1990 PLP (Trib (PTD)

This appeal has been filed at the instance of an `Individual' who is a Director in a Limited Company. The appeal assails order dated 19‑3‑1986 passed by the learned Commissioner of Income Tax (Appeals), Faisalabad in respect of the assessment year 1980‑

81. The only issue in dispute relates to an amount of Rs. 35,588, which was deemed as income by resort to subsection (7) of section 12 of the Income Tax Ordinance. This action was based on the discovery of an interest free loan/advance at Rs. 967,571 on which deemed interest was calculated at 12%. The learned counsel for the Appellant submitted that it was not in controversy that the loan/advance was made by the Appellant. It was however, explained to the assessing officer that the loan/advance was made to enable the company to tide over its financial difficulties hence, it was covered by CBR Notification S.R.O. No.50 dated 23‑8‑1989. This Notification was issued in exercise of powers vested in the CBR by the clause (b) of the first proviso to subsection (7) of section 12 ‑of the Ordinance. Mr. Zia Kayani, the learned counsel, drew my attention to the observation by the assessing officer where he attempted to judge the financial worth of the Company to which loan/advance was made. He referred to the figures of net profit, the total profit, the cash‑at‑bank, the sundry debtors and creditors (etc.) to finally conclude: "the name of the company has not been notified or published in the official Gazette as "sick company". The learned counsel developed the argument that to be in `financial difficulties" it' "was not necessary to get oneself declared as a "sick unit" hence the assessing officer should have considered the explanation filed with him (alongwith the statement of accounts and the balance‑sheet) to judge whether liquidity or the cash flow were of such magnitude as made it a valid case of being in `financial difficulties'. To this end, learned Mr. Kayani demonstrated tie working of the Quick (or liquidity) Ratio as also the Current (or solvency) Ratio to establish that the former stood at 0.63 :1 and the, latter at 0.80 : 1 while the expected safe margin to meet immediate commitments, as per universally accepted principles of Accountancy, are 1:1 and 2:1 respectively. Reference was made by the learned counsel to letters dated 25‑3‑1983 and 30‑10‑1983 submitted by the Appellant (in response to show‑cause notice under section 62) to the assessing officer where it was explained that a processing unit installed by the Company had run into losses resulting in financial disaster which compelled the Appellant to give up drawing the salary and also to advance money through his current account so that the Company be able to "tide over the financial difficulties". The learned D.R. controverted this argument, but argued in general terms, that no interest having been charged on the loans/advances the provisions of section 12(7) were fully attracted and the `deemed income' at Rs. 35,588 should have been retained by the learned Commissioner, Having considered the rival arguments advanced by the two sides and, having examined the legal as also the factual position I notice that the term "sick unit" has not been defined anywhere in the Income Tax Ordinance nor, for that matter, in any other legislation. However, in business and commercial parlance, as also for the purpose of treatment in the Income Tax Ordinance as respects treatment of loss, a "sick unit" is commonly understood to be the one which has not been operating its business successfully and successive losses have rendered it incapable to meet commitments with the financial institutions ( = PICIC, IDBP or Bankers Equity) who, on their part are anxious in a `rival plan for such unit. However, such an extremely unfavourable and unfortunate state of affairs is not the only criterion to judge whether an enterprise is the one in "financial difficulties. It is normally (and understandably) more difficult for an enterprise not making such progress in terms of growth, to raise loans/advances from outside sources which naturally compel it to seek help from its immediate circle of business partners, directors or even personal acquaintances, the prime concern being a maximum of certainty and minimum of expense. A Director responding to such a call is no unusual phenomenon. The assessing officer's presumption that a company in `financial difficulties' should necessarily be the one whose name has been notified and published in the official Gazette as a "sick unit" is thus contrary to the concept prevailing in business circles besides being erroneous in law. This brings me to evaluate justification for giving up (by the Director/lender) of the interest on such loan/advance and to ascertain whether real "financial difficulties" did exist. Financial statements, rules and principles of Accountancy are useful tools to provide an answer in this behalf. Certain accounting ratios have been used (for decades) to measure the performance of business. These comprise of the balance sheet ratios, the operational ratios and the efficiency ratios of which some provide test of liquidity (i.e. availability of funds) such as the Current Ratio and the Quick Ratio (also called the liquid or the ?acid test? ratio, to which reference was made by the learned counsel, Mr. Kayani. A poor Current Ratio reflects shortage of working capital and an unfavourable Quick Ratio reveals unwise use of funds. A percentage balance sheet' is at times drawn to discover the extent of the capital employed and the finance obtained from outside sources. True, statistical analysis is not an exact science but its conclusions are nonetheless valuable. Therefore, it appears reasonable to assume that only by utilisation of various tests available and the relevant material affecting them, that a fairly accurate verdict could be passed by the assessing officer about the financial difficulties of the enterprise to whom interest‑free loans/advances was extended. So as to fully comprehend the aspect of "financial difficulties" necessitating the making of interest‑free loan/advances to enable the enterprise to `tide over' the difficulties, it was incumbent on the assessing officer to make full use of his knowledge of Accountancy to analyse the financial statements, including the use of ratios. This evidently he did not do, hence blundering on the way he reached a hasty and infirm conclusion. Taking the entire conspectus of the facts and circumstances attending the issue for adjudication, I feel no hesitation to hold that the Appellant was compelled to extend an interest‑free loan/advance so as to help his Company overcome the deteriorating liquidity and solvency position hence the transaction can safely be termed as making a loan/advance by the Director of a Pakistani Company to help `such company to enable it to tide over its financial difficulties'. Such like transactions, in my judgment, are fully covered by clause (b) of the proviso to subsection (7) of section 12 of the Income‑tax Ordinance. In this view of the matter, I vacate quo ad hoc the order by the learned Commissioner and delete the addition at Rs. 35,588 by way of deemed income through resort to section 12(7) of the Income‑tax Ordinance. The appeal, thus, SUCCEEDS. M.B.A./902‑T????????????????????????????????????????????????????????????????????????????????????? Appeal accepted.