1989 PLP 612 (PTD)

SALEEM AKHTAR, J.--The respondents are subsidiary company of Pfizer Corporation an international organization with its head office at Panama. The respondents are manufacturers and vendors of pharmaceutical products in Pakistan. Their status is of a resident and ordinary resident. While examining the accounts of the respondents the Assessing Officer noticed that penicillin and sodium which were purchased by them from their principal were at a higher rate than the prices of these items in the international market He, therefore, held that this was a device arranged between the respondents with a non-resident i.e. their principal so as to produce to respondent's profit less than the ordinary profit which might have arisen to them. He, therefore, invoked section 41 (2) of the Income Tax Act and calculated the loss of profit to the extent of Rs.12,01,115 and added the same to the income of the respondents. The respondents filed an appeal before the Appellate Assistant Commissioner who observed that the provisions of section 42, subsection (2) could not be invoked because the respondents had made purchases from their non-resident principal and purchases could not produce any profits. Therefore, the question of profits being less than the ordinary did not arise. The difference of Rs.12,01,105 was deleted. The Department appealed to the Tribunal, which maintained the order of the appellate Assistant Commissioner. The Department then filed an application under section 66 (1) of the Income Tax Act and the following questions have been referred for our consideration:- "Whether on facts and in the circumstances of the case, the Tribunal was justified in holding that subsection (2) of section 42 of Income-tax Act was not applicable in this case?" The facts found by the Tribunal are that the respondents are residents and ordinary resident in Pakistan. They have a regular course of dealing and business with their Principal who are not resident in Pakistan. During the course of business dealings the respondents purchased penciling and sodium for manufacturing medicines in Pakistan. The price they paid to their principal was much higher than the price of similar goods in the international market. From these facts it can safely be deducted that the respondents in the course of dealing with their principal paid them more than they would have paid if they would have purchased at the ruling price in the international market. In these circumstances or 42(2) of the Income-tax Act. Section 42 is reproduced as follows:- (1) (All income profits or gains accruing or arising,) whether directly or indirectly, through or from any business connection (in Pakistan) or through or from any property in (Pakistan) or through or from any asset or source of income m (Pakistan or through or from any money lent. at interest and brought into (Pakistan) in- cash, pr in kind), (or through or from the sale, exchange or transfer of a capital asset in (Pakistan) shall be deemed to be income accruing or arising within (Pakistan)) and (where the person entitled to the income, profits or gains is not resident in (Pakistan) shall be chargeable to income-tax either in his name of his agent, and in the latter case) such agent shall be, deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax: (Provided that where the person entitled to the income profits or gains is not resident in (Pakistan) the income-tax so chargeable may be recovered by deduction under any of the provisions of section 18 and that) any arrears of tax may be recovered also in accordance with the provision of this Act from any assets of the non-resident person which are, or may at any time come within (Pakistan). (Provided further that any such agent, or any person who apprehends that he may be assessed as such an agent, may retain out of any money payable by him to such non-resident person a sum equal to his. Estimated liability under this subsection, and in the event of any disagreement between the non-resident person and such agent or person as to the amount to be so retained, such agent or person may secure from the Income-tax Officer as stating the amount to be so retained pending final settlement of the liability, and the certificate so obtained shall be his warrant for retaining that amount' Provided further that the amount recoverable from such agent or person at the time of final settlement shall not exceed the amount specified in such certificate except to the extent to which such agent or person may at such time have in his hands additional assets of such non-resident person). (2)??????? Where a person not resident (or not ordinarily resident) in (Pakistan) carries on business with a person resident in (Pakistan) and it appears to the Income-tax Officer that owing to the close connection (between such persons the course of business is so arranged that the business done by the resident person with the person not resident or not ordinarily resident) produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, the profit derived therefrom, or which may reasonably be deemed to have been derived therefrom, shall be chargeable to income-tax in the name of the resident person who shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax` (3)??????? In the case of a business of which all the operations are not carried out in (Pakistan) the profits and gains of the business deemed under this section to accrue or arise m (Pakistan) shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in (Pakistan). Sections 42 (1) and 42 (2) are exclusive to each other. They contemplate different situations. Section 42 (1) declares that income, profit or gain which may arise directly or indirectly from any business connection m Pakistan or any other manner as specified, shall be treated as income. Where such income arises to a non-resident in Pakistan, it shall be chargeable to Income-tax in his name or in the name of his agent. It further provides that if it is charged, in the name of the agent such agent shall be deemed to be an assessee for all intents and purposes in respect of such income-tax. Under subsection (2) a scheme has been devised to bring within the net of taxation such profits which though on record do not appear to have accrued to the assessee but in reality such profit would have accrued provided the dealing between the assessee and the non-resident person would have been in accordance with the normal course of transaction and should not have? been manipulated in. such a manner that the resident assessee is deprived of the profit which it would have normally earned from such business. Such income or profit by fiction of law is deemed to be the income of the non?resident. Therefore, in order to press in service the provisions of section 42, sub?section (2); it is necessary that the assessee be a resident in Pakistan having close business connection with a person not residence or not ordinarily resident in Pakistan and in the course of dealing has so managed that is deprived of his profit or it is reduced to less, than the ordinary profit which might be expected to arise in such business. When the Assessing Officer is satisfied that such profits which are likely to arise have not arisen in the course of such business he can charge it to income-tai in the name of the resilient who shall be deemed to be the assessee in respect of such income. Such profit should arise from business dealings, which contemplates regular and organised commercial activity further that such business dealings should be due to close connection between the parts and should not be a result of stray or solitary business arrangement. Where in the accounts maintained for such dealings between a resident in taxable territory and non-resident the profit which normally should have accrued has not been declared due to managed or manipulated devices the Assessing Officer is entitled to tax such profit. The object of section 42 (2) is to bring to the net of taxation such profit which in 'the normal course of business should have accrued to the resident assessee. The Assessing Authority has therefore, to evaluate and. examine the dealing between the non-resident and resident and to find out whether in the normal course in such transactions any profit could have accrued or a higher profit could have been earned. Where finding is in the affirmative section 42 (2) will be applicable. Section 42, subsection (2) intends to put a curb on the manipulation anti secret business deal between a resident and its close business associate by which the normal profit which 'Would have accrued does not find place in the books of account but actually it is presented in a reduced or depleted form. A further criteria laid down is that the depleted profit declared should be less than the ordinary profit which in the normal course is expected in such dealings. By adopting such device law does not permit an assessee to evade the tax by manipulated and arranged dealings between two close associates one being resident and the other non-resident. The profit, which would accrue normally in such dealing shall be deemed to be the profit of the resident assessee and will be taxed as income. The view that as the respondents have been making purchases from their parent company they could not have earned profits and therefore, section 42 (2) will not apply does not seem to be correct. If any resident company is purchasing at higher price than the international ruling price, it is incurring more expense. If this expense is reduced, the company's profit will automatically increase. Where the real profit is depleted, reduced or made extinct by manipulation and arrange transaction then by fiction of law such profit which would have accrued in the normal course in the absence of such manipulation shall be treated as income of the resident assessee. Here the principle of accrual of income as contemplated by the Income-tax Act will not be applicable. Section 42 is under chapter V entitled liability in special cases suggesting such income, which do not fall within the category of income and profit, which ordinarily accrue in the normal way. In this regard reference has been made to Mazagaon Dock Ltd. v. Commissioner "f Income-tax and Excess Profit Tax (1958) 34 I T R 368 which is a judgment of the Supreme Court of. India. In this case the appellant company which carried on business as marine engineers and ship repairers was' resident and ordinary resident in. India. Two non-resident British companies engaged in business of plying ships were beneficial of the appellant company. Under the agreement between both the non-resident and resident companies the appellant repaired their ship and charged no profit: The question arose whether the profit which the appellant would ordinarily have made in the normal course of business can be charged under section 42(2) of the Income-tax Act. After analyzing the provisions of section 42(2) it was observed that under it the notional profit is taxable and the charge is imposed in respect of profit he had not in fact made. It was further held that subject-matter of tax under section 42(2) is the business of the resident and not that of the resident. Section 42(2) was therefore, held to be applicable. In our view in the light of the Tribunal's finding regarding business connection and business activities between the respondents and their parent company and a further finding that the, business was managed as to deplete the profit of the respondents from the normal profit which should have been expected to be earned keeping in regard the international ruling market price of the goods purchased by them, the provisions of section 42, subsection (2) clearly apply to it. We, therefore, answer the question in the negative. M.B.A./C-85/K ????????? ????????????????????????????????????????????Reference answered in negative.