2026 PLP 269 (PTD)

SARDAR EJAZ ISHAQ KHAN, J.

When a customer contracts with a courier company to deliver his package to its international destination, does the customer pay for the use of the courier's computer network, the cargo planes and the cargo vehicles? Does a customer ordering a coffee at a coffee shop pay for the use of the coffee machine? Does an industrial concern contracting with a utility company for supply of power pay for the use of, or acquire the right to use, the power generation equipment of the power utility? The commonsense answer to all these questions is in the negative, reflecting the true commercial and legal character of such transactions. In all these cases, it would be inane to say that the customer contracted to use, or acquired the fight to use, the equipment of the services or goods provider. But this is precisely the inanity that underpins the repeat orders passed by the tax department and, we say with somewhat reserved respect, by the learned Appellate Tribunal also, all of whom held that the taxpayer companies used or acquired the right to use the equipment and networks of their counterpart international interconnecting telecom companies for the conveyance of telecommunication traffic between and across their respective networks.

2. These clubbed income tax reference applications owe their genesis to the demands generated by the tax department under sections 161 and 205 of the Income Tax Ordinance, 2001, for the alleged failure of the applicant taxpayer companies to withhold tax from the payments made by them to their international interconnecting counterparties, characterized by the tax department as 'royalty' payments, in view of section 2(54)(e) of the Ordinance, which, in relevant part, reads as follows: "royalty" means... [the] consideration for... (e) the use of or right to use any industrial, commercial or scientific equipment...

3. The tenor of the assessing officer's order-in-original and of the appellate orders was that the interconnect agreements between the applicant taxpayer companies and their international interconnecting partners were intended for, or resulted in, the use of the telecommunication networks of the latter in the conveyance of traffic between the respective networks, which translated into the use of or right to use the scientific equipment (or industrial or commercial equipment) of the foreign companies. The orders reasoned from that premise that the payments by the taxpayer companies were therefore royalty payments, which were subject to withholding under section 152 of the Ordinance that was not deducted.

4. There are scarcely any business or consumer transactions in today's time and age where some industrial, commercial or scientific equipment is not used to deliver the contracted goods or services. If the interpretive logic of the tax department is allowed to prevail, then the consideration for all such transactions will constitute royalty payments; even the payments for refueling at a petrol station or an X-ray or CT scan at a hospital will tantamount to royalty. One is bewildered how the entire tax hierarchy could come to this utterly preposterous interpretation that flies in the face of all commercial, logical and practical realities of the myriad transactions in everyday life.

5. The reasoning of the tax department and of the appellate bodies is the result of the logical fallacy commonly known as the fallacy of illicit conversion. This fallacy occurs when the converse of a statement is, ex facie, taken to flow of necessity with equal validity as the original statement of which it is the converse. An example would be 'All communists are atheists, therefore, all atheists are communists.' Another example of illicit conversion would be 'All dogs are mammals, therefore, all mammals are dogs'. The statement of law in section 2(54)(e) that 'payments are royalty if made for the use or right of use of industrial, commercial or scientific equipment' does not command the validity of its converse, namely, wherever Industrial, commercial or scientific equipment is used in a transaction, the consideration for such transaction is royalty . It cannot be so because, arguendo, if it be so, then what are we to make of, say, section 2(23)(a) defining "fee for technical services" for 'construction, assembly, or like project', or of "information technology services" defined in section 2(30AD), as both will invariably entail the use of some industrial, commercial or scientific equipment by the construction or the IT companies. As noted above, there would be very little left in the Ordinance of any characterisation of transactional payments other than royalty if the tax department's interpretation of section 2(54) is followed.

6. Anyone with even a superficial familiarity with the interoperability of telecommunication networks knows that the interconnection agreements are made for conveyance of traffic between the interconnecting networks, with the use of the respective equipment and networks being necessarily incidental to the contracted services of two-way conveyance of traffic. Neither party confers any right of use of its equipment to the other, but uses it itself, only to provide the contracted service. The ones familiar with interconnect agreements know quite well that the host operator determines the traffic reception, routing, switching, handover, and other operating parameters (within the bounds of standardised interoperability and regulation-mandated protocols) of its network vis- -vis the traffic received in its network at the interconnection point, and retains full control and dominance of its own network equipment; the guest network operator uses (or exercises the right of use of) the host operator's network equipment no more than, say, a customer who buys a car manufactured by an automobile manufacturer using its plant and machinery the customer pays the consideration for the car, not for the use of the plant and machinery.

7. In interconnect agreements, as in all the illustrations given here, the use of equipment of the counterparty is not the transaction the parties enter into; it occurs as a necessary incident of the transaction. There is no warrant in law or logic for the tax department to characterise a transaction contrary to what the parties contracted between them if the operative nature of the transaction remains what is contracted and is not a sham cover for the real underlying transaction. In a nutshell, the proposition and stance of the tax department is so preposterous that unveiling it tests the very limits of common sense and logic.

8. Section 2(54)(e) on its proper construction stipulates that, in order to constitute royalty, the consideration must be for the use or right of use of the counterparty's equipment; the contractual promise by the counterparty must be that the first party will use, or will have the right to use, the counterparty's equipment. If, however, the promise is that the counterparty will provide services or goods that, in order to perform that promise, will entail the use of the counterparty's equipment by the counterparty, then the consideration is not for the use of the counterparty's equipment, but for the services or goods procured by the first party. This simple distinction is ignored purposely by the tax department in its ravenous hunger for taxes. By its fallacious and ludicrous interpretation, the tax department has made a mockery of centuries old customary character of royalty, and has obliterated the distinction between the myriad legal constructs of agency, franchise, distribution, fee for technical services, construction, technology services, and countless others, subsuming all into one umbrella appellation of royalty.

9. Learned counsel for the tax department referred to various regulatory instruments by the telecommunications regulator making it necessary for the dominant telecom operators to allow non-dominant operators to access and interconnect with the former's equipment and networks, and sought to argue from that premise that the regulatory framework envisages the 'use or the right to use the dominant operator's network and equipment by the non-dominant operators. This argument stems from unfamiliarity with the commercial and Technical realities of interconnection and its regulation. The right to access and interconnect with the dominant network is the outcome of the anti-monopoly regulation, so that the dominant operators 'open up' the communication highways in the interest of competition and to remove barriers to entry, only to enable wider interoperability of networks. The regulatory intervention was not to enable the use or the right to use the dominant networks as an objective in and of itself, but only to the end of ubiquitous flow of telecom traffic across large and small networks, for which consideration remains payable to each other by both the interconnecting networks depending on the net flow of traffic. The reciprocal payment obligations of interconnecting companies (depending on the net accounting of traffic and pricing) is another feature distinguishing them from royalty; section 2(54)(c) envisages only one-way flow of payments by the user of the equipment, with the reciprocal consideration being the provision of the equipment to the user.

10. The bulk of the analysis in the Appellate Tribunal's judgment is devoted to the discussion of the exemptions from taxation of royalty income under the treaties for the avoidance of double taxation. That discussion becomes quite irrelevant once it is concluded that the interconnect payments did not constitute royalty.

11. Resultantly, the question of law in this and the clubbed reference applications, namely, whether interconnect payments constitute royalty, is answered in the negative, that is, for the taxpayer companies and against the tax department.

12. Let a copy of this order be sent to the Registrar of the learned Tribunal under the seal of this Court. UN/225/Isl Order accordingly.