1. The Taxpayer has filed this instant appeal against the order dated 9-5-2011 passed by the learned CIR(A-I) Islamabad for the tax year 2005 on the following grounds:--
(1) That the appellate Order No.1231 of 2011 dated 9th May, 2011 [the Appellate Order] of the learned Commissioner Inland Revenue (Appeals-I), Islamabad under section 129 of the Income Tax Ordinance, 2001 is bad in law and contrary to the facts of the case.
(2) That the learned CIR(A) erred in confirming the order dated 14th March, 2011 (the impugned Order) of the Assistant Commissioner Inland Revenue, Audit-[I] Large Taxpayers Unit, Islamabad
[ACIR] issued under section 122(1) read with section 122(5) of the Ordinance without appreciating the facts of the case and the legal position.
(3) That the reliance placed by the ACIR on Annexure IIB and IIB/2 of the tax return in support of his contentions that the reversal of interest and penal charges 'interest income' and 'gain on disposal of assets', were declared as 'income from other sources' and the decision of the CIR(A) to confirm the same is completely misplaced as the said Annexure only pertain to the business results declared as per financial statements and not for computation of income as per the Ordinance for which separate Annexures have been provided.
(4) That the ACIR fell in error in subjecting 'waiver of interest and penal charges' of Rs.767,297,896 to tax; and the CIR(A) in confirming ACIR's contention' without appreciating that such charges had never been claimed by the appellant as tax deductible and hence the question of taxation of reversal of such charges does not arise. The action of the ACIR and that of the CIR(A) are against the provisions of section 70 of the Ordinance.
(5) That the ACIR is not justified in taxing accounting gain of Rs.146,740 on disposal of fixed assets to tax as the said assets did not constitute 'depreciable assets' for the purposes of the Ordinance. The action of the CIR(A) in confirming the same is illegal and unjustified.
(6) That without prejudice to Grounds Nos.4 and 5, the ACIR and the CIR(A) completely ignored the fact that the appellant had already reduced its pre-commencement costs eligible for amortization in the Tax Year 2007 by the amount of interest and penal charges reversed of Rs.767,297,896, gain on disposal of assets of Rs.147,740 and interest income of Rs.403,275 and hence taxing the same again in the Tax Year 2005 clearly amounted to double taxation.
(7) That the arguments put fort by the ACIR in the impugned order in support of his contentions are self-contradictory as on one hand, he has contended that expenditure incurred during pre- commencement phase was non-admissible; and on the other hand, he has stated that claiming interest and penal charges during pre-commencement phase was 'sweet will' of the appellant. The self-contradictory positions taken by the learned ACIR clearly depict his lack of dnderstanding of the legal and factual position of the matter. The action of the learned CIR(A) in not adjudicating upon this matter is without any basis and is unjustified.
(8) It is requested to accept the appeal by quashing the orders of the authorities below or by giving any other relief that the appellant deserves under law or equity.
2. Brief facts leading to this appeal are that taxpayer is a Public Limited Company engaged in manufacture and sale of cement. Assessment for the tax year, 2005 was deemed assessment under section 120 of Income Tax Ordinance, 2001. Later on, the concerned Assistant Commissioner, while scrutinizing the record observed that the Company has claimed deduction which is inadmissible under the Income Tax Ordinance, 2001 but the same stood allowed in the assessment deemed completed under section 120. According to the ACIR the deduction of Rs.638,800,619 was not admissible to the Company in terms of section 25 of the Income Tax Ordinance, 2001 as the some represented pre-commencement expenditure and had to be amortized after commencement of commercial production. The same was the case with administrative expenses of Rs.50,888,015 other operating expenses of Rs.541,700 and finance cost of Rs.6,505,164 all of which were pre-commencement expenditure and hence were required to be amortized. Additionally, expenses claimed as "fair value adjustment of deferred liabilities " amounting to Rs.71,112,413 were also disallowed being notional. The assessment order was accordingly amended by the Assistant Commissioner by passing an order under section 122(1) of the Income Tax Ordinance, 2001 after providing an opportunity to the appellant under section 120(9) and not agreeing with the version presented to him by the AR. Being aggrieved with the treatment given by the Assistant Commissioner Inland Revenue, the Taxpayer preferred appeal before the learned CIR(A) who after considering the facts and circumstances of the case-rejected the claim of the taxpayer.
3. Being dissatisfied with the treatment accorded by the learned CIR(A), Taxpayer has come up in 2nd appeal before the Tribunal on the grounds raised supra.
4. Arguments put forth by the learned representatives of both the parties have been heard.
2. Submissions by the Taxpayer in support of appeal: (1) Before giving our submissions in support of the grounds of appeal, we consider it imperative to discuss the facts relevant to the assessment of the Company for the subject tax year: (1.1) The appellant company was incorporated in 1993 by the name of Chakwal Cement Company (Pvt.) Limited by the Chakwal Group of Companies, with the aim of manufacturing and sale of cement. Initiation of the project commenced with the construction of a 5,500 tons per day clinker plant and a Danish engineering company FL Smidth was engaged to supply and set up the plant and ancillary machinery. In 1994, the Company was converted into a public limited company and listed on all three Pakistani Stock Exchanges. However, in 1995 due to certain financial setbacks including litigation with F.B.R. On customs duties on imports, the Chakwal Group had to unwillingly abandon the Project. The project couldn't take of and hence the imported plans and machinery remained in custody of customs authorities due to issues relating to payment of import duties. The Company also could not repay its foreign loans as there was no revenue.
3. (1.2) In 2005, Orascom Construction Industries (OCI), part of the Orascom Group, which had been operating in Pakistan in the telecom industry for several years expressed interest in Chakwal Cement and in April 2005, OCI acquired a majority shareholding of Chakwal Cement from Chakwal Group. The Company was renamed as Pakistan Cement Company- Limited. In late 2008, OCI sold its shares to Lafarge SA of France and the Company was renamed as Lafarge Pakistan Cement Limited.
4. (1.3) It was under the auspices of OCI that the Project steadily began to pace towards operations and commercial operations started in December, 2006 after the supplier of plant and machinery was re-engaged to set-up the plant. The new management also negotiated the outstanding long term foreign loans with the lenders besides settlement of outstanding customs duties and succeeded in getting waiver of interest and penal charges on long term loans as well as customs duties from F.B.R.
5. (1.4) With respect to the tax matters during this period, the Company filed tax returns showing 'Nil' income for and up to Tax Year 2006 (including the Tax Year 2005 for which the subject appeal has been filed) as the entire expenditure incurred till then was either capitalized as part of cost of plant and machinery to the extent it was covered by section 76 of the Ordinance or was treated as 'pre- commencement expenditure' in terms of section 25 of the Ordinance which defines 'pre- commencement expenditure' in the following words: "In this section, "pre-commencement expenditure " means any expenditure incurred before the commencement of a business wholly and exclusively to derive income chargeable to tax, including the cost of feasibility studies, construction of prototypes, and trial production activities, but shall not include any expenditure which is incurred in acquiring land, or which is depreciated or amortized under sections 22 and 24."
6. (1.5) It was in the Tax Year 2007 that the Company first started its operations and claimed depreciation on its assets as well as amortization of pre-commencement expenditure' which comprised all expenditure incurred till the date of commercial production excluding expenditure that had earlier been reversed in accounts such as interest and penal charges on long term loans.
7. (1.6) The learned taxation officer issued notice under section 122(5) of the Ordinance for the Tax Year, 2005 contending that the Appellant Company had claimed deduction in its tax return for Rs.638,800,619 which in his view was inadmissible on account of being 'pre-commencement expenditure'. He further contended in the Notice that deductions of Rs.50,888,015, Rs.541,700 and Rs.6,505,164 were claimed on account of administrative expenses, other operating expenses and finance cost respectively which were also inadmissible being 'pre-commencement expenditure '.
8. Intentions were also expressed to disallow expense of Rs.71,847,911 allegedly claimed on account of fair value adjustment of deferred liabilities.
9. (1.7) It was explained to the learned taxation officer that the amount of Rs.638,800,619 shown in Annexure IIC of the return was not a claim for deduction but was in fact accounting loss for the year which was not claimed in the return as a 'Nil' return was filed. Similarly, no deduction for any other expenditure was claimed as entire expenditure was treated as 'pre-commencement expenditure' by filing a 'Nil' return. The taxation officer however made reference to Annexure IIB of the return and contended that the appellant had earned taxable income of Rs.767,847,911 mainly on account of waiver of interest and penal charges; without appreciating the fact that Annexure IIB was not for computation of taxable income but was meant only to disclose accounting =sults for the year as per audited accounts. The computation was shown in Annexure IIC of the return in which the entire expenditure (after accounting for the aforesaid reversal) was shown as pre- commencement expenditure. However, the learned taxation officer subjected the amount of Rs.767,847,911 to tax on the pretext that the Appellant Company had borne these expenses in the preceding lax years and that the cumulative amount of Rs.767,847,911 appeared in the profit and loss account in the financial statements for the previous tax years.
(2) We now explain the legal position with respect to the action of the Taxation Officer: (2.1) The impugned order of the Taxation Officer reflects his lack of understanding of the facts as well as legal position on the matter as prior to the year 2005, the Company had never prepared a profit and loss account and entire expenditure was being capitalized in the books of account. It was in the year 2005 that a profit and loss account was prepared with a restatement of comparative figures for the year 2004 due to a change in the requirements of International Accounting Standards. Further, the Company had been filing, Nil tax returns since its inception in 1993, a fact which has not been disputed by the taxation officer. As no expenditure was claimed in the tax return on account of being 'pre-commencement expenditure' it is a misstatement of fact on part of the taxation officer that the Company had borne 'these expenses in preceding years. The reversal recorded in the books only affected the 'pre-commencement expense' that was to be claimed on commencement of commercial production.
10. (2.2) It is also pertinent to note that in the Tax Year 2007, the Company for the first time claimed amortization of pre-commencement costs that had already been reduced by the amount of Rs.767,847,911 being reversal of penal charges and interest.
11. (2.3) We also draw your kind attention to the provisions of section 70 of the Ordinance with reference to taxation of 'recouped expenditure'. The legislative intent is to tax such expenditure only when it had earlier been allowed as tax deductible. The said provision is reproduced below:-- "70. Recouped expenditure. ---Where a person has been allowed a deduction for any expenditure or loss incurred in a tax year in the computation of the person's income chargeable to tax under a head of income, and subsequently, the person has received, in cash or in kind, any amount in respect of such expenditure or loss, the amount so received shall be included in the income chargeable under that head for the tax year in which it is received."
12. (2.4) The Taxation Officer did not dispute the fact that expenditure representing interest and penal charges was not claimed by the appellant in any of its tax returns for periods prior to Tax Year 2005.
13. He rather stated on page 5 of the impugned order that it was 'sweet will' of the taxpayer whether to have claimed deduction of the expenditure, whereas he himself stated in the Order that financial expenses were not tax admissible to the appellant on account of being 'pre-commencement expenditure'. The stance of the taxation officer is self-contradictory as one hand, he contended to disallow the expenditure being 'pre-commencement' and on the other hand he contended that claiming such expense was sweet will of the appellant.
14. (2.5) The Taxation Officer also subjected accounting gain of Rs.146,750 to tax without appreciating the facts that these assets did not constitute 'depreciable assets' in terms of section 22 of the Ordinance as the Company had neither claimed tax depreciation on these assets nor these were DEPARTMENTAL SUBMISSIQN: 1.6 Notice was issued under section 122(9) for amendment of assessment under section 122(1) read with section 122(5) of the Income Tax Ordinance, 2001. Remaining contentions are accepted.
15. 1.7 Learned AR contended that the reliance placed by the ACIR on annexures IIB and IIB/2 of the tax return in support of his contentions that the 'reversal of interest and penal charges' 'interest income' and 'gain on disposal of assets', were declared as 'income from other sources', is completely misplaced as the said Annexure only pertained to the business results declared as per financial statements and not for computation of income as per the Ordinance for which a separate Annexure IIC have been provided.
16. The contention of the AR is incorrect. It is very clear from the return that Annex IIB provides for computation of Income/(Loss) from Business and Annex IIC provides for "Adjustments in Book Profits" as per the title of the two annexure. This technicality however cannot detract from the fact that Annex IIB also provides for inclusion of income from other sources at Serial No.8 (Markup/Interest Earned) where appellant had itself declared an interest income of Rs.403,275 and at No.10 (Other Revenues) where it had declared Gain on disposal of fixed assets of Rs.146,740 and waiver of interest and penal charges of Rs.767,297,896. Accordingly, the AR's argument that reliance placed by the ACIR on annexures IIB and IIB/2 regarding income from other sources is incorrect and should therefore be rejected.
17. 2.1 and 2.3 Learned AR contended that ACIR fell in error in subjecting 'waiver of interest and penal charges' of Rs.767,297,896 to tax without appreciating that such charges had never been claimed by the appellant as tax deductible and hence the question of taxation of reversal of such charges does not arise. AR's contention is incorrect because the assessment order under section 122(1) shows that the ACIR had not taxed the 'reversal' of 'interest and penal charges' in terms of "recouped expenditure" under section 70. Instead, the said "waiver of interest and penal charges" had been taxed as being a benefit in the hands of company in terms of section 69 of the Income Tax Ordinance 2001. Section 70 cannot restrict the operation of section 69. For this reason, the contention of the AR should be rejected. It was also a benefit because it was business income under section 18(1)(d) as it had been derived by the taxpayer in the course of its business relationship with its principal. This latter argument was not made while passing the assessment order because the taxpayer had itself declared the amount as its income in its computation at ,Annexure IIB and later on claimed deduction.
18. 2.2 This argument may please be disposed of with the observation that appellant is free to take into account the impact of the amended assessment while offering tax treatment in subsequent years and the Department too is free to consider such treatment on its merits.
19. 2.4 Liberal use of language cannot be taken as evidence of lack of understanding of the legal and factual position of the matter. The comments of the assessing officer in the assessment order are being taken out of context. It was for the taxpayer to claim the expenses in its returns which had actually been incurred as reflected in its financial statements for previous years and then for the Department to disallow them if considered by the Department to be part of its pre- commencement expenditure. The entire argument of the Department is that when the expenses were claimed as a deduction on account of being pre-commencement expenditure, it could not be done and in fact had to be amortised in a subsequent year i.e. From the date when the commercial production commenced. For this reason, the AR's contention should be rejected.
20. 2.5 According to the AR, the ACIR is not justified in taxing accounting gain of Rs.146,740 on disposal of fixed assets to tax as the said assets did not constitute 'depreciable assets' for the purpose of the Ordinance. A review of the assessme nt order under section 122(1) as well as the replies filed by the AR before the ACIR indicates that no such objection was raised at first instance. Additionally, no evidence has been put forth by the AR to support the argument that the assets involved were not depreciable assets. Accordingly, the argument of AR should be rejected on this account.
21. 2.6 Invoking the provisions of section 70 of the Income Tax Ordinance, 2001 is irrelevant in this case. The treatment by the appellant of reducing its pre-commencement expenditure in Tax Year 2007 by an amount of 'waiver of interest and penal Charges' was incorrect thereby seeking escape from its tax liability for Tax Year 2005 was incorrect.
22. Findings: We have heard the order and hereby record our findings issue were WAIVER OF INTEREST AND PENAL CHARGES In support of Ground No. 06 of the appeal, it is submitted that the Department has taxed the reversal of interest and penal charges under the head 'income from business ignoring the fact that these financial expenses were 'pre-commencement expenses' in terms of section 25 of the Ordinance and the Appellant company had already accounted this reversal as for claiming amortization of pre-commencement expenses for the first time in Tax Year 2007. '
23. The operative parts of section 25 of the Ordinance are reproduced below:
(1) A person shall be allowed a deduction for any pre-commencement expenditure in accordance with this section.
(2) Pre-commencement expenditure shall be amortized on a straight line basis at the rate specified in Part Ill of the Third Schedule.
(3) ................ (4) (5) In this section, "pre-commencement expenditure" means any expenditure before the commencement of business wholly and exclusively to derive income chargeable to tax, including the cost of feasibility studies, construction of prototypes, and trial production activities, but shall not include any expenditure which is incurred in acquiring land or which is depreciated or amortized under section 22 or 24.
24. As the aforesaid section requires pre-commencement expenditure (which includes any and all expenditure incurred before commencement of business) to be amortized over 05 years after commencement of business, the Appellant Company had been filing Nil tax returns (including the return for the Tax Year 2005) thereby not claiming any expenditure treating the same as 'pre- commencement'. Amortisation of pre-commencement expense was first claimed in the return for the Tax Year 2007 wherein an amount of Rs.448.55 million was shown for the first time as expenses incurred in prior years eligible for amortization. While arriving at this amount, the reversal of Rs.767.29 million has already been accounted. For and accepted by the Department. This fact can again be verified by the department.
2. It is a concluded fact that waiver of interest/markup and penal charges is a benefit. This was liability upon Taxpayer Company hooked as expense during pre-commencement period for being amortised subsequently. It was, a benefit/concession in the shape of less payment of expense/liability. In such situation if benefit of the waiver of markup is under the head of expense, then only the expense is to be disallowed. By disallowing an expense, Tax Officer is heading towards achievement of target of converting loss into income also. Section 69 is a definition/deeming provision for treating as having received an amount, benefit or perquisite under the head of Receipt of income. It is not a charging section. It does not embody methodology as how and under which head it will be taxed. The department has taxed it under the head of business income. Later on legislature has also treated the waiver under head of business income as envisaged in section 18(i)(d). For reference it is reproduced as under.
25. Income from Business.---(1) the following of a person for a tax year, other than income exempt from tax under this Ordinance shall be chargeable to tax under the head "Income from Business"-
(a) .... . ......
(b) (c) (d) The fair market value of any benefit or perquisite; whether convertible into money or not, derived by a person in the course of, or by virtue of, a past, present, or prospective business relationship.
26. Explanation:---for the purposes of this clause, it is declared that the word "benefit" includes any benefit derived by way of waiver of profit on debt or the debt itself under the State Bank of Pakistan, Banking Policy Department, Circulars No. 29 of 2002 or in any other income scheme issued by the State Bank of Pakistan.
27. So the officer has rightly taken it under the head business income.
3. Expenses incurred during the pre-commencement period are to be amortised in the subsequent years after the commencement ,of production, but the waiver of interest in this case means that this expense was not incurred. If an expense is not incurred, it has not to be amortised. This expense was booked in accounts but subsequently subtracted due to waiver; so proposition is very simple that this expense was not incurred. Needless to mention here that income is to be taxed. No doubt, waiver of interest falls under the ambit of business income, but when Answer is obvious, when revenue receipts starts to pour in and business income, starts. In this case business income has started in Tax year 2007. No income can be computed without awarding the expense.
4. The department has taxed it when the business income has not started. If this was to be taxed, then expenses of business cannot be disallowed on the plea that Taxpayer has not claimed the expense. Infact tax payer has not claimed the expenses because of reason that business has not commenced and expenses were being accumulated for C amortization of business in come. The department has to start taxing of business income, when business has commenced and production has been started i.e. In Tax year 2007. If the Revenue prefers to tax it in 2005 i.e. Within pre commencement period, then expenses claimed are embodied in return. So business expense cannot be disallowed. It is not the choice of pick and choose that benefit/income while treating it business income is being taxed as a separate block of income without giving the expense. This methodology is not warranted under the law. In this case this benefit, although an income but also claimed as expense. Through waiver neither there is any income in negative nor on the positive side. If being liability, it is assumed as negative income. Through waiver it is presumed as positive income. Resultantly net effect is again zero. To tax it directly as income without giving an expense on the plea that expenses were not claimed due to filing of Nil return, in pre-commencement production period, has resulted into double taxation because the expense has ajso been reversed by the taxpayer. Hence the case has become that of double jeopardy. So the orders passed by both of the officer below on this issue are hereby vacated.
28. INTEREST INCOME 5. Interest income is to be taxed as separate Block of income. Hence there is no concept of double Taxation. So the impugned order is hereby upheld.
29. GAIN ON DISPOSAL OF FIXED ASSETS 6. As far as gain on disposal of asset is concerned, the taxpayer can produce the evidence before Officer Inland Revenue to support his contention that said assets did not constitute depreciable assets, Impugned orders are set aside only on this issue and. Case is remanded to officer Inland Revenue on this issue with the direction to receive evidence and provide opportunity of being heard.
7. Taxpayer's appeal stands disposed of in the manner as indicated above.
30. Order. Accordingly.