ince the phrase, “treated to have derived, as income”, used in the impugned Section 7E, fails the test of the principles and the provisions, ibid, to presume anything as income, therefore, it is held that Federal Legislature was not competent, under Entry 47, to treat fair market value of an immoveable property as income — Muhammad Osman Gul & others v Federation of Pakistan & others (2023) 127 TAX 512 (Lahore High Court)

The constitutional boundary between Entry 47 and Entry 50, Part I of Federal Legislative List (FLL), Fourth Schedule to the Constitution of Islamic Republic of Pakistan [“the Constitution”] has become the most contested and least understood aspect of Pakistan’s fiscal framework.

Recent decision of the Federal Constitution Court (FCC) of Pakistan declaring section 7E of the Income Tax Ordinance, 2001 [“ITO 2001”] ultra vires of the Constitution, and pending cases involving Capital Value Tax (CVT) 2022 [CVT 2022] on foreign assets have exposed a deeper structural confusion. This goes beyond statutory interpretation and strikes at the heart of constitutional jurisprudence in taxation.

Courts and counsel alike have largely framed the debate in terms of pith and substance of both taxes, and territorial competence for imposing CVT in the wake of Constitution (Eighteenth Amendment) Act, 2010 [18th Amendment]. The most pivotal issue of doctrinal distinction between taxation of “income” and “capital” remains unattended in the light of Constitution.

Entry 47, Part I of FLL empowers Parliament to levy taxes on “income” other than agricultural income. Entry 50, as reconfigured by the 18th Amendment, permits taxes on the capital value of assets, expressly excluding immovable property. This exclusion is explicit and unambiguous.

The exclusion represents a deliberate constitutional choice to transfer the entire field of taxation of capital value of immovable property taxation—including its value and accretions — to the provinces. The amendment marks a clear departure from earlier pre 18th Amendment arrangements and reflects a conscious effort to align fiscal powers with territorial governance.

The difficulty arises when statutory provisions blur the distinction between income and capital. Section 7E of ITO 2001, violating Constitution, attempted to treat the fair market value of immovable property as deemed income. Section 37(1A) of ITO 2001 taxes capital gain on disposal of immovable property, which after release of detailed judgement by FCC would need serious reconsideration in terms of Entry 50, Part I of FLL.

Both provisions, though different in form, raise the same constitutional question: can Parliament tax the value or accretions of immovable property by characterising them as “income” or “capital gains”?

A proper answer requires a return to basic principles. “Income”, in constitutional and economic terms, refers to a flow — a periodic or realised return arising from the use of capital or labour. Rent derived from immovable property, profits from its commercial exploitation, or gains arising from business dealings in land and/or building fall squarely within this concept. These all fall under Entry 47, Part I of FLL because they represent “income” in its true sense.

Capital, by contrast, represents a stock — an accumulation of wealth embodied in assets. Any increase in the value of that stock, unless realised, remains a notional accretion. Even upon realisation, such gain does not automatically become “income” in the constitutional sense unless the taxing entry so permits. This distinction is fundamental to tax systems across the world, where income taxation and capital taxation are treated as conceptually and legally distinct domains.

Our Constitution also recognises this distinction. Entry 50, Part I of FLL deals with capital value of assets, while Entry 47 deals with “income.” The 18th Amendment further refines this scheme by excluding immovable property from the ambit of Entry 50. The implication is clear: the Federation may tax income arising from immovable property, but not its capital value or capital accretions or gains. Those powers lie with the provinces.

The statutory framework of ITO 2001 when properly interpreted is broadly consistent with this constitutional design. Section 18 read with section 2(10) of ITO 2001 taxes business income, including any adventure in the nature of trade.

Where a person is engaged in the business of buying and selling land or building, such property constitutes stock-in-trade, and any gain on disposal is business income falling under Entry 47, Part I of FLL. In such cases, immovable property is not a ‘capital asset’ but part of a trading activity. Section 37(5)(a) of ITO 2001 excludes it as stock-in-trade. Section 37(1A) only overrides section 37(1) and not section 37(5).

Difficulty arises where gains on disposal of immovable property are brought within section 37(IA) of ITO 2001 as ‘capital gains’. This inclusion raises serious constitutional concerns. By treating immovable property as a capital asset for federal taxation, section 37(1A) of ITO 2001 effectively allows Parliament to tax capital accretions in immovable property — a field that has been expressly excluded from federal competence under Entry 50, Part I of FLL.

The same conceptual flaw is visible in section 7E of ITO 2001, which seeks to tax an imputed return on the value of immovable property by treating it as income. The Lahore High Court in above cited cases has already recognised the difficulty in this approach, observing that treating the market value of immovable property as income falls outside the scope of Entry 47, Part of FLL.

The attempt to sustain such taxation by recharacterising it under Entry 50 ignores the constitutional exclusion of immovable property from that entry. The result is a legislative and interpretive anomaly.

Taxation of capital value of immovable property, which the Constitution assigns to provincial jurisdiction, is being brought back into federal taxation through definitional expansion and conceptual re-labelling. This is not merely a question of statutory overreach; it is a constitutional mischaracterisation.

A comparative perspective reinforces this conclusion. In most jurisdictions, income taxation and capital taxation are kept distinct, both conceptually and administratively. Capital gains are typically taxed upon realisation and often subject to separate rules reflecting their nature as accretions to capital rather than recurring income. Wealth taxes, where they exist, are imposed directly on net worth and not disguised as income. This clarity prevents overlap and preserves the integrity of taxing powers.

The Subcontinent’s experience of taxation of immovable property has been unique. Under the British Raj, tax policy often accommodated political realities, including the interests of princely states and landed elites. Capital accretions in land were treated inconsistently, and distinctions between income and capital were blurred to avoid political resistance. This legacy continues to influence contemporary tax structures, where hybrid constructs persist despite constitutional reforms.

The 18th Amendment sought to correct this historical distortion by clearly demarcating taxing powers. The Federation was to tax income; provinces were to control immovable property and its capital value. This constitutional settlement cannot be undone by statutory ingenuity.

The doctrine of pith and substance provides the appropriate test. A law must be judged by its true nature and effect, not by the label assigned to it. If a tax, in substance, operates on the capital value of immovable property, it falls outside federal competence regardless of how it is described. Conversely, if it taxes income arising from the use or business exploitation of such property, it is valid under Entry 47, Part of FLL.

The boundary between Entry 47 and Entry 50, Part I of FLL is, therefore, neither blurred nor ambiguous. It is precise and constitutionally grounded. The confusion lies not in the text of the Constitution but in its application by Parliament and Revenuecracy, as confirmed in the short order of FCC of May 7, 2026 on section 7E.

Restoring that boundary is essential not only for doctrinal clarity but for the preservation of fiscal federalism. A constitutional order in which taxing powers can be expanded through definitional devices ceases to be a constitutional order. It becomes an exercise in legislative convenience that is rightly disapproved by FCC in section 7E cases. The FCC by upholding the integrity of constitutional entries has encountered the blatant attempt through section 7E to erode it using “semantic innovation” on the part of FBR, which was unfortunately endorsed by Parliament.

The writers are lawyers, adjunct faculty at Lahore University of Management Sciences and members of the advisory board of Pakistan Institute of Development Economics.