1. Through this order, we intend to dispose of the cross appeals filed by both the parties i.e. Revenue/department as well as assessee/appellant-company against the order passed by the learned CIR(Appeals-1), Lahore, dated 23-8-2010 against the respective grounds set forth in the memo. Of grounds of appeals.
2. Brief facts of the case are that the appellant is a public limited company involved in manufacturing and assembly of tractors. The appellant filed its income tax returns for tax years 2004 and 2005 which were treated as assessm ent orders under sections 122(3)(a) and 120(1) of the Income Tax Ordinance, 2001 respectively. Subsequently, the Additional Commissioner/Taxation Officer (Large Taxpayer Unit, Lahore) found the deemed order to be erroneous and prejudicial to the interest of revenue and subsequently amended the assessment orders by making several additions in the income under section 122(5A) of the Ordinance for both the years.
3. We have heard the learned counsel for both the parties and have gone through the relevant orders. The grounds taken by the appellant as well as by the Department are disposed of as hereunder:-- Addition of on account of compensated absences. (Tax Years 2004 and 2005) The Addl. CIR/TO made addition of Rs.5,917,000 and Rs.2,468,000 for tax years 2004 and 2005 respectively which were deleted by the learned CIR(A). The department has agitated this ground on the deletion of said additions by the learned CIR(A).
4. The learned DR supported the treatment given by the learned Addl. CIR/TO in his order while making the addition on account of "provision for compensated absences". The learned DR argued that subsection (3) of section 34 of the Income Tax Ordinance, 2001 indicates that ".... An amount shall be payable by person when all the events that determine liability have occurred and the amount of the liability can be determined with reasonable accuracy".
5. He further made reference to International Accounting Standard 37 (1AS 37), that deals with treatment of Provisions and Contingent Liabilities differentiate the provisions with accruals. The learned DR further argued that no reliance can be placed on actuarial report.
6. The learned AR referred to the following in his support:- "The court have now accepted that the provision for gratuity is a definite and ascertained liability even when it is cited as accrued expense and it is possible to precisely calculate/extrapolate the gratuity amount due to an employ at the time of his superannuation/retirement given the terms of his employment agreed to between employer and employee when he first took up employment."
7. Re: 2001 PTD 1427 . Wherein it was duly held that leave encashment is the estimation of liability which is accrued.
8. It will thus be seen that expenses on account of compensated absences is not a free reserve but the accrual of the actual expenditure duly incurred and totally expended during the year to which it relates.
9. We have considered the arguments of both parties. The learned CIR(A) while disposing of this ground has passed a detailed speaking order relying on the facts and reported judgments.
10. The claim of provision is based upon actuarial valuation by the aforesaid actuaries. The liability has been created on the basis of actuarial valuation and after satisfying the conditions laid down in section 34 of the Ordinance. The principle was laid down by the honourable apex court of Pakistan in the judgment reported as 1992 SCMR 763 that liability already accrued thought to be discharged at a future date would be a proper deduction is applicable in this case.
11. "Whether on the facts and in the circumstances of the case, the learned ATIR was justified in law to hold that provision made in the books of accounts of compensated absences was allowable expenses even though it was not based on the demand in this regard Honourable High Court answered the question in the following manner:-- International Accounting Standards - 19; Employee Benefits section 34 of the Ordinance, CBR Circular No. 16 of 1990, dated December 4, 1990 International Accounting Standards - 37; Provisions, Contingent Liabilities and Contingent Assets 1992 SCMR 763, 2008 PTD 647, 2006 PTD (Trib.) 1800, 1985 PTD 413 and 2001 PTD 1427.
12. It was argued that Compensated Absences are the legitimate right of employees to claim the benefit from the company. The Company after careful calculation under the law creates the liability which is recurring nature expense. If at one point of time, all the employees wish to leave, it is the statutory obligation of the company to pay them their compensated absences.
13. Section 34(3) of the Ordinance deals with accrual accounting as;
34. "Accrual basis accounting"
(3) Subject to this Ordinance, an amount shall be payable by a person when all the events that determine liability have occurred and the amount of liability can be determined with reasonable accuracy".
14. It was stated that the event has already occurred, wherein the employee has rendered his services to the company and the amount of the liability determined with the reasonable accuracy in the form of Actuarial Valuer's Report, the preconditions of section 34(3) are met with.
15. The treatment of Compensated absences as given in the IAS 19 is as under:-- "when an employee has rendered services to an enterprise during an accounting period, the enterprise should recognize the undiscounted amount of short term employee benefits expected to be paid in exchange for that services"
16. As per IAS 19, actuarial valuation of these compensated absences has to be carried out by the actuaries to determine the liability of the company. To comply with the law, the company appoints actuaries, who authoritatively calculate the liability of the company for that particular year.
17. This is just another regular natured expense which regularly accrues in one year and is paid in subsequent years, provided all the claimants claim the same.
18. The learned AR referred the clarification of the Board vide CBR's Circular No.16 of 1990, dated December 4, 1990, explaining that:-- "...It is clarified that "over time" and leave encashment" fall within the ambit of "salary" being the remuneration or compensation for service rendered by an employee."
19. The AR also referred to para 11 of IAS 37:-- "Provision can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast; Trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the suppliers; and Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid. Invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount timing of accruals, the uncertainty is generally must less than for provisions.
20. Accrual are often reports as part of trade and other payables, whereas provisions are reported separately.
21. Reading of section 34(3) read with accounting treatment under IAS 37 indeed goes in the favour of the taxpayer. All the treatments meted out are according to established practices of the company and international accounting standards (IAS 19 and 37) to which the company adheres.
22. The liability on account of compensated absences for the year arises as a statutory obligation and is to be paid in phases to the employees as per terms of contract. The liability is worked out by the Actuaries who are independent specialists in this area as provided in International Accounting Standard 19. The expenditure is of statutory. E nature and accrues on account of the services received from the employees by the employer during the assessment year 2004. This accrued is the actual salary expenditure although not paid immediately. In this regard the Honorable Supreme Court has already affirmed in the reported case as follows:-- CIT v. Oriental Dyes and Chemicals Co. Ltd. Cited as 1992 SCMR 763 that liability already accrued thought to be discharged at a future date would be a proper deduction while working out the profits and gains of business under the accepted principles of commercial practice and accountancy and that it is not necessary that the amount actually be expended or paid."
23. Re: 2006 PTD (Trib.) 1800 Reference was drawn from 1985 PTD 413 "With great respect to their lordships of the Peshawar High Court we would like to observe that the judgment of the Honorable apex court and this court are in correct interpretation of law as the implication of the section 10(2) (v) has not been considered by their lordship of the Peshawar High Court. Respectfully following the above judgments, we uphold the judgment of the Income Tax Appellate Tribunal and since the matter has already been adjudicated by the honorable apex court, we refuse to answer the proposed question."
24. The honourable High-Court upheld the judgment of ITAT and did not interfere with the treatment given by the ITAT.
25. Placing reliance on (1992) 65 Tax 254(sic) 2009 PTD (Trib.) 1559 and 2008 PTD 647 it is clear that the liability already accrued thought to be discharged at a future date would be a proper deduction while working out the profits and gains of business under the accepted principles of commercial practice and accountancy and that it is not necessary that the amount actually be expended or paid.
26. Depreciation disallowed on rented building (Tax Years 2004 and 2005) Facts in brief are that the appellant has rented out small portion of 125 square yards of its building to United Bank Limited.
27. Depreciation has been claimed for the etire building whereas the Addl. CIR/TO curtailed the claim by 5% for the reason that this portion was not being used for the purposes of business. The taxpayer has agitated this ground.
28. The learned AR argued that rental income is not the primary business of the company, and that it has taken the said rental income as other income and has not claimed any statutory repair allowance on the same except depreciation @ 5%.
29. The learned DR however supported the order of CIR(A) arguing that this portion of property was not being used for the purpose of business.
30. We do not wish to interfere with the order of CIR(A) on this score, hence addition on this score is confirmed.
31. Add back expenses attributable to dividend income (2004 and 2005).
32. The Addl. CIR/TO has made the addition by allocating expenses on dividend income by prorating the same. The learned CIR(A) has upheld the proration of financial expenses and curtailed the proration of other expenses only to the extent of expenses claimed under the head 'salary' in administrative expenses. Both the taxpayer and the department have agitated this ground.
33. The learned AR argued that dividend income is distinctively maintained as separate head of income by the company. It was stated that since the Company is not incurring any expense incidental to the income from dividend, therefore, the question of proportionate expenses in this activity does not arise. He further stated that the investment had not been made out of borrowed capital and there is no borrowing of the company from where this investment was made to earn the dividends.
34. The learned AR further stated that no expenditure was to be allocated which fact was duly supported by Chartered Accountants under sub-rule (3) of Rule 13 of the Income Tax Rules, 2002, as no expenses were allocated to Dividend Income in the financial statement.
35. The learned AR stressed that the taxpayer company has regularly been employing the same method of accounting for over 30 years. Moreover, it was maintained that allocation on this, score was not sub judice matter, having attained finality. The learned AR relied on the II cases referred as following:-- Re: (2005) 91 Tax 1 (Trib.) = 2005 PTD (Trib.) 1208 "Whether if appellant regularly employs particular method of accounting and if no defects are found in maintenance of accounts Assessing officer is bound to accept same - HELD YES.
36. The AR further relied on the following judgments referred as:--Re: 2009 PTD (Trib.) 1559 Re: (2009) 99 Tax 68 (Trib.) = 2009 PTD (Trib.) 869 "Where inevitably certain expenditure has relation to various source of income, deposit it that there are certain expenditure which are directly relatable to any one source of income. Such expenditure which are general in nature or could not be assigned to any one source, these shall be prorated after proper scrutiny. The expenditure should be allocated to each head of income with supporting evidence"
37. On the other hand the learned DR relied on the treatment given by the TO by prorating all the expenses on dividend income. He stressed that no income can be earned without expenses, therefore expenses must be allocated to the dividend income under section 67 as per rules.
38. We have observed that no exercise had been taken by Taxation Officer to allocate the expenditure specifically, whereas a general proration was made on the basis of turnover. We are inclined to agree with the findings of learned CIR(A) on the score that selling expenses have no concern with the earning of dividend income.
39. We are also inclined to agree with the arguments of learned AR on the ground that since no borrowed funds were utilized towards purchase of shares and no exercise was carried out by the TO to establish the same, the proration on this account is deleted.
40. It is an established fact that no income can be earned without incurring any expense. However, allocation of expenses under the head "salaries" by the learned CIR(A) is excessive since all the employees are not working towards earning the income from dividend. It is only the management who is involved in the decision making of carrying on the investments in sharies of the companies to earn dividend income. Consequently, salaries of directors and CFO of the company are to be apportioned to the head 'dividend' income.
41. Add back under section 21(k). (2004) The Addl. CIT/Taxation Officer had made the addition on account of perquisites to the directors which were more than 50% of their salaries. The learned CIR(A) has confirmed the addition on the finding that nothing had been submitted to controvert the findings of the TO. The taxpayer has agitated this ground.
42. The learned AR argued that die excess payments are not made as perquisite of salaries, but in fact paid as reimbursement of expenses. A comparison of addition under section 21(k) with and without reimbursements was furnished to the court as under; Particulars With reimbursements (As per T.0.)Without reimbursements (under section 21(k))
43. Salaries of Directors 2,840,000 2,840,000 Bonus 4,108,000 4,108,000 Total Salaries 6,948,000 6,948,000 50% above 3,474,000 3,474,000 Perquisite/allowances etc. Medical 912,000 912,000 Utilities 655,000 655,000 House rent 1,278,000 1,278,000 Reimbursements 1,887,000 Total 4,732,000 2,845,000 Addition under section 21(k)1,258,000 NIL The leaned AR contested that the learned TO by simply stating "that the amount of any expenditure incurred by an employee i.e. Reimbursed by the employee is to be taken as part of the salary" under section 12(2)(d) has not appreciated the exceptions stated therein; Section 12(2)(d) of the Ordinance:-- "12(2)(d); the amount of any expenditure incurred by an employee that is paid or reimbursed by the employer, other than expenditure incurred on behalf of the employer in the performance of the employee's duties of employment;"
44. The learned AR also referred to the following reported judgments:-- Re: 1981 SCMR 1029, Re: 2009 PTD (Trib.) 1559 and Re: 2007 PTD (Trib.) 1055 "The mandatory payments made by the Tax Payer company to its employees for reimbursement of medical expenses incurred by the employees did not represent expenditure resulting directly or indirectly and the provision of any benefit or amenity incurred by taxpayer Company of reimbursement of medical expenses of employees could not be treated as perquisites and cannot be disallowed. [Ref: Page 113-A] Medical expenses cannot be included in excess perquisites and therefore the addition made in this respect by TO has been upheld by learned CIT(A) without any justification. The addition made in this respect is deleted. [Ref: Page 114-B)
45. The learned AR also stated that these reimbursements are not part of salaries expenses, but are debited to actual heads of expense verified by independent professional auditors.
46. On the other hand, learned DR contested that the treatment meted out by the learned Taxation Officer is justified as no evidence was produced to the Taxation Officer or to CIR(A) to justify the said claim.
47. However, we concur with the arguments of the learned AR and observe that no exercise was made by the TO to determine the exact amount or nature of perquisites rather addition was made on half reliance on section 12(2)(d) without appreciating that reimbursements are not perquisites in the light of above referred judgments. We are, therefore, inclined to agree with the arguments of leaned AR and delete the addition made under this ground.
48. Addition on account of disposed-of assets. (Tax year 2004) The appellant has written of assets worth Rs.15,578,473 out of which assets worth Rs.2,900,674 were sold and balance amount of Rs.12,677,799 was claimed as expenses which were not allowed by the Addl. CIT/TO. The learned CIR(A) has confirmed the addition, hence this ground is agitated by the taxpayer.
49. The learned AR argued that being a listed company, as a matter of statutory measures, the company gets its Fixed Assets physically verified from independent professionals once in five years.
50. The company was statedly carrying on this treatment for the last 20 years and this written of amount had never been subjected to addition on account of assets disposed of.
51. The AR was personally present with the complete report and justified the company for the sums to be written of stating that wrong capitalization on account of Building on free hold land amounting to Rs.38,651 needed to be corrected. The written of amount of Rs.502,215 of plant and machinery over a span of 5 years is an average of Rs.5 per tractor. Writing of of tools and equipment shows Rs.72 per tractor on the average. He further stated that very old vehicles comprising cycles and one accidental motorcycle which were totally worn out were written of amounting to Rs.75,207.
52. The company's history shows that similar verifications had earlier been carried out as of 31-12-1998 and 31-12-1993 and similar amounts were written of. These write offs duly appear in the accounts and were always allowed in totality in the past.
53. The AR further argued that the very purpose of such independent physical verification of assets' exercise is to show the fixed assets at the most realistic and factual values.
54. The learned AR further stated that Company has duly deducted the disposal written down value from its fixed assets schedule (for tax computation) as per computation of depreciation attached with the return.
55. The learned AR referred that the entire treatment had been given in terms of section 75 of Ordinance and the assets were disposed of with reference to sections 77 and 68 of Income Tax Ordinance, 2001. He further stressed that while making the addition on account of section 22(8) of the Ordinance, the Assessing Officer had forgone the treatment of allowance under section 22(8)
56. (b).
57. Section 75 (disposal and Acquisition of Assets) of Income Tax Ordinance, 2001, explains the disposal of assets. Clause (b) of subsection (1) of section 75 states hereunder:- "A person who holds an asset shall be treated as having made a disposal of the asset at the time the person parts with the ownership of the asset, including when the asset is-.
(a) ........... (b) Cancelled, redeemed, relinquished, destroyed, lost, expired or surrendered. "
58. Section 77(3) states; "The consideration received for an asset treated as disposed of under subsection (3) or (3A) of section 75 shall be the fair market value of the assets determined at the time it is applied to personal use or discarded or ceased to be used in the business, as the case may be".
59. Further, clause (3A) of section 75 states as hereunder; "Where a business asset is discarded or ceases to be used in business, it shall be treated to have been disposed of "
60. Section 68 - Fair Market Value "For the purposes of this Ordinance, the fair market value of any property, assets, services, benefits or perquisite at a particular time shall be the price which the property or rent, asset, service, benefit or perquisite would ordinarily fetch on sale or supply in the open market at that time."
61. The learned AR referred the following cases; Atta Hussain Ltd. v. CIT East Pakistan Dhaka cited as 1969 PTD 679 He further referred 2009 PTD (Trib.) 1559 wherein it was held that "the stores and spares characterized as stock and trade written of can be claimed as admissible expenses in P & L account"
62. The learned AR further argued that the Taxation Officer in the notice under section 122(5A), confronted the fixed assets written of amounting to Rs.9,965,000, whereas, while framing the assessm ent, made the addition of Rs.12,677,799 taking the disposal of assets in totality from the fixed assets schedule amounting to Rs.15,578,473 and taking assets shown as sold Rs.2,900,674. This amount (Rs.2,900,674) taken by the Taxation Officer as sold is in fact the "Written Down" of the assets disposed of during the year as per audited accounts of the company.
63. The AR vehemently argued that taking of wrong facts by the Assessing Officer was lack of application of mind on part of Taxation Officer who without looking into the facts and correct figures made the addition of excess amount which was not confronted in the notice.
64. On the other hand, the learned DR tried to justify the treatment given by the taxation officer in making the addition by stating that gain or loss can only be claimed within the meaning of section 22(8) of the Income Tax Ordinance, 2001. Furthermore, it was claimed that when depreciation is allowed under section 22, then gain or loss can be claimed or allowed only according to the provisions of section 22(8):--
22. Depreciation.---(1) Subject to this section, a person shall be allowed a deduction for the depreciation of the person's depreciable assets used in the person's business in the tax year.
(8) Where in any tax year, a person disposes of a depreciable asset, no depreciation deduction shall be allowed under this section for that year and--
(a) if the consideration received exceeds the written down value of the asset at the time of disposal, the excess shall be chargeable to tax in that year under the head---Income from Business; or
(b) if the consideration received is less than the written down value of the asset at the time of disposal, the difference shall be allowed as a deduction in computing the person's income chargeable under the head---Income from Business for that year.
65. We have gone through the rival arguments of both the parties as well as perusal of the assessment orders. The appellant has rightly claimed the disposal of assets as written of as per its on history and has rightly claimed the disposal under section 75 of the Ordinance. Even section 22(8)(b) supports the appellant in the sense that when the consideration received is less than the WDV, the same is allowed as a deduction. Moreover, when no sale proceeds are received in writing of the asset, the consideration received is treated as NIL and any written down value of redeemed assets is allowable under section 22(8)(b) read with section 75 of the Ordinance. We concur with the arguments of the learned AR and delete the addition made under this head.
66. Depreciation of vehicle (Tax Year 2005)
67. The Addl. CIR/TO observed that the company had provided more than one vehicle to certain directors of the company. After giving proper details in the order to made an addition of Rs.3,602,458 on account of depreciation claimed for these vehicles. The learned CIR(A) has deleted the addition made under this head, this ground was agitated by the Department.
68. The learned DR argued that the company had provided more than one vehicle to certain directors of company which should be considered as second car given to directors and can not be held as business expenses within the meanings of section 20(1) of the Ordinance. It was maintained that the second car is obviously used for the purposes other than business.
69. The learned AR argued that there is no bar on providing vehicles to the company executives. He stressed that the CIR(A) order on this issue is a speaking order and has rightly deleted the addition on this ground based on established case-law.
70. We have, considered the arguments of both the parties and placing reliance on judgments reported as 2005 PTD (Trib.) 2041 and 2007 PTD (Trib.) 2583, we find no justification for curtailment of depreciation claim on account of conveyance provided by the employer. It is a well established fact that somebody other than assessee benefited by the expenditure should not come i.e the way of. Au expenditure being allowed by way of deduction. The expenses must 1 e adjudged from tl point of view of businessm en and not of the department. We uphold the findings of CIR(A) and find no interference under this ground.
71. Warranty and maintenance service (Tax Year 2005)
72. The appellant during the tax year 2005 received Rs.230.936(M) from the customers against warranty and free services for two years. Out of this amount Rs.71.505(M) was offered for tax and the balance Rs.159,431(M) which remained untaxed, has been shown as balance for deferred revenue. The Addl. CIR/TO did not accept the treatment and made an addition of Rs.159,431(M). The learned CIR(A) has deleted the addition, hence this ground is agitated by the Department.
73. The learned DR argued that the these receipts should be taxed in the year as the company has received these amounts during the year. The learned AR opposed the arguments of DR relying on section 34(1) and para 20 of International. Accounting Standards - 18, relying on the definition of Revenue and its recognition.
74. The learned CIR(A) has held that "keeping in view the situation, I think it fit to tax the same which has actually been accrued and accept the balance amount as deferred advance. It is worth mentioning that assessm ent of the year 2006 has also been finalized under section 122(5A) and no such addition has been made by the Addl. CIR/ITO under this head. The addition is accordingly deleted."
75. After going through the facts and order of the CIR(A), we concur with the findings of CIR(A) and find that no interference is warranted on this account.