Tax refunds under Section 7E

Question is how taxpayers can recover amounts paid under provision subsequently declared void

KARACHI:

The constitutional validity of Section 7E of the Income Tax Ordinance, 2001, has been settled, but the practical issue has entered a new phase. The judgment does not automatically amend an income tax return, remove an amount appearing in IRIS or generate a refund. The present question is therefore no longer whether Section 7E was constitutionally valid. It is how taxpayers can correct their tax records and recover amounts paid under a provision subsequently declared void from its inception.

Section 7E was introduced through the Finance Act, 2022. It treated 5% of the fair market value of specified capital assets held by a resident person as deemed income and imposed tax on that amount at 20%, producing an effective levy of 1%. Although framed in terms of capital assets, it operated, in substance, upon immovable property. Its validity produced conflicting decisions, while certain petitioning taxpayers received interim protection subject to depositing 50% of the disputed liability.

The controversy was resolved in Sher Muhammad Mughari v Federation of Pakistan. On May 7, 2026, the Federal Constitutional Court declared Section 7E ultra vires the Constitution and struck it down as void ab initio. It also annulled the proceedings, actions, assessments, demands and notices initiated under the provision and restrained the authorities from giving effect to it. The expression "void ab initio" is important because the court did not merely discontinue the levy prospectively. Applying the doctrine of pith and substance, it found that the levy was imposed upon the capital value of immovable property rather than income. Following the Eighteenth Amendment, Entry 50 of the Federal Legislative List excludes taxes on immovable property from federal authority over capital value, while Entry 47 authorises taxation of income other than agricultural income. Calling the levy "deemed income" could not alter its essential character or enlarge parliament's legislative competence.

The judgment provides the substantive basis for relief, but taxpayers must still follow the procedure. FBR issued instructions to its field formations on September 23, 2026, directing that requests for revision of returns filed in consequence of the judgment should not be rejected. Where revision results in a refund, the subsequent refund application is to be processed expeditiously in accordance with the applicable law and procedure. Revision therefore establishes the corrected tax position but does not, by itself, constitute an order granting repayment.

The appropriate treatment depends upon how the taxpayer originally dealt with Section 7E. Some taxpayers included and paid the complete liability while filing their returns, while others filed their returns first and subsequently furnished a separate Section 7E computation and payment through IRIS. Petitioners covered by interim judicial directions may have deposited only 50% of the computed liability.

Where the full amount was paid, the entire Section 7E liability should be eliminated and the corresponding payment recognised as excess tax. Where the liability was computed at 100% but only 50% was deposited under an interim order, the entire computation should be removed, but the potential refund is confined to the amount actually paid. The unpaid balance is not refundable; it merely ceases to represent a valid liability. Where payment was made separately after the original return, correction may be required both in the return and in the separately furnished computation or associated payment record. In practice, the first step should be a year-wise reconciliation of the original return, wealth statement, Section 7E computation, computerised payment receipt, any interim order, departmental correspondence and the IRIS ledger. The amount computed must be distinguished from the amount deposited. Unless records are correctly linked, a valid claim may not translate into a refundable balance in IRIS. Where revision is required, an application may be submitted under Section 114(6), identifying the omission or wrong statement requiring correction and explaining its connection with the constitutional judgment. The revision should ordinarily remain confined to the consequences of Section 7E. Once the revised return and related records correctly eliminate the liability and recognise the payment, a separate refund application would ordinarily be required under Section 170.

Section 170 permits a taxpayer who has paid tax exceeding the amount properly chargeable under the ordinance to apply for a refund. Any admitted excess is first applied against other outstanding tax liabilities under Section 170(3), after which the remainder is refunded. Section 170(4) requires the commissioner to issue a written decision within 60 days of receiving the application, after providing an opportunity of being heard. An adverse order, or failure to decide within the stipulated period, may attract the appellate remedy under Section 170(5).

Limitation requires particular care. A refund application must generally be filed within three years of the relevant assessment order or the date on which tax was paid. Older payments may therefore raise questions concerning the applicable starting date and the effect of a subsequently revised return or assessment record. FBR's direction to process applications in accordance with law does not resolve every limitation issue, and taxpayers should not assume that revision necessarily renews the period for claiming a refund. Affected persons should act promptly and address limitation expressly.

FBR can facilitate implementation through a standard electronic workflow, a dedicated revision category, a documentary checklist and automated reconciliation of Section 7E payments. IRIS should display the original liability, amount paid, revised liability and amount potentially refundable. This would protect revenue against unsupported claims while allowing genuine refunds to be processed consistently.

The judgment has settled the constitutional status of Section 7E. The remaining challenge is administrative implementation. Taxpayers must use the statutory route carefully, while the tax administration must ensure that a levy declared void does not continue to survive merely as an unreconciled figure in an electronic record. The wider institutional test is whether a final constitutional judgment can be translated into accurate corrections and timely financial relief without generating another cycle of litigation. A transparent revision-and-refund process would protect taxpayers, provide certainty to field officers and demonstrate that effective tax administration includes not only collecting amounts lawfully due, but also returning amounts that the law no longer permits the state to retain.

The writer is a tax professional with extensive experience in corporate and international taxation in Pakistan