paying tax. 7E was no different. While citizens who purchase properties through their hard earned money were squeezed more, the government officials who are allotted plots for peanuts remained excluded," she added.
Several lawyers also believe that certain influential real estate groups had sought a reversal of the tax imposed on immovable property, particularly plots.
The petitions had challenged the provision on the grounds that it imposed tax on deemed income irrespective of actual accrual or receipt of income.
Counsel for the petitioners argued that the provision effectively amounted to a property tax disguised as income tax, thereby exceeding the parliament's legislative competence under Article 77 read with Entry 47 of the Federal Legislative List.
It was further contended that the provision created artificial income without realisation and violated Article 25 of the Constitution by introducing arbitrary classifications among taxpayers.
However, the federal government defended Section 7E as a valid fiscal measure aimed at broadening the tax base and addressing untaxed economic capacity.
The respondents argued that deemed income constituted a recognised legal fiction in taxation jurisprudence and fell within the parliament's constitutional authority to levy taxes on income.
Appearing for the Secretary Revenue Division, senior counsel Hafiz Ahsaan Ahmad Khokhar advanced detailed submissions on constitutional jurisdiction, legislative competence and fiscal jurisprudence.
He argued that under Article 191 of the Constitution, read with the Supreme Court Rules, 2025, the two-member bench was fully competent to adjudicate the matter.
A substantial portion of his arguments focused on Article 189 and the doctrine of precedent.
He contended that following the constitutional restructuring establishing the FCC, earlier Supreme Court judgments operated as persuasive rather than strictly binding authority in matters falling within the FCC's exclusive constitutional jurisdiction.
On merits, Mr Khokhar defended Section 7E as a valid exercise of parliament's fiscal powers under Article 77, read with Entry 47 of the Fourth Schedule.
He argued that the doctrine of legal fiction permitted taxation of deemed or notional income and that Section 7E taxed presumed economic benefit arising from ownership of certain high-value immovable assets rather than the property itself.
He further submitted that taxation statutes enjoyed wide latitude in classification under Article 25 and invoked the principle of judicial restraint in fiscal matters, arguing that courts should exercise caution before interfering in economic and taxation policy decisions made by the parliament.
However, the bench did not agree with the arguments advanced by the federal government and ultimately ruled against it.