1. These appeals have been filed by Messrs MOL Pakistan Oil and Gas Company against Appellate Orders Nos. 745/746/747/748/749/2015 dated 27.02.2015 passed by Commissioner Inland Revenue (Appeals I) Islamabad.
2. Briefly the relevant facts of the case for the disposal of appeals are that taxpayer is registered in Pakistan as a Branch office MOL Pakistan Oil and Gas. Co. B.V., Netherlands, which is fully owned subsidiary of MOL NYRT, Hungry. The taxpayer derives income from exploration and production of Oil and Gas. Returns for the tax years 2010, 2011, 2012, 2013 and 2014 were filed on due dates declaring profit/(loss) of Rs.(1,093,973,895), Rs.131,240,414/-, Rs.1,083,458,198/-, Rs.1,415,422,609/- and Rs.3,375,614,307/- respectively which constituted deemed assessment orders under section 1-20(1) of the Income Tax Ordinance, 2001 (the Ordinance). Subsequently the Additional Commissioner Audit-I after examining the record found that the assessments in question were erroneous as well as prejudicial to the interest of revenue. Accordingly, show-cause notices A were issued confronting the taxpayer on different issues (being discussed in the later part of this order). The reply submitted by the taxpayer was found unsatisfactory and accordingly the officer passed the amended orders under section 122(5A) of the Income Tax Ordinance, 2001 (hereinafter called Ordinance, 2001). Being aggrieved from the aforementioned order the taxpayer filed appeals before the Commissioner Inland Revenue (Appeals-I) Islamabad, who rejected the appeals. The treatment meted out by the CIR (A) has been impugned before this forum on the following grounds:-- GROUNDS OF APPEAL:- Tax Year 2010:
1. That the Appellate Orders Nos. 745, 746, 747, 748, 749/2015 dated February 27, 2015 (the Order) issued by the learned Commissioner Inland Revenue (Appeals-I), Islamabad (CIR-Appeals) under section 129 of the Income Tax Ordinance, 2001 (the Ordinance) is bad in law and facts of the case and therefore is illegal, null and void.
2. Without prejudice to above grounds of appeal; 2.1 That the learned CIR-Appeals has erred in upholding the treatment meted out by the Additional Commissioner Inland Revenue, Audit-I, Large taxpayer Unit, Islamabad (ADCIR) and not allowed following geological and geophysical expenditure of Rs.742,957,320 claimed by the appellant under sub-rule (5) of Rule 22 of the Part I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979/Income Tax Ordinance, 2001 which allow expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible.
2. 2.2 without prejudice to the above, the learned CIR-Appeals has erred in upholding in action the treatment meted out by the learned ADCIR by not considering the judgment of Honourable Supreme Court of Pakistan in the case reported at 1993 PTD 758 whereby it has been held that once a taxpayer has commenced its operations, no two separate commercial commencements can be attributed to it for separate plants/lines of production as one return, income and assessm ent is to be framed there related.
3. 2.3 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR by not allowing indirect charges of Rs.39,148,478 by involving provisions of clause (c) of subsection (1) of section 105 of the Income Tax Ordinance, 2001.
4. 2.4 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in adding back realized exchange gain of Rs.8,004,461 to declared income/loss of the appellant.
5. 2.5 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in not allowing provisions for staff gratuity of Rs.30,468,966.
6. 2.6 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR, in disallowing amortization of decommissioning cost of Rs.5,878 202.
7. 2.7 that the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in disallowing decommissioning accretion charges of Rs.2,181,675.
8. Tax Year 2011:
1. That the Appellate Orders Nos. 745, 746, 747, 748, 749/2015 dated February 27, 2015 (the Order) issued by the learned Commissioner Inland Revenue (Appeals-1), Islamabad (CIR-Appeals) under section 129 of the Income Tax Ordinance, 2001 (the Ordinance) is bad in law and facts of the case and therefore is illegal, null and void.
2. Without prejudice to above grounds of appeal 2.1 That the learned CIR-Appeals has erred in upholding the treatment meted out by the Additional Commissioner Inland Revenue, Audit-I, Large Taxpayer Unit, Islamabad (ADCIR) and not allowed following expenditure claimed by the appellant under sub-rule (5) of rule 22 of the Part I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979 / Income Tax Ordinance, 2001 which allow expenditure (not being the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible. Rs.20,352,489 on account of Geological and Geophysical expenditure Rs.956,843,176 on account of Exportation expenditure 2.2 Without prejudice to the above, the learned CIR-Appeals has erred in upholding in action the treatment meted out by the learned ADCIR by not considering the judgment of Honourable Supreme Court of Pakistan in the case reported at 1993 PTD 758 whereby it has been held that once a taxpayer has commenced its operations, no two separate commercial commencements can be attributed to it for separate plants/lines of production as one return, income and assessm ent is to be framed there related.
9. 2.3 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR by not allowing indirect charges of Rs.53,988,433 by invoking provision of clause (c) of subsection (1) of section 105 of the Income Tax Ordinance, 2001.
10. 2.4 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing realized exchange loss of Rs.274,521,649 without considering the fact that exchange loss is an allowable expense.
11. 2.5 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in not allowing provisions for staff gratuity of Rs.61,470,672.
12. 2.6 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing Workers' Profit Participation Fund of Rs.104,874,931 without considering that the fact that the same is allowable deduction in terms of section 60B of the Ordinance.
13. 2.7 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in not disallowing depletion allowance of Rs.279,526,191 based on contention contrary to the provisions of Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979.
14. 2.8 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in computing depletion allowance under Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979, the expenditure incurred on account of royalty is to be deducted from "gross receipts".
15. 2.9 That the learned CIR-Appeals has also erred in upholding the action of the learned ADCIR in applying tax rate of 52.5% on its profits and gains assessable under Part I of Fifth Schedule to the Income Tax Ordinance, 1979 company to the provisions of Rule 4 of the said Schedule.
16. 2.10 Your Appellant seeks consequential relief in Workers' Welfare Fund.
17. Tax Year 2012:
1. That the Appellate Orders Nos.745, 746, 747, 748, 749/2015 dated February 27, 2015 (the Order) issued by the learned Commissioner Inland Revenue (Appeals-1), Islamabad (CIR-Appeals) under section 129 of the Income Tax Ordinance, 2001 (the Ordinance) is bad in law and facts of the case and therefore is illegal, null and void.
2. Without-prejudice to above grounds of appeal.
18. 2.1 That the learned CIR-Appeals has erred in upholding the treatment meted out by the Additional Commissioner Inland Revenue, Audit-I, Large Taxpayer Unit Islamabad (ADCIR) and not allowed following expenditure claimed by the appellant under sub-rule (5) of Rule 22 of the Part I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979/Income Tax Ordinance, 2001 which allow expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible. Rs.47,003,489 on account of Geological and Geophysical expenditure Rs.706,971,240 on account of Exportation expenditure 2.2. Without prejudice to the above, the learned CIR-Appeals has erred in upholding in action the treatment meted out by the learned ADCIR by not considering the judgment of Honourable Supreme Court of Pakistan in the case reported at 1993 PTD 758 whereby it has been held that once a taxpayer has commenced its operations, no two separate commercial commencements can be attributed to it for separate plants/lines of production as one return, income and assessm ent is to be framed there related.
19. 2.3 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR by not allowing indirect charges of Rs.30,309,738 by invoking provisions of clause (c) of subsection (1) of section 105 of the Income Tax Ordinance, 2001.
20. 2.4 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing realized exchange loss of Rs.269,517,430 without considering the fact that exchange loss is an allowable expense.
21. 2.5 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in not allowing provisions for staff gratuity of Rs.112,014,442.
22. 2.6 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing Workers' Profit Participation Fund of Rs.139,776,391 without considering that the fact that the same is allowable deduction in terms of section 60B of the Ordinance.
23. 2.7 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in not disallowing depletion allowance of Rs.84,574,690 based on contention contrary to the provisions of Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979.
24. 2.8 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in computing depletion allowance under Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979, the expenditure incurred on account of rqyalty is to be deducted from "gross receipts".
25. 2.9 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in applying tax rate of 52.5% on its profits and gains assessable under Part I of Fifth Schedule to the Income Tax Ordinance, 1979 contrary to the provisions of Rule 4 of the said Schedule.
26. 2.10 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in not considering the refunds available to the appellant.
27. 2.11 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in levying tax on interest income at the rate of 52.2% without considering the fact that income is subject to tax at the rate of 35%.
28. 2.12 Your Appellant seeks consequential relief in Workers' Welfare Fund.
29. Tax Year 2013:
1. That the Appellate Orders Nos.745, 746, 747, 748, 749/2015 dated February 27, 2015 (the Order) issued by the learned Commissioner Inland Revenue (Appeals-I), Islamabad (CIR-Appeals) under section 129 of the Income Tax Ordinance, 2001 (the Ordinance) is bad in law and facts of the case and therefore is illegal, null and void.
2. Without prejudice to above grounds of appeal 2.1 That the learned CIR-Appeals has erred in upholding the treatment meted out by the Additional Commissioner Inland Revenue, Audit-I, Large Taxpayer Unit, Islamabad (ADCIR) and not allowed Geological and Geophysical expenditure of Rs.278,995,145 claimed by the appellant under sub-rule
(5) of rule 22 of the Part I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979 / Income Tax Ordinance, 2001 which allow expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible 2.2 Without prejudice to the above, the learned CIR-Appeals has erred in upholding in action the treatment meted out by the learned ADCIR by not considering the judgment of Honourable Supreme Court of Pakistan in the case reported at 1993 PTD 758 whereby it has been held that once a taxpayer has commenced its operations, no two separate commercial commencements can be attributed to it for separate plants/lines of production as one return, income and assessm ent is to be framed there related.
30. 2.3 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR by not allowing indirect charges of Rs.78,027,407 by invoking provisions of clause (c) of subsection (1) of section 105 of the Income-Tax Ordinance, 2001.
31. 2.4 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing realized exchange loss of Rs.578,312,098 without considering the fact that exchange loss is an allowable expense.
32. 2.5 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in not allowing provisions for staff gratuity of Rs.83,185,369.
33. 2.6 That the learned CIR Appeals has erred in upholding in action of the learned ADCIR in disallowing Workers' Profit Participation Fund of Rs.181,273,612 without considering that the fact that the same is allowable deduction in terms of section 60B of the Ordinance.
34. 2.7 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in not disallowing depletion allowance of Rs.106,238,802 based on contention contrary to the provisions of Rule 3 of. Part I of Fifth Schedule to the Income Tax Ordinance, 1979.
35. 2.8 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in computing depletion allowance under Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979, the expenditure incurred on account of royalty is to be deducted from "gross receipts".
36. 2.9 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in applying tax rate of 52.5% on its profits and gains assessable under Part I of Fifth Schedule to the Income Tax Ordinance, 1979 contrary to the provisions of Rule 4 of the said Schedule.
37. 2.10 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in levying tax on interest income at the rate of 52.2% without considering the fact that income is subject to tax at the rate of 35% 2.11 Your Appellant seeks consequential relief in Workers' Welfare Fund.
38. Tax Year 2014:
1. That the Appellate Orders Nos. 745, 746, 747, 748, 749/ 2015 dated February 27, 2015 (the Order) issued by the learned Commissioner Inland Revenue (Appeals-I) Islamabad (CIR-Appeals) under section 129 of the Income Tax Ordinance, 2001 (the Ordinance) is bad in law and facts of the case and therefore is illegal, null and void.
2. Without prejudice to above grounds of appeal 2.1 That the learned CIR-Appeals has erred in upholding the treatment meted out by the Additional Commissioner Inland Revenue, Audit-I, Large Taxpayer Unit, Islamabad (ADCIR) and not allowed following expenditure claimed by the appellant under sub-rule (5) of Rule 22 of the Part I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979 / Income Tax Ordinance, 2001 which allow expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or Expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible. Rs.927,220,088 on account of Geological and Geophysical expenditure Rs.276,557,348 on account of Exportation expenditure 2.2 Without prejudice to the above, the learned CIR-Appeals has erred in upholding in action the treatment meted out by the learned ADCIR by not considering the judgment of Honourable Supreme Court of Pakistan in the case reported at 1993 PTD 758 whereby it has been held that once a taxpayer has commenced its operations, no two separate commercial commencements can be attributed to it for separate plants/lines of production as one return, income and assessm ent is to be framed there related.
39. 2.3 That the learned ,CIR-Appeals has erred in upholding in action of the learned ADCIR, by not allowing indirect charges of Rs.80,621,786 by invoking provisions of clause (c) of subsection (1) of section 105 of the Income Tax Ordinance, 2001.
40. 2.4 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing realized exchange loss of Rs.6,972,978 without considering the fact that exchange loss is an allowable expense.
41. 2.5 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in not allowing provisions for staff gratuity of Rs.124,787,509.
42. 2 6 That the learned CIR-Appeals has erred in upholding in action of the learned ADCIR in disallowing Workers' Profit Participation Fund of Rs.244,197,213 without considering that the fact that the same is allowable deduction in terms of section 60B of the Ordinance.
43. 2.7 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in disallowing technical assistance fee of Rs.8,923,204 without considering the fact that technical assistance fee is an allowable expense and the appellant has duly deducted the tax @ 15% on the amounts paid as technical services. Further learned ACIR has not allowed adequate time to produce the reconciliation and evidence of the withholding tax on payments of technical assistance fee.
44. 2.8 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in not disallowing depletion allowance of Rs.136,101,747 based on contention contrary to the provisions of Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979.
45. 2.9 That the learned CIR-Appeals has erred in upholding the action of the learned ADCIR in computing depletion allowance under Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979, the expenditure incurred on account of royalty is to be deducted from "gross receipts".
46. 2.10 That the learned CIR-Appeals has also erred in upholding the action of the learned ADCIR in applying tax rate of 52.5% on its profits and gains assessable under Part I of Fifth Schedule to the Income Tax Ordinance, 979 contrary to the provisions of Rule 4 of the said Schedule.
47. 2.11 Your Appellant seeks consequential relief in Workers' Welfare Fund.
3. All the grounds of appeal raised by the taxpayer are being disposed of the following parts of order Geological and geophysical costs Expenditure:-- (G &. G cost) and Exploration
4. The assessing officer made addition of Rs.742,957,320/- in tax year 2010, Rs.20,352,849/- in tax year 2011, Rs.47,003,489/- in tax year 2012, Rs.278,995,145/- in tax year 2013 and Rs.927,220,088/- in tax year 2014 on account of geological and geophysical cost. Moreover addition was made on account of exploration expenditure amounting to Rs.956,843,176/- in tax year 2011, Rs.706,971,240/- in tax year 2012 and Rs.276,557,348 in tax year 2014. White making the impugned addition the Assessing Officer observed that the claimed cost related to the fields where no commercial activity had taken place during the period under consideration. The claim was therefore, treated to be not admissible under the provisions of Rule 2(5) of the Fifth Schedule to the Income Tax Ordinance, 2001 (the Ordinance) as the prerequisite events in terms of Sub-Rules (2) to (4) of Rule 2 Part-I of the Fifth Schedule to the Income Tax Ordinance, 2001 which constituted a prequel to Rule 2(5) of the Part-I of the Fifth Schedule to the Ordinance had not occurred. This treatment was confirmed by Commissioner (Appeals) vide his impugned order holding that computation of profits from petroleum exploration and production business had to be made on the principles of "ring fencing".
48. In this manner income and deductions of each Petroleum Concession Agreement (PCA) is to be computed separately. It was taxpayer's contention that total income of the business of oil exploration and petroleum from all PCAs had to be lumped together for the purpose of taxation.
49. This contention was rejected by the CIP(A) by placing reliance on judgment of the Appellate Tribunal Inland Revenue (ATIR) in the case of Messrs OGDCL vide I.T.As. Nos.642 and 219/IB/2013 and I.T.A. No.666/IB/2013 dated 19.8.2014 with the observation that taxpayer was not entitled to deduction of expenditure under these heads incurred in one PCA prior to commencement of commercial production in that area against profits of concession area falling under different PCA.
5. Learned A.R. of the appellant stated that the expenditure under consideration had rightly been claimed by the company under the provisions of Sub-rule (5) of Rule 2 of Part-I of Fifth Schedule to the Repealed Income Tax Ordinance, 1979 (1979 Ordinance)/2001 Ordinance which allows expenditure (not being in the nature of capital expenditure or personal expenses of the assesses) laid out or expended after the commencement of commercial production (CCP) wholly and exclusively for the purpose of the business of production and exploration of petroleum as tax deductible. Relevant extract of Sub-rule (5) of Rule 2 of Part I of Fifth Schedule to 1979 Ordinance/2001 Ordinance reads as under:--
(5) Any expenditure, including a royalty paid to the Federal Government by an onshore petroleum exploration and production undertaking on, or after, the first day of July, 2001 (not being in the nature of capital expenditure or personal expenses of the taxpayer) laid out or expended after the commencement of commercial production wholly and exclusively for the purpose of the business of production and exploration of petroleum carried on by such undertaking shall be allowed as a deduction.
6. Learned A.R. emphasized that in view of the above provisions of Sub-rule (5) of Rule 2 of Part I of Fifth Schedule, any expenditure incurred after the commencement of commercial production is an allowable expenditure for the purpose of computing profit and gains of the company from exploration and production of petroleum, if incurred for the purpose of business of production and exploration of petroleum not being in the nature of capital expenditure or personal expense. The learned A.R. further argued that the business of exploration and production of petroleum is assessable under special provisions contained in Rule of Part I of the Fifth Schedule to the Ordinance which reads as under.
50. RULES FOR THE COMPUTATION OF THE PROFITS AND GAINS FROM THE EXPLORATION AND PRODUCTION OF PETROLEUM.
51. Exploration and Production of Petroleum a Separate Business:
1. Where any person carries on, or is treated as carrying on, under an agreement with the Federal Government, any business which consists of, or includes, the exploration or production.of petroleum in Pakistan or setting up refineries at Dhodak and Bobi fields, income of exploration and production companies from pipeline operations, and manufacture and sale of liquefied petroleum gas or compressed natural gas, such business or part thereof, as the case may be, shall be, for the purposes of this Ordinance, treated as a separate business undertaking (hereinafter referred to as "such undertaking") and the profits and gains of such undertaking shall be computed separately from the income, profits, or gains from any other business, if any, carried on by the person."
7. The learned A.R. stated that the provisions of Rule 1 of Part I of the Fifth Schedule to the 1979 Ordinance are, in essence, identical to those of Rule 1 of Part I of the Fifth Schedule to the 2001 Ordinance. As per Rule 1 of Part I of Fifth Schedule to the 1979 Ordinance / 2001 Ordinance, the entire business of exploration and production of petroleum under agreements with the Government of Pakistan has to be treated as one unit. It is very categorically provided in Rule-1 that where any person derives income from exploration and production of petroleum such business shall be, for the purposes of Income Tax Ordinance, 2001 treated as separate "business undertaking".
52. Moreover the profits and gains of such "business undertaking" shall be computed separately from the profits and gains from any other business, if any, carried on by the person. A plain reading of these provisions reflects that income from business of oil production is assessable as "separate block". Income Profit and gains of any business other than petroleum business is assessable separately. Learned A.R emphasized that entire income from petroleum business has to be lumped together for the purposes of assessm ent. He stated that the income from petroleum business is a "separate basket" of income and assessable under special provisions contained in Part-I of the Fifth Schedule. The A.R. of the appellant stated that learned CIR(A) misconstrued the provisions of Rule-I of Part-I of the Fifth Schedule while holding that income from each PCA is separate block of income and its assessm ent has accordingly to be made separately. According to learned A.R. the CIR(A) was not justified to hold that each PCA is separate project or undertaking and the income and profits of such undertaking have to be "ring fenced" for the purposes of taxation. He stated that "ring-fencing" is undoubtedly an accepted accounting system and followed by some oil companies in few countries. He emphatically stated that so far as Pakistan taxation system is concerned, the system of "ring-fencing" has been disapproved. According to learned A.R. Article 10.8 of Petroleum Exploration and Production Policy, 2012 clearly provides that: "In accordance with the Fifth Schedule of the Income Tax Ordinance, 2001, there will be no ring fencing for the purpose of calculation of corporate tax".
53. Learned A.R. further stated that when the concept of "ring-fencing" has been clearly barred, then it would automatically mean that for the purposes of computation of tax liability of petroleum business income from all PCAs has to be put in one basket. The concept on "one-basket assessm ent" is also internationally accepted and it has been clearly adapted in our country. The Fifth Schedule to the Income Tax Ordinance, 2001 contains rules for the computation of the profits and gains from exploration and production of petroleum. The heading of Rule 1 Part I of the Fifth Schedule reads as; Exploration and production of petroleum a separate business". Learned A.R stated that income of a person from exploration and production of petroleum is treated as separate business. It is nowhere provided that each PCA is assessable as separate unit for a Company. A company should be seen from the perspective of an umbrella and any/all PCAs signed by the same Company should come under the corporate umbrella of that company. He stated that if each PCA is separately assessed, it would result in accounting complications. In such situation it would be very difficult to compute profit from such business because so many expenses which are common to the PCAs and so many other expenses relating to Head Office would remain unaccounted for. Accounting and assessment of common expenses and other administrative and technical casts could not be taken into account. Resultantly it would be impossible to arrive at the taxable income of the taxpayer. Learned AR stated that the department has dragged in a novel interpretation. Rule 1 of Part I says that "... the exploration or production of petroleum... shall be for the purposes of this Ordinance, treated as separate business undertaking (hereinafter referred to as "such undertaking"). .... But the department has isolated the word "undertaking" from the word "such undertaking") which means "business undertaking". In this manner the department misconstrued the entire concept and dragged in a distortion in the interpretation of concept of separate business" and its "separate assessment".
8. It was stated by the AR that business of exploration and production of petroleum was governed by the Regulation of Mines and Oil-fields and Mineral Development (Government Control) Act, 1948.
54. The said Act contained special provisions relating to the exploration companies. It was subsequently amended through the Regulation of Mines and Oil-fields and Mineral Development (Government Control) (Amendment) Ordinance, 1976 which was later on made an Act of the Parliament bearing Act No.LXXX of 1976 promulgated on 4.01.1977. The relevant provisions read as under:-- "3-A Production sharing agreement.---(1) Notwithstanding anything contained in any other law or rule for the time in force the President may enter into an agreement with any company, whether incorporated in Pakistan or outside Pakistan, for the grant of a license or lease to explore, prospect and mine petroleum on the basis of a Production sharing Agreement and on such terms and conditions as may be agreed upon between the Federal Government and the company."
(2) Notwithstanding anything contained in the Income Tax Act, 1922 (IX of 1922) a company with which an agreement such as is referred to in subsection (1) is for the time being in force shall not be liable to pay tax on its become, profits or gains.
55. "3-B Concession to Petroleum exploration companies.---(1) Notwithstanding anything contained in any other law for the time being in force, every company, whether incorporated in Pakistan or outside Pakistan, to whom a license or a lease to explore, prospect and mine petroleum is granted under this Act, not being a company such as is referred to in subsection (1) of section 3-A, shall be entitled to the concessions specified in The Schedule in addition to any concession for the time being admissible to it under any other law or the rules made under this Act."
(2) The Federal Government may, by notification in the official Gazette, amend the Schedule so as to add any concessions thereto or to improve any concession therein."
9. Learned A.R. further argued that the Tribunal vide their decision reported as (1988 PTD (Trib.) 481] undertook a threadbare analysis of this issue in the following manner: "It would, therefore, be seen that by virtue of Clause 3 of the Schedule, the losses suffered by an assessee, which are allocable to a surrendered area and to the drilling of a dry hole, have been allowed as provided in sub-rule (1) of rule 2 of the Second Schedule of the repealed Income Tax Act. Therefore, so far as the issue under consideration is concerned we have to revert back to sub- rule (1) of rule-2 of the Second Schedule to the Repealed Income-tax Act. Now sub-rule (1) of rule- 2 of the Schedule to the Repealed Income Tax Act may here be reproduced:-- "Where a person incurs any, expenditure on searching for, or on discovering a testing petroleum deposit or winning access thereto, (but the search, exploration or enquiry upon which the expenditure is incurred is given up before the commencement of commercial production), such expenditure allocable to a surrendered area and to the drilling of a dry hole shall be deemed to be lost at the time of the surrender of the area or the completion of the dry hole as the case may be. A portion of such loss provided for in any agreement between any such person and the Government, shall be allowed in either of the following ways:--
(a) Such portion of the said loss in any year shall be set off against income, profits or gains from business or under any other head of income, other than income from dividend, of that year. If the loss cannot be wholly set off in this manner, the portion not so set off shall be carried forward to the following year and set off against such income, profits or gains, for that year in the same manner; if it cannot be wholly set off, the amount not so set off shall be carried forward to the following year and so on; but no loss shall be so carried forward for more than six years;
(b) Such portion of the said loss in any year be set off against income, profits or gains of the same business of the previous year in which commercial production commences. If the loss cannot be wholly set off against the profits of the same business for that year, the loss not so set off shall be carried forward to the following year and set off against the profits or gains, if any, of the assessee from the same business for that year; and if it cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following year, and so on; but no loss shall be so carried forward for more than ten years.
10. From the plain reading of the above provision, it is evident that under rule 1 it has been laid down that the business, which consists of exploration and production of petroleum, profits and gains of a person there from are to be computed separately from his income, profits and gains from any other business. This means that a clear bifurcation has been made between the profits and gains from the business of exploration and production of petroleum and any other business and the business of exploration and production of petroleum etc has to be computed separately in accordance with the Second Schedule to the Repealed Income Tax Act. Now sub-rule (1) of rule-2 provides two things:--
(1) That all expenditure on searching for, or on discovering and testing a petroleum deposit etc. allocable to a surrendered area and to the drilling of a dry hole would be deemed to be lost at the time of the surrender of the area or on the completion of the dry hole.
(2) A portion of such a loss provided for in any agreement would be allowed under either of following two ways:--
(a) It would be set off against income or profits etc. from any other business or against income under any other head of income (except income from dividend) of that year. If such a loss cannot be set off in that year it can be carried forward upto six years.
(b) Such loss can be set off against income and 'profits etc. of the same business of the previous year in which commercial production commences. Again if such a loss cannot be set off in that year, the loss can be carried forward for a period of 10 years.
11. Now if the departmental view is accepted then clause \b) would become wholly redundant inasmuch as there is no question of any set off against commercial production. Clause (b) pre- supposes that there roust be some profits and gains by way of commercial production.
56. The departmental view that each area under an agreement is to be treated as a separate business and has to be computed separately would mean that the assessee in regard to a particular surrendered area would not be entitled to carry forward the loss in one of the ways which has been permitted by sub-rule (1) of rule 2 of the Schedule. As stated above, clause (b) pre- supposes commercial production. Assuming that the departmental view is correct then in that case the loss incurred by the assessee allocable to a surrendered area before the commencement of commercial production, though would be allowed entirely in that year in which the area was surrendered but it cannot be carried forward because the profits or gains in regard to other areas or concessions under a separate agreement is separate business and, therefore, cannot be regarded as the same business. This interpretation ignores the second way of the allowance gives clause (b) above, which would make absurd reading. If each surrendered area has to be taken separate business by itself then there is no question of any profits and gains out of the commercial production as mentioned in clause (b) and this clause would not be applicable. The only correct and proper interpretation, which would avoid absurdity would be that business of exploration and production of petroleum would be taken as a whole, consisting of as many agreements and the areas as the assessee possesses. It is only then some meaning can be given to clause (b) of sub- rule (1) of rule 2 of the Schedule. What the law requires is that the business of exploration and production of petroleum should be separately computed under the Second Schedule of the Act as against any other business of the assessee. This however, does not mean that each area of agreement can be taken as a separate business. However, according to sub-rule (1) of rule 2 only a portion of loss under consideration which had been provided for in any agreement can be allowed to be set off and carried forward either under clause (a)' or under clause (b) of the aforesaid rule.
57. For that purpose the terms and conditions of the agreement had to be seen and only that portion of loss allocable to a particular surrendered area has to be set off and carried forward which has been provided for in a particular agreement and for that purpose the terms and conditions of each agreement have to be examined and each case has to be decided on its own terms. What the Income Tax Officer has to do in such a case would be that for each surrendered area he has to go through the terms and conditions of the agreement and then to find out as to whether there was any clause in regard to the allowance of the losses as provided in sub-rule (1) of rule 2 and then it could be set off either under clause (a) or under clause (b) of sub-rule (1) of rule 2."
12. Learned A.R. claimed that under the provisions of Sub-rule (5) of Rule 2 of Part I of the Fifth Schedule to the 1979 Ordinance/2001 Ordinance for the purposes of computing profits and gains of the Company from exploration and production of petroleum, deduction is to be allowed for any expenditure incurred wholly and exclusively for the purposes of the business of production and exploration of petroleum. The company had already commenced its "commercial production" in prior years.. This legal position was further supported by decision of the Income Tax Tribunal in their decision in LT.As. Nos. 551 to 554(IB)/08 dated March 30, 2009 in the case of another petroleum exploration company whereby on placing reliance on the aforementioned earlier order of the Tribunal reported as (1988 PTD (Trib.) 481) held that the expenditure incurred on a concession area where no taxable event occurred i.e. drilling of dry hole or surrender of an area can be set off against the income from concessions where commercial production had commenced. Relevant extract of the aforesaid decision of the Tribunal is reproduced below for ease of reference:-- "However, in our opinion, the ratio decided by the Tribunal is that in the business of exploration and production of petroleum, where various bases (for searching, discovering, testing, exploration or enquiry about petroleum deposits or winning access thereto), have been entered into by an assessee, with the government such business is treated to be a single undertaking encompassing all such leases. Whether an area was surrendered or a dry hole drilled was a peripheral issue.
58. Expenditure pertaining to one area/concession where commercial production had not commenced can be set off against income from those concessions where commercial production had commenced. We are, therefore, of the considered opinion that the taxpayer's claim of expenses on one was rightly claimed against income from other concessions because all these concessions pertain to one undertaking with provisions of Fifth Schedule to the Ordinance."
13. The Learned AR stated that in the order of ATIR in Appeals No. I.T.A. No. 642-/IB/2013 (Tax year 2012) and. I.T.A. No.219/IB/2010 (Tax Year 2010). The correct legal position of the issue in hand was not properly appreciated because in place of "one basket-assessment" the concept of "ring- fencing was approved". He stated that in petroleum policy, as well Income Tax Law a bar has been put on "ring-fencing" and clear provisions have been laid for "one-basket" assessment. Learned AR of the taxpayer adopted same line of arguments as made before the first appellate authority. The main contention of learned AR was that petroleum exploration and production was "one business undertaking" comprising all undertakings under various Petroleum Concession Agreements (IMCA) and the taxpayer's profits could not be assessed separately under each PCA. Learned AR further contended that the Department ignored the provisions of Sub-rule (5) of Rule 2 of Part-I of the Fifth Schedule to the Income Tax Ordinance, 2001, which provides that any expenditure laid out or expended after the commencement of commercial production carried on by such undertaking shall be allowed as a deduction.
59. 14.The above arguments of the taxpayer were countered by the learned Department Representative. It was his contention that each Petroleum Concession Agreement was a single and separate undertaking which was evident from the fact that each Petroleum Concession Agreement (PCA) and its terms could be different in as much as that tax rates could be different for different Concession Areas or Blocks under the respective PCAs. Similarly, the PCAs for on-shore and off-shore exploration and production were different and had different tax rates. It was argued that all activities in a given Petroleum Concession Area, was a distinct single undertaking and its profits and losses were to be computed separately for each such PCA. It was further argued that this method of taxation was being consistently followed in Pakistan and many other countries the world over. It was stated that this method was based on the well known rational concept of "ring- fencing" and the provisions of Part-I of Fifth Schedule of the Income Tax Ordinance are structured on this concept.
60. 15.The earned DR placed reliance on Rule 1 of Part-I of Fifth Schedule of the Income Tax Ordinance, 2001, which provides that where any person carries on or is treated as currying on, under an agreement with the Federal Government, any business which consists of or includes the exploration and production of petroleum in Pakistan shall be treated as a separate business undertaking and profits and gains of such undertaking shall be computed separately. It was contended that the words "an agreement" used by the Legislature were significant and clearly lay down that each PCA was a separate undertaking. It was argued that a business could comprise more than one undertaking and profits of each such undertaking could be computed separately. It was contended by the learned DR that a business could include several undertakings and that profits of each undertaking could be computed separately which was evident from the provisions of section 49 of the Income Tax Ordinance, 1979, section 65D of the Ordinance of 2001 and the various tax holiday clauses of Second Schedule to these Ordinances. It was further stated that the Income Tax Act, 1922 too had similar provisions. Consequently, there was no basis for the assumption that different undertakings of a taxpayer constituted a single undertaking. It was contended by the DR that the Tribunal's judgment reported as [(1988 PTD (Trib.) 481 (supra) was patently per incuriam because its inferences were erroneous being in direct conflict with the express provisions of the Income Tax Ordinance which provided for separate computations of income of each undertaking. Besides, by the said judgment the Tribunal had remanded the case with the following direction: "As a result a the above discussion and conclusions, we remand the case back to the Income Tax Officer with the direction that he should examine each agreement and carry forward only that portion of losses in regard to a particular surrendered area or a dry hole, which is provided in the agreement."
61. 16.The leaned DR further contended that the judgment of the Appellate Tribunal reported as [1988 PTD (Trib.) 481] was distinguishable and not attracted. Similarly, the Tribunal's judgment in Appeals Nos. 551 to 554/IB/2008 in the case of Messrs Orient Petroleum could not be followed, inter alia, because it was based on the Tribunal's said judgment of 1988. The Tribunal having itself remanded the case and having left the matter to the examination and determination by the Income Tax Officer on the basis of terms of each agreement, its conflicting obiter dicta based on erroneous assumptions, could not be taken as a final decision. The judgment also failed to take into account the express provisions of Part I of the Fifth Schedule to the Income Tax Ordinance particularly Rule 1 and other Rules. Consequently, such judgment was not binding on this Bench Since Tribunals judgment in Orient Petroleum was based on the 1988 judgment and the said judgment itself not being correct, the former too was erroneous and could not be followed. Reliance in this regard was placed on the Hon'ble Supreme Court's judgment reported as PLD 1997 Supreme Court 351 Province of Punjab v. Dr. Muhammad Zafar Bukhari.
62. 17.The DR further stated that Sub-rule (2) of Rule 2 of Part-I of the Fifth Schedule provides (i) expenditure on searching for discovery which search is given up and the area is surrendered before the commencement of commercial production and (ii) drilling, a dry hole, was to be allowed According to him, the expenditure allocable to such surrendered area where search had been abandoned is deemed to have been lost at the time of surrender. Similarly, expenditure in drilling deemed to have been lost at the time of completion of dry-hole can be set off, if so provided in the PCA, in either of the two ways as given in clauses (a) and (b) of the said Sub-rule (3). It is, therefore, obvious that only "lost expenditure" can be allowed offset against other business or professional income (not dividend). Nowhere does the law provide for straight deduction of such expenditure from profits of another PCA. It is significant that this offset is allowable against income from receipts/gross profits from commercial production in another PCA. As far as Rule 2(5) is concerned (on which reliance has been placed by taxpayer) provides for deduction of expenditure laid out or expended after commencement of commercial production wholly and exclusively for the purpose of business of such under taking. It was further asserted that the practice of petroleum exploration and production companies themselves is that expenditure which is not deemed to have been lost in respect of surrender area is carried forward and is not deducted from commercial production profits of another PCA.
18. On behalf of the department written arguments submitted are as under:-- DISALLOWANCE OF GEOLOGICAL AND GEOPHYSICAL EXPENDITURE AND EXPLORATION EXPENDITURE TAX YEARS 2010, 2011, 2012, 2013 AND 2014.
63. The appellant was confronted regarding inadmissibility of geological and geophysical expenditure and exploration expenditure on the basis that this cost/expense relates to fields where no commercial activity has taken place during the period under consideration and that the same is not covered under Rule 2(5) of Part-I of the Fifth Schedule to the Ordinance as the events which constitute a prequel to Rule 2(5) of Part-I of the Fifth Schedule to the Ordinance in terms of sub- rules (2) to (4) of Part-I of the Fifth Schedule to the Ordinance have not taken place yet. The main argument of the appellant in this matter is that it is entitled to the aforementioned costs/expenses in accordance with Rule 2(5) of Part-I of the Fifth Schedule to the Repealed Ordinance which allows any expenditure, not being in the nature of capital or personal expense laid out or expended after the commencement of commercial production wholly and exclusively for the purpose of business of production and exploration of petroleum as the entire business of exploration and production of petroleum constitutes an undertaking.
64. Rule 1 of Part I of the Fifth Schedule to the Income Tax Ordinance, 2001 stipulates that where any person carries on, under an agreement with the Federal Government any business which consists of exploration or production of petroleum in Pakistan shall be treated as separate business undertaking.
65. Rule 2 of Part I of the Fifth Schedule to the Income Tax Ordinance, 2001 spells out a comprehensive scheme regarding allowance of expenditure. Rule 2(2) stipulates that where such person incurs any expenditure on searching for or discovering and testing a petroleum deposit or winning access thereto but the search exploration, enquiry upon which the expenditure is incurred is given up before the commencement of commercial production, the expenditure allocable to a surrendered area or to the drilling of a dry-hole shall be treated as lost at the time of the surrender of the area or the completion of the dry-hole, as the case may be.
66. Rule 2(3) provides mechanism about allowance of the lost expenditure as set out in Rule 2(2) The said loss can be set off against income of that year either against income from business or any income (other than income from dividends). The lost wholly set off shall be carried forward to the next year and so on but not for more than six years.
67. Similarly the said loss can be set off against income of the undertaking where commercial production has commenced and the portion not wholly set off can be carried forward and so on, but no loss can be carried forward for more than ten years.
68. Rule 2 (4) provides that all expenditure incurred prior to the CCP (not being capital expenditure and lost) shall be allowed after CCP as a deduction, not exceeding ten per cent of the aggregate amount deductible in respect of onshore areas.
69. Rule 2(5) states that any expenditure laid out or expended after the CCP wholly and exclusively for the purpose of business of production and exploration of petroleum carried on by such undertaking shall be allowed as deduction other than expenditure incurred on the acquisition of depreciable assets.
70. In order for an expense to be allowable, the events as mentioned in sub-rules (2) to (4) of Rule 2 of. Part I of the Fifth Schedule to the Income Tax Ordinance, 2001 must be established. In case of lost expenditure from one PCA (concession area), the same can be set off against business or other income (except dividend income) and profits and gains from petroleum exploration of other PCA where commercial production has commenced.
71. Suppose there are two concession areas. In PCA one there is CCP and in PCA two geological and geophysical activities are going on which is an event prior to CCP. The scheme as envisaged in sub-rules (2) to (4) of Rule 2 of Part I of the Fifth Schedule to the Income Tax Ordinance, 2001 specifies that the expenditure in respect of geological and geophysical activities in one concession area can not be claimed against the income from concession area where commercial production has commenced. It can only be claimed when such expenditure is declared as lost after the approval of Director General Petroleum Concessions (DGPC). After the commencement of commercial production, all expenditure incurred prior thereto and not treated as lost and not represented by physical assets in use at the time of commercial production is allowed as deduction and amortized over a period of ten years.
72. This scheme of things is logical in the sense that if a taxpayer starts claiming expenditure related to a concession area where no CCP has taken place against the income of another concession area where CCP has taken place, then the concept of lost expenditure and its subsequent off setting mechanism stands defeated and. Rule 2(3) becomes redundant.
73. Another significant point worth mentioning in this context is this that every PCA has different tax rates. It is for this reason that the taxpayer company having different PCA's has to worked out its profits and gains according to each PCA (a such computation filed by OGDCL is enclosed for ready reference. If a taxpayer claims expenditure related to a concession area where no CCP has taken place against the income of another concession area where CCP has taken place and tax rates in each PCA is different then it will create an anomaly.
74. In a nut shell allowable expenditure will be aggregated till the commencement of commercial production. Accumulated expenditures are then allowed in the year of commencement of commercial production to be amortized over a period of 10 years. All unsuccessful exploration costs in other concession areas can be set off against income in such concession area in which commercial production, has successfully commenced.
75. Putting limitation on consolidation of income and deductions for tax purposes across different PCAs undertaken by the same taxpayer are a practice followed universally (India, Indonesia, UK, African countries etc). Some countries ring-fence oil and gas activities, others ring-fence individual contract areas or projects primarily for two main reasons: Absence of putting such limitations can postpone government tax revenue because -a company that undertakes a series of concessions will be able to deduct exploration or development expenditures from each new project against the income of projects that are already generating taxable income.
76. As an oil and gas area matures, absence of limitations may discriminate against new entrants that have no income against which to deduct exploration or development expenditures.
77. It was further stated that on behalf of the department in its written arguments that the contention of the AR of the taxpayer company is devoid of merit for the following reasons:-- (i)It is an established fact that prospecting expenditure on account of seismic acquisition and data processing, geological and geophysical activities etc. cannot be incurred unless the Government signs an agreement with the taxpayer company. Article-III of every Petroleum Concession Agreement provides the mechanism for incurring aforesaid minimum expenditure in the first year of grant of license. If the contention of the. AR of the taxpayer company that commencement of commercial production in any concession area makes the taxpayer company as eligible for claiming expenditure relating to any concession (where no commercial production commenced) is accepted than it will make the provisions of sub-rules (2), (3) and (4) of Rule 2 of Part-I of the Fifth Schedule to the Income Tax Ordinance, which deals with the surrender of Area "and the allowability of the "Lost Expenditure" and amortization of Pre-commencement expenditure as " redundant.
78. (ii)The case law i.e. (1988 PTD (Trib.) 481) quoted by the learned AR has been examined and found irrelevant to the issue involved in the instant case. In this case-law the Honourable ITAT considered the provisions of sub-rules (2), (3) and (4) of Rule 2 of the Fifth Schedule to the Repealed Income Tax Ordinance, 1979 to consider set-off of lost expenditure of one concession area against income from another concession area. The question before the ITAT was whether such set-off was permissible within the allovvability parameters of sub-rules (2) and (3) of Rule 2 Part-I of Fifth Schedule. In backdrop of this question, the Honourable ITAT answered the question in affirmative because the "Expenditure" of one concession area which was the subject matter of the allowability/set off against the income of another concession related to the "surrendered area" and was "lost expenditure" in terms of Rule 2(2) of Part-I of Fifth Schedule. The question of admissibility of expenses under rule 2(5) as in the instant case was never debated before the Honourable ITAT and was not a matter of contention. It is worthwhile to mention that in the case decided by the Honourable ITAT through its judgment referred to by the learned AR's the Assessing Officer had refused to carry forward the loss on surrendered area falling in two concession agreements on the ground that the area in regard to this concession had already been surrendered by the taxpayer company and there was no expectation of any commencement of commercial production in these concession areas. The case of the taxpayer company for the tax year under consideration is entirely distinguishable on the facts and circumstances from the case decided by the Honourable ITAT. No such proposition (i.e., the allowability of the expenditure (Lost) of the surrendered area) is involved in the case of the taxpayer company. Hence, it is of no assistance to the taxpayer.
79. There are two broad categories that are generally used in this industry namely Block/Area and well.
80. Where any expenditure is incurred on searching for or discovering and testing a petroleum deposit or winning access thereto but the search, exploration or enquiry upon which the expenditure is incurred is given up before the commencement of commercial production, the expenditure allocable to a surrendered area or to the drilling of a dry-hole shall be treated as lost at the time of the surrender of the area or the completion of the dry-hole as the case may be and the respective expense is claimed as abortive expenditure after the approval of the Director General Petroleum Concession (DGPC). Likewise after the commencement of commercial production, all expenditure incurred prior thereto and not treated as lost/abortive and not represented by physical assets in use at the time the commercial production is allowed as a deduction, and such deduction is amortized over a period of 10 years. The same principle/practice is being followed by a number of companies which claim expenditure on account of exploration only to the extent of concession areas where taxable event takes place. Names of some of the companies following aforesaid practice are as under:- (i)Messrs Government Holdings (ii)Messrs OMV (iii)Mari Gas (iv)The judgment of the learned ITAT in I.T.As. Nos. 551 to 554(IB)/08 as quoted by the AR of the taxpayer company is also not relevant as in this judgment the important aspects regarding applicability of sub-rules (2) to (4) of Part-I of the Fifth Schedule to the Income Tax Ordinance, 1979/2001 and specific clauses of the PCAs dealing with the expenditure in hand, have not been considered/discussed. Moreover, the tribunal judgment in Appeals Nos.551 to 554/IB/2008 in the case of Messrs Orient Petroleum could not be followed, inter alia because it was based on the Tribunal's earlier judgment. The tribunal having itself remanded the case and having left the matter to the examination and determination by the Income Tax Officer on the basis of terms of each agreement, its conflicting obiter dicta based on erroneous assumptions, could not be taken as a final decision. The judgment also failed to take into account the express provisions of Part-I of the Fifth Schedule to the Income Tax Ordinance particularly Rule 1 and other Rules. Consequently, such judgment could not be binding. Since Tribunal's judgment in Orient Petroleum was based on the 1988 judgment and the said judgment itself not being correct, the former too was erroneous and could not be followed. Reliance in this regard has been placed on the Honourable Supreme Court's judgment reported as PLD 1997 Supreme Court 351-Province of Punjab v. Dr. Muhammad Zafar Bukhari.
(v) The issue in question has also been decided by the learned ATIR in the case of Messrs OGDCL in I.T.As. Nos.642 (IB)/2013 and 219(IB)/2013 dated 19-08-2014 in favour, of the department. While deciding the appeals the Honourable ATIR also dilated upon the judgments relied upon by the taxpayer company and found the same as distinguishable.
81. Since none of the events mentioned in sub-rules (2) to (4) of Rule-2 of Part-I of Fifth Schedule to the Income Tax Ordinance, 1979/2001 occurred in respect of the concession areas involving geological and geo physical/exploration expenditure discussed above, the same were, therefore, be disallowed being inadmissible and not covered by sub-rule (5) of Rule-2 of the aforesaid Ordinance.
82. However, the lengthy arguments delivered and recorded supra, in its rebuttal the learned AR stated that the decision of the ATIR in I.T.As. Nos. 642 and 219/IB/2013 dated 19.8.2014, in it the concept of "ring-fencing" was approved whereas Division Bench of the ATIR in their decision reported as (1988 PTD (Trib.) 481) had already disapproved the concept of "ring-fencing" and clearly decided that the entire income of petroleum from all PCAs is assessable as one basket. In anether unreported decision of ATIR dated 30.03.2009 in I.T.A's. Nos. 551 to 554(IB)/08. It was again held that in the business of petroleum the income/loss from all PCAs is assessable as "one basket of income". The above mentioned reported Judgment of ATIR relied upon by learned AR of the appellant was not contested in appeal/reference before the Honorable High Court one in this manner attained finality. On the presence of two identical decisions by two separate benches of ATIR (still holding the field). It was requirement of the judicial discipline that a Division Bench of ATIR should have followed the decision of another Division Bench. He stated that on the issue of binding precedent following decisions of superior Courts are relevant to find that ratio settled by a Bench of equal level could not be ignored by another Bench of same level. To this effect L/AR of the taxpayer referred to the following cases law: PLD 1963 SC 296, PLD 1995 SC 423, 2007 PTD 1533, 2004 PTD 62, 93 Tax 72, PLD 2004 Pesh. 47, 1998 PTD 3319, 2003 PTD 2321 and 1997 PTD 879.
19. We have given due consideration to arguments of both the parties. Perusal of Rule 1 of the Fifth Schedule shows that there is no bar on .the taxpayer to claim expenses of one PCA against the income from the other. The concept of" ring-fencing" has no place in the law. The law is very much clear on this point. It provides that all PCAs constitute "one business" and income from all PCAs has to be aggregated and the expenses there from have to be deducted in case the company has been notified with commerciality. All the receipts as well as expenses would be put in one basket.
83. The consolidated amount of receipts and expenses has to be treated as a single business. In other words the concept of "one-basket" assessment is applicable in the assessment of petroleum companies. In our opinion both the authorities below put wrong construction on the interpretation of Rule 1 of Sub-Rule (2) of the Fifth Schedule and in this manner the taxpayer had been deprived of his legal right. We have no doubt, in our mind to hold that the business of exploration and production of petroleum is to be treated as a separate business encompassing all PCAs for exploration of petroleum deposits. We tend to agree with learned AR that in ATIR's order dated 19.08.2014 in the case of OGDCL the legal provisions were not correctly construed. The concept of "ring-fencing" may be applicable in some parts of the world but in our taxation system it has been clearly disapproved. Further the cases relied upon on the issues of binding of earlier conclusion of bench of equal strength, the relevant portion of aforementioned judgment is as under:-- PLD 1963 SC 296", "Division Bench differing from earlier Division Bench, should refer case to Larger Bench or while following earlier cases express their doubt and leave matter to be raised by appeal before Supreme Court.
84. PLD 1995 SC 423.
85. "Earlier judgment of equal bench in the High Court of the same point is binding upon Second Bench. If however, a. contrary view has to 6e taken then request for constitution of a Larger Bench should be made"
86. 2007 PTD 1533.
87. "Difference of opinion between two Division Benches---Bench disagreeing with the earlier view has to make reference to a Larger Bench for resolution of such difference---If the Income Tax Appellate Tribunal while passing its order was in disagreement with the earlier view of another Bench of the Tribunal, the proper course available to it was to refer the matter to its Chairman for constitution of a Larger Bench to resolve such difference of opinion between the two Benches."
88. 2004 PTD 62.
89. When a Bench adopts a view different or contrary to the view earlier expressed by a Bench of equal jurisdiction then legal propriety demands reference of case for constitution of a larger Bench or leave it to be settled in appeal by higher Court"
90. 93 Tax 72.
91. "Whether Second Bench of Tribunal in judicial courtesy should not have proceeded to decide matter in presence and availability of judgment of Bench of equal strength in favour of assessee on some legal and factual issues--Held Yes. Whether such matter ought to have been referred to Chairman for constitution of larger Bench-Held, yes-High Court set aside both impugned orders and remanded case to Chairman for constitution of Full Bench or Larger Bench not comprising any member of two Division Benches which had earlier decided appeals"
92. PLD 2004 Pesh. 47.
93. "Division Bench differing from earlier Division Bench should refer case to Larger Bench or while following earlier case express their doubt and leave matter to be raised by appeal before Supreme Court."
94. 1997 PTD 879.
95. 'The object of this principle is to maintain uniformity and consistency of view/decisions in different Benches of the same Court and is aimed at to foster, develop and channelize the system of justice to an extent sufficient enough for the general public to repose its firm confidence in the same.
96. Principles of consistency and certainty occupy a very prominent position in the law of precedent which has to be adhered to in order to maintain discipline in the administration of justice."
97. 1998 PTD 3319.
98. "Conflict of view by different Benches of the same forum is bound to create confusion and ultimately chaos. Decision of a Division Bench is binding on other Division Benches of the same judicial institution and it is absolutely necessary to observe the principle in order to avoid conflicting decisions by the Benches of equal strength which is bound to create complication, confusion and chaos which will result in uncertainty and would be ultimately disastrous to the administration of justice. Ratio settled by the Appellate Tribunal is binding upon a Bench of equal strength".
99. 2003 PTD 2321.
100. Principles of consistency and certainty occupy a very prominent position in the law of precedent which has to be adhered to in order in order to maintain discipline in the administration of Justice.
101. 1997 PTD 879.
102. "We have been observing during the last few years with anxiety that due to lack of assistance and several other reasons the law of precedent has not been followed strictly in the administration of Justice. In addition to various other principles, the principles of consistency and certainty occupied from prominent position and these principles should always be adhered to in order to maintain discipline in the administration of justice and maintain discipline in this behalf. Thus, we proposed to consider the principles in this behalf as enunciated and affirmed by the Superior Courts, in the interest of better administration of Justice and to bring certainty in this behalf. It needs no emphasis that the conflict of views by different benches of the same forum is bound to create confusion and ultimately chaos which is not desirable on the face of it."
20. Keeping in view the legal position emanating from arguments of both the rival parties we have no hesitation to hold that income from exploration and production of petroleum from all PCAs is assessable as one business. The profit and gains of such business; shall be assessable separately from the income and profits of any other business. All the receipts and expenses of all the PCAs have to be lumped and tax liability has to be worked out accordingly on the basis of resultant income. The issue of "ring-fencing "viz-a-viz" one-basket" assessment had been thoroughly dilated upon in the above referred decision reported as [1988 PTD (Trib.) 481]. After detailed analysis of the issue, it was clearly held that the entire income of the petroleum company from cla. PCAs has to be placed in "one-basket" and to be assessed accordingly. Moreover the assessment of such income is regulated by special provisions contained in Regulation of Mines and Oil-fields and Mineral Development (Government Control) Act, 1948 as amended by Act No.LXXX of 1976 read with Part I of 5th Schedule to the Income Tax Ordinance (as applicable on the signing date of PCAs).
103. Subsequent amendments in law will not have any bearing on the mode of computation of income and profits as determined on the date of signing of PCA(s). The concept of "ring-fencing" has been unequivocally disapproved in all the relevant laws including the Income Tax Law as well as Petroleum Exploration and Production Policy, 2012. Through the impugned assessment a settled issued had been un-necessarily re-opened. Such action is absolutely against the law. We tend to agree with learned AR that issue of "one-basket" assessment had already been settled by the ATIR through Judgment of Division Bench reported as (1988 PTD (Trib.) 481) which was followed by another bench of the ATIR in their decision dated 30.03.2009 in I.T.As. Nos.551 to 554(IB)/08. In the light of above mentioned reported decisions of superior courts, decision of one Division Bench of ATIR was binding upon the other Division Bench. But in total disregard of judicial discipline and principles of binding precedents the Division Bench of ATIR in their above mentioned order dated 19.08.2014 in I.T.A's. Nos.642 and 219/IB/2013 gave a finding which was totally contrary to the decisions already holding the field. The Division Bench had no judicial mandate to sit and pass an order containing a ratio which is totally contrary to the ratio already settled by two separate Division Benches of equal level. If it was felt by Members of the Division Bench that they were going to hold different opinion than that already holding the field, then the proper course was to refer the matter to the Chairman or the constitution of Full or Larger Bench. But they did not do so and violated the principles of binding of precedent. In this manner the order of Division Bench of ATIR dated 19.08.2014 is deviation of entire judgment of the Tribunal, therefore, we have no hesitation to follow the ratio settled by two Division Benches of ATIR in their decisions reported as (1988 PTD (Trib.) 481) and unreported decision dated 30.03.2009 in I.T.A's. Nos. 551 to 554/IB/2008. The orders of both the authorities below are therefore <vacated and. the impugned additions under these heads are deleted."
104. Indirect Charges:--
21. The Assessing Officer made addition of Rs.39,148,478/- in tax year 2010, Rs.53,988,433/ in tax year 2011, Rs.30,309,738/- in tax year 2012, Rs.78,027,407/- in tax year 2013 and Rs.80,621,786 in tax year 2014. While making the impugned addition the assessing officer observed that under section 105(1)
(c) no deduction is allowable for amounts paid or payable by the permanent establishment to it's head office on account of royalties, fees or other similar payments, compensation for any services or profit on debt on moneys lent to the permanent establishment. This treatment was confirmed in first appeal and has now been contested in second appeal.
105. 22.Learned A.R. stated that provisions of section 105 are not applicable because the company is doing business of petroleum exploration and is governed by special provisions contained in Part I of the Fifth Schedule. The appellant is under legal obligation through Petroleum Concession Agreement (PCA) to pay certain expenses to its head office which were incurred in performance and discharging functions and duties as an Operator. These expenses generally include expenses incurred on legal treasury, tax (other than corporate income tax) etc. These are totally different than the head office expenses. These are recovered by the Head Office of the appellant on the basis of rates specified in Article II (charges to the Joint Account) clause 3 of Joint Operating Agreement (JOA) to the Petroleum Concession Agreement (PCA). A.R. also stated that, such indirect charges are recovered from all Joint Venture Partners including the company itself) for settlement against invoices from Head Office. Learned A.R. also submitted the invoices from the company's head office on this issue and further stated that, tax was duly deducted on each and every payment against the invoices received from Head Office, and complete evidence of tax deductions were provided to the Assessing Officer. Learned A.R. argued that, the assessing officer failed to bring on record any legal justification, while disallowing this claim. Learned DR opposed these arguments and stated that the claim being inadmissible was rightly disallowed.
106. 23.We have considered arguments of both the parties in the light of relevant law. We are convinced that, there was no justification for making this addition. The expenditure was made in line and according to the terms and conditions of JOA/PCA one tax was duly deducted on all such payments of Indirect Charges paid to Head Office. Evidence to this effect was again produced by the learned AR of the appellant. In view of the above, the addition made on this account is deleted for all the years under appeal.
107. Provision for Staff Gratuity:-- 24.The assessing officer made addition of Rs.30,468,966/- in tax year 2010, Rs.64,470,672/- in tax year 2011, Rs.112,014,442/- in tax year 2012, Rs.83,185,369/- in tax year 2013 and Rs.124,787,509/- in tax year 2014. While making the impugned addition the assessing officer observed that the taxpayer did not actually incur the expenditure claimed under this head. Simple provision was created in the books of accounts. According to the assessing officer no evidence was submitted to establish that it was on ascertainable liability. This treatment was confirmed in first appeal. Second appeal has been filed against this confirmation.
25. Learned A.R. stated that, the Company maintains an approved and funded Gratuity Scheme for all of its local permanent employees. The scheme entitles the members to a lump sum payment at the time of retirement, resignation or death. Gratuity is payable to employees who have completed at least six months of service. Such employees are entitled to a gratuity of one month's salary for each completed year of service. An actuarial valuation of the scheme is conducted each year. The valuation uses the Project Unit Credit (PUC) actuarial cost method. Actuarial gains and losses are in immediately recognized in profit and loss during the year in which they arise. Learned A.R. further contended that, the company follows mercantile system of accounting. Accordingly provision for gratuity is an allowable expense. He stated that Honourable Karachi High Court in a case reported as 2008 PTD 647 has upheld this view. Head notes of the decision are reproduced below.
108. "Reference to High Court-- Allowable expense--Determination of-- Commissioner of Income Tax in his reference, had sought opinion of the High Court regarding question, 'whether Appellate Tribunal was justified in law to hold that provision made in the books of accounts of compensated absences was allowable expenses, even though it was not based on the demands in that regard'-- -Main contention of counsel for department was that expenditure claimed in respect of compensated absences was not an allowable expense as same was merely a provision and had not been paid---Validity---If the taxpayer followed the mercantile system of accountancy, then he was entitled to the deduction of the bonus provided during the year despite the fact that it was not paid during the year-Provision for gratuity being an ascertained liability was an allowable expense, even though not actually paid during the year---Judgment of the Income Tax Appellate Tribunal, was upheld."
25. Learned A.R further stated that on the issue in hand there is a direct judgment of Honourable Supreme Court reported as 1992 SCMR 763 which read as under:-- Appellate Tribunal was justified in upholding the disallowance o the claim of gratuity payable to the employees"
109. High Court after hearing the counsel for both parties answered the question in negative following two decisions of the same High Court rendered earlier in the case reported as Commissioner of Income-tax, Karachi v. Messrs Pakistan Security Printing Corporation (1985 PTD 413) and Messrs S.J. G, Fazal Elahi Ltd., v. Commissioner of Income-tax, Central Zone, Karachi 1989 PTD 579. In fact latter reported case has followed rule laid down by former reported case in which there is detailed discussion in the light of sections 10(2) and 2(6-BB) of Income-tax Act No. XI of 1922 on description of 'free reserve, gratuity and trading liability'. In support of the proposition, reliance is placed upon a large number of reported cases, relevant paragraph from the aforementioned judgment in 1985 PTD 413 is reproduced as under:--- "We have quoted the relevant portion of the order of the Income-tax officer hereinabove in Para 4, from which it is evident that every year the respondent assessee made a provision for the gratuity of the staff on the basis of the emoluments received by them'and the amount was credited to this account, on the basis of the accounting principle that the amount of gratuity is earned every year by the employees and thus it is debatable against the profits of the year in which it is earned though it is payable only when the employees retire from the service, he learned Income Tax Appellate Tribunal in its order, dated 3rd April, 1973 has held that the reserve, for gratuity has been created to meet ascertained liability and therefore, cannot partake of the nature of free reserve in other words, it is not the actual amount of the liability incurred by the respondent assessee towards =its employees in respect of the gratuity of the years in question nor it is the case of the department that the respondent-assessee was not liable to pay the above gratuity either under the contract or under the statutory provision. Factually the case proceeded before the Income-tax Officer as well as before the learned Income-tax Tribunal on the assumption that the respondent assessee's liability to pay gratuity is a legal liability and it is not an ex gratia payment by the respondent to its employees. We may place on record that Mr. Shaikh Haider, learned counsel for the appellant has fairly cited the cases which were in fact against the department, namely, the cases referred to hereinabove in Paras. 5(a) (vii) (viii) and (ix) which are the decisions of the Madras High Court and which clearly lay down that the liability of gratuity ascertained each year is a proper charge against P&L accounts though the liability to pay may accrue subsequently.
110. Reference may also be made to the House of Lord's case Owen (H.M. Inspector of Taxes) v.
111. Southern Railway of Peru Ltd. 1953-56 TC 602 referred to, hereinabove in para. 5 (b)(vi), in which it was held that provision for the payment of compensation to the assessees' rate of pay etc. is a proper charge on P&L upon the basis of proper principles of commercial accountancy from year to year. Further, reference may also be made to the case of the Indian Supreme Court reported in (1969) 73 ITR 53 quoted hereinabove in para. 5(b) (vii), in which it has been held with reference to a scheme of gratuity that liability already accrued though to be discharged at a future date would be a proper deduction while working out the profits and gains of business under the accepted principles of commercial practice and accountancy and that it is not necessary that the amount actually be expended or paid."
112. Mr. Shaikh Haider contended before us that gratuity paid in the relevant year is allowable deduction but amount can be within the control of the Company for payment in future is not an allowable deduction. Secondly, that under the provisions of Labor laws, liability for payment arises only on resignation, retirement or termination; hence Income-tax authorities were justified in disallowing the some. Both these contentions stand answered in the judgment of the reported case mentioned above, relevant paragraph of which is quoted above. High Court has rightly relied upon case-law in support of answering the question negatively formulated in the reference placed before it. In support of his contentions, reliance is placed by Mr. Shaikh Haider on the case of Commissioner of Income-tax, U.P. v. N.L. Laxmi Sugar and Oil Mills Ltd. 1989 PTD 169 (Supreme Court of India), which is misplaced for the reason that the point discussed in that case is different and distinguishable from the point in issue in the instant case For the facts and reasons stated above, we are of the considered view that no exception can be taken to the judgment of the High Court impugned in this petition for the reason that it has answered the question correctly to the effect that claim of gratuity payable to the employees cannot be disallowed in the light of and for the reasons stated in the case-law mentioned above.
113. No interference is warranted, as such leave is refused and petition is dismissed."
27. According to learned AR, the assessing officer held in the order that the company did not provide audited accounts of the funds, whereas fact of the matter is that these accounts were duly provided to the assessing officer during the hearing. The A.R contended that the company is maintaining mercantile system of accounts and is thus entitled to claim the expenditure under this head.
114. 28.The learned DR stated that the claim of the taxpayer is based upon a simple provision in the account books. The amount of actual expenditure has not been reflected anywhere in the relevant statements submitted by the taxpayer. He contended that deduction on account of "provisions" is not admissible under the law. If such deductions are allowed, there is a going to be no end to such notional claims. Therefore, the same cannot be allowed under the law.
29. We have considered arguments of both the parties. The Income Tax Ordinance provides that income of a person chargeable to tax is computed in accordance with the method of accounting employed by the taxpayer. In case of a company, section 32(2) provides that income chargeable to tax under the head "Income from business" shall be computed on an accrual basis, while other persons may account for such income on a cash or accrual basis. Under cash-basis accounting, a taxpayer derives income when it is received and incurs expenditure when it is paid. While under accrual basis accounting, the taxpayer derives D income when it is due or receivable and shall incur expenditure when it is payable. There are two principal methods of keeping track of a business's income and expenses: cash method and accrual method (sometimes called cash basis and accrual basis). In a nutshell, these methods differ only in the timing. It has been held by superior courts that where mercantile system of accounts is maintained such deductions are admissible. In the light of arguments of learned A.R. and the decisions of superior appellant forum, it is held that addition under this head was not justified and the same is accordingly deleted.
115. Amortization of Decommissioning of Cost and Decommissioning of Accretion Charges: 30.The taxpayers claim of Rs.5,878,202 was disallowed by the assessing officer for the reason that no documentary evidence, was furnished in support of this claim. The taxpayer's appeal on this issue was rejected by CIR(A) for the similar reasons. This action has been challenged in second appeal.
116. 31.The A.R. of the appellant contented that the assessing officer erred in not allowing amortization of decommissioning cost of Rs.5,878,202 along with decommissioning or accretion charges of Rs.2,181,675/- in tax year 2010 with the observation that certificate on prescribed format as envisaged under Rule 2(4A) of Part-I of the Fifth Schedule had not been provided. Learned A.R. stated that the tax payer/appellant claimed the amortization of decommissioning cost in accordance with Rule 69 of Pakistan Petroleum (Exploration and Production) Rules, 1986 (Petroleum Rules) and Rule 2(5) of Part I of the Fifth Schedule to the Income Tax Ordinance, 2001. He further argued that the company claimed deduction of Rs.5,878,202 on amortization for de- commissioning cost in the return of income filed by it for tax year 2010 and the learned officer disallowed the same by contending that the de-commissioning cost being a provision was not allowable under the law. Learned A.R further stated the section 4(A) relating to the certificate on prescribed format, was inserted through Finance Act, 2010 on June 30, 2010 whereas the company's financial year was closed on December 31, 2009 (as the appellant has a special income year).
117. Accordingly the appellant had rightly not obtained the Audit Certificate for this year. Learned A.R of the appellant stated that such claims were allowed by the accessing officer in the succeeding years. Learned A.R stated that the appellant started to follow the practice of obtaining Audit Certificate to claim the amortization of decommissioning cost after year 2010 whereas no such certificate was required for the earlier years. He contended that amendment in law, to this effect was made in tax year 2010 after which the company has started obtaining the requisite certificate.
118. He contended that the tax assessm ent of the company is regulated through special provisions contained in Regulations of Mines and. Oil-fields and Mineral Development (Government Control)
119. Act, 1948 as amended by Act No. LXXX of 1976 read with Part I of 5th Schedule to the Income Tax Ordinance (as applicable on the signing date of PCAs). Subsequent amendments in law will not have any bearing on the mode of commutation of income and profits as determined on the date of signing of PCA(s). So the certificate under consideration could not otherwise, be requisitioned.
120. 32.Learned DR stated that the taxpayer failed to furnish the requisite certificate from its auditors and even at this stage of litigation, the said certificate had not been made available. In these conditions the taxpayer's claim could not be entertained.
121. 33.We have considered arguments of both the parties in the light of above discussions and found it better to remand the case back to the assessing officer on this along with issue of decommissioning of accretion charges, with the direction to look into the matter afresh in the light of relevant law.
122. Tax Rates:- 34.This issue is involved in tax years 2011, 2012, 2013 and 2014. The assessing officer applied tax rate of 52.5% on profits and gains of the company before deduction of royalty. This treatment was confirmed in first appeal. It has now been contested in second appeal.
123. 35.Learned A.R stated that there was no justification to apply the tax rate of 52.5% or profits and gains of the company before royalty paid to the government. Learned AR stated that the Petroleum Concession Agreement is binding on Government of Pakistan and has got sanctity under Rule-4 of Part-I of Fifth Schedule to the Ordinance, 1972. In majority of the taxation articles, it has been stated that 'payments' to Government shall be limited to 55 percent of profit and gains. Accordingly In case of almost all petroleum companies in Pakistan tax rate that is provided in the respective FCAs has been applied on the profits and gains prior to deduction of payments to Government Tax Department is misapplying the provisions and principles laid down in the FCAs. The taxation officers are reading the terms 'profit and gains' and 'profit and gains before deduction, of royalty' as being synonymous, which is a fundamental error. The ,word 'prior' to deduction of payments to Government" are not contained in PCAs the sentence relating to the rate. Learned AR further stated that Clause 2 of the Schedule to the Mining Act specifies that the rate within the range of 50 to 55 per cent is to be applied on the 'profits and gains after deduction of payments to Government'. This provision about the rate of tax, it provides the ceiling and the floor within which, range of the rate can be fixed by the government. This clause is being misconstrued. It provides that the limit of payments to Government shall be fixed in the PCA. Learned AR stated that each PCA contains a clause about rate. Some PCA's state that this rate has to be either on Profit and gains or profit and gains after to deduction of payment to Government. The amount payable to Government arrived at in the above manner needs to be compared with the amount calculated under the Fifth Schedule to the Ordinance on profit and gains net of payments to Government. There is nothing in the Mining Act, petroleum policy or any concession agreement having different principles.
124. 36.Learned DR stated that schedule to Mining Act, 1948 was inserted through amendment in 1976, which clearly set out an upper cap at 55% and floor at 50% of the profit or gains "before deduction of payments", to Government of Pakistan. Any limit to be set in PCA cannot be more or less than the limit provided in the Mining Act, 1948, but in each case it must be "before the deduction of payments" to the government. The PCA is subject to section 4 of Mining Act, while the last Para of each PCA in its taxation clause also describe the same. No PCA can be in breach of mandatory law.
125. Section 4 of Mining Act, 1948 provides "that any rule made under this Act and any order made under such rule shall have effect notwithstanding anything inconsistent therewith contained in any enactment or any instrument having effect by virtue of enactment other than this Act". Any basis if provided in PCA is against the mandate of law, the law of Mining Act shall prevail. If the arguments of ARs are accepted, then the "55% "after "royalty" will always be lower than 50% (before royalty).
126. Mathematically 55% limit (after royalty) will always be lower than 50% limit (before deduction of royalty), unless the rate of royalty is reduced from 12.5% to a lower rate, which is legally not possible as the rate of royalty at 12.5% is fixed under the law. Rate of payments and taxes as per Mining Act, 1948 range from 50% to 55% but rate shall always be based on (profit and gains (before deduction of royalty. If the PCA impliedly provides the rate of 55% of Profit and gains and does not further expressly state (before deduction of royalty, it does not mean that such rate will be applied on profit and gains after deduction of royalty.
37. We have given due consideration to arguments of both the parties. In the decision of larger bench of ATIR (consisting of five members), reported as 2012 PTD 581 this issue has been considered at length and decided in the fallowing manner.
127. "It is clear by the words used in the 1994 Policy that the above rates are to be calculated before deducting payments to Government. If the E&P Companies interpretation is taken, the above rates pertaining to different zones would be rendered ineffective and purposeless. In case the contention of companies is accepted then the lower limit will always be the applicable amount and consequently the rates of 55% or 52 1/2% will never be possible to be collected from the E&P Companies by the Government. This clearly shows that the taxation article as interpreted by the E&P companies is not only inconsistent with the 1948 Act on the face of it but its inconsistency is also deeply rooted. Furthermore, the fact that upon every calculation the higher rate results in an amount that is less than the result of the lower limit is an absurd result and cannot be taken as the intention of the legislature or the intention of the parties to the PCA. Such interpretation therefore renders the setting of any higher rate in a PCA redundant because there would be no scenario where the higher rate would come into play. Such situation will arise only if the royalty is less than 12.5%. Such circumstances cannot arise because the laws (including the rate of royalty) are frozen in accordance with Rule 1 and the later part of Rule 2 of the Schedule to the 1948 Act as reproduced supra. This freezing of the laws and the rate is also accepted by the E&P Companies. The E&P Companies interpretation leads to inconsistency with the law and absurd results, the language of the statute can and should be accorded with the legislative intent. The E&P Companies interpretation is also against the appropriate meaning of 'Profits and Gains' and in this manner too such interpretation is inconsistent, with the law. Profits and Gains include royalty, it only does not contain those allowable deductions as stated by Rule 2(5), Part I of the Fifth Schedule to the 1979 Ordinance. The fact that Profits and Gains include royalty is also evident from subsequent changes in legislation, which is vital in ascertaining whether Profits and Gains was meant to include royalty before such changes.
128. The Finance Ordinance, 2001 made an amendment to Rule 2(5) Part I of the Fifth Schedule to the Ordinance, 1979 in the following manner:- "(5) Any expenditure, [including royalty paid to the Government by an on shore petroleum exploration and production undertaking on, or after, the first day of July, 2001] (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production wholly and exclusively for the purpose of the business of production and exploration of petroleum carried on by such undertaking shall be allowed as a deduction:..."
129. Simultaneously, a corresponding change was made to Rule 4 of the Fifth Schedule to the Income Tax Ordinance, 1979 whereby royalties were excluded from being part of the aggregate sum paid to the government. This makes it evident that Royalty before 2001 was not an allowable expenditure and was therefore necessarily included in Profits and Gains. The appellate Tribunal Inland Revenue in the case of Attock Oil Company Ltd. MA (R) No.185/2007 vide is order dated 4th December 2007 has held; "The profits or gains derived from oil exploration business are liable to taxes before any deduction from such profits and gains. The department cannot add anything to such profits or gains and the taxpayer cannot subtract anything from this profit. The tax liability of such undertaking has to be worked out keeping in view the amount of profits and gains, "before payment to Government on account of any other liability".
130. Similarly in the other judgments the Appellate Tribunal has held that the tax rate as fixed between the ranges of 55% to 50% as per the Mining Act must be 'before the deduction of royalty".
131. The C.B.R's. Circular No.2 of 1974 is an executive order of C.B.R., whereas it is settled principle of law that executive order, which is repugnant to the law are not to be applied or followed. The said Circular was issued in 1974. While Schedule to the 1948 Act was introduced in 1976, which is subsequent in time, the Act will always prevail over the circulars, S.R.Os. and notifications. The above discussion leads us to the conclusion, that in each case, whether tax rate is fixed at cap or floor, the payment and tax to the Govt. must be before deduction of royalty, the department has done so therefore its action is approved"
132. 38.Following the ratio already settled on this issue through aforementioned order of the larger bench of the ATIR the departmental action is confirmed and the taxpayer's appeal is rejected.
133. Worker's Profit Participation Fund:-- 39.The assessing officer made addition of Rs.104,874,931/- in tax year 2011, Rs.139,776,391/- in tax year 2012, Rs.181,273,612/- in tax year 2013 and Rs.244,197,213 in tax year 2014. While making the impugned addition the assessing officer observed that provisions of section 60B of the relevant Ordinance were not fulfilled because the expenditure was not actually incurred. It was claimed on the basis of provision in the account books. This treatment was confirmed in first appeal. Second appeal has been filed against confirmation of this addition.
134. 40.The learned A.R. explained that the Ordinance provides that income of a person chargeable to tax is computed in accordance with the method of accounting employed by the taxpayer. Section 32(2) provides that income chargeable to tax under the head "Income from business" shall be computed on accrual basis, while other persons may account for such income on cash or accrual basis. Under cash-basis accounting a taxpayer derives income when it is received and incurs expenditure when it is paid. While under accrual-basis accounting, the taxpayer derives income when it is due or receivable and shall incur expenditure when it is payable. There are two principal methods of keeping track of a business's income and expenses: cash method and accrual method (sometimes called cash basis and accrual basis). In a nutshell, these methods differ only in the timing. It has been held by superior courts that where mercantile system of accounts is maintained, such deductions are admissible.
135. 41.Learned DR stated that the claim of the taxpayer is based upon a simple provision in the account books. The amount of actual expenditure has not been reflected or where in the relevant statements submitted by the taxpayer. He contended that deduction on account of "provisions" is not admissible under the law. If such deductions are allowed, there is a going to be no end to such notional claims. Therefore, the same cannot be allowed under the law.
42. We have considered arguments of both the parties. We tend to agree with the arguments of AR that the Ordinance provides that income of a person chargeable to tax is computed in accordance with the method of accounting employed by the taxpayer. In case of a company, section 32(2) provides that income chargeable to tax under the head "Income from business" shall be computed on accrual basis, while other persons may account for such income on cash or accrual basis. Under cash-basis accounting, a taxpayer derives income when it is received and incurs expenditure when it is paid. While under accrual-basis accounting, the taxpayer derives income when it is due and incurs expenditure when it is payable. There are two principal methods of keeping track of a business's income and expenses: cash method and accruel method. In a nutshell, these methods differ only in the timing. It has been held by superior courts that where mercantile system of accounts is maintained, such deductions are admissible, in the light of arguments of learned A.R. and the decisions of superior appellant forum, it is held that addition under this head was not justified and the same is accordingly deleted.
136. Workers' Welfare Fund:-- 43.The assessing officer calculated Rs.49,472,512/- in tax year 2012, Rs.54,429,101/- in tax year 2013 and Rs.103,619,624 in tax year 2014 on account of WWF. While creating the impugned liability the assessing officer mentioned that it is chargeable @ 2% on accounting profits of the company.
137. Learned A.R stated that an amendment was made through Finance Act, 2003 whereby WWF was levied @ 2% of accounting profits This amendment was challenged in writ petitions. Honorable Lahore High Court it it's judgment reported as 2013 PTD 1548 and Honourable Peshawar High Court in their judgment reported as 2015 PTD 193 held that WWF is in the nature of 'Fee' and it could not be levied through Money Bill. This levy was therefore, declared unconstitutional.
138. 44.The DR stated that in the light of decision of Honorable Sindh High Court reported as (PLD 2013 Sindh 449 = 2013 PTD 969) WWF is in the nature of "Tax" and it could be levied through Money Bill.
139. However, this issue is now pending before the Honorable Supreme Court of Pakistan.
140. 45.Keeping in view the legal position this point is remanded back to the assessing officer with the directions to look into the matter afresh in the light of final decision of Honourable Supreme Court.
141. Exchange Gain/ Loss:- 46.The assessing officer made addition of Rs.8,004,461/-on account of exchange gain in tax year 2010 whereas claim of Rs.274,521,649/- in tax year 2011, Rs.269,517,430/-in tax year 2012, Rs.578,312,098/- in tax year 2013 and Rs.6,972,978/- in tax year 2014 on account of exchange loss was disallowed for the reason that it was of capital nature. This treatment was confirmed in first appeal and has now been challenged in 2nd appeal.
142. 47.On this point, the Learned A.R stated that the exchange gain during Tax year 2010 represented notional income. He further stated that during Tax years 2011, 2012, 2013 and 2014 the exchange loss was claimed because of fluctuation in exchange rate of Dollar. Learned A.R. stated that aforesaid realized exchange loss did not constitute a capital expenditure as the company has not recorded it as on asset in its audited financial accounts and has not claimed any depreciation thereon.
143. Financial statements of the company are prepared/presented/reported in Pak Rupees which is its local currency and US dollar which is its functional currency. Assets and liabilities are translated into presentation currency in Pak Rupee at the rate prevailing at the balance sheet date and the items of profit and loss account are translated at the exchange rate prevailing on the date of transaction. The exchange differences arising on this transaction of currency are taken directly to a separate component of equity which is translation reserve. The A.R. stated that the ACIR has erred in not considering the fact that financial statements of the company are prepared in accordance with accounting standards, as applicable in Pakistan, i.e. International Accounting Standards (IAS).
144. In terms of the provisions of paragraphs 39(c) and 41 of IAS 21, exchange differences are not recognized in profit and loss account and cumulative amount of exchange differences is presented in a separate component of equity translation reserve until disposal of foreign operations. Any realized exchange loss or gain is adjusted against this reserve. The ACIR has also erred in not considering the fact that exchange loss is an allowable expense and arises due to restatement of assets and liabilities used exclusively for the purpose of business. Accordingly realized exchange loss is an allowable expense in terms of the provisions of section 20 of the Ordinance. Relevant extracts of section 20 of the Ordinance is reproduced below.
145. "20. Deductions in computing income chargeable under the head "Income from Business"---.(1)
146. Subject to this Ordinance, 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."
147. 48.Learned A.R. further stated that honorable ATIR in their judgment reported as 2010 PTD 1568 decided the issue of exchange gain/loss in the following manner:-- "As is evident from pre-paras, the assessing officer had, initially, two reservations: (a) that the exchange loss was notional, and (b) it was inadmissible since it pertained to acquisition of capital asset. Both these objections stand duly repelled during the course of assessment proceedings as well as before us. Perusal of the relevant documents confirms that, as per terms and conditions of the foreign currency loan, it had to be utilized for repayment of an earlier syndicated loan, thus leaving no doubt as to its misappropriation.
148. There is, however, another aspect of the issue. Now suppose a person obtains loan No.1 (in this case the local syndicated loan) which is utilized for acquisition of capital asset and interest payable thereon is inadmissible expense under the provisions of the Ordinance. Now he obtains loan No.2 (in this case the foreign currency loan) which is utilized to repay the loan No. 1 . The question would arise as to admissibility of financial cost of loan No.2. That is to say we have to see whether a loan is utilized directly or indirectly for the acquisition of a capital asset or to cater for business needs. In the first situation the cost of the loan is to be categorized as capital expenditure whereas in the later situation it is admissible revenue expense.
149. In the case before us, admittedly the local syndicated loan had earlier been utilized for expansion project of polyster staple fibre. It is, however, not established nor it is borne out from record that the cost of said local currency loan had been held to be inadmissible being capital expense. It is pertinent to mention that for the tax year, 2003 appellant's tax affairs have been thoroughly audited. And also for the tax year, 2004 a number of issues have been raised in proceedings under section 122(5A) of the Ordinance. Nowhere it is challenged and established that the cost of local- syndicated loan has been disallowed. Meaning thereby even the financial charges incurred in respect of the earlier syndicated loan stand allowed as revenue expense. This being so, there is not even an iota of doubt in our minds regarding allowability of exchange loss incurred by the appellant in relation to repayment of its foreign currency loan.
150. There is still another aspect of this issue. For the tax year, 2005 (I), tax year, 2005 (11) and tax year, 2006, the total financial expenses incurred by the appellant stand thoroughly scrutinized. Some of these expenses have also been proportionately disallowed. (We would be dealing with that issue in later part of this order). Even while partially disallowing total financial expenses, the assessing officer has nowhere objected to the admissibility or otherwise of the interest portion/financial charges attributable to repayment of the subject foreign currency loan. It is not understandable as to how in the absence of objections to repayment of foreign currency loon and interest thereupon, the taxation officer could proceed to reject the claim of resultant exchange loss.
151. Result of the above discussion is obvious. The exchange loss claimed by the appellant for three years under consideration at Rs.36,275,000, Rs.8,998,175 and Rs.5,863,318 respectively is directed to be allowed."
152. 49.The learned DR stated that the claim of the taxpayer is not admissible because of being notional and also being in the nature of capital expenditure. That is why the assessing officer rejected the taxpayer's version and accordingly made the addition.
153. 50.We have considered arguments of both the sides. The issue of exchange gain loss has been decided by ATIR in their decision reported as 2010 PTD 1568. Following the ratio already settled, it is held that the stance of the appellant is legally correct with regard to the admissibility of exchange loss, whereas plea of the learned A.R. with regard to realized exchange gain arising in tax year 2010 is not correct. In these circumstances appeal for tax year 2010 is rejected whereas addition on account of realized exchange loss made in tax years 2011, 2012, 2013 and 2014 is deleted.
154. Technical Assistance Fee:- 51.The Commissioner Appeals upheld the order of assessing officer who disallowed Technical/assistance Fee of Rs.8,923,204/- paid to MOL NYRT (ultimate parent company) for tax year 2014 as the taxpayer failed to provide the proof of tax deduction on fee for technical services under section 152(1) of the Ordinance at the rate specified in Division IV of Part I of the First Schedule.
155. 52.Learned AR explained that extension in time was requested by the company to produce required data on Technical Assistance Fee which was not allowed by the Assessing Officer. Learned AR provided details of all invoices paid by the company to MOL NYRT (Ultimate parent company) along with the copies of invoices, bank statements and evidences of tax deduction and deposit to Government Treasury i.e. Tax Challans. Learned AR further explained that the details provided by the company are on 100% basis which is then allocated to different Joint Ventures (Including the taxpayer) depending upon the relevant usage of Services and time write basis after which MOL's share from each Joint Venture is calculated and consolidated to the Financial Statements of the Company under different account heads one of which is Technical Assistance Fee. Therefore, to produce the evidences of withholding Tax deductions on Technical Assistance Fee of the Company's share (i.e. Rs.8,923,204), the Company would actually require to produce 100% withholding Tax on 100% amounts paid by the company as it is deducting withholding tax on 100% amounts of invoices. It is not possible' for the company to produce withholding tax evidences against Rs.8,923,204/-. The Learned AR further submitted that the company has provided all the invoices of MOL NYRT which the company has paid during tax year 2014 and all the invoices are paid to MOL NYRT after proper deduction of withholding' tax under section 152(1) of the Ordinance and no invoice is paid to MOL NYRT without deduction of withholding Tax.
156. 53.Learned DR stated that proof of tax deduction was not provided despite proper opportunity having been provided. That is why the claim was disallowed by the assessing officer and this treatment was upheld in appeal.
54. We have considered arguments of both the sides. We have found that the company was not provided with the adequate opportunity to provide the required details. As the company has provided all required data as per which it is evident that the company has released all the payments of Technical Assistance Fee to MOL NYRT after the proper deduction of taxes under section 152(1) of the Ordinance, therefore, additions by the assessing officer under this head is not justified. Keeping in view facts and circumstances of the case this issue is remanded back to the assessing officer with the directions that it should be examined afresh with the help of relevant documentary material and also in the light of relevant law.
157. Deputation Allowance:--
55. The assessing officer made addition of Rs.84,574,690/- in tax year 2012, Rs.106,233,802/- in tax year 2013 and Rs.136,101,747 in tax year 2014 on account of depletion allowance. While making the impugned addition the assessing officer observed that for the purpose of computing depletion allowance under Rule 3 Part I of Fifth Schedule to the Income Tax Ordinance, the expenditure incurred on account of royalty is to be deducted from "Gross receipts". This treatment was confirmed in first appeal against which the instant 2nd appeal has been filed.
158. 56.The A.R. stated that according to the assessing officer royally is to be deducted from gross receipts for the purpose of calculating depletion allowance. It is tantamount to considering net receipts (i.e. gross receipts minus royalty expense) and not gross receipts which is contrary to the provisions of Rule 3 of the Part I of Fifth Schedule of the Ordinance. He contended that for the purposes of calculating depletion allowance the gross receipts' representing the well head value of production are relevant and the "well head value" itself is irrelevant since it is "well head value of the production "that is to be considered in this respect. He contended that the assessing officer completely ignored the words "gross receipts representing" and the word "production" contained in the Rule 3 of Part I of the Fifth Schedule to the 2001, Ordinance. He further stated that the definition of well head value given in Rule 2(k) of the Pakistan Petroleum (Exploration and Production) Rules, 1936 (Rules 1986) is relevant for the purposes of calculating royalty to be paid to the Government of Pakistan (GOP). Rule 3 of Part I of the Fifth Schedule to the Ordinance is applicable for the purposes of calculating depletion allowance whereby such allowance is to be calculated @ 15 percent of gross receipts including royalty, representing well head value of the production. In view of the petition explained above, for the purposes of calculating depletion allowance, it is the gross receipt which are relevant and thereby the question of deducting royalty there from does not arise. He stated that assessing officer's action tantamount to allowing depletion allowance on net receipts (i.e. gross receipts minus royally) and not on gross receipts referred to in Rule 3 of Part I of the Fifth Schedule to the 1979 Ordinance.
159. 57.Learned DR stated that it is not the issue of considering the 87.5% of the well head value (WHV) for depletion allowance. The department is computing the value of 100% of "well head value".
160. Royalty is charged at 12.5% of WHV. Once the royalty is paid being Government levy, the value, net of royalty represent the receipts/market value of belonging to taxpayer companies. Inclusion of royalty in the gross receipt of WHV would amount to double benefit, as the same is also adjustable towards payments and taxes to the government.
161. 58.We have given due consideration to arguments of both the parties. In the decision of larger bench of (ATIR consisting of five members), reported as 2012 PTD 581 this issue has been considered and it was held that depletion allowance has to be worked out after deduction of royalty from the well head value of the product. A settled discussion has been made in the said order about every feature of this issue. Following the ratio already settled through order reported as 2012 PTD 581, the departmental action is confirmed and taxpayer's appeals are rejected for all the years. revisions by the competent authorities. Therefore, it is advisable to consult the official sources or legal professionals for the most up-to-date and accurate information.