' This appeal is filed by the Commissioner challenging the decision of Commissioner (Appeals) dated 17-9-2007, whereby addition under section 34(5) of Income Tax Ordinance 2001 was deleted.
2. The taxpayer is an, unlisted Public Limited Company which derives income from manufacturing and sale of yarn. Return for the tax year 2003 was duly filed by the taxpayer declaring loss, along with audited accounts and supportive documents. However, the case was selected for audit under section 177 of Income Tax Ordinance, 2001. After issuing necessary notices, an IDR (Information Documents Request) dated 26-2-2007 was issued by the department, in response whereof details/evidences were submitted by the taxpayer. The evidences were scrutinized and consequent findings under the audit proceedings were given and were approved by the office of the Commissioner (Audit Division). As a result, a notice under section 122 dated 26-4-2007 was issued and reply thereto was duly filed by the taxpayer. Inter alia, additions proposed under section 34(5) of the Income Tax 'Ordinance, 2001 were also confronted to the taxpayer. The departmental point of view, was that the interest payable to different financial institutions against trading loan remained unpaid after lapse of the statutory period of three years as stipulated in the subsection
(5) to section 34. Therefore, the same were liable to be charged to tax under the head "Income from Business". The taxpayer contended, since the loan against which the interest was payable as expense stands rescheduled, therefore, it amounts to have been paid and could not be termed as payable within the words of section 34(5). 'Reliance was placed on the case of Chaudhry Dairies (Pvt.) Ltd. Decided by this Tribunal vide I.T.A No,1470/LB/1997 dated 13-9-2002. The Taxation Officer brushed aside the contention for the reason that the referred case was challenged before the honourable Lahore High Court Lahore and an advisory verdict, on the issue, was still being awaited.
By reiterating that the amount of interest remained payable over three years, he proceeded on to charge the same to tax vide its order under section 122 of Income Tax Ordinance, 2001. The action of making additions under the section 34(5), amongst other grounds, was challenged by taxpayer before Commissioner (Appeals). The Commissioner (Appeals) 'deleted the additions after reproducing an excerpt from an unreported judgment of this Tribunal in case of Big Mac Foods (Pvt.) Ltd., bearing I.T.A. No, 6304/LB/2005 dated 3-5-2007, wherein the ITAT while disposing of the departmental appeal held as under:-- "Arguments heard and record perused. The arguments advanced on behalf of the revenue are not plausible. We are of the considered view that interest amount of Rs,36,32,500 payable to the IDBP cannot be termed as trading liability and the Assessing Officer had wrongly treated it deemed income of the assessee by invoking provisions of section 25 against which relief allowed by learned CIT(A) was quite justified and does not call for any interference at our level. Resultantly, the impugned order on the issue under consideration too is upheld."
3. The Departmental Representative ("D.R.") assailed the order of CIT(A) arguing that the interest, subject matter of appeal, was a trading liability and that rescheduling of the loan cannot be taken as payment of the liability under the section 34(5) Mr. Khawaja Iqbal, Advocate argued for the taxpayer had relied on section 62 of Contract Act, 1872, while supporting the order of CIT(A). He submitted that the agreement of rescheduling the loan has substituted the original Financing Agreement, which is no more enforceable in view of the principle of 'novation of contract' as enshrined in the section 62. He further submitted, since the interest payable has become part of the principal under the rescheduling agreement of financing, therefore, it ceases to be payable as interest under the original agreement of financing. On this analogy, he claims that the interest payable should be taken to have been paid for the purpose of section 34(5) of the Income Tax Ordinance 2001. In support of the principle of `novation of contract' in banking transactions he has placed reliance on case of UBL v. Aziz Tanneries (Pvt.) Ltd. 2004 CLC 1715. He has also produced a copy of this Tribunal's unreported judgment in I.T.A. No,1470/LB/1997 dated 13-9-2002.
4. Heard learned representatives of the parties and record perused.
5. It is observed that the issues involved in this case have been dealt with by the honourable Lahore High Court in the case Cube Industries v. ITAT 2006 PTD 348 decided on 30-6-2005. The issue of 'interest being not a trading liability' is directly and elaborately been dealt with, whereas, the issue of 'interest amounts to have been paid on rescheduling' is indirectly and tacitly been dealt. While recording facts of the case, the honourable Court found:-- "(4) In the assessm ent year 1988-89 another addition of Rs,46,78,245 was made by invoking the provisions of section 25(c) (Amounts subsequently in respect of deductions) of the late Income Tax Ordinance, 1979 after finding that the assessee had failed to pay the trading liabilities claimed and allowed in the previous three years. The relevant, part of the order of, the Assessing Officer reads as under:- "Addition under section 25(c).
' As per the balance sheet for the period ending 30-6-1988 total bank liabilities have been shown, at Rs,3,46,43,117. The amount includes overdraft of Rs,2,62,93,498 from the National Industrial Cooperative Finance Corporation, Lahore. Scrutiny of these liabilities show that this amount includes interest claimed from year to year which is still unpaid. The amount relating to National Industrial Finance Corporation shown at Rs,262,93,496 include unpaid interest of Rs,76,50,297 which had been the period ending 30-6-1985 and the assessee had duly claimed this amount as an expense in the P&L against business profits. Since the said amount of Rs,76,50,207 attracted the provisions of section 25(c) of the Income Tax Ordinance, 1979 and was thus liable to be treated as income from the year under review, the assessee was confronted on this issue vide notice tinder section 62 dated 4-4-1989. The assessee vide it's A.R.'s reply dated 10-4-1989 contended that the amount of unpaid interest is not a trading liability. It was further contended that amount of unpaid interest becomes the part of the loan for the subsequent year and thus does not remain a trading liability, but becomes a part of the principal amount.
' The contention of the assessee has been considered and found to be misconceived and thus not acceptable. The amount of interest payable against capital borrowed for business purpose is a trading liability as held by the ITAT in case reported as 1983 PTD (Trib.) 320. The assessee has also derived benefit by way of claiming interest as a P&L expense in the earlier years. The amount of interest expense cannot be termed as the principal amount of loan by any definition.
The contention of the assessee on this issue is therefore, rejected." (the underlining/bold is ours to highlight)
' In the opinion of honourable Court, the Assessing Officer did not act in an illegal manner by charging the amount of interest to tax, under the facts and circumstances given above;
(12) In case of the addition under section 25(c) of the late Ordinance however we are not persuaded to agree that the Assessing Officer acted in an illegal manner and that the learned Tribunal unjustly maintained its findings. The ratio settled by the Hon'ble Division Bench of the Delhi High Court in re: Mrs. Ethyl Saxena (Decd) (by L.R.) v. Commissioner of Income Tax, New Delhi (1984)
146 ITR 518) does not in any manner support the case of the assessee.
(13) In the case in hand it is not denied that the assessee claimed the bank interest as an expense in the three years preceding to assessment year 1988-89, it is also not disputed that the claimed interest was allowed to the assessee. However, in the assessment year under review it was found that actually no interest was paid on borrowing earlier made t'or the purpose of business. It has all along been the case of the assessee that interest due on bank borrowing was not a trading liability and therefore, the provisions of section 25(c) of the late Ordinance were not attracted at all.
However, neither before the Revenue authorities, the Tribunal, nor before, us the appellant has been able to dispute the practice of the department in that regard as observed by the Tribunal. Also in our view the provisions of sub-clause (c) need to be read along with the opening part of section 25 which speaks not only of a trading liability but also of allowances and deductions made under section 23 (Deductions) in respect of any loss, bad debt as well as an expense incurred by the assessee. The reference to trading liability in sub-clause (c) of section 25 needs to be read not in isolation but in conjunction with allowances and deductions allowed in respect of loss, bad debt, expense and trading liability. It is also so far the reason that under section 23 the various allowances and deductions allowable under the head business and profession, the word and phrase "trading liability" does not figure out anywhere. The interpretation of the assessee of the word "trading liability" is narrow and is designed to confine itself only to an advance made for the purpose of purchases. That hardly appears to be the intention of the law, Although not all of them but majority of the deductions allowable under section 23 can conveniently be read as trading liabilities unless it specifically finds mention in section 24 (Deductions not admissible). The word "trade" in its most common significance is not confined to mere sale and purchase. In its wide meaning it signifies the whole of business a person is engaged in. That business can be of any nature starting from simple sale and purchase and covering manufacturing, providing services and any other venture which can properly be described to be in the nature of trade. A trading liability in that sense would be any liability incurred with respect and in regard to the business of an assessee. The amount of interest having admittedly been claimed as an expense and the same having admittedly not been paid in the preceding three years the provisions of section 25(e) were clearly attracted. The appellant having claimed an expense without actually having incurred the same in the period allowed by law in that regard cannot be allowed to turn around and claim on the basis of far-fetched interpretation of the word "trade" to refuse to account for the same. The interpretation of the assessee even otherwise will result in an anomalous situation inasmuch as the assessm ents framed in the previous three years will not be correct reflections of the income of the assessee.
(the underlining/bold is ours to highlight)
' The issue 'interest being not a trading liability' was elaborately discussed and stands settled against the taxpayer. However, the issue 'interest amounts to have been paid on rescheduling' has not been dealt with in so many words, therefore, we would like to further examine the same, keeping in view the submissions made by the counsel for the taxpayer.
6. Perusal of UBL v. Aziz Tanneries (Pvt.) Ltd. (also reported as 2004 CLD 1715) shows that honourable Lahore High Court, decreed the recovery suit of bank, filed on the basis of a restructured/rescheduled agreement of financing. The rescheduling agreement was entered into on the request of customer to facilitate it in liquidating its liabilities. The honourable Court, accepted the validity of rescheduling agreement by relying on another judgment in the following manner:-- "The case of Habib Bank Ltd. v. Sarmast Cooking Oil Ltd., (supra) was a case under Banking Companies (Recovery of Loans, Advances, Credits and Finances) Act, 1997 it was observed as under:-- "Section 62 of the Contract Act, 1872, clearly provides that If the parties to a contract agree to substitute a new contract for the old one or to rescind or alter it, the original contract need not be performed. The original contract between the parties required defendant No,1 to pay the amount on or before a specified date which defendant No,1 did not do and instead requested the plaintiff to substitute the old contract with a new one in which it agreed to pay the outstanding amount by 31-7-1996. There is nothing in the Contract Act or in any other law which prohibits the parties or the bank from varying or altering the terms of the original contract or executing a new contract to substitute the old one. The agreement, dated 10-4-1993 in respect of Rs,31.111 million was a novation of the old contract the consideration of which was the agreement of the bank to extend time for paym ent, of the outstanding liabilities of defendant No, 1."
' This judgment speaks only on the validity and enforceability of the subsequent rescheduling agreement, which is not disputed by the Taxation Officer either, while making the disputed additions. Only concern shown by him was of pay ability of the interest already allowed as expense.
Before dilating further, it would be advantageous to have a look on a recent judgment by Sindh High Court in case Qamaruzzaman Khan v. Industrial Development Bank of Pakistan 2009 CLD 460.
The relevant part reads:- "Taking into consideration the 'other aspects of the case which pertains to the rescheduling of the loan and manifestly includes mark up; it is well settled that subsequent agreements do not change the previous agreements when there is no mention or reference of the previous agreement. Bank can only seek/recover all the mark up price under the first agreement. If however the bank is able to establish that the amount has been actually disbursed under the subsequent agreement it is not for the purpose of adjustment of the previous dates, and, there has been difference in sale and purchase of the commodity. In this context reliance is placed in the case of Habib Bank v. Qayyum Spinning Ltd. MLD 2001 Kar.
1351.
' Since there is a settled mode for the business carried under the banking system, the loan once rescheduled, carries interest. It is well settled that the mark up upon mark-up was never the spirit of the law if the recovery is sought under first agreement. In the instant case the recovery was sought on the basis of four finance facilities awarded to the borrowers and subsequently rescheduled, which includes mark up."
(the underlining/bold is ours to highlight)
' The honourable Court has disapproved the rescheduling agreement for including the markup/interest in the principal, upon which further mark-up cannot be charged under the Islamic mode of financing. In our considered view, validity or approval of the rescheduled financing agreement is not an issue relevant for the controversy in hand. However, the important aspect is whether rescheduling carries the interest with it or not? This judgment answers this question in affirmative, meaning thereby the interest, being unpaid, become part of a larger liability called principle. Rescheduling of any unpaid financial liability is based on the admission that the liability, whether in shape of principle or markup/ interest, could not be paid in due course or at a specified time. We B therefore hold that rescheduling on default by the customer/taxpayer is a sufficient proof for the purpose of section 34(5) to the effect that the liability of expense allowed as deduction, in shape of interest, has not been paid. It may be pointed out that, in the instant case, allowance of interest as expenditure is an admitted fact. It is also a fact available on recorded that the taxpayer has never claimed, at any forum; that the amount of interest was actually paid within the stipulated period of three years. Contention of the taxpayer was only to the extent that the rescheduling agreement has superseded the original financing agreement as a consequence, the interest was no more payable, therefore, should be taken to have been paid for the purpose of section 34(5). We are not convinced for the reasons discussed above.
7. As a result, appeal of the department is accepted and order of the Taxation Officer is restored to the extent of additions under section 34(5) of Income Tax Ordinance 2001.