MRS. AMBREEN ASLAM, JUDICIAL MEMBER .----Through this order we intend to dispose of the titled appeal filed by the taxpayer against the Order bearing No.01/2019 dated 11-03-2 019, passed by the learned Commissioner Inland Revenue (Appeals-III), Karachi on the following grounds:
1. That on the facts and circumstances of the case and in law, the order of the Commissioner of Inland Revenue (Appeals-III), Karachi [(CIR(A)] is bad in law , contrary to the facts and circumstances of the case and in law .
2. That on the facts and circumstances of the case and in law, the assumption of revisionary jurisdiction by the Additional Commissioner of Inland Revenue, (ADCIR) under section 122(5A) of the Income Tax Ordinance, 2001 and the proceeding under section 122(5A ) of the Income Tax Ordinance, 2001 were illegal, in excess of jurisdiction and the order requires to be annulled.
3. That on the facts and circumstances of the case and in law, the CIR(A) was not justified confirming the deemed markup (interest) of Rs.141,971,539 generated by the ADCIR while invoking the provisions of Section 108 of the Income T ax Ordinance, 2001. The same is not sustainable in law and requires to be deleted.
4. That on the facts and circumstances of the case and in law, the CIR(A) was not justified in confirming the generation of deemed interest of Rs.141,971,539 by the ADCIR under section 108 of the Income Tax Ordinance, 2001 as the Section 108 of the Income Tax Ordinance, 2001 does not empower creation of new source of income.
The addition of Rs.141,971,539 being deemed markup (interest) made by the ADCIR requires to be deleted.
5. That on the facts and circumstances of the case and in law, the ADCIR has erred in law by invoking the provisions of section 108 of the Income Tax Ordinance, 2001 and creating income of Rs.141,971,539 and the CIR(A) erred in confirming the same.
6. That on the facts and circumstances of the case and in law, the CIR(A) has not objectively considered our explanation filed with the ADCIR vide our letter dated 14-09-2018 and that the formal application filed before the Honorable High Court for sanctioning of Scheme of Arrangement dated 15-04-2016 for merger of the Company and Lucky Cotton Mills (LCM) and that the scheme was duly approved by the Honorable Court vide JCM No.25 of 2016 dated 09-09-2016 and the facts mentioned therein. Copy of the Order of Hon. High Court was filed with the ADCIR.
Serious prejudice has been caused to the appellant.
7. That on the facts and circumstances of the case and in law, the CIR(A) has erred in not following the ratio of the decision of the on Supreme Court of Pakistan in case of Shaikh Mohammed Ismail reported as 1986 SCMR 968, 1992 PTD 954 (SCP) . The ADCIR has erred in law by ignoring the binding judgments of Hon. Superior Courts' on the subject that deemed interest cannot be generated.
That on the facts and circumstances of the case, the ADCIR and so also the CIR(A) were not justified in not following the binding judgments of the DB of the learned ATIR in ITAs Nos.981 and 982/KB of 2013 dated 14-03- 2016 and IT A 387/KB of 2014 dated 05-05-2016 that: "Section 108 empowers the Commissioner Inland Revenue discretion in respect of any transaction between persons who are associates, distribute, apportion are allocate income, deduction or tax credits between the persons as is necessary to reflect the income that the person would have realized in an arm's length transaction.
Under this section the exercise has to be done by distributing, apportioning or allocating income, deductions or tax credits between the persons as is necessary to reflect the income that the persons (associates would have realized in his arm's length transaction) thus no new source of income can be created under said section."
The ADCIR and so also CIR(A) were not Justified in creating and confirming the "new source of income" under section 108 of the Income Tax Ordinance, 2001. The deemed income of Rs.141,971,539 being markup (interest) is not sustainable in law and same requires to be deleted.
10. That on the facts and circumstances of the case and in law, appellant have not made any default and have not contravened with any provisions of Income T ax Ordinance, 2001.
11. That your appellant further crave permission to raise/add/alter/amend the grounds of appeal earlier or at the time of hearing and pray for appropriate relief as may due under the Income Tax Ordinance, 2001 and Income Tax Rules, 2002."
2. Brief facts of the case are that this is a case of private limited company which is engaged in business activity of textile. As per facts of the case M/s. Mustaqeem Dying and Printing Industries (Pvt.) Limited has acquired a company Messrs Lucky Cotton Mills (Pvt.) Limited and declared as subsidiary company in their statement of accounts.
3.. Subsequently Messrs Mustaqeem Dying and Printing Industries (Pvt.) Limited advanced loan of Rs.1,419,715,399/- to subsidiary company Messrs Lucky Cotton Mills (Pvt.) Limited without charging interest. ACIR (Audit), Range-A, Zone VI, CRTO, Karachi spotted this transaction of interest free loan and considered it to be non arms length transaction between associates and adjusted incomes and deductions under section 108 read with Transfer Pricing Rules and more specifically Comparable Uncontrolled Price (CUP) method.
4. ACIR, found that if Messrs Mustaqeem Dying and Printing Industries (Pvt.) Limited has given same amount of loan to other non related party , they would have earned profit of Rs.141,791,539 at rate of 10% and Messrs Lucky Cotton Mills (Pvt.) Limited would have incurred expenditure of same amount on loan. Therefore in opinion of ACIR, he under delegated authority by Commissioner , has been empowered by the law under section 108 to allocate incomes and deductions between associates to bring transaction at par with length standard. Accordingly amended order bearing No.100000034655600 dated 2nd July, 2018 was passed by the ACIR creating tax demand of Rs.46,412,964/-.
5. Against the treatment meted out from aforementioned order passed by the ACIR, the taxpayer preferred appeal before learned Commissioner-IR (Appe als) who decided appeal of the taxpayer by passing Order bearing No.01/2019 dated 1 1-03-2019 with the following observations: "4.1 In ground number one, order has. been challenged on account of jurisdiction, law and facts. Department contended that Appellant is engaged in business of Textile and as per Federal Board of Revenue Jurisdiction order No.F.No.57(2) jurisdiction/20171 13483-R dated 19-09-2017, jurisdiction over the textile sector vests with Zone VI, CRTO, Karachi and moreover additional commissioner enjoys powers to amend assessments under delegation from commissioner under section 210 of Income Tax Ordinance, 2001. Therefore I do not see merit in argument of appellant regarding issue of lack of jurisdiction or defective jurisdiction in this case. Hence ground of jurisdiction is dismissed.
4.2 The grounds on account of law and facts need deeper understanding and discussion. The concept of allocation of Incomes and deductions under Section 108, Re characterization of income and deductions under section 109, Concept of Associates as provided in Section 85 and Transfer Pricing Rules and methods given at Chapter VI of Income Tax Rules, 2002 is new phenomenon and different from repealed Ordinance of 1979. Therefore whole concept needs to be understood in details with fresh insights departing from mindset of Income Tax Ordinance, 1979.
4.3 Chapter VIII of Income Tax Ordinance, 2001 which includes sections 108 and 109, is titled as "Anti-A voidance" and avoidance is arrangement where transaction is constructed in such a manner that burden of tax is either avoided or lessened than the actual one and this chapter caters to such situations.
For convenience subsection (1) of section 108 is reproduced here: "The commissioner may, in respect of any transaction between persons who are associates, distribute, apportion or allocate income, deductions or tax credits between the persons as is necessary to reflect the income that the persons would have realized in an arms length transaction."
This section gives power to examine any transaction between associates and bring it at par with arms length transaction through distribution, apportionment or allocation of income, deductions and tax credits. Here commissioner's power is subjected to three parameters. There has been transact ion and that has been between associates and transaction should be non arms length i.e. the income realized from transaction should not reflect arm length standard. On the other hand, Transfer Pricing Rules provide merely methods to bring a non arms length transaction to arms length standards as provided at sub-rule (3) of Rule 23 of Income Tax Rules, 2002 Whether a transaction qualifies for applicability of section 108 of the Income Tax Ordinance, 2001, there should be transaction between associates at non-arm length which is explained as under:- Transaction Transaction is defined at Rule 21(1) (c) of Income T ax Rules, 2002 as under - "Transaction means any sale, assignment, lease, license, loan, contribution, right to use property or performance of services"
4.4 In this case M/s. Mustaqeem Dying and Printing Industries (Pvt.) Limited has advanced loan of Rs.1,419,715,399 to M/s. Lucky Cotton Mills (Pvt.) Limited. It is found that advancement of loans dearly falls under the definition of transaction.
Associates For convenience section 85 is reproduced here as under - "85. Associates .- (1) Subject to subsection (2), two persons shall be associates where the relationship between the two is such that one may reasonably be expected to act in accordance with the intentions of the other , or both persons may reasonably be expected to act in accordance with the intentions of a third person.
(2) Two persons shall not be associates solely by reason of the act that one perso n is an employee of the other or bother persons are employees of a third person.
(3) Without limiting the generality of subsection (1) and subject to subsection (9), the following shall be treated as associates--
(a) an individual and a relative of the individual;
(b) members of an association of persons;
(c) a member of an association of persons and the association, where the member , either alone or together with an associate or associates under another application of this section, controls fifty per cent or more of the rights to income or capital of the association;
(d) a trust and any person who benefits or may benefit under the trust;
(e) a shareholder in a company and the company , where the shareholder , either alone or together with an associates or associates under another application of this section, controls either directly or through one or more interposed persons-
(i) fifty per cent or more of the voting power in the company;
(ii) fifty per cent or more of the rights to dividends; or MO fifty per cent or more of the rights to capital; and
(f) two companies, where a person, either alone or together with an associate or associates under another application of this section, controls either directly or through one or more interposed persons- (() fifty per cent or more of the voting power in both companies;
(II) fifty per cent or more of the rights to dividends in both companies; or
(iii) fifty per cent or more of the rights to capital in both companies.
(4) Two persons shall not be associates under clause (a) or (b) of subsection (3) where the Commissioner is satisfied that neither person may reasonably be expected to act in accordance with the intentions of the other .
(5) In this section, relative in relation to an individual, means - (a) an ancestor , a descendant of any of the grandparents, or an adopted child, of the individual, or of a spouse of the individual; or (b) a spouse of the individual or of any person specified in clause (a)."
4.5 It can seen from above that definition is very vast and brings almost all sorts of relationships fall under ambit of associates. Two parameters mentioned at subsection (1) and Subsection (3)(f) are of particular importance in this case. A subsidiary is reasonably expected to act in accordance with intension of parent company . The relationship of associates squarely fits in this case under section (3) (f) which is reproduced here again.
(f) two companies, where a person, either alone or together with an associate or associates under another application of this section, controls either directly or through one or more interposed persons-
(i) fifty per cent or more of the voting power in both companies;
(ii) fifty per cent or more of the rights to dividends in both companies; or
(iii) fifty per cent or more ' of the rights to capital in both companies.
Thus I have no hesitation in holding that relationship between the two companies is of associates.
Non Arms Length T ransaction Sub-Rule (1) of Rule 23 of deals with determination of arms length transaction.
Arm's length standard.-
(1) "In determining the income of a person from a transaction with an associate, the standard to be applied by the Commissioner shall be that of a person dealing at arm's length with a person who is not an associate (referred to as the "arm's length standard)"
This rule can be explained by contextualizing the situation of this case. The quest ion is that whether a person will give interest free loan of 1.4 billions to any other non related person. Whereas person itself is short of funds and has raised loans from banks at commercial rates. The reply is obviously No. In world of business, no one lends to . other person without charging interest In arms length transaction, Messrs Mustaqeem Dying and Printing Industries (Pvt.) Limited would have advanced loan on the reasonable rate to boost its earning, Thus transaction is dearly non arms length as defined by rule 23 above.
4.6 Here in this case, two patties are associates and income of one and deduction from other does not affect the earning of the group i-e Parent and Subsidiary Company . However it has impact on the tax. Income of the M/s. Mustaqeem Dying and Printing Industries (Pvt.) Limited shall be taxed 33% as income from other sources and deduction from Messrs Lucky Cotton Mills (Pvt.) Limited will not reduce the tax liability of Lucky Cotton since it is already loss making unit and subjected to minimum tax.
4.7 There is one more question arising from section 108 to be addressed to arrive at right conclusions. Firstly , Can commissioner create income when same is not declared in books?, which appellant calls as notional income in this case.
For the answer to this question, we have to revert back to title of Chapter VII "Anti-A voidance". And it is to be recalled that avoidance is arrangement where transactions are constructed in such a manner that either no liability arises or burden of taxes is lessened. In this, it is argued by the department that transaction has been constructed in such manner that there is no tax liability . Further department contended that section 108 is to be invoked where tax is avoided through means of non declaration of income or under declaration of income between associates for purpose of avoidance through non arms length standard. Department further argued that by power of allocation of income and deductions means same, transaction will make income in hands of one entity and expenditure in hand of other entity . Allocation of income in hands of one associate and deduction in other's hands create income through adjustment of income which was already there but was avoided under the layers of making a transaction which is non-arms length transaction. The commissioner is fully justified to do this under section 108 because all ingredients. for application of section .108 are available that is: a) A transaction, b) Two Associate Entities, c) Transaction made to avoid the actual incidence of T ax, and d) The transaction is not made according to arms length principle.
In this context, I am also fortified with a decision by Honorable Tribunal cited as 2010 PTD 40 (Trib.), wherein it is unequivocally held by the Honorable Tribunal that, "Providing of funds to the Associate concerns without any interest thereon are to be added in the income under section 108(2)"
4.8 The argument of department carries weight that by allocation of income and deduction, it becomes real income taxable under law. Officer has applied interest rate of 10% to arrive at interest of Rs.141,971,539/- in hands of lender M/s. Mustaqim Dyeing Printing Industries (Private) Limited on basis of Cup Method. Comparable Uncontrolled Price (CUP) Method given at Rule 21 which is reproduced as under: "21. Interpretation:
(a) "comparable uncontrolled transaction" ; in relation to a controlled transaction, means an uncontrolled transaction that satisfies one of the following conditions, namely:-
(a) the differences (if any) between two transactions or between persons undertaking the transactions do not materially affect the price in the open market the resale price margin or the cost plus mark up, as the case may be; or
(b) if the differences referred to in sub-clause (i) do materially affect, the price in the open market, the resale price margin or the cost plus mark up, as the case may be, then reasonably accurat e adjustments can be made to eliminate the material effects of such differences; 4.9 While determining arm's length standard, transfer price rules have provided various methods and one of them is CUP method reproduced above. Here controlled transaction means transaction between associates.
Uncontrolled transaction means transaction between non-associates. To determ ine reasonable rate of interest, officer has relied on rate of borrowing of Messrs Mustaqim Dyeing Printing Industries (Private) Limited from Bank.
In transfer pricing jorgan, this is called "internal comparable". Messrs Mustaqim Dyeing Printing Industries (Private)
Limited has borrowed at rate of 6.7% and borrowing is secured by guarantees and collaterals. Whereas, officer has applied interest rate for unsecured loan at rate of 10% in this transaction. Application of method and reasons applied for determination of interest rates does not warrant interference which are found to be reasonable and persuasive.
As per Para No. 12 of the facts of the case, taxpayer contended that this borrower company was operating in loss and that there was no benefit availed by LMC on obtaining interest free loan as it did not affect the tax payable by it. The contention is well articulated but it missed the point that had the transaction been carried out at arm's length standard, then it would have resulted in markup income to the lender which would have generated revenue to government kitty as markup income of the lender but in instant case, the amount stands avoided in instant case because the borrower company is in loss which has to pay turnover tax whether the loss include expenses under the head markup or no. In other words, whether the loss is smaller or bigger . Section 108 is anti avoiding legal provision to retrieve revenue lost in transaction between associates which does not meet arm's length standard
5. In view of above discussion, I tends to agree with contention of department that commissioner is empowered to allocate income and corresponding deduction between associates to arrive at arm's length standard. In view of this situation, I do not find any force in the appellant's contentions or fault in findings of the Additional Commissioner -IR, Audit Range-A, Zone-VI, CRTO Karachi hereby . His findings on this point are, therefore, upheld. The appeal thus fails and is rejected"
6. Being aggrieved and dissatisfied with the Order bearing No.01/2019 dated 11-03-2019 passed by learned CIR (Appeals), the taxpayer preferred titled appeal before this Tribunal.
7. On the date of hearing, Mr. Abid H. Shaban, Advocate, attended Court proceedings on behalf of the appellant/taxpayer while none attended on behalf of respondent/department.
8. The learned counsel for the taxpayer argued that the order of learned CIR(A) is bad in law, contrary to the facts and circumstances of the case and in law as the assumption of revisionary jurisdiction by the Additional Commissioner of Inland Revenue, (ADCIR) under section 122(5A) of the Income Tax Ordinance, 2001 and the proceeding under section 122(5A) of the Income Tax Ordinance, 2001 were illegal, in excess of jurisdiction and the order requires to be annulled.
9. Learned counsel further argued that the learned CIR(A) was not justified confirming the deemed markup (interest) of Rs.141,971,539 generated by the ADCIR while invoking the provisions of Section 108 of the Income Tax Ordinance, 2001, the same is not sustainable in law and requires to be deleted.
10. Learned counsel urged that learned CIR(A) also not justified in confirming the generation of deemed interest of Rs.141,971,539 by the ADCIR under section 108 of the Income Tax Ordinance, 2001 as the Section 108 of the Income Tax Ordinance, 2001 does not empower creation of new source of income. The addition of Rs.141,971,539 being deemed markup (interest) made by the ADCIR requires to be deleted.
11. Learned counsel stated that, the ADCIR has erred in law by invoking the provisions of section 108 of the Income Tax Ordinance, 2001 and creatin g income of Rs.141,971,539 and the learned CIR(A) erred in confirming the same. He further stated that the learned CIR(A) has not objectively considered our explanation filed. with the ADCIR vide our letter dated 14-09-2018 and that the formal application filed before the Honorable High Court for sanctioning of Scheme of Arrangement dated 15-04-2016 for merger of the Company and Lucky Cotton Mills
(LCM) and that the scheme was duly approved by the Honorable Court vide JCM No.25 of 2016 dated 09-09-2016 and the facts mentioned therein. Copy of the Order of Hon. High Court was filed with the ADCIR. Serious prejudice has been caused to the appellant/taxpayer .
12. Learned counsel contended that learned CIR(A) has erred in not following the ratio of the decision of the on Supreme Court of Pakistan in case of Shaikh Mohammed Ismail reported as 1986 SCMR 968, 1992 PTD 954
(SCP) . The ADCIR has erred in law by ignoring the binding judgments of Hon. Superior Courts on the subject that deemed interest cannot be generated. He further contended that the ADCIR and so also the CIR(A) not justified in not following the binding judgments of the DB of the learned ATIR in ITAs Nos.981 and 982/KB of 2013 dated 14- 03-2016 and IT A 387/KB of 2014 dated 05-05-2016.
13. Learned Counsel urged that the ADCIR and so also CIR(A) were not justified in creating and confirming the "new source of income" under section 108 of the Income Tax Ordinance, 2001. The deemed income of Rs.141,971,539 being markup (interest) is not sustainable in law and same requires to be deleted. He stated that the taxpayer/appellant has not made any default and have not contravened with any provisions of Income Tax Ordinance, 2001. Lastly , he prayed for setting aside of the impugned order passed by learned CIR(A).
14. We have considered arguments advanced by the learned counsel for the appellant/taxpayer so also perused the case record including impugned order and the grounds containing in the appeal. To decide the instant appeal the question before us is whether the impugned order requires interference?
15. Precisely the taxpayer alleged against the department that Messrs Mustaqeem Dying and Printing Industries (Pvt.) Limited has acquired a company M/s. Lucky Cotton Mills (Pvt.) Limited as its subsidiary of M/s. Mustaqeem Dying. Such fact is evident in their State ment of Accounts being so the Messrs Mustaqeem Dying and Printing Industries (Pvt.) Limited advanced loan of Rs.1,419,715,399/- to Messrs Lucky Cotton Mills (Pvt.) Limited without charging interest, be that the department observed this transaction of interest free loan and considered it to be non arms length transaction between associates.
16. Keeping in mind above accounts we have gone through the expressions of section 108(1), this section speaks about the powers of Commissioner which may be use by him in respect of any transaction between persons who are associates, distribute, apportion or allocate income, deductions or tax credits, between the persons as is necessary to reflect the income that the person would have realized in an arm's length transaction.
17. So as per our understanding an arm's length transaction is a business deal in which buyers and sellers act independently without influencing each other and both parties act in their own interest so far non arm's length transaction is concerned, it is also known as an arm in arm transaction, this term refers to a business deal in which buyers and sellers have an existing relationship, whether business related or personal. Tax laws throughout the world are designed to treat the results of a transaction differently when parties are dealing at arm's length and when they are not.
18. We further clarify that two subsidiaries of same parent company must be made using arm's length prices and this practice is known as transfer pricing which assures that each country collects the appropriate taxes on the transactions.
19. Keeping in mind above, conceptual comprehension, we would reverted back to the excerpt of Section 108(1), it says that any transaction between person who are associates have the same arrangement/pattern of distribution, apportion, allocation income, deduction or tax credits as would have been realize in an arm's length transaction.
20 We accept and validate that Section 108(1) empowers the Commissioner , he can determine the source and nature of payment or loss, by restricting himself to the extent of components mentioned in Section 108(1), we emphasis here that he cannot generate or create new source of income under the garb of expression tax avoidance.
21. Beside this the issue in hand has already been decided by the Tribunal vide Order dated 05-05-2016 passed in appeal bearing ITA No.387/KB/2014 (The Commissioner Inland Revenue Zone-I, LTU, Karachi v. Messrs Al- Karam Textile Mills Ltd, Karachi ) which is binding upon us being exercising coordinate jurisdiction therefore, very respectfully following the same reproducing here the relevant part of findings of learned bench as under:-
12. In respect of invoking of sections 108 and 109 we have recently decided the issue in the appellant's own case in ITAs Nos.981 and 982/KB of 2013 dated 14-03-2016 where we have held that provision of sections 108 and 109 have been incorrectly applied. In para-6 of this decision we observed of as under: "Perusal of the order of the Additional Commissioner Inland Revenue shows that the provisions of sections 108 and 109 have been referred without any further discussion as to how these provisions were attracted. Section 108 empowers the Commissioner Inland Revenue discretion in respect of any transaction between persons who are associates, distribute, apportion are allocate income, deduction or tax credits between the persons as is necessary to reflect the income that the person would have realized in an arm's length transaction. Under this section the exercise has to be done by distributing, apportioning or allocating income, deductions or tax credits between the persons as is necessary to reflect the income that the persons (associates would have realized in his arm's length transaction) thus no new source of income can be created under said section. Here in this case the officer has created interest income which action is not provided in the section. On the other hand section 109 empowers the Commissioner Inland Revenue in his discretion to re-characterize a transaction, an element of transaction that was entered into as a part of tax avoidance scheme. He may disregard a transaction that does not have substantial economic effect or re-characterize a transaction where from the transaction does not reflect the substance. The entire exercise is for the purposes of determining liability under the Income Tax Ordinance, 2001. None of the conditions mentioned in section 109 have been highlighted by the officer . In the present case both the sections have been mentioned but no reason has been assigned and more particularly the transaction in hand has not been re-characterized.
Further we have observed that the officer has invoked sections 108 and 109 with slash i.e. 108/109 both in show- cause notice as well as in his findings. This action of the officer show that he is not sure which section is to be invoked, by mentioning two sections by using slash, show that he is of the view that two sections have same meaning which obviously is not a correct view. The two sections have different use and meaning as it can never be the intention of legislature that two sections Can be for the same purpose. The learned Advocate has elaborated the use of two sections supra and we fully agree to the views expressed by him. It has not been highlighted by officer in his order any of the conditions of the two provisions which can be equated with the case of the appellant.
Or in other words the officer has failed to highlight the conditions in two provision which can be equated with case of appellant. The act of the officer to our mind is arbitrary and the case law cited by the Advocate throw ample light on this aspect"
14. Keeping in view the above discussion, the principles laid down by us squarely applies in the present case also.
In the present case except mentioning of sections 108 and 109 no reason has been assigned and transaction in hand has not been re-characterized. As held by aforesaid decision sections 108 and 109 have different use and meaning and it cannot be intention of the legislature that said two sections can be for the same purpose. We may further observe that Commissioner Inland Revenue Appeals has correctly appreciated the fact that the officer has not given any finding in respect of tax avoidance scheme whereby the employer and employees were conscious that employees would get interest free loan from the employer who would get bene fit of tax avoidance and that no tax avoidance has been established on factual plane.
15. In view of above action of Deputy Commissioner Inland Revenue cannot be held to be legal which was correctly disapproved by the Commissioner Inland Revenue Appeals. The order on this issue is maintained."
22. So keeping in mind above aspects, we are of the view that the impugned judgment requires interference, the same is set aside, in result appeal of the taxpayer accepted.
23. Appeal stands disposed of f in the manner as indicated above.