MUHAMMAD MAJID QURESHI, ACCOUNTANT MEMBER.---The titled appeals have been preferred at the instance of the appellant calling in question the impugned Orders Nos. 237, 238 and 239, for Tax Years, 2004, 2005 and 2006 all dated 02-01-2009 passed by learned CIR (Appeals-I), Islamabad, who had disposed off appellant's appeals against impugned Assessment Orders passed by ADCIR (Audit-II) LTU under section 122(5A) of the Income Tax Ordinance, 2001 all dated 24-05-2008 treating the assessm ents under section 120 as erroneous in so far as prejudicial to the interest of revenue. The appellant is also aggrieved with the adverse treatment in impugned Orders of first appellate authority for the Tax Years 2008 to 2010, against which it has preferred appeals before us on the following grounds:-- Grounds for Tax Years 2004 to 2006
1. That the order dated January, 2, 2009 issued under section 129 of the Ordinance, 2001 by the CIR(A), Islamabad is bad in law and contrary to the facts of the case to the extent stated below:
2. That the CIT(A) has erred in confirming the order of the Additional Commissioner/Taxation officer, who has amended the deemed assessment order under section 120 of the Ordinance vide order dated May, 24, 2008 which is not erroneous in so far as prejudicial to the interests of revenue under the provisions of section 122(5A) of the Ordinance in the light of several pronouncements of the apex courts.
3. Notwithstanding the above the learned CIT(A) erred in confirming the order without appreciating that: The claim of your appellant is admissible under the provisions of section 29 of the Ordinance.
Once the conditions have been fulfilled as per the section 29, the assessing officer is not competent to add back the amount of bad debts. Such a provision has been made in compliance to the regulatory framework prescribed by the State Bank of Pakistan relating to Development Financial Institutions. The expense allowed and recovered subsequently are chargeable to tax in the year when the same is received by the person and in this way there is no loss of revenue to the exchequer. That the learned AC failed to interpret the phrase "written off" appearing in section 23(1)(x) of the Repealed Ordinance as explained by the Income Tax Appellate Tribunal (ITAT), Lahore Bench, Lahore in the case laws reported as 2002 PTD (Trib.) 1898 and [(2002) 85 Tax 245 (Trib.)].
4. Notwithstanding the above, the learned CIT(A) erred by relying on the judgment passed by the Honourable Sindh High Court in its order I.T.A. No,565 of 2000 dated 10.5.2006 (Messrs Grindlays Bank Ltd.) without appreciating that:-- The facts and circumstances of the instant case are quite different from the Grindlays Bank case. This judgment relied by CIT(A) has been decided in preliminary hearing without appreciating and discussing the correct ratio of Sindh High Court's orders in the case of Messrs National Bank Ltd. reported as (1967) 34 Tax 158 (H.C. Kar.) and Messrs Grindlays Bank Ltd. reported as 1991 PTD 569. The subject case has been decided without substantiating the findings and declaring the cases of Messrs National Bank Ltd. and Messrs Grindlays Banks as per incuriam. In the subject case Honourable Sindh High Court ignored the fact that the department did not file any appeal against the orders of Sindh High Court in the cases of Messrs N'dtional Bank Ltd. reported as (1967) 34 Tax 158 (H.C. Kar.) and Messrs Grindlays Bank Ltd. reported as 1991 PTD 569 and that these decisions have attained finality and are binding on the subordinate authorities under Article 201 of the Constitution of Pakistan.
5. That the learned CIT(A) further erred in confirming the order of learned AC by apportioning the expenses between exempt/PTR and taxable income without taking into account the 'nature and size' of the activity carried on by your appellant as is enshrined in section 67 of the Ordinance. The allocation has been without following the principal elucidated therein.
6. That the learned CIT(A) further erred in not allowing the credit for the tax deducted during the relevant period.
Grounds for Tax Year 2008.
1. The appellate order No, 105/2011 dated May 26, 2010 issued by the learned CIR (Appeal-II) is bad in law, on facts and in the circumstances of the case.
2. The learned CIR (Appeals-II) has erred by not holding that the order passed by the learned DCIR is without jurisdiction and accordingly is illegal, null and void.
3. The learned CIR (Appeals-II) has further erred in stating that the Company's case was rightly selected for audit in accordance with the provisions of section 177 of the Ordinance Without prejudice to the aforesaid grounds of appeal
4. The learned CIR (Appeals-II) has erred in passing the impugned order based on unsubstantiated contentions, without addressing the contention and submissions of your Honour's Appellant on various issues in appeal. Accordingly, the said order is violative of section 24A of the General Clauses Act, 1897 which stipulates that public functionaries are obliged to decide the controversy between the parties with reasons and application of mind. The aforesaid act of the CIR (Appeals-II) is violative of Article 10A of the Constitution of the Islamic Republic of Pakistan.
5. The CIR (Appeals-II) has erred in upholding the action of the learned assessing officer of making disallowance of Appellant's claim for provision against non-performing loans. The learned Commissioner Inland Revenue (Appeals - II) has further erred in not appreciating that aforesaid provision is in accordance with prudential regulations, is admissible under section 29 of the Income Tax Ordinance, 2001 and no loss is caused to revenue as Company offer to tax any amount recovered from previously classified doubtful portfolio.
6. The CIR (Appeals-II) has erred in maintaining disallowance of Appellant's claim for Riyadh office expenses and has further erred in stating that Company had not submitted details in this respect at assessm ent stage.
7. The CIR (Appeals-II) has erred in upholding the disallowance of Rs.256,792 (being provisions/ write off in this respect of non recoverable amount from National Accountability Bureau) on the premise that Company had not submitted related information at the time of assessment.
8. The CIR (Appeals-II) has also erred in not deleting the additions on account of non deduction of tax from reimbursement of medical expenses etc. (i,e, items which do not constitute taxable salary). The CIR (Appeals-II) has further erred in alleging that the Company had not submitted details to the assessing officer at the stage of assessment.
9. Although the CIR (Appeals-II) has deleted the addition of Rs.250,000 (for alleged short deduction) yet he has erred in construing the same as reimbursement of actual expenses
10. The learned CIR (Appeals-II) has failed to appreciate that lease rentals offered to tax on cash basis cannot be subject to double taxation (on accrual basis as well) accordingly the learned CIR (Appeals - II) has grossly erred in upholding assessing officer's contention of making addition on account of unearned lease income.
11. The CIR (Appeals-II) has erred in upholding assessing officer's action of apportioning Financial and Administration Expenses between exempt/final tax regime income and taxable income.
12. The CIR (Appeals-II) has also failed to appreciate that the assessing officer has apportioned incorrect amount of expense.
1. The learned CIR (Appeals-II) has erred by not directing assessing officer to adjust brought forward loss.
Grounds for Tax Year 2009
1. The appellate order No 104/2011 dated May 26, 2010 issued by the CIR (Appeals-II) is bad in law, on facts and in the circumstances of the case.
2. The learned CIR (Appeals-II) has erred by not holding that the order passed by the learned DCIR, LTU, Islamabad is without jurisdiction and accordingly is illegal, null and void Without prejudice to aforesaid grounds of appeal
3. The CIR (Appeals-II) has erred in passing the impugned order based on unsubstantiated contentions, without addressing the contention and submissions of your Honour's Appellant on various issues ha appeal. Accordingly, the said order is violative of section 24A of the General Clauses Act, 1897 which stipulates that public functionaries are obliged to decide the controversy between the .parties with reasons and application of mind.
4. The aforesaid act of the CIR (Appeals-II) is violative of Article 10A of the Constitution of the Islamic Republic of Pakistan.
5. The learned CIR (Appeals-II) has erred in upholding the action of the learned assessing officer of making disallowance of Appellant's claim for provision against non-performing loans. The CIR (Appeals-II) has further erred in not appreciating that aforesaid provision is in accordance with prudential regulations, is admissible under section 29 of the Income Tax Ordinance, 2001 and no loss is caused to revenue as Company offer to tax any amount recovered from previously classified doubtful portfolio.
6. The CIR (Appeals-II) has also erred in not deleting the additions on account of non deduction of tax from reimbursement of expenses, medical expenses etc (i,e, items which do not constitute taxable salary). The CIR (Appeals-II) has further erred in alleging that the Company had not submitted reply to the assessing officer at the stage of assessment.
7. The CIR (Appeals-II) has erred in upholding DCIR's action of apportioning Financial and Administration Expenses between exempt/final tax regime income and taxable income.
8. The CIR (Appeals-II) has also failed to appreciate that the assessing officer has apportioned incorrect amount of expense
9. The CIR (Appeals-II) has erred by not directing DCIR to adjust brought forward loss.
Grounds for Tax Year 2010
1. The appellate order No 568/2011 dated December 10, 2011 issued by the CIR (Appeals-II) is bad in law, on facts and in the circumstances of the case.
2. The CIR (Appeals-II) has erred by not holding that the order passed by the ADCIR is illegal null and void.
3. The CIR (Appeals-II) has erred in upholding the action of the learned assessing officer of making disallowance of Appellant's claim for provision against non-performing loans and has further erred in not following the ratio decided to this effect by 5 member bench of Honourable Appellate Tribunal.
4. The CIR (Appeals-II) has erred in disallowing Appellant claim of penalty.
5. The CIR (Appeals-II) has erred in remanding the issue of tax on property income to ACIR without appreciating that same shall have been deleted from the record that ACIR had proceeded in this issue without confronting the taxpayer.
6. The CIR (Appeals-II) has erred in upholding assessing officer's action of apportionment of Financial and Administration expenses between exempt/final tax regime income and income chargeable under other heads of income.
7. Appellant craves leave to add to, amend or alter the above grounds of appeal.
2. These appeals on behalf of appellant were represented by the learned Authorised Representatives Mr. Rashid Ibrahim, FCA and Hafiz Muhammad Idrees, Advocate Supreme Court.
Whereas Shiekh Anwar ul Haq, Advocate High Court assisted us on behalf of department. The following main contentious issues were pressed on bar for our adjudication:- (i)Disallowance of Provision for Bad Debts in respect of nonperforming loans; (ii)Add back of apportionmed of common expenses between Normal and FTR.
(iii)Addition on account of Non-Deduction of Withholding tax from Salary and perquisites; (iv)Additions of Expenses incurred in Riyadh Office Employees; (v)Add backs on account of amount written off in respect of non-recoverable amount from NAB; and (vi)Additions in income in respect of 'Unearned Finance Lease'.
3. The summary of the submissions by the learned Authorised Representatives on various issues are as under:--
(i) The department has made following additions in respect of non-performing loans and the learned CIR (Appeals-II) has confirmed the addition in computation of income:-- Impugned periodsAmount (Rs.)
Tax Year 2004 130,735,646 Tax Year 2005 40,448,061 Tax Year 2006 267,212,553 Tax Year 2008 448,043,068 Tax Year 2009 603,300,550 Tax Year 2010 180,632,276 In respect of 'Provisions for Non-performing loans' it was argued that this matter has already been decided in favour of the taxpayers that the provision for non-performing loans is an admissible expense in terms of section 29 of the Income Tax Ordinance, 2001 by the Larger Bench of Appellate Tribunal Inland Revenue, Lahore in the cases reported as 2012 PTD (Trib.) ' 1139 and Division Bench in the judgment reported as (2013) 107 TAX (Trib.) 473. He has also relied upon two unreported judgments of Sindh High Court, Karachi in the case of Messrs Securities Leasing Corporation Limited and Messrs Standard Chartered Bank in ITRAs Nos. 219 of 2008 and 216 of 2011 respectively.
In this context they have submitted that these judgments are binding on the appellate tribunal, therefore, the additions made by respective officers on account of non-performing loans may be deleted.
(ii) The second issue was relating to additions on account of apportionment of common expenses.
Being assailed from the order of the first appellate authority where the following additions made by the tax department were confirmed in all tax years:-- Impugned periodAmount (Rs.)
Tax Year 2004 52,385,919 Tax Year 2005 302,778,058 Tax Year 2006 57,457,212 Tax Year 2008 1,375,451,945 Tax Year 2009 616,185,899 Tax Year 2010 521,577,088 The learned A.Rs. of the appellants have submitted that the apportionment of common expenses to income under final tax regime has been rejected by the learned first appellate authority who has not considered the various judgments which were decided in favour of the taxpayers in terms of following judgments of Hon'ble High Court and this Tribunal. They have relied on the following judgment:--
(a) 2005 PTD 2586 (Karachi High Court)
(b)ITA No, 562-61KB/2009 decided on 04-02-2013 in Faysal Bank Case (c)2012 PTD (Trib.) 1268 (d)2011 PTD (Trib.) 1039 (e)2008 PTD (Trib.) 679 (f)2013 PTD (Trib.) 246 = 2012 PTR 124 (Trib.) in the case of Allied Bank
(g) 2013 PTD (Trib.) 1429 In this respect it was submitted that the above authorities were binding on the appellate tribunal, the additions on account of apportionment of common expenses may be annulled and assessm ent on this count may be canceled and order to this extent may be vacated.
(iii)The learned AR also agitated additions on account of salary due non-deduction of withholding tax amounting to Rs. 5,240,980. It was argued that amounts not offered for tax were rerelating to maintenance of car, medical allowance and reimbur sement of expenses which were not taxable in the hands of employees. Provision for vehicles has been offered in accordance with Rule 5 of the Income Tax Rules, 2002. The learned AR of the appellant submitted a reconciliation in this respect.
(iv)The learned A. Rs. of the appellant argued that the additions on account of Regional Office Riyadh (KSA), amounting to Rs.1,165,654 was erroneously added on the pretext that no foreign income was earned during the Tax Year 2008. It was argued before the Deputy Commissioner that these were on account of out-sourced staff in Saudi Arabia whose services were procured from other service providers. ARs submitted that the learned first appellate authority was not justified in rejecting the claim as adequate explanation was provided which was reproduced in his appellate order wherein it was clearly submitted that the company is a joint venture of Government of Pakistan and Government of Saudi Arabia with 50% holding of respective Governments. He stated that the Chairman of the company and two directors are Saudi Nationals. Two employees were deputed in Riyadh Office and the said expense w.as wholly and exclusively for the purpose of business. It was argued that it is not a case of section 21(c) of the Income Tax Ordinance, 2001 on the basis of which the CIR(A) has confirmed the additions. They have placed reliance on the judgment reported as 2012 PTD 704 and 2011 PTD 1893 wherein the Appellate Tribunal has accepted the new documentary evidence not produced earlier. It was prayed that on the strength of above judgments the additions may please be deleted.
(v)Next question is regarding certain add backs to income made on account of amounts written off in respect of non-recoverable amount from National Accountability Bureau. According to the explanation available in the Notes to the audited accounts, this amount of provision represent the advance given to National Accountability Bureau for the purchase of 32.718 million shares in Saudi Pak Commercial Bank Limited. Out of this company received 32.703 million shares in the current year, while the receipt of remaining shares is doubtful.
(vi)It was submitted by the learned A.Rs. that learned CIR(A) was not justified in confirming additions of Rs. 121,472,003 on account of unearned finance lease income for Tax Year 2008. It was contended by the ARs of the appellant that the amount represent unearned lease finance income not recognized in the audited accounts and has been disclosed only in accordance with International Accounting Standard - 17 (Leases) which requires disclosures of the future income to be recognised in the year in which such income accrues. This disclosure has been made in Notes to audited accounts. They submitted that since the first appellate authority has failed to appreciate this fact, therefore, he was not justified to confirm the additions made on this score.
4. The learned counsel on behalf of department has opposed the submissions made on behalf of the appellant and supported the Orders of first appellate authority and departmental officers.
5. We would like to dispose of this appeal on issue to issue basis. The first issue we take up is that of additions on account of 'Provisions for Non-performing loans'. Before adverting to the controversy before us, it is appropriate to reproduce the provisions of the Income Tax Ordinance, 2001 governing Bad Debts.
6.1 Section 29 of the Income Tax Ordinance, 2001 read as under:-- Bad debts.---(1) A person shall be allowed a deduction for a bad debt' in a tax year if the following conditions are satisfied, namely:- the amount of the debt was
(i) previously included in the person's income from business chargeable to tax; or
(ii) in respect of money lent by a financial institution in deriving income from business chargeable to tax;
(b) the debt or part of the debt is written off in the accounts of the person in the tax year; and
(c) there are reasonable grounds for believing that the debt is irrecoverable.
(2) The amount of the deduction allowed to a person under this section for a tax year shall not exceed the amount of the debt written off in the accounts of the person in the tax year.
(3) Where a person has been allowed a deduction in a tax year for a bad debt and in a subsequent tax year the person receives in cash or kind any amount in respect of that debt, the following rules shall apply, namely:- (a)where the amount received exceeds the difference between the whole of such bad debt and the amount previously allowed as a deduction under this section, the excess shall be included in the person's income under the head "income from Business" for the tax year in which it was received; or (b)where the amount received is less than the difference between the whole of such bad debt and the amount allowed as a deduction under this section, the shortfall shall be allowed as a bad debt deduction in computing the person's income under the head "Income from Business" for the tax year in which it was received.
Before resolving the controversy, it is important to look into certain basic concepts relating to the impugned subject in common parlance, income tax statute and cases law. First of all we will examine what is 'debt bad debts' and what it implies?
6.2 Debts, what it implies?
The word 'debt' has been defined in subsection (15) of section 2 of the Income Tax Ordinance, 2001 as well as in various legal dictionaries, thesaurus and cases law as under:-- Subsection (15) of Section .2 of the Ordinance; "debt" means any amount owing, including accounts payable and the amounts owing under promissory notes, bills of exchange, debentures, securities, bonds or other financial instruments; The definition in Income Tax Ordinance, 2001 is enumerative definition with reference to financial and negotiable instruments. In other words, a debt may be defined as a sum of money due from one person to another. As a general rule where a taxpayer is entitled to receive a sum of money from another either at law or in equity, it is accepted that a debt exists for the purposes of section 2(15) of the Income Tax Ordinance, 2001. There is a debt for the purposes of section 2(15) where a taxpayer has merely an equitable entitlement to the debt.
"Debt" has been defined as "a sum of money due from one person to another. A debt exists when a certain sum of money is owing from one person to another.... 'Debt' denotes not only the obligation of the debtor to pay, but also the right of the creditor to receive and enforce payment.... "- (Earl Jowitt in his Dictionary of English Law).
"A sum of money due from one person to another...." (Wharton Law Lexicon, 14th Edition).
The word "debt" comprises an ascertained sum of money provided it is ascertainable by reference to relevant data and the liability to pay is unconditional, that is to say, it has to be paid anyhow and in all circumstances--- Webb v. Stenton, (1883) 11 QBD 518, 527, 528.
"A debt in such cases is an outstanding which if recovered would have swelled the profits. It is not money handed over to someone for purchasing a thing which that person has failed to return even though no purchase was made. In the section a debt means something more than a mere advance. It means something which is related to business or results from it. To be claimable as a bad or doubtful debt it must first be shown as a proper debt"- A. V. Thomas & Co. Ltd. v. CIT (1963)
48 ITR (SC) 67, 75.
6.3 Bad Debt, what it implies? What is bad debt and what it implies is evident from the following treatises, dictionaries and cases law: According to Principles of Income Tax Law with Glossary by Huzaima Bukhari and Ikram ul Haq, second edition, pp. 26, "Debt which is unlikely to be paid (for example, because of probable or actual financial failure of the debtor). Bad Debts may usually be treated as losses and written off against reserves for such debts".
According to LEGAL TERM AND PHRASES by M. Ilyas Khan, "The dictionary meaning of a bad debt is that it is a kind of debt which is not recoverable or in other words will never be paid CIT/WT v. Hail Anwar ur Rehman 2004 PTD 1940."
THE LAW AND PRACTICE OF INCOME-TAX IN PAKISTAN by S. M. Raza Naqvi, Fourth Enlarged Edition, Volume II, pp. 409, (which was the most authoritative commentary on the Income Tax Act, 1922) has comprehensively discussed the basic issue of bad debts with reference to its basic concept, discharge of onus by the assessee, conditions for bad debts for the writing off as follows: -- "The debts which are found to be irrecoverable are called bad debts. Before claiming an allowance for bad debts or irrecoverable loans under this clause, the following conditions must be satisfied
(1) The debts or loans must be relating to the business which is carried on by the assessee in the relevant accounting year;
(2) The method of accountancy followed must not be on cash basis, but this condition will not apply in the case of moneylenders;
(3) The loan must have been made in the ordinary course of business, profession or vacation and be incidental to the business;
(4) The debt or loan must have become irrecoverable in the relevant accounting year and not prior to that year.
(5) The sum allowed under this clause should not exceed the amount actually written off as irrecoverable in the books of the account.
Common causes of failure to secure payment are insolvency, poverty, death or disappearance.
Common kinds of sums found to be irrecoverable are amounts owed for goods supplied or services rendered. Losses occasioned by such causes and such debts can, as a rule, be allowed without question."
The burden of proving that a debt has become bad lies on the assessee [Munna Lal Behari Lal v.
C.I.T. (1956) 30 I.T.R. 809].
Such action is sufficient. "Actually written off" can, in the case of doubtful debts, be considered to mean "properly provided for". [C.I.]'. v. Jwala Prasad Tiwari (1953) 24 I.T.R. 537]. According to Shorter Encyclopaedia of Legal Terms by N. K. Acharya (First Edition-2009), pp, 92, "Bad Debts shown in the account of businessman are not mere debts which have since become irrecoverable. It must be shown that notwithstanding all the efforts to recover the debts it has still become irrecoverable. Without showing the efforts at recovery, the income tax Department will not allow the bad debts to be written off. If the debtor becomes insolvent or shown to have no assets, then also the debts may be permitted to be written off. Writing off bad debt means it is transferred to the profit and loss account as a business loss. Bad debts will be permitted to be written off only if it is accounted earlier in the regular account and transaction is taxed. It is only thereafter that bad debts are allowed to be transferred to profit and loss account. Thus bad debt by itself are not exempt from tax. Needless to say that bad debt is one which arises out of the business and not otherwise. [CIT v. Birla Brothers, 1970 (77) ITR 751 (SC); CIT V. Somasundaram Mills, (51) IRR 650 (Mad)].
According to Excellent Legal WORDS AND PHRASES by Mian Habibullah Kakakhel, Vol. 1 (1996). pp. 637 Bad Debt is defined as "a term used in a special sense in the Income tax Act. The mere fact that a debt was incurred at a date beyond the period of limitation will not of itself make the debt a "bad debt" ; still less will it fix the date at which it become a bad debt. A statute-barred debt is not necessarily bad; neither is a debt which is not statute-barred necessarily good. The age of the debt is no doubt a relevant matter to take into consideration. In every case it is a question of fact to be determined after consideration of all relevant circumstances" AIR 1932 P.C.178.
According to BLACK'S LAW DICTIONARY, Sixth Edition, pp. 139, "Bad Debt is debt which is uncollectable; a permissible deduction for tax purposes in arriving at taxable income. .... Different Tax treatment is afforded to business and non-business bad debts. A business debt is defined by the Internal Revenue Code as a debt created or acquired in connection with a trade or business of the tax payer, or a debt which became worthless in the taxpayer's trade or business. Loans between related parties (family members) generally are classified as non-business.
A deduction is permitted if a business account receivable subsequently becomes worthless providing the income arising from debts was previously included in income. The deduction is allowed only in the year of worthlessness."
According to BLACK'S LAW DICTIONARY, Eighth Edition, pp. 432, A debt that is uneollectible and that may be deductible for tax purposes. (Cases: Internal Revenue 342.0. C.J.S. Internal Revenue 275).
According to ADVANCED LAW LEXICON, 3rd Edition, pp. 438, Volume 1, Bad Debt is defined as "An amount receivable but carrying very remote chances (or no chances at all) of its recovery.
(Banking).
According to TAX LAW DICTIONARY with Legal Maxims, Latin Terms, and Words & Phrases (2013 Edition), pp. 87, Lexis Nexis Butterworths Wadhwa enumerates certain situations which involve question based on case law of bad debt as follows: - "Income-tax payable by a non-resident but paid by the assessee as his agent, subsequently, found to be irrecoverable from the non-resident is not a 'bad debt-which cannot be allowed under section 10(2)(xi) of the 1922 Act." CIT v. Abdullahbhai Abdulkadar, AIR 1961 SC 701 : (1961) 2 SCR 949: 41 ITR 545 reversing (1957) 31 ITR 72 (Born.); CIT v. Solomon Moses, (1971) 81 ITR 30 (Born.).
"Loss caused by deflection or embezzlement by an employee could not be allowed as a bad debt'."
Lord's Dairy Farms Limited v. CIT, (1955) 27 ITR 700 (Born).
"The 'bad debt' represented a capital loss and not a trading loss."C/T v. S.P.K.A.R.M. Family, (1941) 9 ITR 685,693 (Rang).
"Which did not arise in the course of money-lending business and for when no steps for recovery were taken for over a decade, could not be allowed against the income of the money lending business." R.B. Seth Champalal Ramsarup v. CIT (1964) 52 ITR 194 (All), affirmed in (1968) 68 ITR 181 (SC).
A debt becomes bad debts when the creditor has no reasonable chance of recovering it from the debtor. Deoniti Parsad v. Commissioner of Income Tax, AIR 1953 Pat 360. A statute-barred debt is not necessarily bad. CIT v. S.M.Chitnavis, AIR 1932 PC 178; Kantilal v. Commissioner of Income Tax, AIR 1955 Born. 53.
6.4 Bad debt pre-supposes existence of a debt. Following is the account of case law wherein it has been held that the bad debts presupposes existence of debt and such debt must be for the purpose of business. In such circumstances, the debt turned bad is admissible deduction:--
(a) In the land mark judgment of Bombay High Court in the case of National Petroleum Co. Ltd. v.
CIT, (1945) 13 I.T.R. 336, their lordships have ruled that in order to claim bad debts, there need pre- existence of a debt. In this case, the business of Ishardas was taken over by the appellant company who filed a suit in 1934 in the High Court praying to set aside the assessment to custom duty and claiming refund of the sum of Rs.134,000. The suit was dismissed in November, 1941, and the assessee claimed that the sum of Rs. 134,300 became a bad debt in the year 1941 and they were therefore entitled to deduct it from the profits of that year. It was held (1) that a bad debt presupposes the existence of a debt and at no time was there a debt due by the Port Trust authorities to the assessee; (2) that what was paid in 1934 was proper payment of duty and it was property debitable to the profit and loss account as an expense in 1934. It could not be called a debt which became bad in 1941 and the assessee was therefore not entitled to the deduction claimed.
(b)In the case titled C.I.T. v. Abdullabhai Abdulkadar reported at (1961) 3 TAX 277 ( S.C.); (1967) PTD 410, where assessee was treated agent of a non-resident and paid the non-resident's tax, the amount of tax was held neither allowable as a trading loss nor as a bad debt. Reversing the High Court's judgment (1957) 31 ITR 72 the Supreme Court observed (i) in order that a loss might be deductible it must be a loss in the business of the assessee and not a payment relating to the business of somebody else which under the provisions of the Act was deemed to be and became the liability of assessee Loss was allowable if it "is prang directly from and was incidental to" the business of the assessee ; it was not sufficient that it fell on the trader in some other capacity or was merely connected with his business. The loss which the appellant had incurred was not its own business but arose because of the business of another person and it was, therefore, not a permissible deduction under section 10(1) of the Income-tax Act. It was not a loss which had to be deducted in respect of the business of the respondent firm from the profits and gains of the business; and (ii) under clause (xi) of section 10(2) of the Income-tax Act also a debt was only allowable when it was a debt and arose out of and as an incident to the trade. Except in money- lending trade, debts could only be so described if they were due from customers for goods supplied or loans to constituents or transactions of a similar kind. In every case the test was: was the debt due as an incident to the business? If it was not of that character it would be a capital loss. The amount was therefore, also not allowable under section 10(2)(xi) as a bad debt as it did not arise out of and was not an incident to the respondent's business.
(c) In the case titled C.I.T. v. Mysore Sugar Co. Ltd. reported at (1962) 6 Tax 265 (S.C.) a sugar manufacturing company paid advance of seedings, fertilisers and money for supply of sugar cane to growers, but due to drought no supplies were received, claimed the loss under section 10(2)(xi) and (xv). The claim for deduction was rejected by the Department and the Tribunal but the High Court took the view that it was not a capital expenditure and was deductible as a revenue expenditure. Affirming this view the Supreme Court held that so far as the assessee company was concerned it was merely making a forward arrangement for the next year's crops and paying an amount in advance out of the price; there was no element of a capital investment in making the advance and the loss incurred by the assessee was, therefore, a loss on the revenue side and was deductible.
(d) In the case titled Brij Mohon Laxmi Narain v. CIT reported at (1959) 1 Tax (III) 115, where the assessee stood surety for loan to a company in which he was director, and the loan when became irrecoverable from the company was paid up by the assessee, it was held that the amount could not be claimed by him as bad debt or business expenditure. It was held that the transaction of guarantee did not arise out of the assessee's money-lending business and was not related to it in any way. There was no consideration for the guarantee to the bank and the advantage (by way of increase in share of the profits of the company), that the assessee gained by the giving of the guarantee was indirect. The loss which a the assessee sustained in the enforcement of the guarantee was capital loss and did not amount to a business loss. The assessee was not, therefore, entitled to claim the deduction either under clause (xi) of section 10(2) or in general terms of the Income-tax Act.
(e) In the case of erstwhile I.T.A.T. reported as (1961) 4 Tax 54 (Trib.), the assessee took a loan from bank on the security of a person who also took loan of a similar amount on the security of the assessee. That person having failed to pay his loan, the assessee had to pay the amount which he claimed as bad debts in his personal assessment. Relying on the decision of the Supreme Court of India in Madan Gopal Bagla v. C.I.T., West Bengal the Tribunal held the loss suffered by reason of having to pay a debt borrowed for the business of another person was a capital loss and not a trading loss. The new plea taken before the Tribunal viz., custom under which loans were raised on mutual securities, was not entertained as the same was not raised before lower authorities.
(f) In the case R. B. Seth Champalal Ram Swarup v. C.I.T. reported at (1970) PTD 177 (SC). In a claim of bad debts where (i) the debtor was younger brother of Karta of the assessee, (ii) at the time the promissory note was executed the assessee had taken over the major assets of the debtor, (iii) the last asset was taken over in the earlier account year, (iv) no interest was charged on the promissory note account and (v) no legal steps were taken to recover the debt; the said facts constitute material for the conclusion that the debt became bad prior to the accounting year. The same view held in respect of another item where although the decree was obtained by the assessee against the debtor but no steps were taken to execute it.
(g) It was held in case Sidharamappa Andannappa Manvi v. C.I.T. reported as (1952) 21 I.T.R. 333 that "it cannot be left to the volition of the assessee to decide by his conduct as to when a debt becomes a bad debt. Whether a debt becomes a bad debt is an objective fact to be determined, objectively and the determination must be left to the I. T.O."
(h) In the case of ITAT reported as (1961) 3 TAX 61 (Trib.), it was held that 'Where a debt became time barred in 1957 but was written off in 1958, the amount was held allowable as a deduction in the assessm ent year 1959-60. The Tribunal held that it is now well settled that a time-barred debt does not necessarily (i) become bad. Although the assessee's claim to recover the amount may have been barred by time, yet the debt may still be considered good, depending on the circumstances of the case. In the present case the debt was undoubtedly a trade debt and in the circumstances the assessee was justified in treating the debt as bad in the relevant account year 1958.
(i) It was held in these cases titled Mukundlal Bansilal v. C.I.T. reported as (1952) 22 I.T.R. 94; Tejpal Jamunadas v. C.I.T. reported as (1953) 23 I.T.R. 123, where it was held that " Before a bad debt can be allowed as a deduction it must be proved that it became bad in the relevant year of account".
(j) In the case reported as (1969) 20 TAX 88 (Trib.) it was held that 'Decretal amount written off as bad debt considering further litigation inadvisible, was held admissible deduction.
(k) A debt in order to fall within these provisions must be one which can properly be called a trading debt, i,e,, a debt of the trade, the profits of which are being computed. Madan Gopal Bagla v. CIT (1956) 30 ITR 174 (SC).
(l) A business or trading debt should spring directly from carrying on of a business or trade and should be incidental to it and it cannot be just any loss sustained by the assessee even if it has some connection with his business. Indian Aluminum Co. Ltd. v. CIT, (1971) 79 ITR 514,518 (SC).
(m) When the provisions speak of a bad debt, they mean a debt which would have gone into the balance-sheet as a trading debt in the business or trade that is in question in the case concerned and which has become a bad debt. CIT v. Birla Bros. (Pvt.) Ltd., (1970) 77 ITR 751,755 (SC)
(n) In order that a debt can be treated as a bad debt under these provisions, the test to be applied is, if the trader concerned is not a banker or money-lender, whether the debt is such which if it had proved to be a good debt, would have gone to swell the taxable profits of the assessee in question.
A. V. Thomas & Co. Ltd v. CIT, (1963) 48 ITR (SC) 67, 76.
(o) The advances made by the assessee for securing raw materials were held to be trade Debts CIT v. Rohtas Industries Ltd. (1979) 120 ITR 110 (Cal)
6.5 Bad debt-onus on assessee. It has been matter of controversy between the taxpayer and tax department as on whom the burden of proof lies. The answer was found in the following cases law:--
(i) It was decided in the case titled C.I.T. v. Vallabhdas Murlidhar reported as AIR (1930) Born. 201 = ILR 54 Born 430 = 4 ITC 318 that 'it is for the assessee to establish that the debt becomes irrecoverable during the year in which the income has to be ascertained. It is for the assessee to determine when he should write off the bad debt; the bad debt ought to have been written off within a fair and reasonable time. The Department had no arbitrary discretion to say that the bad debt should be written off in a particular year.
(ii) It was held C.I.T. v. Basumal Jagat Narain v. CIT reported as (1960) 38 I.T.R. 447, (1960) 2 TAX (III)
270) All bad debts may be said to be losses but not all losses are bad debt. A loss is deductible when it occurs or is sustained; bad debts are deductible when the I.T.O. estimates them to be irrecoverable.
6.6 Conditions of Bad debt for the written off in book of account.---It is not out of place to discuss what are the conditions for the writing off the bad debts. Following is the gist of case laws on the subject of burden of proof:--
(a) Where it was clear from the entries in the books of account that barring the amount that was received, the balance amount was written off and there was nothing capricious about the writ off. It was held that the requirements of section 10(2)(xi) were satisfied and the amount written off was allowable in full. PL. KN. M. KN. Firm v. C.I.T., Madras reported as (1960) Tax (India) (3) 291.
(b)Where by a fresh agreement, some cash and promissory note was accepted by the assessee in full discharge of debtor's liability for higher amount under the original usufractuary mortgage, the balance written off by him was held an admissible deduction as bad debt. It was held that the write off was really based on the fresh agreement concluded between the parties, as a result of which the old contract was not enforceable, and in that sense Rs. 6,125 became irrevocable; the requirements of section 10(2)(xi) were satisfied and the assessee was entitled to the deduction claimed. R.K. Kamakshi Chettiar v. C.I.T. reported as (1960) 2 Tax 343.
(c) Embezzlement of funds by an agent, like a speculative adventure, does not necessarily result in loss immediately when the embezzlement takes place, or the adventure is commenced.
Embezzlement may remain unknown to the principal, and the assets embezzled may be restored by the agent or servant. In such a case in the commercial sense no real loss has occurred. Again it cannot be said that in all cases when the principal obtains knowledge of the embezzlement loss results. The erring servant may be persuaded or compelled by process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore, so long as a reasonable chance of obtaining restitution exists, loss may not in a commercial sense be said to have resulted.
Associated Banking Corporation V. C.I.T. reported as (1965) 11 TAX 342.
(d) Where a company took over a proprietary concern as an integral whole with all assets and liabilities, trade debts of predecessor were taken to be trade debts of the successor company and such debts when irrecoverable were allowable as bad debts in the hands of the successor. [(1965)
11 Tax 19 (Trib)].
(e) Managing agents advanced loans to the managed company and guaranteed along with a director of the managed company, a loan of Rs. 2 lakhs from a bank. The Tribunal found that the advances and the guarantee was in pursuance of the objects of the managing agents and were made in the course of their business. It was held, reversing the High Court decisiondisallowing the claim of bad debt, that the debt being in the course of the business was deductible on becoming bad. Essen (Pvt.) Ltd. v. CIT, (1967) 65 ITR 625 (SC).
(f) In the case of money-lending or banking business, a bad debt or an irrecoverable loan is allowed irrespective of the method of account adopted by the assessee, because in such a case money is the assessee's stock-in-trade or circulating capital. Arunachalam Chettiar v. CIT, (1936) 4 ITR 173, 183 (PC).
(g) The mere fact that a debt was incurred at a date beyond the period of limitation will not of itself make the debt a bad debt; still less will it fix the date at which it became a bad. A statute-barred debt is not necessarily bad; neither is a debt which is not statute-barred necessarily good. The age of the debt is no doubt a relevant matter to take into consideration. CIT v. Sir S.M, Chitnavis, AIR 1932 PC 178.
(h) In order to succeed in claiming that a debt has become bad in a particular year, it is incurnbent upon the assessee to establish that debt was good immediately at the commencement of the relevant year of account. R. B. Champalal Ramsarup v. CIT, (1964) 52 ITR 194 (All), affirmed in (1968) 68 ITR 181 (SC).
(i) The assessee HUF lent Rs. 325,000 to a business owned by a younger brother of the Karta apart from debits in another current account with him. In November, 1932, the assessee took a pro-note from the brother for this loan when it had already taken major assets of the debtor in respect of the current account. The last asset, a membership card, was taken over for a sum of Rs. 20,000 in 1937-
38. No interest was charged in any of these two accounts and no legal steps were taken to recover the loan of Rs. 325,000. It was held that the Tribunal had material to disallow the assessee's claim that the loan became bad not in the year of claim (asst. year 1942-43) but in an earlier year. R.B.
Seth Champalal Ram Swarup v. CIT (1968) 68 ITR 181 (SC).
(j) Finally, it is not out of place to mention the principles laid down by Supreme Court of Pakistan in the case of Roberts Cotton Association Limited v. CIT reported as 1982 SCMR 658. Firstly, for a debt to claim a deduction, the amount has to constitute badand doubtful debt under section10(2)(xi) , secondly, the amount of expenditure laid out wholly and exclusively for the purpose of the business, and thirdly, it has to constitute a business loss and should not relate to third parties.
6.7 After going through the above cases law on the subject and placing two provisions in juxtaposition (i,e,, section 2(15) read with section 29 of the Income Tax Ordinance, 2001) the following position emerges:--'
Debts which are bad debts and are written off as such during the year of income, and;
(a) have been brought to account as assessable income of any year; or
(b) are in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business, shall be allowable deductions.
The above discussion can be recapitulated wherein it can be said that Four conditions must be satisfied in order to qualify for a bad debt deduction.
First, a debt must exist.
Second, the debt must be bad.
Third, the debt must be written off as a bad debt during the year of income in which the deduction is claimed.
Fourth, the debt must have been brought to account as assessable income in any year or, in the case of a money lender, the debt must be in respect of money lent in the ordinary course of business of lending of money.
Whether a debt is bad depends upon an objective consideration of all the relevant circumstances of case. Strictly speaking, in the case of an individual debtor, a debt is not 'bad' until the debtor has died without assets, or has become insolvent and his estate has been distributed, or the debt has become statute barred. In the case of a corporate debtor a similar situation would arise on receipt of the liquidator's final distribution or when the company is completely wound up.
Although the debt need not be bad in the strict sense it must nonetheless be more than merey doubtful. For example, a debt will not be accepted as bad merely because a certain set period of time for payment (e.g. 180 days or 270 days) has elapsed with no payment or contact having been made by the debtor. A debt may be considered to have become bad in any of the following circumstances:
(i) the debtor has died leaving no, or insufficient, assets out of which the debt may be satisfied;
(ii) the debtor cannot be traced and the creditor has been unable to ascertain the existence of, or whereabouts of, any assets against which action could be taken;
(iii) where the debt has become statute barred and the debtor is relying on this defence (or it is reasonable to assume that the debtor will do so) for non-payment;
(iv) if the debtor is a company, it is in liquidation or receivership and there are insufficient funds to pay the whole debt, or the part claimed as a bad debt;
(v) where, on an objective view of all the facts or on the probabilities existing at the time the debt, or a part of the debt, is alleged to have become bad, there is little or no likelihood of the debt, or the part of the debt, being recovered.
While individual cases may vary, as a practical guide a debt will be accepted as bad under category (v) above where, depending on the particular facts of the case, a taxpayer has taken the appropriate steps in an attempt to recover the debt and not simply written it off as bad. Generally speaking such steps would include some or all of the following, although the steps undertaken will vary depending upon the size of the debt and the resources available to the creditor to pursue the debt:
(a) reminder notices issued and telephone/mail contact is attempted;
(b) a reasonable period of time has elapsed since the original due date for payment of the debt.1 This will of necessity vary depending upon the amount of the debt outstanding and the taxpayers' credit arrangements (e.g. 90, 120 or 150 days overdue);
(c) formal demand notice is served;
(d) issue of, and service of, a summons;
(e) judgment entered against the delinquent debtor; (0 execution proceedings to enforce judgment; (g) the calculation and charging of interest is ceased and the account is closed, (a tracing file may be kept open; also, in the case of a partial debt write-off, the account may remain open);
(h) valuation of any security held against the debt;
(i) sale of any seized or repossessed assets.
While the above factors are indicative of the circumstances in which a debt may be considered bad, ultimately the question is one of fact and will depend on all the facts and circumstances surrounding the transactions. All pertinent evidence including the value of collateral securing the debt and the financial condition of the debtor should be considered. Ultimately, the taxpayer is responsible for establishing that a debt is bad and bears the discharge of onus of proof in this regard.
Now, we come to the case in hand and the cases law relied upon by the AR of the Appellants. The appellant has relied upon the judgment of larger bench reported as 2012 PTD (Trib.) 1139 and attempted to interpret in the favour of appellant. In the above case, the following question was before the larger bench of the Appellate Tribunal Inland Revenue:-- 'Whether on facts and in the circumstances of the case the receivable amount could be written off by debiting it in the Profit and loss Account as expenditure, with the nomenclature 'provision for bad debts' or not."
After threadbare discussion in the Order the bench has concluded as under: - ".... we have no doubt in our mind that there is no reason for disallowance of the claim of bad debt for the banks under discussion. The only criteria is adoption of rules fixed by the State Bank. If there is no deviation of the Prudential Bank Regulations' the claim of bad debt cannot be disallowed. Since it is not the case of the department that there is deviation, the claim of bad debt of the banks are hereby allowed in full. "
From the above conclusion, it is crystal clear that the larger bench of this Tribunal was very conscious in answering the question put forth before it. The precise question before the appellate tribunal was WHETHER THE PROVISION FOR BAD DEBTS CAN BE WRITTEN OFF IN PROFIT AND LOSS ACCOUNT AS EXPENDITURE OR NOT. The larger bench of this Tribunal has not answered the question in straight forward manner but in a qualified manner. The statement of allowance of bad and doubtful debt is to the extent of (actual) bad debts in accordance with the criteria laid down in Prudential Regulations for Banks. This clearly means that the 'provision for bad debts' is not admissible as transpires from the audited accounts. Thus, the reliance is of no help to the appellant.
The next case relied upon by the appellant is (2013) 107 TAX (Trib.) 473 is the case of division bench where the judgment of larger bench was relied upon. As we held that the reliance on the judgment of 2012 PTD (Trib.) 1139 does not support taxpayer, therefore, this case law can't rescue the appellant The next case law relied upon by the learned AR of appellant was the decision of Hon'ble High Court of Sindh, Karachi in the I.T.R.A. No, 219 of 2008 decided on 13-10-2010 in the case of Comissioner (Legal), LTU v. Security Leasing Corporation Limited. The following questions arising from the order of Tribunal have been proposed for opinion of Hon'ble High Court: -
(i) Whether on the facts and in the circumstances of the case, learned ITAT was justified to hold that the amount of receivable could be written off by only adjusting the provision without actually crediting to the accounts of debtors?
(ii) Whether in the facts and circumstances of the case, the provision for receivables is an admissible deduction under section 29 of the Income Tax Ordinance, 2001 without crediting the said provision to the individual debtor's accounts?
The Hon'ble High Court of Sindh has consciously made the following decision:-- Quote
7. perusal of the assessm ent order reveals the fact that it has been passed in a summary manner and no reasons have been given as to why the Assessing officer was of the opinion that the bad debt had not been written off in the accounts of the person and the debts had not become irrecoverable. The CIT Appeals and the learned tribunal have given a factual finding that the debt had become irrecoverable and the bad debt had been written off in accordance with definition of 'writing off' as specified by the CBR in its instructions and as held by the judgments of the Supreme Courts. A persuel of the judgment specially para 5 of the judgment in Jwala Prasad Tiwari's Case, leads to the conclusion that for the purpose of writing off, as mentioned in section 29, and pari- materia statute of the other Statutes it has been defined. This pare is reproduced for the aid of convenience.
"5. "writing of is a technical term used by financiers and auditor. There are two methods of dealing with a debt which has been written off in the books of account, (1) by giving the corresponding credit to the debtor's account, and (2) by giving the corresponding credit to the bad and doubtful debts account. The first method only employed where it is desired to close the account of the debtor. The second method is employed where there are some chances of recovery whatsoever remote they may be.
When we talk of "writing off" we are not concerned with the credit to be given to an account.
"Writing off" mean the raising of a debit entry. This can only be to the debit of the profit and loss account. This is the only debit which can possibly be raised as a result of writing off a bad debt."
8. We also consider it relevant to reproduce the instruction given by the CBR in sub-para (2) of para 23.8 of its Manual of Instruction:- "28.8(2). So far as the requirement of writing of is concerned the Board is of the view that there is no authority in law under which an assessee should be required to write off the debt or loan in the account of the debtor. The assessee bank would be within its right to claim the deduction under section 23(1)(x) if it so chooses by debiting the profit and loss account maintained for the purpose, such as suspense account of an irrecoverable loans account. This view is in conformity with the decision cited as Begg Dunlop and Company Ltd."
9. After reading the above extract from the judgment and the judgment of this Court in the case of National Bank of Pakistan and the instruction of CBR reproduced above, we are satisfied that the bad debts had been properly written off in accordance with the provisions of Section 29. We will, therefore answer Question Nos. 1 and 2 in affirmative in favour of the Respondent and the Appellant.
Unquote The above authoritative judgment was decided in favour of the respondent (taxpayer) in the tax reference (Security Leasing Corporation Limited) because there was a candid finding of Commissioner (Appeals) and Appellate Tribunal that the debt became irrecoverable and the bad debts had been written off as specified in the CSR's instructions. In the case in hand, the appellant has failed to show any such finding by the first appellate authority. The appellant has failed to produce any data which may contain the detail of debtors with reference to reminders or notices issued and telephone/mail contact attempted; what reasonable period of time has elapsed since the original due date for payment of the debt; whether it any formal legal or demand notice is served; whether it has issued and serviced summons to its debtors; whether has obtained any judgment against the delinquent debtor and the execution proceedings to enforce judgment; no list or detail of calculation and charging of interest is prepared and the account closed with reference to delinquents was prepared and submitted before us or any lower forum; there was no valuation of any security held against the debt was prepared and submitted; there was no indication of sale of any seized or repossessed assets.
In view of above facts before us, reliance on the decision of Hon'ble High Court of Sindh, Karachi in the I.T.R.A. No,219 of 2008 decided on 13-10-2010 in the case of Commissioner (Legal), LTU v. Security Leasing Corporation Limited is totally misplaced and can't be invoked in the present case.
The next case cited at bar and relied upon was of M/s. Standard Chartered Bank in ITRA No, 216 of 2011. The perusal of the above judgment reveals that in this case Hon'ble High Court of Sindh has relied upon its earlier judgment in the ITRA No, 219 of 2008 decided on 13-10-2008 and allowed the relief in ITRA No, 216 of 2011. Since factual matrix of the case of appellant is different from the case being relied upon, therefore, we are not persuaded to place reliance on this judgment being distinguishable in facts and circumstances.
In view of above discussion it is not possible for us to pass an order for deletion of additions in respect of 'Provisions for Non-performing loans'. The decision relied upon by the ARs of the appellant were distinguishable. In view of above discussion on the subject of admissibility of the bad debts we can't allow the appellant to claim any relief. They have failed to submit any document to controvert the claim of authorities below. For these reasons we confirm the additions made by the first appellate authority and dismiss the appeal on this count.
6. The second issue before us is that of the apportionment of common expenses to income under final tax regime. In terms of section 20 of the Income Tax Ordinance, 2001 in computing the income of a person chargeable to tax under the head "Income from Business" for a tax year, a deduction shall be allowed for any expenditure incurred by the person in the year wholly and exclusively for the purpose of business. The following conditions and basic principles which should concur in order that a particular item of expenditure is deductible under this section:-- the expenditure should be in nature of expenses described in section 21; i) it should have been incurred in the accounting year; ii) it should be in respect of business which was carried on by the taxpayer and profit of which shall be computed and assessed, and should be incurred after the business is set up; iii) it should not be in the nature of personal expenses of the taxpayer; iv) it should have been laid out wholly and exclusively for the purposes of such business; v) it should not be in the nature of capital expenditure.
Section 67 deals with the apportionment of expenses which states that where an expenditure relates to (a) the derivation of more than one head of income; or (b) derivation of income comprising of taxable income and any class of income to which final or presumptive tax regime is applicable; or (c) derivation of income chargeable to tax under a head of income and to some other purpose, shall be apportioned on any reasonable basis taking account of the relative nature and size of activities to which the amount of expenditures relates.
This section provides for allocating expenditure where income is derived from more than one head of income or part of income relates to presumptive tax regime (PTR) or expenses have been incurred for a purpose other than that of deriving income. Rule 13 of the Income Tax Rules, 2002 provides the formula for apportionment of expenses based on attribution principle. Sub-rule (6) of Rule 13 enumerates 15 classes of different incomes which include almost all .types of incomes including exempt, final or presumptive and normal. It also covers salary and income from business, speculation income or dividend income etc. During the course of hearing we were provided a list of judgments of this Tribunal were the litigants were allowed relief. The perusal of these judgments postulate that the result is in accordance with the rules of apportionment defined in the statute. However, neither any document was produced before us where the computation of apportioned or excessively apportioned expenses were impugned/challenged in respective assessment orders, nor the appellant challenged the quantum of excess expenses. The only point contested before us was that the first appellate authority erred in confirming the order of learned Additional CIR by apportioning the expenses between exempt/PTR and taxable income without taking into account the 'nature and size of the activity carried on by your appellant as is enshrined in section 67 of the Ordinance. The allocation has been without following the principles elucidated therein. In the absence of specific objection on the calculation with reference to wrong application of facts and figure and/or erroneous application of statutory principles laid in the Ordinance and Rules of Income Tax, we agree with the finding of lower authority. Resultantly, we refuse to interfere in the orders passed by the authorities below.
7. The next controversy in hand is relating to the addition on account of Non-Deduction of Withholding tax from salary and perquisites. The ARs of the appellant have produced a schedule of 13 employees who were paid non-taxable allowance on account of POL, maintenance of vehicle and reimbursement of medical expenses as per annexure. It was stated at bar that these allowances were either reimbursement of expenses to these officials or directly connected with the business of the appellant and were in accordance with the banking industry practices. It was submitted at bar these expenses were not part of take-home salary but are sort of privilege to the employee and vary with the usage and occurrence of certain event. In nut shell these amounts were not offered for tax because these were relating to maintenance of car and medical allowance and other reimbursements which are not taxable in the hands of employee. The provision of vehicle was in accordance with Rule 5 of the Income Tax Rules, 2002. We are of the considered opinion that the tax department has not acted in accordance with the law and arbitrarily added the amount on the pretext of withholding regime. First of all POL are not subject to withholding tax under S.R.O. 586(1)/91 dated June 30, 1991 as all the oil marketing companies are exempt from withholding provisions. The other expenses are relating to reimbursement of expenses. The revenue could not produce a single piece of evidence which shows that such reimbursement was paid as part of monthly salary and was part of take-home salary. There is no withholding tax on account of reimbursement of expenses. In view of above situation, the appellant's appeal on this point succeeds.
8. The next point to adjudicate is the Additions of Expenses incurred on Riyadh Office Employees. It was argued at bar by the A.Rs. of the appellant that the only ground for addition of expenses incurred in Riyadh Office by CIR(A) was that the stance taken by the appellant was different from the stance taken before the assessing officer and confirmed the addition in his appellate order. In the amended assessm ent order the appellant has informed about the nature of expenses in threadbare way which was ignored. The appellant placed reliance on the judgments of this Tribunal reported at 2012 PTD (Trib.) 704 and 2011 PTD (Trib.) 1893. We agree with the judgment of single bench in the case reported at 2012 PTD (Trib.) 704 where it was held that:-- "8. Under the aforementioned provision of subsection (5) of section 128 of the Income Tax Ordinance, 2001 the Commissioner Inland Revenue (Appeals) has been empowered to admit fresh evidence if he found himself satisfied that the taxpayer was prevented by sufficient cause to produce the same before the Assessing Officer. It is a settled principle of law that mere technicalities should not be hindrance to do complete justice as laid down by the Hon'ble Supreme Court of Pakistan reported in PLD 1975 SC 678. Moreso, the exercise of the discretion in law by the competent authority would not be opened to any exception. In this regard reliance may conveniently be placed on the cases reported in (2006) 94 Tax 1451 (H.C.) (sic) and 2004 PTD 173."
We have examined the record of authorities below and are of considered opinion that Order of the CIR(A) is not sustainable because he rejected the matter merely on technicalities. According to assessm ent order an amount of Rs.1,165,654 was added back on this account. It was the point of the department that where no foreign income was earned, no foreign expense can be allowed. The appellant made these payments to outsourced staff whose services were secured from other service providers. Moreover, any payment in this respect is not admissible for services rendered liable to deduction of tax at source in terms of section 153 of the Ordinance, 2001 and because of non-withholding and non-submission of withholding on this count filed in tax return filed under section 165 the same was disallowed in terms of section 21(c) of the Ordinance, 2001. During the appellate proceedings before CIR(A), the appellant pleaded that the company is a joint venture of Government of Pakistan and Government of Saudi Arabia with 50% shareholding each and stated that the Chairman of the company and two directors are Saudi Nationals. Two employees are deputed in Riyadh Office and is wholly and exclusively incurred for the purposes of business.
Any expenditure incurred outside Pakistan in respect of employee salary shall be dealt with the laws of other country where the salary has been paid or expenses incurred. If any salary is paid in Saudi Arabia, it should be dealt in accordance with the Tax Treaty between the two countries. The Government of Pakistan has signed a document called 'tax treaty' with Saudi Arabia vide S.R.O.1194(0/2006 dated November 15, 2006. Articles 14 and 15 of the Convention between Government of Pakistan and Government of KSA for avoidance of double taxation and the prevention of tax evasion with respect to taxes on income is a binding document on the tax department and shall overtake the provisions of Income Tax Ordinance, 2001. According to this tax treaty salaries or remuneration paid in Saudi Arabia shall be taxed according to their laws and they shall not be exposed to the provisions of section 153 of the Income Tax Ordinance, 2001. Thus, the DCIR as well as first appellate authority patently ignored these binding provisions. We allowed the appeal on this count and direct the department to delete the additions made in the computation of income.
9. The next point is the issue of add backs on account of amounts written off in respect of non- recoverable amount from National Accountability Bureau, (NAB). According to the explanation available in the Notes to the audited accounts, this amount of provision represent the advance given to NAB for the purchase of 32.718 million shares in Saudi Pak Commercial Bank Limited. Out of this, the company only received 32.703 million shares in the current year, while the receipt of remaining shares is doubtful, therefore, the appellant deemed appropriate to provide the provision for Rs. 256,792 being and doubtful debt. During the course of hearing, neither the amount's complete nature of the transaction with background was submitted, nor any documentary evidence from N.A.B. was produced which reflect that this amount will not be refunded. Applying the rules laid down by Supreme Court of Pakistan in the case of Roberts Cotton Association Limited V. CIT reported as 1982 SCMR 658 we feel. that the above additions cannot be allowed because, these are not meant for wholly and exclusively for the purposes of business of the appellant.
Moreover, apparently, the loss does not constitute the business loss. For these reasons, we feel not inclined to interfere in the Orders of lower forums.
10. The last point is relating to the addition of unearned lease finance to the computation of taxable income of the appellant. The financial statement of the appellant reflecting summary of the lease with reference to net investment in finance lease, minimum lease payments receivable, residual value of lease assets, gross investment in lease finance and computation for potential lease loss which is reconciled with lease rentals, residual value, minimum lease payments, unearned lease payments and present value of minimum lease payments is reproduced as under:-- 2007 2006 Net Investment in finance lease Minimum lease payments receivable568049173 674610522 The unearned Financial starterAdd: Residual value of lease assets Gross Investment in lease assets Less: Unearned finance income Net Investment in lease Provision for potential lease loses568,049173 121,472,003 446,577,170 157,427,202 289,149,968674,610,522 157,195,919 517414603 91,245,958 426,168,645Less to the audited Net Investment in finance lease2007 Less than one yearOne year to five yearTotal Rupees Lease Rental receivable 247,143,721 320,905,452 568,049,173 Residual Value - - - Minimum lease payment 247,143,721 320,905,452 568,049,173 Unearned finance income 68,929,637 68,929,637 121,472,003 Present value of minimum lease payment194,601,355 251,975,815 466,577,710 It was vehemently submitted on behalf of appellant that learned CIR(A) was not justified in confirming additions of Rs.121,472,003 on account of unearned finance lease income. The reasoning contested was that unearned lease finance income not recognized in the audited accounts and has been disclosed only in accordance with International Accounting Standard - 17 (Leases) which only requires disclosures of the future income to be recognised in the year in which such income accrues. This disclosure has been made in Notes to audited accounts. It was argued that first appellate authority has failed to appreciate this fact, therefore, he was not justified to confirm the additions made on this score.
The learned Departmental Representative of the respondent contested that the taxpayer (as lessor) has entered into lease agreement with various parties (lessees) during the year and previous years. The taxpayer has claimed initial and normal depreciation on the assets leased out.
The taxpayer should offer all type of incomes accrued during the tax year. He suggested that the appellant could not prove before the CIR(A) that all the incomes accrued from the leasing activities are offered for tax. He further contested that the leasing activity the taxpayer got unjustly enriched by illegally invoking the tax planning techniques where total income is divided into earned and unearned leasing income by using complex accounting techniques. He prayed that the additions made by the Additional Commissioner IR which was confirmed by the first appellate authority may be confirmed by us.
Learned ARs of the appellant using right of rejoinder vehemently opposed the argument of the learned Departmental Representative. He argued that contention of learned DR is totally baseless.
The claim of depreciation is not in question before the appellate tribunal and the unearned lease income is entirely with the accounting principles and consistent with the method of accounting regularly employed by the taxpayer in terms of section 32 of the Income Tax Ordinance, 2001. Such treatment cannot be allowed because it amounts taxation of lease rentals offered to tax on cash basis as well as accrual basis which amounts to double taxation. Since, the adequate compliance has been made by the taxpayers, therefore, the first appellate authority as well as the department was not justified in making the additions and it merits deletion of additions on account of unearned lease income.
11.1 We have heard the arguments, perused the orders passed by the lower authorities and have given anxious consideration to audited accounts and case law submitted before us. It is an admitted fact that the appellant has entered into lease agreement with the lessees. No such lease agreements were ever produced before us. The perusal of extracts of audited financial statement for the relevant Tax years reveals that this is a case of 'finance lease'. Nevertheless, the treatment meted out in tax return adopted by the taxpayer seemed to be of operating lease because of claim of tax depreciation and adding income from lease as operating income. Due non- production of complete audited financial statements, computation of taxable income and lease documents, we cannot give precise findings on the treatment. Keeping in view of veracity of the matter and relief in another observation by CIR(A) in respect of finance lease in para 14 of the first appellate authority wherein addition in the lease finance income of Rs. 68,484,279 was deleted, we feel, neither taxpayer nor the tax department is aware of the correct treatment of lease in tax law in terms of section 28 of Income Tax Ordinance, 2001. We deem appropriate to hypothesise underlying principles for postulating the taxing of leasing under finance lease and operating lease regime.
11.2 According to accounting literature there are two kinds of accounting methods for leases: operating capital lease. A vast majority are operating leases. An operating lease is treated like renting -payments are considered operational expenses and the asset being leased stays off the balance sheet. In contrast, a capital lease is more like a loan; the asset is treated as being owned by the lessee so it stays on the balance sheet. The accounting treatment for capital and operating leases is different, and can have a significant impact on taxes owed by the business. A capital lease is called a "finance lease" by the IFAC.
11.3 There are acceptable accounting conventions in Pakistan known as International Financial Reporting Standards (IFRS)/International Accounting Standards. For tax purposes, these standards form part of what is referred to as generally accepted accounting practice.
11.4 International Accounting Standards (IAS) No, 17 is on Leases and deals with the classification of operating and finance leases. The relevant extracts of the IAS are reproduced as under:-- A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. All other leases are classified as operating leases. Classification is made at the inception of the lease. [IAS 17.8] Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]
(a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that at the inception of the lease, it is reasonably certain that the option will be exercised;
(c) the lease term is for the major part of the economic life of the asset, even if title is not transferred;
(d) at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset;
(e) the lease assets are of a specialised nature such that only the lessee can use them without major modifications.
Other situations that might also lead to classification as a finance lease are: [IAS 17.11]
(a) if the lessee is entitled to cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee;
(b) gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments); and
(c) the lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent.
11.5 According to UK's HMRC Manual on "Business Leasing Manual", a lease is an agreement whereby one person (the lessor) hires an asset to another (the lessee) for a series of rental payments over an agreed period of time. Leasing can cover anything from the hiring of a power tool for a day or so through the hiring of a car for months to the hiring of a fleet of aircraft for decades or the hire of a building for centuries. Where assets are hired for longer periods they are usually referred to as being 'leased' than 'hired' but there is no clear distinction between the two terms. 11.6. The case law of Pakistan, clearly distinguishes finance lease and operating lease. In the KASB Bank Limited v. Messrs Trans Lima Private Limited reported as PLD 2007 Kar. 508, the Hon'ble Sindh High Court, Karachi has very lucidly drawn distinction between the finance lease and operating lease as follow:-- Finance Lease Operating Lease Financial lease is a long term lease on fixed assets, the same may not be cancelled by either party.Operating Lease is a non-pay out lease which may be cancelled by the lessee prior to its expiration In financial lease the leasing company buys the equipment and leases it to the lessee.The sum of all the lease payments by the lessee does not necessarily fully provide for the recovery of the assets cost.
It is a full payout lease involving obligatory payment by the lessee to the lessor that exceeds the purchase price of the leased property and financial cost.In operating lease sphere of operation is limited which generally cover those goods which could be needed by different users.
Financial Lease is a lease that transfers substantially all the risksand rewards incident to ownership of an asset. Lessor is only a financier and is not interested in the assets.In Operating Lease, the lessor will have the continuing interest in the leased equipment and thereby undertakes to bear the maintenance etc. Lessor retains the usual risks and rewards that come from-the ownership of the assets.
The Financial Lease is not cancellable by the lessee prior to its expiration date.The Operating Lease is cancellable by the lessee prior to its expiration.
The Financial Lease provides for maintenance services at the cost of lessee.The lessor provides service, maintenance and insurance.
The asset is fully amortized over the life of the lease.Under such lease the equipment cost is not fully amortized over the leased tenure.
Such lease is usually for a short period i,e, less than 75% of the estimated life of the assets, which period may not be adequate to recover to the full extent the investment in the asset.The present value at the beginning of the lease term of the minimum amounts payable under the lease (exclusive of amounts payable for insurance, maintenance and similar normal outgoings) is at lease equal to 90% of the cost of the leased assets net of investment grants.
In the above judgment the distinction in the operating lease and financial lease (i,e,, finance lease) with reference to nature and substance of the contract of lease. In this context paras 24 and 25 of the judgment is appropriate that define the true nature of finance lease. This is reproduced as follow for the advantage of ready reference:-- "24.....where an operating lease is extended under a written contract extending over a fixed tenure the remedy available to the lessor in case of default in payment or discontinuation of the lease by the lessee would be to lease out the property elsewhere and to recover the amount of difference, if any, form the lessee for the unexpired period of lease under written contract in addition to the higher leased charges for the period that the property remained with the lessee.
25. This view finds support from the facts that in such circumstances the leasing of the property or the chattel, as the case may be, is the normal business of the lessor. Cases involving financial lease, where the main business of the lessor is not that of hiring of machinery but it is that of providing purchase of chattels or machinery to be leased out on lease suitable to the particular needs and requirements of the specific lessee. Default such cases of financial lease can be distinguished from that in case of an operating lease for the reasons already stated in the above paragraph. However as in such cases the lessor indulges only to the extent of financing which is his main vocation, the ordinary course to be followed to minimize the losses would be to dispose of the chattel or machinery. The amount of sale proceeds be adjusted towards the unpaid instalments due for the entire tenure of the lease under contract. The balance outstanding, if any, may be recovered from the lessee to secure the agreed amount of return and the finance, as already stipulated under the terms of the agreement between the parties."
In the above judgment Sindh High Court, Karachi has made reference to Books titled, (1) Lease Financing and Hire Purchase 4th Edition, by Dr. J.C. Verma; and (2) Lease Financing and Hire Purchase by Vinod Kothari in reaching its conclusion. The description of these authors on the subject is relevant.
11.7 In Lease Financing & Hire Purchase by Dr. J.C. Verma (4th Edition, 1999 at p.33), Financial Lease has been so defined:-- 'Financial lease is a long-term lease on fixed assets, it may not be cancelled by either party. It is a source of long-term funds and serves as an alternative of long-term debt financing. In financial lease, the leasing company buys the equipment and leases it out to the use of a person known as the lessee. It is a full payout lease involving obligatory payment by the lessee to the lessor that exceeds the purchase price of the leased property and finance cost.
Financial lease has been defined by International Accounting Standards Committee as "a lease that transfers substantially all the risks and rewards incident to ownership of as asset. Title may or may not eventually be transferred." Lessor is only a financier and is not interested in the assets. This is the reason that financial lease is known as full payout lease where contract is irrevocable for the primary lease period and the rentals payable during which period are supposed to be adequate to recover the total investment in the asset made by the lessor."
11.8 In Lease Financing & Hire Purchase by Vinod Kothari (4th Edition), the features of 'finance lease' have reproduced as under:--
1. The risks and rewards incident to ownership are passed on to the lessee. The lessor only remains the legal owner of the asset.
2. Therefore, the lessee bears the risk of obsolescence.
3. The lessor is interested in his rentals and not in the asset. He must get his principal back along with interest. Therefore the lease is non-cancellable by either party.
4. The lease period usually coincides with the economic life of the asset and may be broken into primary and secondary period.
5. The lessor enters into the transaction only as a financier. He does not bear the costs of repairs, maintenance or operation.
6. The lessor is typically a financial institution and cannot render specialized service in connection with the asset.
7. The lease is usually full payout, that is, the single lease repays the cost of the asset together with the interest.
11.9 According to Dictionary of Accounting & Finance by R. Brockington (Pitman Publishing, Universal Book Traders, 1996 at page 136) finance lease is defined as under:-- "A Finance Lease is one where the Lessee uses the asset for substantially the whole of its useful life and the lease payments are calculated to cover the full cost together with interest charges. It is thus a disguised way of purchasing the asset with the help of a loan. SSAP 23 required that assets held under a finance lease be treated on the balance sheet in the same way, as if they had been purchased and a loan had been taken out to enable this."
11.10 It is not out of place to mention two important judgments of Indian Supreme Court wherein this subject has been lucidly discussed with reference to the substance of the finance lease in Asea Brown Boveri Limited v. Industrial Finance Corporation of India and others reported as (2004) 12 SCC 570 and Association of Leasing and Financial Service Companies v. Union of India reported as (2011) 2 SCC 352.
11.10.1 In the case of Asea Brown Boveri the Supreme Court has summed up the features of finance lease as under:-- "In our opinion, financial lease is a transaction current in the commercial world the primary purpose whereof is the financing of the purchase by the financier. The purchase of assets or equipment or machinery is by the borrower. For all practical purposes, the borrower becomes the owner of the property inasmuch as it is the borrower who chooses the property to be purchased, takes delivery, enjoys the use and occupation of the property, bears the wear and tear, maintains and operates the machinery/equipment, undertakes indemnity and agrees to bear the risk of loss or damage, if any. He is the one who gets the property insured. He remains liable for payment of taxes and other charges and indemnity. He cannot recover from the lessor, any of the above mentioned expenses. The period of lease extends over and covers the entire life of the property for which it may remain useful divided either into one term or divided into two terms with clause for renewal. In either case, the lease is-non-cancellable."
11.10.2 In other case of Association of Leasing and Financial Service Companies, the Apex Court of India has highlighted the distinction in the following words:-- 20In this connection, as and by way of illustration we need to give an illustration which brings out the distinction between a "finance lease" and "operating lease". A finance lease transfers all the risks and rewards incidental to ownership, even though the title may or may not be eventually transferred to the lessee. In the case of "finance lease" the lessee could use the asset for its entire economic life and thereby acquires risks and rewards incidental to the ownership of such assets. In substance, finance lease is a financial loan from the lessor to the lessee. On the other hand an operating lease is a lease other than the finance lease. Accounting of a "finance lease" is under AS- 19, which as stated above, is mandatory for NBFCs. It is a completely different regime. According to Chitty on Contract, a hire-purchase agreement is a vehicle of installment credit. It is an agreement under which an owner lets chattels out on hire and further agrees that the hirer may either return the goods and terminate the hiring or elect to purchase the goods when the payments for hire have reached a sum equal to the amount of the purchase price stated in the agreement or upon payment of a stated sum. The essence of the transaction is bailment of goods by the owner to the hirer and the agreement by which the hirer has the option to return the goods at some time or the other. Further, in the bailment termed "hire" the bailee receives both possession of the chattel and the right to use it in return for remuneration to be paid to the bailor. Further, under the head "equipment leasing", it is explained that it is a form of longterm financing. In a finance lease, it is the lessee who selects the equipment to be supplied by the dealer or the manufacturer, but the lessor [finance company] provides the funds, acquires the title to the equipment and allows the lessee to use it for its expected life. During the period of the lease the risk and rewards of ownership are transferred to the lessee who bears the risks of loss, destruction and depreciation or malfunctioning. The bailment which underlies finance leasing is only a device to provide the finance company with a security interest [its reversionary right]. If the lease is terminated prematurely, the lessor is entitled to recoup its capital investment [less the realizable value of the equipment at the time] and its expected finance charges [less an allowance to reflect the return of the capital]. In the case of hire-purchase agreement the periodical payments made by the hirer is made up of:--
(a) consideration for hire
(b) payment on account of purchase
21. To sum up, NBFCs essentially are loan companies. They basically conduct their business as loan companies. They could be in addition thereto in the business of equipment leasing, hire purchase finance and investment. Because NBFCs are basically loan companies, they are required to show the assets leased as "receivables" in their balance sheets. That the activities of hire-purchase finance/equipment leasing undertaken by NBFCs come under the category of "pare banking". That, in substance a finance lease, unlike an operating lease is a financial loan (assistance/facility) by the lessor to the less i,e, That, in the bailment termed "hire" the bailee receives both possession of the chattel and the right to use it in returned for remuneration. On the other hand, equipment leasing is long term financing which helps the borrower to raise funds without outright payment in the first instance. Here the "interest" element cannot be compared to consideration for lease/hire which is in the nature of remuneration (consideration) for hire.
11.11 After going through the International Accounting Standard/IFRS, judgments of Sindh High Court, Karachi and Indian Supreme Court cited above we can draw following broad features of the finance lease:--
(i) Such a lease is non-cancellable and there is a fixed obligation on the lessee for payment of lease money. In case lease is terminated prematurely by the lessee, the lessor is entitled to recover his investment with expected interest.
(ii)Such a lease is always for a fixed period, which period is decided by taking into consideration the economic life of the asset.
(iii)The initial lease period is settled in such a way so as to fully recover the investment of the lessor together with interest thereon.
(iv)Lessor is always interested in the recoupment of his investment with interest in the shape of rentals over the period of lease and not the asset or its user.
(v)It is the responsibility of the lessee to bear all costs of insurance, repairs and maintenance and other related costs and expenses for the leased equipment.
(vi)Though the equipment is chosen by the lessee but the payment to the supplier is made by the lessor. Thus it is the lessee who chooses the assets, takes delivery enjoys the use of the asset, bears its wear and tear. It is the lessee who becomes the real owner of the asset.
(vii) It is the lessee who pays taxes etc. in relation to such asset.
(viii) The risks and rewards incidental to the ownership vest with the lessee.
(ix) The features of bailment are absent in such a lease.
(x) The lessor simply holds the title of asset as his security till his investment and interest thereon is recouped. The lessor is only symbolic owner during the period of lease and on the expiry of lease period, even such symbolic ownership also comes to an end.
11.12 Now after making threadbare analysis of definition of finance lease, we have to look into the other key factors which are basic ingredients of deciding whether a lease is a operating lease finance lease. In order to decide the controversy, we need to appreciate the true meaning and purport of the term 'lease'. Section 105 of the Transfer of Property Act, 1882 defines lease. It provides that "a lease of immovable property is a transfer of a right to enjoy such properly, made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms."
From the above definition it can be seen that the fundamental characteristic of any lease is to separate the "use" from "ownership' of the assets. As per the above section 105 of Transfer of Property Act, 1882 a person owning the asset, called the 'lessor', provides the asset for use for a certain period of time to another called the 'lessee' for some consideration.
We have noticed that in the case finance lease, risks and rewards of ownership rest with ,the lessee and not lessor. Various rewards of ownership of an asset can be illustrated as under:--
1. right to exclusively use the asset.
2. right to prohibit anybody else from using the asset or sharing the benefits of appreciation;
3. right to prohibit anybody from transferring the asset;
4. right to claim damages, warranties, etc. from the supplier;
5. right to claim any subsidies or other benefits or concessions attached to ownership of the asset etc. 11.13 At this point of time, it is also equally relevant to illustrate the various types of risks attached to the ownership of an asset, these can be enumerated as under:--
(a) loss due to idle capacity;
(b) loss due to technical obsolescence of the asset;
(c) loss due to the asset not being fit for the purpose or merchantable; (d)loss due to damage in transit;
(e) loss due to damage during installation or operation;
(f) liability to pay any taxes attaching to ownership of the asset;
(g) liability due to any statutory offences committed because of ownership, use or operation of the asset.
11.14 The next question come into mind is that of 'ownership' in the finance lease.
Whether the word 'owner' should be assigned wider meaning to include any person, who is entitled to hold property in his own right, notwithstanding a formal title deed may not be registered in his name? In doing so whether such person is de-facto owner and should be the reel owner?
Now the question is that whether any depreciation can be allowed to lessor in the case of finance lease? Here we will concentrate only on the finance and operating lease, in order to provide guidelines for the resolution of the controversy between the taxpayer and the Revenue. At this point it is appropriate to have a look into the various provisions of the Income Tax Ordinance, 2001 which deal with the subject of lease either with reference to classification or to type of lease income as 'Income from business' allowance of depreciation and initial allowance and deductions available from lease income, treatment of consideration received on the disposal of leased asset and the application of withholding taxes on the lease agreement. These provisions are contained in sections 18, 22, 23, 28, 77 and 153 of the Ordinance.
11.15 The allowability of the depreciation is governed by section 22 of the Ordinance. In terms of subsections (1) and (7) of section 22, one has to consider the twin conditions of use of asset and ownership of asset. Let us examine whether the lessor satisfies these conditions being an owner of the asset in a case of finance lease. It is one of the salient features of the finance lease that it is the lessee who chooses the type of equipment (i,e,, asset), the model and cater special features required. He then negotiates with the supplier about the delivery, installation and purchase price.
The role of the lessor is to provide finance. In a case of finance lease, the lessor recovers his entire investment together with interest during the lease period itself and such lease agreement is non- cancellable. It is the sole responsibility of the lessee to bear all costs of insurance, repairs and maintenance and also suffer any obsolescence loss. All risks and rewards incident-al to the ownership of asset vest with the lessee alone. The title of the lessor in the asset is only sym bolic, which serves no purpose other than a security for the renouncement of his investment with interest in the shape of lease rentals. Such nominal ownership also ordinarily ceases with the coming to an end of the lease period. On the test laid down above in terms of subsections of (1) and (7) the section 22 the answer becomes somewhat clear that as against the lessor's nominal or the so called perceived ownership, it is the lessee who is the actual and real owner of the asset.
11.16 We are also fortified with the two judgments of the Indian Supreme Court with reference to income tax where the question of legal ownership came before their lordships. The first ease in this context is relating to CIT v. Podar Cement (Private) Limited reported as (1997) 226 ITR 625 (SC). In this case, the assessee took the possession of flats after payment of the consideration. Such flats were let out to various persons. The assessee claimed that the rental income should be considered as "Income from other sources" and not "Income from house property" as it was not a "legal owner" of the property in the flat. This contention was rejected by the Assessing Officer. When the matter finally came up before the Hon'ble Supreme Court, it was observed that the liability under section 22 is on a person who receives or is entitled to receive the income from the property in his own right. The requirement of the registration of sale deed in the context of section 22 was held to be not warranted. The Hon'ble Supreme Court, in reaching this conclusion also took into consideration the definition of owner given under section 27(iii) to (iiib) containing the deeming provision about the treatment of a person as owner. In the light of these provisions the assessee was held to be owner of the property as it was he who was "entitled to receive income from the property in his own right". From the above judgment of the Hon'ble Supreme Court it can be observed that the charge under section 22 has been held to be attracted on a person who is entitled to receive the income from the property in his own right albeit he may not be a legal owner of such property. At the same time it is equally true that while reaching this conclusion, the Hon'ble Supreme Court took into consideration the deeming provision contained in section 27(iii) to (iiib) as regards owner of house property. At this stage it will be relevant to consider the crux of the judgment reproduced as under: -- "We are conscious of the settled position that under the common law, 'owner' means a person who has got valid title legally conveyed to him after complying with the requirements of law such as the Transfer of Property Act, Registration Act, etc. But, in the context of section 22 of the Income-tax Act, having regard to the ground realities and further having regard to the object of the Income-tax Act, namely, 'to tax the income', we are of the view, 'owner' is a person who is entitled to receive income from the property in his, own right."
11.17 Now, we shall examine another case which came up for consideration before the Indian Supreme Court is Mysore Mineral Limited v. CIT reported as (1999) 239 ITR 775 (SC). According to the factual matrix of the case, the taxpayer has purchased certain houses for the use of its staff.
Part payment was made followed by delivery of possession. Actual conveyance was not executed in favour of the assessee. A claim for depreciation under section 32 was made which was rejected by the Assessing Officer on the ground that the taxpayer is not the owner of the asset. When the matter came up before the Hon'ble Summit Court, it considered its earlier judgment in Podar Cement (P) Ltd. and described it "as a trend settor" in the concept of ownership. Assistance from the law laid down therein was taken by the Hon'ble Supreme Court in the latter case for adopting the meaning of the term "owned" as occurring in section 32(1) of the Indian Income Tax Act.
Accepting the assessee's claim for allowing depreciation, the Hon'ble Supreme Court held as under:-- "In our opinion, the term "owned" as occurring in section 32(1) of the Income Tax Act, 1961, must be assigned a wider meaning. Anyone in possession of property in his own title exercising such dominion over the property as would enable others being excluded therefrom and having the right to use and occupy the property and/or to enjoy its usufruct in his own right would be the owner of the buildings though a formal deed of title may not have been executed and registered as contemplated by the Transfer of Property Act, the Registration Act, etc. "Building owned by the assessee" the expression as occurring in section 32(1) of the Income Tax Act means the person who having acquired possession over the building in his own right uses the same for the purposes of the business or profession though a legal title has not been conveyed to him consistently with the requirements of laws such as the Transfer of Property Act and the Registration Act, etc., but nevertheless is entitled to hold the property to the exclusion of all others."
11.18 If we analyze these judgments of the ratio <i>decidend</i> laid down in the case of (1997) 226 ITR 625 (SC) on the question of inclusion of income in the hands of the person who is entitled to receive income in his own right, has been applied on the question of allowing depreciation to a person who is entitled to hold the property to the exclusion of others though he is not a legal owner.
There can be hardly any difficulty in finding an owner of a property when the person using the property in his own right as owner (i,e, real owner) also happens to be the legal owner. In such a case the real owner is both a de facto and also de jure owner of an asset. But the problem arises in a case when there are apparently two simultaneous owners of the same property at the same time, viz, the de facto owner and de jure owner. Difference between the de facto owner and de jure owner has been highlighted by the Hon'ble Supreme Court in the above two cases. The crux of these judgments is that in such a case it is the de facto owner entitled to hold the property in his own right and entitled to receive income therefrom in his own right, who is to be treated as the real owner of the asset for the purposes of the Income Tax Act, unless stated otherwise in relevant provision, in preference to the one who is simply a de jure owner, not entitled to hold the property in his own right or to receive income therefrom in his own right.
11.19 The corollary which follows on consideration of the (1997) 226 ITR 625 (SC) along with (1999)
239 ITR 775 (SC), is that for the purposes of section 32(1) the word "owner" is to be assigned a wider meaning so that anyone in possession of such property in his own title exercising such dominion over the property as would enable others as being excluded there from and having a right in his own right would be the owner of building for the purpose of section 32(1) notwithstanding the fact that a formal deed of title may not have been executed and registered in his name. By applying the ratio decidendi of the judgment in the case of (1999) 239 ITR 775 (SC) there would hardly remains any complexity in deciding that it is the lessee who is the real owner of asset. It is the lessee who is in possession of property exercising control over the boiler by excluding others including the assessee-lessor there from. All the risks and rewards attached to the property are that of the lessee. By no standard whatsoever the lessor can be described as the owner of the property. Thus, in a case of operating letse, the lessor is both de facto and de jure owner in the case of finance lease, the lessee is de facto owner and the lessor is only de jure owner.
11.20 To sum up the discussion, the perusal of provision of Income Tax Ordinance, 2001, it is evident that the statute has dealt with the subject with reference to lease only. From the bare language of the law, it is unequivocally clear that operating lease is fully covered in these provisions of the statute. Now, the question arises whether agreement clothed with the financing arrangement (i,e,, finance lease) is include in that or not. We are clear in our mind that in case of a finance lease it is the lessee who is the owner of the property for all practical purposes and is entitled to depreciation under sections 22 and 23 and not the lessor. When the lessor's so called symbolic ownership is pitted against the lessee's real ownership, one hardly encounters any trouble in finding out that it is the lessee who is the real owner.
11.21 Reverting to controversy between the rival parties in this case, we have laid down the principles interpreted the provisions of the law of income tax. Since neither party has produced lease agreements during the course of pleading it is not possible for us to decide with reference to underlying facts and figures. Since it was the claim of the department that the taxpayer got unjustly enriched by claiming initial and normal depreciation allowance and yet has not offered all the incomes accrued therefrom. Since, both the authorised representatives of the Appellant and Departmental representative could not provide the details of nature of leases and its related computation, we deem it appropriate to remand back the matter to DCIR to decide the controversy in the light of guidelines supra and make the treatment as laid down below:--
(i) In case department ascertains that it is a case of an operating lease, the lease rentals received by the taxpayer during the impugned Tax Year will constitute the revenue income against which taxpayer is entitled for deduction of claim under sections 22 and 23 of the Income Tax Ordinance, 2001. If any portion is splitted into earned and unearned portions, the entire amount of lease (earned and unearned lease rentals) shall be taxed.
(ii) In case of finance lease, where the lease is a matter of financial arrangement, each lease rentals shall be splitted into interest/ finance charges and principal portion. The interest/finance charges (i,e,, the Income of Appellant) will constitute as revenue of the Taxpayer and principal amount shall be reduced from the principal lease amount payable. No depreciation in terms of sections 22 and 23 shall be admissible for the reasons recorded above to the lessor. Against the appellant's income, lessor is entitled to claim all such expenses incurred for making such finances available with it. The unearned finance charges have to be computed in stricto-senso of section 32 of the Income Tax Ordinance, 2001.
(iii)In case of finance lease, only the lessee shall be treated as owner of the asset. It is lessee, who is entitled to claim depreciation in accordance with the provisions of sections 22 and 23 of the Income Tax Ordinance, 2001. No depreciation is allowed to the lessor as it is a case of a financial agreement where lessor is merely a deemed owner and retains title for security reasons. It should be treated as any other financing/ loan arrangement.
12. The appeal is disposed of in the manner as indicated above.
13. At the end we would like to appreciate the valuable assistance of the learned counsel from both side & in this appeal and record the same. This section is pan i materia to section 29 of Income Tax Ordinance, 2001