ICA No.338/2017 Ayesha A. Malik J: This common judgment decides upon the issues raised in the ICAs detailed in Schedule "A", appended with the judgment. The ICAs have been filed by the Taxpayers and the Federal Board of Revenue ("FBR") as they both are aggrieved by the impugned judgment dated 9.1.2017 passed by the learned Single Judge in WP No.32597/2015 and in connected petitions.
2. The Taxpayers challenged the Audit Policy of 2015 ("Audit Policy") as well as the selection for audit through random ballot carried out by the FBR on 14.9.2015 and the issuance of notices thereafter.
Their grievance is that the FBR carried out a random selection for the purposes of audit without framing any rules. It is their case that the framing of rules was mandatory pursuant to the judgment of this Court dated 20.6.2015 passed in WP No.30253/2014 being the Defence Housing Authority v. Commissioner Inland Revenue etc.("DHA Judgment"). It was also argued that in terms of the judgment an authoritative pronouncement was given that the FBR must regulate its powers for selecting and conducting audit through rules failingwhich any selection or process of audit would be in contravention to the judgment of this Court. Therefore they argued that in the absence of rules, the FBR could not select the Taxpayers for audit nor could they issue notices in pursuance thereof. It is also their case that the Audit Policy clearly demonstrates that the objective of the audit is to achieve quantitative targets and revenue generation. They argued that this is contrary to the scheme of law and to the purpose of the audit. Learned counsel for the Taxpayers argued against the Audit Policy urging that it is discriminatory and that the random selection is arbitrary as the FBR excluded certain classes of persons from the ballot which is also violative of Article 25 of the Constitution of the Islamic Republic of Pakistan, 1973.
3. The FBR is aggrieved by the impugned judgment only to the extent that the impugned judgment has declared 30.6.2017 as the cut off date for completing the audit for the tax year 2014 failing which the audit will be deemed to have been dropped. Learned counsel for the FBR argued that the law does not contemplate a time frame nor does it provide that if an audit is not completed it must be dropped. The counsel argued that audit is the ICA No.338/2017 primary function of the FBR and it will severely prejudice the scheme of tax collection if voluntary assessm ent is not made subject to audit. The counsel explained that there are delays in the audit, however the impugned judgment has erred in law by declaring that if the audit is not completed by 30.6.2017 it will deemed to have been dropped. It was argued that the law allows the FBR to conduct the audit for a period up to six years, therefore there is no legal justification for fixing the cut off date that is 30.6.2017. It was also argued that meeting the cut off date is practically impossible given the number of cases that have been selected and the pendency of the litigation.
In this regard, Najeeb Qadir, Chief Audit Officer and Khalid Sultan, Secretary Taxpayer Audit explained that the audit cannot be time bound as the process of audit commenced after the framing of the Audit Policy in September 2015. They explained that the Audit Policy changes every year and once a policy is issued the selection process commences. In this case random ballot was carried out on 14.9.2015. Notices were issued thereafter to the Taxpayers and the dispute was brought before this Court where after the entire process stopped on account of interims order dated 24.11.2015. passed by this Court which was extended till 25.11.2016. They further explained that the impugned judgment was announced on 9.1.2017 and the ICAs were filed thereafter. Therefore it became practically impossible to complete the audit by 30.6.2017. In any event they explained that the Audit Policy requires the audit to be completed within a reasonable time and the FBR--is- conscious of the fact that the audit should not be prolonged, hence they require it to be completed within a reasonable time.
4. The impugned judgment also requires the FBR to divide the function of audit into two parts. Firstly selection for audit and the preparation of the audit report being one function which should be done by one set of officers. Secondly the assessment and amendment orders should be passed by another set of officers being a separate function from the audit. The counsel argued that the distinction created between an administrative function and quasi-judicial function within the audit is contrary to the mandate of the law and is practically impossible. It was explained that the separation between the selection process and the assessment process was not cost effective an ICA No.333/2017 amounts to duplication of work. It also means creating a new structure within the department which is not necessary as the existing Commissioners are fully competent to carry out the audit as provided for under the law. Furthermore it was argued that the impugned judgment has issued policy directives which do not fall within its constitutional jurisdiction.
5. The impugned judgment upheld the Audit Policy as well as the selection process but also found that the objective of the Audit Policy and the capacity of the FBR to carry out the audit was insufficient. In this regard, the Court held that over the years the FBR has been unable to improve its capacity to conduct the audit within a reasonable time frame through trained audit officers and that invariably the audit is delayed for a long period of time. It is also observed that untrained audit officers generally show inclination to move towards assessment without formulating an audit report in the hope of meeting recovery targets. With reference to the Audit Policy, the impugned judgment finds that the Qualitative Indicators given in the Audit Policy reflect the FBR's bent of mind to raise demands and make recovery which is against the general spirit of audit. The Court in the impugned judgment goes on to explain that the role of audit officers is primarily to issue an audit report after seeking an explanation from the Taxpayer and thereafter to proceed with the assessm ent process if required. In this regard, the Court held that: audit, necessarily, is administrative in nature, which starts by selection for audit and ends on issuance of "Audit Report" after seeking explanation from the Taxpayer. Issuance of "Audit Report" is sine qua non for completion of audit Proceedings under respective provisions of the Federal Taxing Statutes. To maintain separation between administrative and judicial powers, as envisaged in Article 175(3) of the Constitution of 1973, it is necessary that quasi-judicial proceedings be carried out by a taxation officer other than audit officer who conducted the audit because adjudication and audit are separate proceedings under the Federal Taxing Statutes. The intent of legislature is to provide another opportunity of being defended to the Taxpayer by responding to the show cause notice. Needless to say that procedural standards, under judicial or quasi-judicial proceedings, are different from standards of administrative proceedings. Audit is an inquiry/investigation of the tax affairs and adjudication ICA No.338/20 I7 needs to satisfy the requisites of fair trial as guaranteed to the Taxpayer under Article 10A of the Constitution.
With reference to the time frame, the Court held that: Since no cut of date for completion of audit is given in the Audit Policy and matter remained under litigation to the extent of petitioners, therefore, the authorities under FBR shall complete pending audits till 30.6.2017 and in case of failure the selection for audit shall be deemed to have been dropped.
Finally, the Court found that the State has a right to audit and correspondingly the Taxpayer must make correct declaration and comply with the statutory requirements under the Federal Taxing Statutes. A direction was given to the FBR to rectify the defects pointed out with the impugned policy and certain directions were given by the Court which are to be incorporated in the rules and the policy, which are as follows.
A Taxpayer selected and audited in preceding tax year/period shall not be selected and audited without giving reasons for such selection. FBR shall enhance its capacity to audit a selected Taxpayer for last five years to give respite from consecutive selections.
Audit,- being administrative proceedings, shall complete on issuance of Audit Report. If audit is not completed within the given time frame, the selection shall be deemed to have been dropped. After issuance of Audit Report; adjudication proceedings shall be carried out by some other taxation officers to satisfy command of the Constitution under Article 10A.
After selection for audit, any demand for increase in payable tax to drop audit proceedings is not only against the scope and spirit of audit but is in violation of the provisions relating to audit under the Federal Taxing Statues as well.
The audit shall be conducted in accordance with "Income Tax Manual Part V" and "Sales Tax Audit Hand Book" and such procedure for conduct of audit shall be incorporated in the Rules for Selection and Conduct of Audit.
Remedy against any grievance, regarding selection or conduct of audit, under Section 7 of FBR Act, 2007 shall, henceforth, be read as part of every Audit Policy and its procedure is directed to be incorporated in the Rules for Selection and Conduct of Audit.
ICA No.338/2017 The decision, directions and observations made in this judgment shall be followed while implementing the impugned Audit Policy 2015 and future audit policies.
Opinion of the Court
6. The dispute before the Court arises out of the selection for audit and the audit process, which power is conferred under Section 214C of the Income Tax Ordinance, 2001 ("Ordinance"), Section 72B of the Sales Tax Act, 1990 ("Act") and Section 42B of the Federal Excise Act, 2005 ("2005 Act") collectively referred as to the ("FTS"). The powers under the FTS for the purposes of selection and process for audit are similar. The impugned selection for audit is with respect to the tax year 2014 and the impugned policy is the Audit Policy, 2015.
7. In general, it is noted that the Court is faced with regular challenges to the selection process for the purposes of audit, be it random ballot or parametric selection. In various different judgments, it has been held that carrying out of the audit, the selection process under the FTS for random ballot or parametric is provided for under the law and mere selection for audit does not cause any injury or prejudice to the Taxpayer. The raison d'eter is that the Taxpayer has merely been called upon to explain his case and it is not necessary that selection will culminate into an amendment to the returns. This is because mere selection for audit itself is not a complete process but is just the beginning of a process whereafter several steps have to take place before it can be decided whether or not an assessment order needs to be passed.
Furthermore, selection for the purposes of audit is necessary in order to verify compliance with the FTS. In this regard, various different judgments have been rendered such as judgment dated 27.5.2015 passed in WP No.2857/2010 titled M/s Prime Boilers & Engineers v. Federation of Pakistan, etc., order dated 4.3.2015 passed in WP No.5083/2015 titled M/s Pak Auto v. Federation of Pakistan, etc and the case cited at Messrs Syed Bhais (Pvt.) Ltd through Director v. Central Board of Revenue, Islamabad through Chairman and another (2007 PTD 239) wherein the question of selection was decided.
8. In the instant cases once again the Taxpayers have challenged the selection process through random ballot on the ground that it is ICA No.338/2017 discriminatory and that it is not random as all taxpayers have not been included in the ballot. They argued that ballot was made from amongst a selected class of taxpayers, hence increasing their chances of selection. They also argued that random selection must be from amongst all taxpayers and the FBR cannot exclude classes of persons from the random selection process. The relevant sections for selection of audit in the FTS are Section 214C of the Ordinance, Section 72B of the Act and Section 42B of the 2005 Act. All sections are the same. Section 214C of the Ordinance allows the FBR to select persons or classes of persons for audit through computer ballot which can be random or parametric, as the FBR deems appropriate. The Section therefore in itself contemplates that the FBR can select persons or classes of persons for the purposes of audit. The grievance of the Taxpayers that random ballot means that all taxpayers must be included in the ballot is misconceived as the law authorizes the Board to select persons or classes of persons for this purpose. In this context, the Taxpayers are also aggrieved by the exclusions provided in the Audit Policy in Part 6 wherein non-filers and salaried persons have been excluded from the selection process. It was explained by Najeeb Qadir, Chief Audit Officer and Khalid Sultan, Secretary Taxpayer Audit that the reason for excluding salaried persons was that they are not considered high risk taxpayers and that non-filers are excluded as a specific remedy is provided under the FTS to deal with them. Hence the FBR decided to exclude both classes of taxpayers. We are of the opinion that the selection of persons or class of persons for audit is provided under the law and the FBR is well within its authority to exclude certain classes of persons from the audit, if it deems necessary.
Therefore the exclusion of salaried persons and non-filers does not tantamount to discrimination.
In this case, the FBR is well within its right to exclude classes of persons for random ballot or parametric selection. So far as the ballot process is concerned, from amongst the pool of persons selected for audit, a transparent selection process was undertaken which is totally automated, hence there is no element of arbitrariness or discrimination in the process. In this regard, this Court has upheld the fact that the FBR is entitled 1CA No.338/2017 to select persons or class of persons for the purposes of audit and that in creating exclusions no discrimination is made out.
9. The basic objection of the Appellant Taxpayers was that the audit for the tax year 2014 was carried out without framing rules as required under the DHA Judgment. We have gone through the DHA Judgment and find that the said case was in relation to parametric selection for audit where the question was whether the paramptrics were actually risk based. The Court held that if the FBR failed to rationalize and regulate its powers for selecting and conducting audit through rules, the Court may have to intervene in order to undo arbitrary or discriminatory exercise of power. The instant case is one of random ballot and the basis of selection are random not risk based. Hence per se no rules are required for selection purpose. The FBR commenced the audit for the tax year 2014 after framing the Audit Policy which regulates the audit process and time amongst other things. The FBR has explained that the Audit Policy rationalizes and regulates the selection and conduct of audit, hence the requirements of the DHA Judgment are met with. We find the arguments that without rules there can be no audit as meritless. The rules are required to be framed where the FBR deems it necessary in furtherance of the purpose of the Act. In this case the random ballot was carried out through an automated process and there are no allegations of it being arbitrary or-capricious. We have dealt with the arguments related to the selection process in para 8 finding it to be lawful. So far as the conduct of audit is concerned we note that the Audit Policy caters to the methodology, standards and objectives for the audit of 2014. We also note that each taxpayer will have a separate policy based on the requirements of that year as forecasted by the FBR, hence their stance that the Audit Policy regulates the process and powers is correct and reasonable. Under the circumstances, in this case rules are not required before conducting the audit and the DI-LA Judgment is not applicable to this case.
10. The Taxpayers are also aggrieved by the Audit Policy on the ground that it does not settle any issue with respect to the conduct of audit and that it gives unstructured discretion to the audit officer to carry out an audit. They argued that the learned Single Judge while accepting the contentions of the ICA No.338/2017 Taxpayers did not set aside the Audit Policy and instead issued directions primarily structuring the discretion of the Commissioner and the Audit Officer as well as regulating the time factor within which the audit has to be conducted. Counsel for the Taxpayers argued that under the circumstances the Audit Policy should have been set aside. The FBR on the other hand supported its Audit Policy and are aggrieved with the cut off date and the separation of functions directed by the Court. We have heard the arguments and have gone through the Audit Policy and find that it sets out the aims and objectives of the audit for the year 2014 and provides for the methodology for selection as well as processing the audit cases. The Audit Policy requires the Commissioner to assign audit cases to relevant teams to be headed by officers of appropriate level and to ensure that the Income Tax Manual and Sales Tax Audit Hand Book be followed and that all discrepancies found within the Taxpayers' documentation be pointed out to the Taxpayers before finalizing its case for audit. The Audit Policy also requires that the FBR fix the prescribed time for disposal of cases and it further stipulates that the audit should be completed within the same financial year in which cases are selected. In this regard, it is noted that the FBR did not prescribe a cut off date but has clearly indicated that the audit must be completed within the same financial year in which the cases were selected. The counsel for the FBR have argued that the date prescribed by the Court to complete the audit by 30.6.2017 is unlawful. It is their case that in the first instance the law does not contemplate a cut off date and secondly there was not enough time m to complete the audit due to the pending litigation. The random ballot took place on 14.9.2015, cases were filed against the selection and thereafter due to pending litigation the process of audit came to a stop. In the meantime some cases were processed for which detailed reports were submitted in Court. The impugned judgment was announced on 9.1.2017 where after both the FBR and the Taxpayers filed their respective appeals. During this time the audit did not continue, hence the deadline given in the impugned judgment for the purposes of completing the audit for the tax year 2014 became virtually impossible. We are of the opinion that since the Audit Policy itself prescribes that the audit must be completed within the tax year, ICA No.338/2017 hence a cut off date is implied. There is no denying the fact that there are long delays in completing an' audit which not only burdens the taxpayer but is also not conducive to revenue management so far as the FBR is concerned. Therefore the cut off date of 30.6.2017 is as per the Audit Policy and necessary in order to ensure timely completion. The argument that six year is prescribed under the law to complete an audit is totally misconceived. The six year limitation is for the period for which an audit can be carried out in terms of Section 2I4C of the Ordinance and similar provisions in the FTS. However, this does not mean that the audit itself can last for six years.
Furthermore no doubt the FTS does not prescribe a time frame for completing the audit, however that does not mean that an audit can continue for years and the FBR merely acknowledge that there is a delay without attending to the causes of the delay. The whole purpose of the audit is defeated if compliance of Taxing Statutes is not met within the desired tax year. Under the circumstances a cut off date is necessary to regulate the conduct of audit. We are also of the opinion given the practical difficulties explained in completing the audit, the cut off date given in the impugned judgment is modified such that the date of 30.6.2017 is extended to 31.12.2017.
Furthermore we are of the opinion that the finding in the impugned judgment that the audit if not completed within the stipulated time will be deemed to be dropped, is not in consonance with the law. However given that a deadline is provided for within which the audit has to be completed it is necessary to provide for a consequence in the event that the audit is not completed. We therefore hold that dropping the audit in its entirety will prejudice the requirements of the law to carry out an audit and ensure tax compliance, yet at the same time we recognize the fact that the time frame of the audit must be regulated and closely monitored by the FBR. Therefore the finding of the learned Single Judge that if the audit is not completed by 30.6.2017 it will deemed to have dropped is modified to the effect that if the audit is not completed within the stipulated time, the audit officer will have to explain the delay before proceeding with the matter and will have to seek an extension from the FBR to complete the audit within the requested time. This process will enable the FBR to ICA No.338/2017 monitor the delay and to analyze the reasons and causes of delay and improve the process where required.
11. Another aspect of the Audit Policy which has been challenged is the Performance Evaluation Indicators given in Part-5 of the Audit Policy. The counsel for the Taxpayers argued that the Performance Evaluation Indicators are all qualitative in nature thereby clearly depicting the intention of the FBR is revenue collection. Najeeb Qadir, Chief Audit Officer and Khalid Sultan, Secretary Taxpayer Audit have refuted this argument stating before the Court that the intention is not to collect revenue but to impose standards and ensure consistency in the process of audit. In this regard, it is noted that the manner in which the audit is carried out, the consistency to be obtained and the standards that the audit officers are to follow is the discretion of the FBR. The primary objective of the Audit Policy is to ensure compliance with the FTS and it is for the FBR to regulate this requirement. However, in doing so it is vital that due process is followed and the basic requirements of the FTS are not ignored. In terms of Section 177 of the Ordinance read with Section 25 of the Act and Section 46 of the 2005 Act, the Commissioner can call for the record or documents for conducting the audit of the income tax affairs of person provided that he give reasons in writing and the reasons must be communicated to the Taxpayer. Under Section 177(3) of the Ordinance the Commissioner can seek an explanation from the Taxpayer on the issues raised during the audit and only if satisfied that the explanation is unsatisfactory, may proceed to amend the assessm ent under Section 122 of the Ordinance. The requirement of due process is given under the law and the FBR is required to ensure that that the audit is effectively completed in a timely manner as per law. The problem faced while conducting the audit, as explained in the impugned judgment and to some extent accepted by the FBR, is the capacity of the FBR to carry out the audit.
On account of capacity issues the impression and experience of the taxpayer is that the audit officers are looking to meet revenue targets, so they hastily decide the cases and do not follow the mandatory process. Another issue highlighted is the long delay caused in concluding an audit. For one reason or another, an audit--continues for years subjecting the taxpayer to unnecessary and ICA No.338/2017 repeated hearings without any conclusive results. This adds on to the impression that the FBR is unable to regulate the process of the audit and its conclusion. Furthermore we note that even after an audit for a given tax year is completed no sector study has ever been published highlighting the risk factors and bench marks for that particular tax year. No report is published detailing whether the objectives of the Audit Policy have been met, where compliance issues are found and what measures will be taken in the next financial year to address the concerns raised and promote compliance. Such reports not only ensure transparency but also create confidence in the system leading to greater compliance. In an attempt to rectify these issues the learned Single Judge required that a separate audit wing be established which will carry out the administrative function of selection for audit and issuance of audit report after seeking an explanation from the taxpayer.
Thereafter quasi-judicial proceedings be carried out by a taxation officer other than the audit officer, who will deal with the amendments and assessments under the law.
12. We are of the opinion that the separation in functions between an audit officer and the assessm ent officer and the distinction between administrative function and quasi-judicial function has not been provided under the law, hence cannot be directed by the Court. No doubt the FBR is required to enhance and improve the capacity of its officers for the purposes of audit, however, the distinction drawn by the learned Single Judge does not necessarily enhance capacity or ensure that the audit is completed within the prescribed time. We hold that this is a policy matter which lies squarely With the FBR. In terms of the FTS after selection for audit the Commissioner can call for the record and decide whether audit is required. In terms of Section 177(11) of the Ordinance, the FBR can appoint special audit panels comprising of two or more members to carry out the audit.
Therefore the FTS provides for the mechanism and the process to carry out the audit and caters to providing specialized panels to proceed with the audit. Any further requirements to improve upon capacity issues or delay issues have to be dealt with by the FBR on the basis of their experience and the practical difficulties faced by the taxpayers during the audit proceedings. It is ICA No.338/2017 precisely for this purpose that an audit policy is made for every tax year so that specific issues are catered to. We are of the opinion that the FBR must be more responsive and vigilant while deciding its policies and must be clear on the objectives it needs to meet with. It is only after studying the target reports of a tax year that the FBR will be able to improve upon the policy and its objectives for the next year. While framing its policy the FBR must take on a move vigilant and dynamic approach to raise the confidence of the taxpayer. Policies should cater to capacity issues which include directives to deal with delays and hasty decisions. It is a serious challenge for the FBR and the government to reduce tax evasion and to encourage compliance with the FTS. However if the Courts have to push the FBR to formulate a policy or to carry out its necessary function it does not speak much for the efforts of -- the FBR in ensuring compliance or confidence. Any modern tax system based on self-assessm ent and, voluntary compliance works when the taxpayers themselves recognize the responsibility to pay tax and the tax authority manages compliance by serving and educating the taxpayer to discharge its tax obligation with ease, least amount of complexity and burden free. Hence the FBR should work towards promoting compliance and develop approaches which are cost effective and manages risk. We are of the opinion that it is not the function of the Court to devise policy to improve capacity or reduce delay. This is the mandate of the FBR and if the Audit Policy was found to be deficient in some respects, the Court could at best require the FBR to reconsider its policy and improve the areas identified by the Court. However the Court cannot formulate a policy and direct the FBR to ensure that its requirements are incorporated in the policy. Therefore the directions given in para 21 of the impugned judgment by the learned Single Judge should be considered by the FBR and may be included in its future policies if-deemed necessary and beneficial.
13. Under the circumstances and in view of the aforesaid, these appeals are partly accepted and the impugned judgment is modified in the terms provided in our judgment and reiterated below:
(a) The cut off date given in the impugned judgment is modified such that the date of 30.6.2017 is extended to 31.12.2017.
ICA No338/201.7
(b) The finding of the learned Single Judge that if the audit is not completed by 30.6.2017 it Will deemed to have dropped is modified to the effect that if the audit is not completed within the stipulated time, the audit officer will have to explain the delay before proceeding with the matter and will have to seek an extension-from the FBR to complete the audit within the requested time.
(c) The directions given. in Para 21 of the impugned judgment by the learned ingle Judge should be considered, by the FBR and may be included in its future policies if deemed, necessary and Beneficial.