Through these two cross appeals, the impugned order dated 26-6-2006 passed by the learned Commissioner (Appeals-I), against the amended assessment order framed under section 122(1) of the Income Tax Ordinance, 2001 for the above-referred tax year under review has been objected.
The Taxpayer has objected the impugned order on the following ground:-- "(2) That the learned Commissioner of Income-tax (Appeals) was not justified in confirming the order of the Taxation Officer who erred in disallowing bad debts amounting to Rs.233.478 million allegedly for being pre-mature and mere provisions without having any regard to the fact that the appellant company has ceased to exist after having been amalgamated, thus lost all rights of their recovery.
While the department has assailed the order on the following ground:- "(2) That the learned CIT(Appeals) has eared in deleting the addition of Rs.2.844(Million) made under section 75(1)(a) of the Income Tax Ordinance, 2001."
2. Mr. Syed Hassaan Naeem appeared on behalf of the Taxpayer Bank while Mr. Faisal Rauf Memon appeared as the learned D.R. Both the learned representatives have been heard and the impugned order of the learned CIT(A) order of the Taxation Officer passed under section 122(1) and other relevant available record has been perused.
3. The facts of the case as gathered from the arguments put forward by both the learned counsel as well as from the available documents depicts that the Taxpayer Bank was operating in Pakistan as a branch of a non-resident Dubai based banking company having two branches in Pakistan each located at Karachi and Lahore. The Bank operated as a schedule bank and was engaged in banking business under the authority of a license granted by the State Bank of Pakistan under section 28(1) of the Banking Companies Ordinance, 1962. During the tax year under consideration the Bank decided to amalgamate/merge its Pakistan Operations. In terms of section 48 of the Banking Companies, 1962, the State Bank of Pakistan vide its order dated 10-6-2004 approved the scheme of amalgamation of the Bank with and into Crescent Investment Bank Limited (CIBL) to form a new banking company. Effective from 9-7-2003 the Taxpayer Bank and CIBL had been amalgamated to form a listed company and the Mashreq Bank Pakistan Limited, which was renamed as Messrs Crescent Commercial Bank Limited on the same day duly approved by the State Bank of Pakistan. As at the effective date of amalgamation, the fair values of assets/ liabilities were re-measured in order to decide the swap ratio of the shares of the new company Mashreq Bank Pakistan Limited.
4. The Bank filed its return of income in respect of the tax year under appeal i.e. From 1-1-2003 to 8- 7-2003 (tax year 2004). The return so filed was treated as assessment order passed by the Commissioner under section 120 of the Income Tax Ordinance, 2001. The case was selected for Tax Audit in terms of section 177 of the Ordinance and upon completion of tax audit by the Taxation Officer, an amended assessm ent order in terms of section 122(1)(5) of the Ordinance was passed Which is the subject matter of this order in respect of the issues raised in the respective grounds of appeals.
5. The Taxation Officer in his notice under section 122(9) dated 23-1-2006 noted that surplus on revaluation of buildings was not accounted for correctly by the Bank and in this connection he observed and confronted the Bank as under:-- "Surplus on Revaluation of assets - Disposal thereof in terms of section 75(1)(a): Out of the total surplus at Rs.113.864 million, the surplus relating to the land constitute 91.18% at Rs.103.474 million whereas, the remaining 8.82% at Rs.10.043 million is relevant to the transferred buildings. The building situated at Gulberg-III, Lahore has been valued at Rs.2.606 (M), yielding at deficit of Rs.6.238 (M). Whereas the other building situated at Shahrah-eQuaid-e-Azam, Lahore has been valued at Rs.17.56 M and thus has registered gain of Rs.16.628 M.
As per law, the entire gain on land is exempt from the incidence of tax whereas, the surplus on depreciable buildings, is to be taxed to the extent of 'entire tax depreciations claimed/ allowed on the respective buildings', till their transfer, under sections 22/77 of the Income Tax Ordinance, 2001."
The Taxation Officer intended to take the tax gain at Rs.12.98 million as under:-- "As worked out above, the tax gain on this account under section 22 at Rs.12.983 (M) is intended to taken and conversely the tax loss booked on the transfer of said buildings at Rs.5.300 (M) is also to be added."
6. It is contended by the learned counsel of the Taxpayer that though proposed action of the Taxation Officer was not objected but it was pointed out that certain issues with respect to the computation of net tax gain is not correct as instead of Rs.12.983 million, the tax gain works out to Rs.2.844 million which the Taxation Officer has finally added in the computation of income.
It is contended that the Taxation Officer accepted the revaluation of buildings which as a matter of fact were revaluated in order to quantify the swap ratio of the share capital of the new company the Mashreq Bank Pakistan Limited. In this connection, page 3 of the amended order the Taxation Officer has been referred wherein it is observed as under:- "Both of the properties namely "91-D/1, Main Boulevard, Gulberg-III, Lahore" and "48 Shahrah-e- Quaid-e-Azam, Lahore" were got evaluated from professional valuators namely Messrs Surval (Office No.27, Second Floor, Gulberg Centre, Gulberg-III, Lahore) and Messrs Iqbal A. Nanjee and Company (301-303, Third Floor, Commerce Centre, Hasrat Mohari Road, Karachi) as per their valuation reports dated 21-2-2003 and 9-4-2002 respectively. The reports of the valuators have been considered and found reasonable in terms of section 68 read with sections 77/76 and 22 of the Income Tax Ordinance, 2001."
Against this treatment of Taxation Officer taxpayer filed first appeal before the learned CIR(A) and before the learned Commissioner (Appeals) the Taxpayer took the plea that in case of merger/ amalgamation, no gain/(loss) arises to the amalgamating companies and therefore the action of the Taxation Officer is not valid in law. Certain case-law were also relied upon which were accepted by the learned Commissioner (Appeals) and he ordered deletion of the addition on account of tax gain on revaluation of the above buildings. Apart from the above, the Taxation Officer disallowed the claim of bad-debts of Rs.233.478 million observing that the claim is premature and that once the taxpayer has transferred the rights of their recovery to the successor company in which the taxpayer with all of its assets and liabilities has been merged, the claim of bad-debts on provisional basis is not legally valid. The Commissioner (Appeals) upheld the disallowance of the claim of bad-debts holding the action of the Taxation Officer to be valid in law
7. We have noted that in the Primary Narrative Report (PNR) which was served on the Bank vide letter dated 7-1-2006, the Taxation Officer accepted the amalgamation/merger of the Bank with and into Crescent Investment Bank Limited whereby a new banking company namely Mashreq Bank Pakistan Limited was formed. In the PNR the Taxation Officer observed as follow:-- "AUDIT OBSERVATIONS/FINDINGS:
(1) CONTRADICTIONS IN THE NAME OF AMALGAMATED COMPANY "You have mentioned in your letter that as per the return of income, the name of amalgamated company has been shown as M/s. Crescent Commercial Bank Limited (CCBL) whereas, as per audited accounts it is Mashreq Bank Pakistan Limited (MBPL). In this regard, we would inform you that the name of MBPL had been changed to CCBL and we have already informed this vide our Letter No. T/1393/M-55 dated August 30, 2004 to the Member Taxes, Central Board of Revenue, Islamabad with a copy to the Director General, Large Taxpayers Unit, Karachi. A copy of aforesaid letter is enclosed for your ready reference.
(2) AMALGAMATION AND RELATED ASPECTS Regarding various queries contained at para 2 of the IDR, the taxpayer vide para 2 and para 8 of its AR's letter dated 5-1-2006 has examined as under-- Para-2 "In terms of section 48 of Banking Companies Ordinance, 1962, the State Bank of Pakistan vide its order dated June 10, 2003 has approved the scheme of amalgamation of the Bank and Crescent Investment Bank Limited (CIBL) into MBPL. Effective July 9, 2003 the Bank and CIBL have been amalgamated to form a listed company MBPL".
Para-8 "Surplus on revaluation of assets is mainly in respect of land which is not the subject of Income Tax Ordinance, 2001. However, the treatment of surplus on revaluation of assets is in line with the treatment provided in the International Accounting Standards on the basis of which the bank has prepared the Financial Statement."
The explanation furnished by the taxpayer merits consideration but in the absence of the supporting documents, like judgment of the court and the reports of valuators - disclosed as per note 12.1 of the accounts, the same cannot be relied upon. In this regard, relevant documents along with the accounting/ tax working are required to be filed for proper appreciation of the facts."
8. It is apparent from the above that the Taxation Officer accepted the amalgamation/ merger of the Bank as in the notice issued to taxpayer dated 23-1-2006 the relevant part of which has already been reproduced above, the Taxation Officer has not recorded any adverse findings on this aspect.
He has also shown his satisfaction on the valuation of the impugned buildings, which were carried out by two independent valuators the reports of which, as per the amended order were duly submitted to the Taxation Officer. Accordingly, once it has been accepted that the Bank has amalgamated/ merged and the scheme of amalgamation has also been approved by the State Bank of Pakistan, we do not find any reason to cast any doubt thereon.
9. At the time when the above merger/amalgamation took place there was no specific provision available in the scheme of the Income Tax Ordinance, 2001 relating to tax issues and implications connected with merger of two or more companies except section 2(1A) that defines the meaning of the term "amalgamation" and section 57A that speaks about the setting of of business losses consequent to amalgamation. Therefore, the issue needs to be examined in the light of the principles deduced from the general provisions of the Ordinance whether such an event could have any tax implications on the amalgamated company or the companies that are being merged. It is a settled proposition that a merger of two or more companies is essentially a process of corporate reconstruction whereby assets of the merging companies are either clubbed or brought together in the surviving or the new company. However, proprietary rights of assets remain intact. No financial transaction could be said to have taken place between the merging companies. As such in the scheme of merger arrangement there does not take place any sale, disposition, exchange or relinquishment or E extinguishment of any right on the part of the amalgamating companies that gives rise to any income or gain resulting in a taxable event. The repositioning of the amalgamating companies through a due process of law resulting in the emergence of an amalgamated company only gives rise to one thing i.e. The shareholders of the merging companies eventually become the shareholders of the amalgamated company.
Accordingly, the ultimate interest and ownership of shareholders of a merging company remains unchanged based on appropriate share swap ratio forming part of the scheme of arrangement under which the merger is ultimately sanctioned by the State Bank of Pakistan or the Court of law as the case may be. It would be, therefore clear that a shareholder's intrinsic right/interest remains the same as was prior to the merger. In view of this situation, whereupon merger the net assets of the merging companies remain unaltered as also the proprietary interest of the shareholders in the amalgamated company remains the same, a corporate merger does not give rise to any taxable event.
10. In this respect the counsel of the Taxpayer has referred the case of Indian jurisdiction titled Commissioner Income Tax, Delhi (Central) v. Bharat Development (Pvt.) Limited reported in (135 ITR 456), which is of the Delhi High Court and the issue under hand has been considered regarding the implications of an amalgamation in detail. Following were the important considerations laid down in this respect:- The effect of amalgamation between two companies is that the assets come to the amalgamated company, which in turn issues fresh share capital to the shareholders of the amalgamating company.
No actual cash payment is involved, as far as the amalgamated company is concerned.
There is no purchase involved in an amalgamation and no expenses at all. All that the amalgamated company to do is to obtain the assets as well as the liabilities and shareholders of the amalgamating company get shares in the amalgamated company.
Both the assets and liabilities of the amalgamating company are transferred to the amalgamated company. Any shareholding in the amalgamating company stands cancelled.
After having explained the effect of amalgamation, their lordships the Judges of the Delhi High Court concluded as under:-- "amalgamation does not involve any sale or purchase and any surplus of value of shares issued by the amalgamated company over the value of one asset transferred does not result in any taxable gain."
11. We are of the view that even if for argument's sake; the action of the Taxation Officer about taxing the notional surplus on revaluation of buildings is visualized in an another perspective supposing that had the Taxpayer company made the revaluation of its buildings for the purpose of obtaining loan, even then would the resultant surplus will suffer the incidence of tax? In the light of the settled principal of law on this subject, the Taxation Officer would not have any right to tax such surplus on revaluation for the simple reason that the company has not yielded any actual gain on such revaluation. Applying the similar methodology on the arrangement of merger in the instant case where G revaluation of buildings has been made strictly following certain legal requirements as laid down in the scheme of .Merger and as per section 2(1A) of the Income Tax Ordinance, 2001, the unrealized amount on revaluation of buildings is not taxable. It would not be out of place to mention that in the case of merger/amalgamation, the amalgamated company charges depreciation on assets so transferred after amalgamation on the basis of tax WDV of the assets instead of their book value at which the assets were transferred. It appears that the Taxation Officer has completely ignored this aspect and he unreasonably taxed the notional gain without going into the depth of the subject transaction.
12. Even otherwise, the gain on revaluation of buildings owned by the Taxpayer Bank in the circumstances explained above could not be treated as income/revenue chargeable to tax since it does not represent receipt arising out of any business or commercial activity. We are of the view that this gain can only be regarded as an unrealized receipt not being real income, which could not be brought into the ambit of taxation. It is a cardinal principal of revenue laws that in order to bring an amount in the ambit of taxation, the form of the transaction may not be given preference over the substance. In the case of CIT v. Gammon Pak. Limited reported as (1966) 14 Tax 304 the Hon'ble Karachi High Court relying on the observations recorded by Vivian Bose J. In the case of Sir Kikabhai Premchand v. CIT (Central), Bombay reported as (1953) 24 ITR 506 has observed that it is a well-settled principal that in revenue II cases regard must be had to the substance of the transaction rather than its mere form. It is also a trite law that mere book keeping entries are not determinative of the question whether the Taxpayer has earned any profit or incurred a loss, and that a receipt, which in law cannot be J regarded as income, cannot become so, merely because the Taxpayer credited it to the Profit and Loss Account. In CIT, West Bengal v. India Discount Co. Ltd.
Reported as 1970 ITR 191 (SC Ind.) the respondent company received Rs.43,925 being arrears of dividends and credited this sum to the Profit & Loss account and thereafter transferred it to a reserve fund. No adjustment was made in the share purchase account and the value of the shares remained the same both in the opening and the closing stocks. The question before the Supreme Court of India was whether the sum of Rs.43,925 was assessable to income tax in the hands of the assessee. The Supreme Court of India after analyzing the whole transaction of purchase of shares held that the respondent had entered into contract not only to purchase the shares but the arrears of the dividends and this clearly implied that the price paid by him was not only for the shares but also for the sum of Rs.43,925, which was going to be realized in the form of arrear dividends. The sum of Rs.43,925 was not income which could be assessed in the hands of the respondent and that the receipt being one which in law could not be regarded as income, it could not become income merely because the respondent erroneously credited it to the profit and loss account the reference in this regard has been made on the case titled CIT v. Shoorji Vallabhadas and Co. Reported as 1962 46.ITR 144 (S.C. Ind.).
Wherein it has been held that:-- "If income does not result at all, there cannot be a tax, even though in book-keeping an entry is made about a 'hypothetical income', which does not materialize. Where income has in fact been received and is subsequently given up in circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said to have not resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might in certain circumstances have been made in the books of account."
1997 PTD 1370 this Tribunal relying on the above referred case has held that exchange gain arising as a result of mere revaluation of foreign currency was not real income and hence not chargeable to tax.
13. The learned counsel of the Taxpayer has referred another case of Indian Jurisdiction titled Sutlej Cotton Mills Ltd. v. CIT, West Bengal reported as (1979) 116 ITR 1 wherein the appellant company which had its head office in Calcutta, had a cotton mill in West Pakistan where it manufactured and sold cotton fabrics. During the assessment year 1954-1955, the appellant made large profits amounting to Indian Rs.16,897,232 converted at the then prevailing rate of exchange of Pak. Rs.100 to 144 Indian rupees. On August 8, 1955, Pakistan devalued its rupee restoring the parity between the Indian rupee and the Pakistani rupee. Thereafter, during the accounting periods relevant to assessm ent years 1957-1958 and 1959-1960, the appellant obtained permission of the State Bank of Pakistan and remitted to India Rs.2,500,000 and Rs.1,250,000 respectively. The appellant claimed that on remittance the appellant ,suffered respectively a loss of Rs.1,100,000 and Rs.550,000 but the claim was rejected by the department. The Tribunal also maintained the disallowance. On a reference against the decision of the Tribunal, the Hon'ble High Court held that no loss was sustained by the appellant on remittance of the amounts from West Pakistan and that, in any event, the loss could not be said to be a business loss because it was not a loss arising in the course of the business of the appellant. The appellant feeling aggrieved of the decision of the Hon'ble High Court moved to the Supreme Court of India. Their lordships of the Supreme Court held as under:- "It is now well settled that the way in which entries are made by an assessee in his books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. The assessee may, by making entries, which are not in conformity with the proper principles of accountancy, conceal profit or show loss and the entries made by him cannot, therefore, be regarded as conclusive one way or the other. What is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee."
14. We have already observed that the Taxation Officer in explicit terms has recorded in his order the scheme of amalgamation of the Taxpayer with and into Crescent Investment Bank Limited which was duly approved by the State Bank of Pakistan in terms of section 48 of the Banking Companies Ordinance, 1962 as a result of which a new banking company Mashreq Bank Pakistan Limited. Has came into existence. We have also noted that the Income Tax Ordinance, 2001 by virtue of sections 2(1A) and 57A recognizes the concept of merger which is apparent from the fact that subsequently also, a number of amendments have been introduced in the Income Tax Ordinance, 2001 dealing with the subject of merger and the related tax benefits. It therefore emerges that the concept of merger is a recognized concept not only after the specific provisions were introduced in the Income Tax Ordinance, 2001 but also under the erstwhile Income Tax Act, 1922 and the repealed Income Tax Ordinance, 1979. There is a plethora of case-law, which defines as to what merger is, and what are its effects on the amalgamating companies vis-a-vis the amalgamated company. As held by the Delhi High Court in CIT (Delhi) v. Bhahrat Development (Pvt.) Limited 135 ITR 456 which was subsequently upheld by the Supreme Court of India in a number of decisions, a merger does not give rise to any financial transaction which becomes a taxable event and there is no cash payment involved in any manner. It was then held that "amalgamation does not involve any sale or purchase and any surplus of value of shares issued by the amalgamated company over the value of one asset transferred does not result in any taxable gain". Moreover, the contention of the learned A.R. That mere revaluation of assets for any reason does not gives rise to income that could be taxed, is also supported by a number of case-law discussed above. Under the Income tax law, only real income accrued or received by a taxpayer can be brought into the ambit of taxation.
Hypothetical entries resulting in M accretion to notional income or in the value of assets do not, in any manner, give rise to a taxable event. We also find that this Tribunal in its decision reported as 2007 PTD (Trib.) 1885 while dealing with an appeal covered by the provisions of the Income Tax Ordinance, 1979 (since repealed) discussed the concept of merger of two companies. In this case, the Tribunal has held that in the repealed Ordinance there was no provision regarding merger or the amalgamation of the companies which is made through the winding up proceedings by the Courts under section 297 of the Companies Ordinance, 1984. It was held that since the merger was approved by the Hon'ble Lahore High Court in terms of the provisions of the Companies Ordinance, 1984, the same is binding on the Departmental Officers. The relevant findings in this respect are reproduced here under:- "We have no doubts in our mind that the merger approved by the Hon'ble High Court had the legal effect of giving a continuity to the operations of the merged company, which in the instant case is Messer Elahi Spinning and Weaving Mills as a part of the assessee company i.e. Messer Taj Textile Mills consequent and vesting the assessee company with all assets and liabilities of Messrs Elahi Spinning and Weaving Mills (merged company). It is evident that if there was any un-discharged tax liability of the aforesaid non-surviving company, the same would have been recoverable from the assessee company and that the assessee company would have been bound to duly discharge the same. Similarly, the assessee company is clearly entitled to have adjustment of the unabsorbed losses that have been brought forward.
We are of the view that the departmental officers are bound by the orders passed by the Hon'ble High Court. This order sanctioned the Scheme of Arrangement under which the assessee company came to be vested with all rights and liabilities of merged company. These rights included the right of brought forward losses also. ............................. The Superior Courts of Pakistan have repeatedly held that a merger approved by the Hon'ble High Court is binding on all concerned including tax authorities. In this regard, case titled Ujala Cotton Mills v. ITO etc. Reported as 1985 PTD 510 is referred wherein it has been held that - "The contention that the Income Tax Department was not party to those proceedings cannot be heard. There is no such provision to implead theta as a party and hence for all the purposes any order in this behalf made by the High Court shall be binding on them, otherwise no sanctity could be attached to it and for that purpose the wholes exercise in obtaining it will be quite an otiose act.
The order by its very nature determines the vesting of assets and incurring of liabilities."
Considering all these facts, circumstances and legal position, we are of the considered view that the appellant, in this case, is entitled to claim of carrying forward assessed losses of Elahi Spinning and Weaving Mills Ltd. Being merged with appellant's company through the orders of the Hon'ble Lahore High Court. The impugned orders of the officers below in this regard are, therefore, vacated and Taxation Officer is directed to allow the claim."
15. Although the above case pertains to merger of non-banking companies which was approved by the Hon'ble High Court, but we are of the view that it discusses the concept of merger both with respect to the repealed Income Tax Ordinance, 1979 as well as the income Tax Ordinance, 2001 and the principles decided and enunciated by this Tribunal squarely apply to the instant case in hand as well.
16. Considering the above discussion we find no reason to interfere with the order of the learned Commissioner (Appeals), which is hereby upheld. Resultantly, the appeal filed by he department is dismissed.
Since we have upheld the order the learned Commissioner (Appeals) holding that the estimation of tax gain of taxpayer properties (pursuant to merger/amalgamation duly approved by the State Bank of Pakistan) was not in accordance with law due to the effect of merger/amalgamation, the action of the Taxation Officer in disallowing bad-debts which was confirmed by the learned Commissioner (Appeals) is also upheld. This is for the reason after the aforesaid merger/amalgamation the right to recover the impugned bad-debts rests with the new company formed as a result of the merger. As a result, the appeal filed by the Taxpayer Bank is also dismissed.
17. Both the appeals are disposed of in the manner indicated above. .