1963 PLP 512 (PTD)

FARUQUI, J.‑The Income‑tax Appellate Tribunal, Karachi, has under section 66 (1) of the Income‑tax Act, referred the following question for the opinion of this Court :‑ "Whether in the case of the applicant company, which is assessed in Pakistan under the second method provided in rule 33, the provisions of section 10, subsection (2), clause (vi) proviso (b) should apply in calculating depreciation allowance on the company's world business, in each successive year, for the purpose of determining the profits or loss attributable to the business in Pakistan?"

2. The facts are these. The United Netherland Navigation Co., hereinafter referred to as the assessee, is a non‑resident shipping company with its registered place of business in Holland. Its assessment in this country is made through Messrs Volkart Bros. who are their local agents. As the company did not maintain any separate accounts for its business in Pakistan, assessment of profits and loss in all the assessment years in question, viz., 1950‑51 to 1954‑55 were made under rule 33 of the Income‑tax Rules on the basis of freight earnings in Pakistan. The Income‑tax Officer determined net losses including unabsorbed depreciation in the assessment for the years 1947‑48 to 1951‑52 but he did not determine the trading losses and unabsorbed depreciation during those years separately. Therefore, in setting off the previous losses from the years 1947‑48 to 1951‑52 from the profits of the subsequent assessment years 1952‑53 to 1954‑55 he did not follow the provision contained in section 24 (2) proviso (b) of the Income‑tax Act. The assessee being dissatisfied with the method followed by the Income‑tax Officer took the matter in appeal before the Appellate Assistant Commissioner who upheld the contention of the appellant in so far as the question of setting off the trading losses was concerned. He held that the trading losses of the business carried forward from the assessment years 1947‑48 to 1951‑52 should have been first set off against the net profits of the assessment years 1952‑53 to 1954‑55 and after that the unabsorbed depreciation should have been set off, if necessary. However, with regard to the con tention of the assessee relating to the method of determining and setting off depreciation the learned Commissioner observed as follows :‑ "But as regards the contention that unabsorbed depreciation of one year should have been added to and deemed as part of the depreciation allowance for the next assessment, the con tention is acceptable if in this case it is restricted to depreciation in respect of the appellant's business in Pakistan only. The idea behind this contention of the appellant as appears from statements submitted at the time of hearing to be that the unabsorbed depreciation of the Company's world business should have been added and deemed as part of its depreciation for the next assessment year and that it should have been apportioned in that year in accordance with freight earnings in Pakistan for the purpose of determining the depreciation in respect of the appellant's business in Pakistan for that year and so on. I cannot accept such contention of the appellant as this does not appear to be the meaning of proviso (b) to section 10 (2) (vi) of the Act." The assessee took the matter in appeal before the Appellate Tribunal in respect of all the five years and the only contention, which was raised by the assessee, was in respect of the depre ciation allowance which had been rejected by the Appellate Assistant Commissioner. The Tribunal, however, upheld the view taken by the Appellate Assistant Commissioner and observed as follows :‑ "As the income of a non‑resident is limited to the amount accruing or arising to it within the taxable territories we think that the depreciation allowance too has to be allowed on a proportionate basis irrespective of the total amount due in respect of its world assets and its business activities outside its territorial jurisdiction." The assessee then applied to the Tribunal who have now referred the question as stated above to this Court.

4. The question which has been referred to us is not happily framed. The real contest between the assessee and the Department is that whereas, according to the former it is the unabsorbed depreciation of the company's world business which has to be added and deemed to be a part of its depreciation for the next assessment year and has to be proportionately set‑off against the freight earnings in Pakistan in that year, and according to the latter the depreciation allowance has to be determined every year in proportion to the assessee's freight earnings in Pakistan in that year and carried forward, if necessary. In other words, as stated by the learned counsel of the respective parties, the question was whether the set‑off should be in relation to the world depreciation pool or restricted to the Pakistan depreciation pool, if any. The contention of Mr. Fazlur Rahman, the learned counsel for the assessee, was that inasmuch as his client was taxed upon the basis of its world income under the second part of rule 33 of the Income‑tax Rules, the assessee's world pool of unabsorbed depreciation should be taken into consideration for the purpose of applying the provisions of proviso (b) of sub‑clause (vi) of section 10 (2) of the Income‑tax Act. It would now be necessary to refer to these provisions. Under section 10 (1) tax has been made payable by the assessee in respect of the profits or gains of any business . . . carried on by him. Subsection (2) lays down that in computing such profits or gains certain allowances have to be made. We are concerned with the allowance contained in sub‑clause (vi) which relates to depre ciation. Then proviso (b) of this sub‑clause lays down as follows :‑ "(b) Where, in the assessment of the assessee or, if the assessee is a registered firm, in the assessment of its partners, full effect cannot be given to any such allowance in any year not being a year which ended prior to the 1st day of April 1939, owing to there being no profits or gains chargeable for that year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of clause (b) of the proviso to subsection (2) of section 24, the allowance or part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following year and deemed to be part of that allowance, or if there is no such allowance for that year, be deemed to be the allowance for that year, and so on for succeeding years." There is a similar provision for the carrying forward of trading loss contained in subsection (2) of section

24. When it comes to setting off the trading loss or depreciation of the previous year it is the trading loss which has to be set‑off first and the depreciation allowance comes after it. Now, let us examine the effect of the aforesaid proviso. Under sub‑clause (vi) depreciation allowance has to be given while computing the profits and gains of the business. In a particular year when full effect cannot be given to such a depreciation allowance owing, either to there being no profit or the profit being less than the allowance, then subject to section 24 (2) (b) which relates to trading losses, the depreciation allowance or part of it to which effect has not been given, has to be added to the depreciation allowance for the following year and the allowance so carried forward shall be deemed to be a part of the allowance of the following year.

4. From the above it seems to be clear that the depreciation allowance has to be determined every year like the trading losses regardless of the fact whether full effect to it can or cannot be given in that year. We do not see how the unabsorbed depreciation allowance is to be carried forward and added to the depreciation allowance of the following year unless it is calculated. The next question is with regard to the application of this rule in case of a non‑resident assessee who is taxed under the second part of rule

33. Rule 33 reads as follows: "

33. In any case in which the Income‑tax Officer is of opinion that the actual amount of the income, profits or gains accruing or arising to any person residing out of the taxable territories whether directly or indirectly through or from any business connection in the taxable territories, or through or from any property in the taxable territories or through from any asset or source of income in the taxable territories, or through or from any money lent at interest and brought into the taxable territories in cash or in kind cannot be ascertained, the amount of such income, profits or gains for the purposes of assessment to income‑tax may be calculated on such percentage of the turnover so accruing or arising as the Income‑tax Officer may consider to be reasonable, or on an amount which bears the same proportion to the total profits of the business of such person (such profits being computed in accordance with the provisions of the Income‑tax Act) as the receipts so accruing or arising bear to the total receipts of the business, or in such other manner as the Income‑tax Officer may deem taxable." (The material part has been italicised by us). In the present case the principle contained in the italicised portion of the rule has throughout been applied to the assessee.

6. Mr. Noorul Arfin, the learned counsel for the Depart ment, urged that inasmuch as there is no provision for the apportionment of the depreciation allowance in rule 33 which applies to the assessee the rule contained in the proviso (b) to sub‑clause (vi) referred to above cannot apply to the present case. We cannot agree, because this rule does provide that the profits have to be computed in accordance with the pro visions of the Income‑tax Act, and since section 10 lays down that in determining the profits certain allowances have to be made the allowance contemplated in sub‑clause (vi) of section 10 (2) must be given effect to. Mr. Arfin then argued that if that is so, then of necessity the depreciation allowance has to be calculated every year in relation to the assessee's earnings in Pakistan vis‑a‑vis their world earnings. We are of the opinion that having regard to the provision of the proviso, with which we have dealt earlier, this contention of the learned counsel for the Department must be given effect to. Mr. Fazlur Rahman for the assessee argued that there was no provision in the Income‑tax Act for determining the proportionate depre ciation every year with reference to Pakistan earnings and, therefore, his formula of relying upon the world pool of depreciation of the assessee should be accepted, and this, according to him, was a fair formula having regard to the fact that the assessee was being taxed upon the basis of its world income. We do not agree. We have attempted to show from an analysis of the proviso (b) to sub‑clause (vi) that in order to give effect to the scheme of carrying forward an unabsorbed allowance it would be necessary to determine that allowance even though it cannot be given effect to in a particular year. That being so, the need for determining proportionate depreciation with reference to Pakistan earnings is easily deduceable from the proviso itself. And if the company is assessed in relation to its Pakistan earnings upon the basis of its proportion to the world income we do not see any unfairness in the formula followed by the Department whereby the depreciation allowance has also to be determined upon the same basis. Mr. Fazlur Rahman drew our attention to the instruction contained in the Income tax Manual at page 250 relating to the application of rule

33. This instruction is in respect of foreign shipping companies carrying on business in the taxable territories. It provides that if a company furnishes annual account for the whole of its business, Pakistan and foreign, the second method provided by rule 33 will reasonably be applied. It further says that depreciation has only to be considered in calculating the world profits and these are to be calculated according to the Income‑tax Act. It then says :‑ "What follows applies to the calculation of depreciation according to the Pakistan rules. For this purpose, a complete depreciation record has to be maintained for the entire fleet. Depreciation begins to run from the first year in which the Company is `assessed' in the taxable territories, that is, the first year in which its profits or (loss) where determined for the purpose of deciding whether it was liable to income‑tax. Unabsorbed Depreciation, i.e., any balance of depreciation which cannot be allowed if the year owing to the profits not being sufficient to cover the full amount permissible under the rules in force in the taxable territories will be carried forward and allowed as far as possible in calculating the world‑profits according to the method followed in the taxable territories in the following year and if necessary in subsequent years provided that unabsorbed depreciation for 1938‑39 and earlier years cannot be set‑off against an assessment for 1939‑40 or any subsequent year. The proportion in the taxable territories receipts/total receipts is applied to the world‑profits calculated according to the method followed in the taxable territories (if there are any such profits) and the result is the Pakistan income liable to tax. No further deduction is permissible from the amount thus arrived at on account of depreciation (unabsorbed or otherwise) or anything else. The due proportion of all allow ances permissible is automatically set‑off against the Pakistan profits by the above method." We do not think that these instructions lay down anything contrary to what proviso (b) of sub‑clause (vi) has laid down as we have tried to explain earlier. But if it did, we would have to overlook it, because what we are required is to answer the question of law and it is nobody's case that these instructions have the force of law.

6. Our answer, therefore, to the question referred to us is that the provision to section 10 (2) clause (vi) proviso (b) should apply in calculating depreciation allowance on the company's business in Pakistan upon the same principle of apportionment which is applied in determining its income every year for the purpose of assessment. Reference answered in affirmative.