COMPENSATION ON DELAYED REFUND IS NOT CHARGEABLE TO TAX

COMPENSATION ON DELAYED REFUND <!--[if gte mso 10]> COMPENSATION ON DELAYED REFUND IS NOT CHARGEABLE TO TAX By Dr. Ikramul Haq, Advocate, Lahore In Business Recorder and Dawn of September 28, 2004, one Haideruddin Tipu, through a letter to Editor, sought the guidance of Central Board of Revenue (C.B.R.) regarding taxability of compensation on delayed refund. He raised some pertinent questions that reflect sadly on the malfunction of our tax system and the plight of those who do not get refunds in time. Adding insult to injury, on receipt of compensation for delayed refunds, the Department taxes it! Mr. Haideruddin Tipu has raised the following questions in his letter: " 1. How would a taxpayer (a private limited company) whose refund is delayed and when finally paid is accompanied with additional payment for delayed refund treat the additional payment (compensation)?. (a) Treat the compensation as income from business and pay tax on the same as per regular source of income? (b) Treat the same as 'special receipts', show it in the profit and loss account and at the time of calculation of taxable income for payment of tax 'exclude the same from the purview of taxable income' (c) Treat the same as 'capital receipts' and show it as part of profit and loss appropriation account and claim exemption of the same as 'not taxable' 2. Compensation (additional payment for delayed refund) being healing of wounds of the assessee and/or 'penalty imposed on the department for delay and not upholding the law in letter and spirit' and/or 'fine‑cum‑penalty on the department for wilful delay in issuance of refund' (refer to various) rulings by the FTO). Is compensation for delayed payment a source of income of the assessee? 3. Can compensation for which no venture in the nature of trade, business or profession is carried out and which is not at all the regular/occasional source of income of a taxpayer be termed taxable or be taxed? 4. If such amount of compensation is taxable, then why deduction of tax at source is not done by the Income Tax Department at the time of issuance of compensation? 5. If compensation is taxable and received by a private limited company, wouldn't the very objective of compensation be defeated if the same is taxed at 43% thus practically leaving very little compensation? 6. Delay in issuance of refund having been declared mal administration. Can redressal of injustice for delayed refund be undone by treating it as taxable? 7. Can compensation be axed by bringing it into the taxable net? 8. Is there any clear provision in the Income Tax Ordinance, 2001 which categorizes and speaks of taxing 'additional payment under section 171 as taxable?" In the light of above questions and issues, Mr. Haideruddin Tipu sought the guidance and clarification from C.B.R. mentioning that it "would help us in streamlining the filing of income tax return of our company and others." I, being a humble student of tax laws, feel duty bound to express my views on the subject for the consideration of Mr. Haider and all concerned including C.B.R. The following points merit consideration in .the matter: 1. It is an established law that what is not "income" is not chargeable to tax under the Income Tax Ordinance, 2001 [hereinafter "the Ordinance"] unless deemed to be so. There is no dearth of case‑law on the subject as to what is income and what is the scope of `deemed income'. The apex Court of Pakistan in Elahi Cotton Mills Ltd v Federation of Pakistan and others PLD 1997 SC 582 = 1997 PTD 1555 dealt with this issue at length, the summary of which is: ‑ The Revenue has no authority to deem something as income unless legal fiction is created by the legislature itself, which too has to be construed narrowly to discern the true intent and import of the fiction and its application. Although the word `income' is of wide import and elastic nature but it does not include capital receipts unless the legislature taxes it through some explicit statutory provision. Widest amplitude of even Constitutional Entry relating to taxation of `income' does not extend to tax something that is not a citizen's income. 2. Keeping in mind the above principles, first of all it needs to be determined whether compensation received on delayed refund comes within the ambit of `income' as envisaged in section 2(29) read with section 4 the Ordinance or not. The definition of the word "income" as given in section 2(29) of the Ordinance only gives a general concept of the term. Use of the word "includes" in a definition clause means that apart from the generally accepted meaning of the term, certain other things have also been included in it by fiction of law. 3. It is a generally accepted principle that legal fiction is to be strictly construed and strictly used for the purpose for which it was created. It is always for the Revenue to bring a receipt under any one or more heads specified in a section. The law does not provide that whatsoever is received or is accrued to a person, it must be regarded as income. 4. It is an unquestionable position of law that compensation relating to capital assets is a capital receipt and that relating to stock‑in trade is, revenue receipt. The following case‑law is explicit on this issue: Commissioner of Income Tax (East) Karachi v. Forbes Campbell & Co. Ltd. (1979) 39 Tax 21 (H.C. Kar.). Oberoi Hotel Ltd. v. CIT 236 ITR 903 (SC). E.I.D. Parry Ltd. v. CIT (1998)233 ITR 335 (Mad.): CIT v. Seshasayee Bros. (P.) Ltd. 239 ITR 471 (Mad.). CIT v. Barium Chemicals Ltd. (1987) 169 ITR 164 (AP). Kettlewell Bullen & Co. Ltd. v. CIT (1964) 53 ITR 261. Probhu Dayal (1971) 82 ITR 804 (SC). Gillanders Arbuthnot‑& Co. v. CIT (1964) 53 ITR 283. Godrej & Co. v. CIT.(1959) 37 ITR 381. CIT v. Shaw Wallace & Co. AIR 1932 PC 138. CIT v. Wazir Sultan & Sons (1959) 36.ITR 175 CIT v. Bombay Burmah Trading Corporation (1986) 161 ITR 386(SC) Kalyansingh (Rao Raja) (1974) 97 ITR 690 (Raj.). 5. If we apply the ratio decided in above cases, the inescapable conclusion is: the nature of compensation on delayed refund is capital as it represents damages received for injury caused to the profit‑making structure of a taxpayer. These capital receipts are not chargeable to tax‑C.I.T. v. Krishna Industrial Corp. Ltd. (1973) 92 ITR 261 (AP). 6. The non‑taxation of compensation on delayed refund is further reinforced from the following case‑law: Interest on refund is really a part of the refund and interest and refund are not two different things CIT v. T.V. Sundaram Iyengar & Sons Ltd. 2000 PTD 2776 = 263 ITR 524. Any relief granted to a taxpayer cannot be his income 6 ITR 434. Money deposited remains un‑refunded, interest earned on such money is not income as Income Tax Department stood in a fiduciary position to the taxpayer ‑ 84 ITR 713, 75 ITR 433 and 96 ITR 646. Payment under section 171 is in the nature of damages, it is not "interest". It is part and parcel of capital sum due, hence not income chargeable to tax, being capital receipt in nature. Simpsons v. Executor of Bonner Mairice 14 ITC 580 (CA) & IR v. Ballantine T.C. 595, (page 157, Law and Practice of Income Tax by Mian Zahooruddin). Compensation awarded for wrongful withholding or detention of money constitutes a capital sum Godreg & Co. v. CIT (1954) 25 ITR 108. 7. The Supreme Court held in CIT v. Smith Kline & French of Pakistan Ltd. and two others 1991 PTD 999 = 1991 SCMR 2374 that to treat a receipt as income necessarily requires a finding of fact that it was covered by the word income as defined in section 2(24). In all the cases in which a receipt is sought to be taxed as income, the burden lies upon the Department to prove that it is within the taxing provisions. In Pakistan Industrial Development Corp. v. Federation of Pakistan 1992 PTD 576 = PLD 1992 SC 562, the apex Court held that "an amount which is not income cannot be taxed". 8. C.B.R.'s Circular No. 21 of 1975 also confirms that any compensation received for loss of injury to a capital asset is a capital receipt. The onus lies on the Department to establish that compensation falls within the ambit of the word income as envisaged under the Ordinance. There is no onus on the taxpayer as no exemption has been claimed. The question of exemption arises‑where a receipt undeniably comes within the definition of income, but is specifically granted exemption by a provision of law. When a receipt is not an income the, question of claiming exemption does not arise. The taxpayers should claim that compensation on delayed refund falls outside the ambit of chargeability being capital in nature and if the Department opines otherwise then the onus lies on it to prove its point. In the light of authentic case law cited above, it can safely be concluded that compensation on delayed refund is capital in nature. Since it arises out of injury caused to capital asset [refund due is not revenue receipt], it is not taxable in the light, of decision of the Judicial Committee of Privy Council in Girish Chunder Lahiri v. Shashi Shashi Shikhareswar Roy (27) Indian Appeal 110 [quoted and relied upon by High Court of Kerala in CIT v. Mrs. Annamma Alexander (1998) 58 Taxman 47] that any interest awarded for loss suffered on account of deprivation of property [unlawful possession of refund by the Department falls in this category] amounts to compensation and would not be taxable.