Section 108 of the Income Tax Ordinance, 2001 – Legal Framework for Transactions Between Associates

Introduction

In Pakistan’s tax system, Section 108 of the Income Tax Ordinance, 2001 is one of the most important provisions for regulating transactions between associated persons. It ensures that dealings between related parties—whether within Pakistan or cross-border—are conducted at arm’s length to prevent base erosion and profit shifting (BEPS).

Often referred to in the transfer pricing context, Section 108 is supported by detailed rules, international guidelines, and provisions from the Companies Act, 2017 to ensure transparency and fairness.

This blog provides a comprehensive legal analysis for tax professionals, corporate entities, and multinational groups operating in Pakistan.

Statutory Provision – Section 108 of the Income Tax Ordinance, 2001

Section 108(1) empowers the Commissioner Inland Revenue to intervene if a transaction between associates is not at arm’s length. The Commissioner may:

• Re-allocate income, deductions, or tax credits between parties

• Disregard or re-characterize a transaction

• Re-compute tax liabilities

Key Points:

• Applies to all types of transactions – goods, services, loans, royalties, intellectual property, etc.

• No minimum threshold – even small transactions are covered.

• Focuses on true economic value rather than stated legal form.

Definition of “Associates” – Section 85

Section 85 gives a broad definition of associates, covering:

Here, “control” can mean voting rights, shareholding, or contractual influence (e.g., through loans or agreements).

Transfer Pricing Rules – Legal Framework

The Income Tax Rules, 2002 (Chapter VI – Part I, Rules 231A–231I) detail Pakistan’s transfer pricing system.

Recognized Methods:

1. Comparable Uncontrolled Price (CUP)

2. Resale Price Method

3. Cost Plus Method

4. Profit Split Method

5. Transactional Net Margin Method (TNMM)

Mandatory Documentation (Rule 231E):

• Master File – global group structure & policies

• Local File – Pakistan-specific transactions & pricing

• Country-by-Country Report (CbCR) – required for MNEs with consolidated revenue over EUR 750 million

Penalties for Non-Compliance

Under Sections 182 & 205:

• Missing documentation: PKR 25,000–50,000 per default

• Concealment of income: Up to 100% penalty on evaded tax

• Possible audit under Section 177 or best judgment assessment under Section 122(5A)

Interplay with the Companies Act, 2017

The Companies Act strengthens governance of related party transactions (RPTs):

International Alignment – OECD Guidelines

Pakistan’s Section 108 mirrors the OECD Transfer Pricing Guidelines:

• Arm’s Length Principle

• Substance over form

• Standardized documentation requirements

This alignment improves Pakistan’s compliance with global BEPS action plans.

Judicial & Administrative Principles

Key principles from tribunal and court cases:

1. Substance Over Form – Real economic impact matters more than legal labels.

2. Burden of Proof – Taxpayer must justify transfer pricing method.

3. Comparability Analysis – Must match functions, assets, and risks with market comparables.

Practical Compliance Tips for Corporates

• Always sign formal inter-company agreements with pricing terms.

• Maintain up-to-date transfer pricing documentation.

• Get board/shareholder approvals under Companies Act for related party deals.

• Conduct annual benchmarking studies.

• Disclose RPTs in audited accounts and board reports.

Common Legal Pitfalls

• No prior corporate approvals for related transactions

• Missing master/local file documentation

• Weak or outdated market benchmarks

• Charging royalties or service fees without clear justification

• Providing loans to associates without interest/security

Remedies & Dispute Resolution

If the Commissioner makes an adjustment under Section 108, companies can:

• Appeal to CIR (Appeals) under Section 127

• Further appeal to ATIR, High Court, Supreme Court

• Use Alternate Dispute Resolution (ADR)

• Apply for Mutual Agreement Procedures (MAP) under tax treaties

Final Thoughts

Section 108 is a powerful tool for the FBR to challenge artificial pricing between associates. For corporates, compliance requires:

• Aligning prices with market standards

• Meeting documentation requirements

• Following Companies Act governance rules

Failure to comply risks penalties, audits, and reputational harm.

How Legal Synergy Can Help

At Legal Synergy, we specialize in:

• Drafting & reviewing inter-company contracts

• Preparing transfer pricing files & defending audits

• Securing board/shareholder approvals for RPTs

• Advising on cross-border tax & treaty issues

📱 WhatsApp: +92 334 9555252
🌐 www.legalsynergy.pk
📧 Email: info@legalsynergy.pk