IRFAN SAADAT KHAN, J. The instant Income Tax Reference Application (ITRA) was admitted for regular hearing vide order dated 26.09.2019 to consider the following questions of law:-
1. Whether under the facts and circumstances of the case the learned Tribunal was justified to uphold the order of Commissioner (Appeals) allowing the notional exchange loss when all the events that determined the liability had not occurred and the liability could not be determined with reasonable accuracy?
2. Whether under the facts and circumstances of the case the learned Tribunal was justified to uphold the order of Commissioner (Appeals) allowing the notional exchange loss, without taking into account the principle that when the law required something to be done in certain way, it had to be done in that way or done not at all?
3. Whether under the facts and circumstances of the case the learned Tribunal was justified to uphold the other of Commissioner (Appeals) allowing the notional exchange loss, without giving any reasons of its own, as required under section 24A of the General Clauses Act, 1897?"
At the very outset, the counsel appearing for the department/applicant does not press Questions Nos.1 and 3, as according to him the Question No.2 is the only relevant question arising in the matter, which may be answered. The Questions Nos.1 and 3, therefore, stand dismissed as not pressed.
3. Briefly stated, the facts of the case are that the respondent/ taxpayer is a private limited company and is a subsidiary of a foreign company. The return of total income for the tax year 2009 was filed by declaring a taxable income of Rs.1,66,97,654/-, which was accepted as a deemed Assessm ent Order (AO). Thereafter, the matter was selected for audit. Proceedings under Section 122(9) read with Section 122(5A) of the Income Tax Ordinance, 2001 (hereinafter referred as the Ordinance) were then initiated and an assessment to that effect was made on 21.12.2010 by assessing the taxable income of the respondent/taxpayer at Rs.36,17,84,986/-. While assessing the income of the taxpayer the Assessing Authority (AA) observed that as per Note No.19, in the accounts, exchange loss of Rs.3,46,26,892/- was claimed. The AA then considered the said exchange loss to be a notional loss and added the same to the income of the taxpayer, by referring to Sections 20, 34(1) and 34(3) of the Ordinance. Being aggrieved with the said order an appeal thereafter was preferred by the respondent/taxpayer before the Commissioner Inland Revenue (Appeals-I), Karachi (CIRA), who vide order dated 11.10.2013 deleted the said addition of the exchange loss. Being aggrieved with the order of CIRA, an appeal was preferred by the applicant/department before the Appellate Tribunal Inland Revenue (ATIR), who vide their order dated 20.9.2016 upheld the order by observing that the findings of the learned CIRA do not suffer from any infirmity or illegality. It is against the said orders of the CIRA and ATIR that the present ITRA was filed by the department.
4. Mr. Kafeel Ahmed Abbasi Advocate has appeared on behalf of the applicant/department and stated that the exchange loss claimed by the respondent/taxpayer was a notional loss and not actual, therefore, the AA was fully justified in adding the same, as per the provisions of Section 34(1) read with Section 34(3) of the Ordinance. The learned counsel then read out the provisions of Sections 20 and 34 of the Ordinance to support his view point that any loss or claim, which is not actual, is not allowable under the tax laws until and unless the same is actually incurred. According to the learned counsel since the loss claimed was only notional and not actual, hence, the same was not allowable. He submitted that the answer to the Question No.2 may be given in negative i.e. in favour of the department and against the taxpayer.
5. Mr. lqbal Salman Pasha Advocate has appeared on behalf of the respondent/taxpayer and stated that the said exchange loss claimed was not a notional loss but was an actual loss. He stated that the respondent is maintaining Mercantile System of Accounting, hence on the date when the accounts were closed, whatever was the gain or loss realized on said date in respect of the payments to be made to the foreign counterpart, which occurred due to the exchange fluctuation, has to be considered as an actual loss to the taxpayer, as per the system of accounting maintained by the taxpayer. The learned counsel stated that the loss claimed was not a notional loss which could be disallowed by the department but was based on the difference accrued to the tax payer and quite rightly entered in the books of accounts of the company, which was allowable under the provisions of Section 32 read with Section 34(3) of the Ordinance. He stated that the procedure adopted by the respondent was as per the accounting system followed by them and, therefore, the department has erred in considering the loss to be a notional or fictional loss; whereas the same, according to him was a loss incurred as per the books of accounts and the accounting system regularly maintained by the respondent/taxpayer. He stated that CIRA and ATIR were justified in deleting the said addition made by the AA. In support of his contention the learned counsel has placed reliance on the following decisions:-
1. Commissioner of Income Tax, Companies II, Karachi v. General Tyre and Rubber Company of Pakistan Ltd. (1993 PTD 383)
2. Commissioner of Income Tax, Companies II, Karachi v. Messrs Oriental Dyes and Chemical Co.
Ltd. (1992 PTD 668).
3. Abbot Laboratories Ltd. v. Commissioner of Income Tax, Central Zone, Karachi (1989 PTD 602).
4. Commissioner of Income Tax Central Zone Messrs Chemdyes Pakistan Limited (1990 PTD 248).
5. General Tyre and Rubber Co. of Pakistan Ltd. v. The Commissioner of Income Tax, Central Zone, Karachi (1989 PTD 582).
6. In the end the learned counsel for the respondent/taxpayer submitted that the answer to the Question No.2 may be given in affirmative i.e. in favour of the taxpayer and against the applicant/ department.
7. We have heard both the learned counsel at considerable length and have also perused the record and the decisions relied upon by the learned counsel for the respondent.
8. Before proceeding, we would like to discuss herein below the relevant provisions of law upon which emphasis has been laid down by the learned, counsel for both the sides. Sections 20, 32 and 34 of the Ordinance are reproduced herein below.
20. Deductions in computing income chargeable under the head "Income from Business.---(1)
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 purposes of business].
32. Method of accounting--- [(1) Subject to this Ordinance, a person's income chargeable to tax shall be computed in accordance will, the method of accounting regularly employed by such person.]
(2) Subject to subsection (3), a company shall account for income chargeable to tax under the head "Income from Business" on an accrual basis, while other persons may account for such income on a cash or accrual basis.
(3) The [Board] may prescribe that any class of persons shall account for income chargeable to tax under the head "Income from Business" on a cash or accrual basis.
(4) A person may apply, in writing, for a change in the person's method of accounting and the Commissioner may, by [order] in writing, approve such an application but only if satisfied that the change is necessary to clearly reflect the person's income chargeable to tax under the head "Income from Business':
(5) If a person's method of accounting has changed, the person shall make adjustments to items of income, deduction, or credit or to any other items affected by the change so that no item is omitted and no item is taken into account more than once."
34. Accrual-basis accounting.--(1) A person accounting for income chargeable to tax under the head "Income from Business" on an accrual basis shall derive income when it is due to the person and shall incur expenditure when it is payable by the person.
(2) Subject to this Ordinance, an amount shall be due to a person when the person becomes entitled to receive it even if the time for discharge of the entitlement is postponed or the amount is payable by installments.
(3) Subject to this Ordinance, an amount shall' be payable by a person when all the events that determine liability have occurred and the amount of the liability can be determined with reasonable accuracy 1[* * *] 2[* * *]
(5) Where a person has been allowed a deduction for any expenditure incurred in deriving income chargeable to tax under the head "Income from Business" and the person has not paid the liability or a part of the liability to which the deduction relates within three years of the end of the tax year in which the deduction was allowed, the unpaid amount of the liability shall be chargeable to tax under the head income from Business" in the first tax year following the end of the three years.
3[(5A) Where a person has been allowed a deduction in respect of a trading liability and such person has derived any benefit in respect of such trading liability, the value of such benefit shall be chargeable to tax under the] head income from Business for the tax year in which such benefit is received.]
(6) Where an unpaid liability is chargeable to tax as a result of the application of subsection (5) and the person subsequently pays the liability or a part of the liability, the person shall be allowed a deduction for the amount paid in the tax year in which the payment is made.
9. Perusal of the above provisions of law, clearly stipulate that a liability accrued in a year becomes eligible for deduction, as per the mercantile system of accounting. It is a settled principle of law that the entry made in the accounts, as per the accounting system employed by a person regularly maintained by him, is considered to be valid and allowable, if it is not contrary to the other provisions of law. In the mercantile system of accounting any ascertained liability accruing to any person, with the reasonable apprehension that it would become payable, is an allowable deduction.
10. In the instant matter, the ascertained liability, with regard to the payment, which was to be made to the foreign company on the date on which the accounts were closed and was yet to be payable, becomes determinable on the basis of the valuation of the rupee on that very date. In the instant matter, the tax year was 2009 as the accounts ended on 31.12.2008. Hence as on 31.12.2008 whatever the amount of liability was payable to the foreign company the same has to be taken into account and shown, as per the rate of the rupee on the date the amount is taken into account for that purpose and any fluctuation in the rupee has to be shown as per the accounting system maintained either as a gain or a loss to the company. In the instant matter, it is an admitted position that the amount was payable to the foreign company, hence the said outstanding /payable amount has to be reflected in the accounts of the company, as per the rate of the rupee as on 31.12.2008, hence in our view the respondent was justified to disclose the same in its accounts, which it did as per Note 19 of the accounts, with regard to the variation/fluctuation in the rupee.
11. The important thing which is to be noted is whether such gain or loss- was fictional or actual.
Both the CIRA and ATIR have reached to a finding of fact that the loss so declared by the respondent was an actual loss and not fictional. It may be noted that the exchange loss accrued due to the exchange fluctuation difference and since the respondent was maintaining accounts on mercantile system therefore, the same has to be shown as exchange fluctuation loss of the respondent. It may also be noted that no double addition or double allowance is permissible on actual payment or receipt, as the case may be, since allowance of the same has already been made on accrual basis, as per the mercantile system of accounting. It is also settled principle of law that any amount of expense incurred wholly and exclusively for the purposes of the business is an allowable expenditure.
12. In the instant matter it has not been disputed that certain amount was payable by the respondent to its foreign company, which, in our view, has to be considered as an ascertained liability and allowance of the same has to be made on accrual basis, as per the mercantile system of accounting, and the extra amount payable at the time of actual payments due to the devaluation of the rupee, has to be taken care of in the accounts as an ascertained liability of the respondent, as per the accounting system employed, which has to be considered as a lawful deduction in the hands of the respondent. The decisions relied upon by the learned counsel for the respondents also speaks of the situation that if the amount is accrued and ascertained, but actual payment is made afterwards, the same would be an allowable expenditure, as per the system of accounting maintained by the said person. Hence the entries made in the books of accounts, as per the accounting method followed by the respondent, being mercantile are to be considered as valid entries for the purposes of allowing the said exchange loss.
13. We, therefore, are of the view that the order of CIRA and ATIR do not suffer from any legal infirmity and have been passed in conformity with the provisions of Sections 32 read with Section 34 of the Ordinance. We, therefore, answer the question No.2 in affirmative i.e. in favour of the respondent and against the applicant. The instant ITRA stands disposed of in the above terms.
14. Let a copy of the present order be sent to the Registrar ATIR for information and necessary action.