SYED ARSHAD ALI, J. This Tax Reference as well as connected Tax References No.50/2007, 59/2007, 101/2007, 10212007 and 103/2007 arise under the Income Tax Ordinance, 1979 ("Ordinance") and relate to assessm ent years 1993-1996 and 1996/1997 to 2002/2003. The questions raised in this Tax Reference as well as connected References are somewhat common, therefore, we intend to dispose of all the references through the instant consolidated judgment. > Tax Reference No.04/2006:
2. The respondent assessee is a company listed in stock exchange and derives income as an investment bank. The present issue relates to the finance year 1996 to 1997 wherein; the respondent assessee has declared net loss at the rate of Rs.19,672,600/-. The returns filed by the respondent/company was accompanied with a balance sheet and statement of accounts audited by M/s. FORD, PHODES, OBSON, MORROW, New Garden Town, Lahore.
3. The crucial issue relating to adjudication of question of law raised in this petition relates to the method of maintaining accounts by the respondent-bank whereby interest against sticky loan has been debited to a separate account (mark-up suspense account). It is the case of revenue that the same interest should be offered for calculating the income tax liability being accrued income of that tax year.
4. Against that it was the explanation of the respondent assessee that every financial institutions reports their receivable against advances after netting off suspended markup on advances, as required by the State Bank of Pakistan and International Accounting Standard Para 22 of IAS-30, which reads as "the amount at which any assets or liability is stated in the Balance Sheet should not be offset by the deduction of another liability of asset unless a legal right of setoff exists and the offsetting represent the expectation to the realization or settlement of the assets or liability."
S. It was held by the assessing officer that the assessee has not credited the amount on accruals to suspense account and has rather resorted to netting off the same from receivable in an attempt to conceal the amount to be credited to suspense account without prejudice to the fact that the Ordinance of 1979 is not subservient to the International Accounting Standards. The said order-in- original was passed on 22.06.2022.
6. The respondent/assessee has challenged the said order before Income Tax Appellate Tribunal, Peshawar who has decided the issue on 02.08.2005. It is evident from the judgment of the Tribunal that other good number of issues relating to the relevant financial years were challenged and thus a composite order was passed by the Tribunal. Regarding the present controversy, the Tribunal has decided the matter by relying on a law reported as 2002-85-Tax-245(Tribunal), however, the exact decision relied upon is not forthcoming from the said judgment. > Tax Reference No. 50/2007:-
7. The allegations against the assessee are that according to the ledger accounts maintained by the respondent, an amount of Rs. 48,980,410/- accrued to the assessee on non performing advances. The said interest accrued on non-performing advances has rather been netted off from receivable and thus as in the preceding year contrary to the principles of mercantile system of accountancy, an attempt has been made to suppress the receipts by an equal amount, therefore, the amount was taxed by the Assessing Officer vide order of assessment dated 14.05.2003. The said order was annulled by the worthy Tribunal. > Tax Reference No.59/2007:-
8. In the present case, inter-alia, before the assessing officer, the issue relating to mark-up/interest accrued on nonperforming advances were raised for the financial year 2002 to 2003. > Opinion of the Assessing Officer:
9. The ledger accounts copies of advance on examination revealed that an amount of Rs.34,756,893/- accrued to assessee on loan classified as non-performing advances. Scrutiny of the receipts on the other hand revealed that the assessee has not offered the interest account on non-performing advances on accrual basis nor it has credited this amount suspense account.
Interest accrued on non-performing advances has instead been found netted off from receivable as in preceding years.
10. The assessing officer found the respondent/assessee guilty of offering and suppression of receipts on accrual basis and thus held that liable to a penalty under Section 111(2)(a) of the Ordinance of 1979. The first Appellate forum has reversed the said findings keeping in view the judgment of the Tribunal reported as (2002)-85-Tax-245(Tribunal) and has thus deleted the entry vide order dated 30.10.2006, the said order was also affirmed by the Tribunal vide impugned order dated 08.02.2007. > Tax Reference No.101/2007:
11. For the tax years 1994, 1995, 1996 and 1997, addition on account of suspense account under Section 66(a) of the Erstwhile Income Ordinance, 1979 was made by the assessing officer. The appeal filed by the respondent/assessee failed and rejected by the first Appellate forum vide order dated 31.03.2004.
12. A further appeal was filed before the Income Appellate Tribunal, Islamabad which was decided by the Tribunal vide order dated 21.12.2006 in the following manner: "5. The appellant/bank in these identical grounds pertaining to assessment years 1994-1995 to 1996-1997 and 2000-2001 has claimed the admissibility of markup on nonperforming loans, which has been disallowed by both forums below. This item of expense the AR explained was on account of markup calculated on stuck up or sticky loans where chances of recovery are minimal.
The bank instead of crediting these amounts to accrued income head credited it to with other liabilities under separate sub-head "markup suspense account" and on the other side debited other assets under the sub-head income markup recoverable. If subsequent at any stage the same markup is totally or in partly recovered the same is offered for taxation in the year income in which it is received. This is an accounting arrangement, which is in compliance and in accordance with state Bank of Pakistan prudential regulations. The taxation officer and CIT(A) the AR contended, had not appreciated the law and facts and wrongly disallowed it as expense under Section 23(1) (xxi). It was further argued that the amendment in the law w.e.f. l' July, 2000 for allowing such markup as an expense could be applied retrospectively. Reliance was placed Supreme Court's of Pakistan decision (i) Order No.1992 SCMR 1652 and (ii) order No.1993 SCMR 73." > Tax Reference No. 102/2007:-
13. Brief facts of the case are that the respondent is a banking company and derives income from banking business, however, its assessment under section 62 of the Ordinance for the years 1994- 95, 1995-96 and 1996-97 was completed. Later, additions under section 66A of the Ordinance on account of 'Markup on Suspense Account' were made at Rs. 2,651,000/-, Rs. 15,677,000/- and Rs.
32,139,000/-respectively. On filing appeals by the assessee before the Commissioner Inland Revenue (Appeals), the said additions were confirmed with observation that the amount credited to suspense account in each year should not be taxed in that year and the amount accumulated in the account from previous years should not be taxed again. The assessee again filed appeals before the Commissioner Inland Revenue (Appeals), however, the same were rejected vide order dated 31.03.2004. The assessee, then, filed appeals before the worthy Appellate Tribunal, which were decided vide order dated 21.12.2006 and the additions made on account of 'Markup on Suspense Account' were deleted. > Tax Reference No.103/2007: -
14. The case of the respondent/assessee is reproduced as under: - "5. The appellant/bank in these identical grounds pertaining to assessment years 1994-1995 to 1996-1997 and 2000-2001 has claimed the admissibility of markup on nonperforming loans, which has been disallowed by both forums below. This item of expense the AR explained was on account of markup calculated on stuck up or sticky loans where chances of recovery are minimal.
The bank instead of crediting these amounts to accrued income head credited it to with other liabilities under separate sub-head "markup suspense account" and on the other side debited other assets under the sub-head income markup recoverable. If subsequent at any stage the same markup is totally or in partly recovered the same is offered for taxation in the year income in which it is received. This is an accounting arrangement, which is in compliance and in accordance with state Bank of Pakistan prudential regulations. The taxation officer and CIT(A) the AR contended, had not appreciated the law and facts and wrongly disallowed it as expense under Section 23(1) (xxi). It was further argued that the amendment in the law w.ef l' July, 2000 for allowing such markup as an expense could be applied retrospectively. Reliance was placed Supreme Court's of Pakistan decision N Order No.1992 SCMR 1652 and (ii) order No.1993 SCMR 73."
15. The impugned findings of Tribunal relating to suspense account is reproduced as under: - "10. We have considered facts, the arguments of the AR as well as perused the relevant case law in this regard and are inclined to agree to the reasoning offered above that in such cases where income actually has not been received but has accrued as a result of the method of accounting adopted by the appellant will not constitute income. The subsequent amendment in section 23 of the repealed Income Tax Ordinance, 1979 the outcome of which was realization by the legislature to provide relief to such legitimate claims of hardship, where actually no income has arisen to the appellant. Therefore, the amount of markup in the suspense account is liable to taxation merely on the basis of accounting entries. Hence, the addition made to the appellant's income of the amount markup placed in suspense account is hereby ordered to be deleted:"
16. The revenue has referred the following question of law for adjudication of this Court.
"Whether under the facts and circumstances of the case, the Learned ITAT Peshawar was justified to hold against the principals of mercantile system of accountancy that interest accrued on non performing loans will not form income of the assessee whereas as per section 11 (1) (a) (ii) of the repealed Income Tax Ordinance 1979 such income can be taxed on accrual basis".
17. The admitted factual position is that the respondent-bank has calculated the mark-up on sticky loans where the chances of recovery were minimum and in this regard has maintained a suspense account (non-performance loans) where the interest on the sticky account has been debited.
18. It is the case of the revenue that in terms of section 11 (1) (a) (ii) of the erstwhile Income Tax Ordinance, 1979 since the mark-up has accrued to the respondent-bank, therefore, it should have been offered for taxation and by not doing so, the said mark-up becomes a taxable income of the respondent-bank. Since the revenue is relying upon the meaning of total income as provided under section 11 (1)(a) (ii) of the erstwhile Income Tax Ordinance, 1979, therefore, for ready reference, the same is reproduced as under: "11. Scope of total income. (1) Subject to the provisions of this ordinance, the total income, in relation to any assessment year, of a person:- who is resident, includes all income from whatever source derived, which ...............
(ii) accrues or arises, or is deemed to accrue or arise, to him in Pakistan during such year".
19. The word 'accrues or arises' as occurred in Section 11 above has not been defined in the erstwhile Income Tax Ordinance, 1979. However, the issue before us is the total income of the respondent subject to the impost of income tax under the erstwhile Income Tax Ordinance, 1979. The revenue claims that the interest accrued on sticky loans even if parked in a separate account must be offered to the impost of income tax during the said tax year being an essential component of total income. We do not subscribe to the said view because the `sticky' advances in commercial parlance is that amount whose recovery becomes highly improbable or doubtful. The interest accruing on such advance are debited to the parties concerned by those institutions which maintained their accounts on mercantile system, and at the same time instead of carrying such an interest to the profit and loss account, the same is credited to a separate account styled as suspense account or interest suspense account. "Kerala Financial Corpn vs. CIT (1994 AIR SC 2416)."
20. In the case of Commissioner of Income Tax, Bombay City I v. Messrs Shoorji Vallabhdas and Co. (1962 46 ITR 144 SC) Hidayatullah, J (as he then was) speaking for the Court observed: "Income-tax is a levy on income. No doubt, the Income-tax takes into account two points of time at which the liability to tax is attracted viz. the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a "hypothetical income", which does not materialize. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though, an entry to that effect might, in certain circumstances, have been made in the books of account".
21. The law is by now settled that mere fact that interest become receivable to a bank against its sticky loan does not necessarily become its income when the banks are maintaining their accounts on mercantile base or even maintaining a hybrid method of accounting. The said interest becomes subject to impost of tax when it is offered for taxation by the bank or lending institution as per mercantile practice.
22. The choice of the bank to adopt any method of accounting recognized by the State Bank of Pakistan and to offer the income for taxation has been elaborately explained by the Hon'ble Islamabad High Court in the case of Commissioner of Income Tax (Legal), Islamabad vs. Messrs Askari Commercial Bank Limited, Rawalpindi (2018 PTD 1089). For our own guidance, we would like to reproduce the relevant para from the judgment.
"We therefore hold that the timing for offering income for taxation purposes relating to interest on securities under the Ordinance of 1979 was solely dependent on the method of accounting which was regularly employed by the Banks. If the method of accounting termed as on 'cash basis' was employed then income was required to be recorded in the books of account in the tax year when the interest or part thereof was actually received. In the case of the instant References, on the factual side, it stands determined that the Banks were regularly following and had adopted the mercantile, or in other words the 'accrual basis' of accounting method. This was never contested by the Banks. Moreover, it is not the case of the latter that income from interest was recorded in the accounts on the basis of actual receipt nor that the recording of income in the books of accounts was based on the method of accounting known as on `cash basis'. We have carefully gone through the judgment of the august Supreme Court rendered in the case titled `Commissioner of Income Tax v. Habib Bank Limited and ANZ Grindlays Bank PLC' [2014 SCMR 1557] and we feel that our above interpretation stands fortified. In the facts before the august Supreme Court, the respondent Banks had adopted the method of accounting which was hybrid while in the instant tax References the method employed was mercantile or on accrual basis. The august Supreme Court has affirmed in the said judgment that the regularly adopted method of accounting by an assessee will inevitably determine the tax liability in the case of interest on securities. As the interest on securities were not recorded in the accounts of the Bank on 'cash basis' i.e. when actually received or paid, therefore, the relevant tax year was when they were shown or recorded in the accounts as receivable or earned".
The law laid down by the Hon'ble Islamabad High Court in the case of Messrs Askari Commercial Bank Limited, Rawalpindi has also been approved by the Apex Court in the case of Deputy Commissioner of Income Tax, Circle C-4, Karachi vs. National Bank of Pakistan, Karachi (2019 SCMR 1011). Relevant para of the judgment is reproduced as under: "Having considered the case law, in our view two broad propositions emerge in relation to the 1979 Ordinance (with which alone we are here concerned). Firstly, as a matter of law, an assessee was not limited to using either the accrual or the receipt basis of accounting. It was, in law, permissible to use the "hybrid" system of accounting by mixing and merging elements from the other two systems. This was a question of law, and must be regarded as having been answered and settled accordingly".
23. In the present case, the observation of the Tribunal that the taxpayer has a choice to adopt or maintain a third system of maintaining its account i.e. hybrid method where the element of both the systems are present being a recognized method of accounting is in consonance with the law laid down by the Apex Court of Pakistan and India. Therefore, the word `accrues or arises' as it occurred in section 11(1) (a) (ii) of the erstwhile Income Tax Ordinance, 1979 for the purpose of counting total income by a banking company or lending institution is to be applied keeping in view the recognized accounting method adopted by the institution and thus the interest entry debited in the account of customer relating to the non-performing assets would be subject to impost of tax when the same has actually become recoverable and as such is offered for taxation by the bank.
24. In view of the above, this as well as the connected references are answered in Negative. Copy of this judgment be sent to the worthy Tribunal in terms of section 133(5) of the Ordinance.