2012 PLP (Trib (PTD)

MUHAMMAD IQBAL KHAN (ACCOUNTANT MEMBER).

Through this order we intend to dispose of cross appeals filed, by the Taxpayer and the Department against the Order of the learned Commissioner Inland Revenue (Appeals-I), Karachi dated 13-11-2009. First we take up appeal filed by the Taxpayer. The grounds of appeal advanced by the Taxpayer in I.T.A. No. 144/KB of 2010, are as under:-- "(a) That the learned Commissioner Inland Revenue (Appeal-I) has essentially misdirected himself and has misinterpreted the word 'entitled' and has wrongly disallowed the claim for exemption (on Inter-Corporate Dividends) under Clause 103-A of Part I of the Second Schedule to the Income Tax Ordinance 2001. (b) That the learned Commissioner Inland Revenue (Appeals-I) wrongly disallowed claim of deduction on account of financial charges on borrowing meant for expansion of the business. (c) That the learned Commissioner Inland Revenue (Appeals-I) erred in confirming the prorating of the expenses on account of some passive functions: (d) That the learned Commissioner Inland Revenue (Appeals-I) misconceived the concept of fixed assets and wrongly disallowed initial depreciation on software which is embedded in the hardware. (e) That the learned Commissioner Inland Revenue (Appeals-I) was not justified to hold the Taxation Officer's prorating and assigning the expenses assumed to be relating to earning dividend income from the expenses claimed towards normal tax income. He has therefore misdirected himself in confirming disallowance and prorating expenses relating to dividend income. (f) That the learned Commissioner Inland Revenue (Appeals-I) has erred to consider electricity and gas provided to the company owned houses on factory site as employees' perquisite and has wrongly confirmed addition under section 21(c)."

2. During proceedings before this Court the A.Rs. of the taxpayer argued that the learned CIR(A) was not justified to confirm the Departmental treatment of disallowing the appellant's claim of exemption to inter-corporate dividends of Rs.1,165,000,000 which the appellant had received from its wholly owned subsidiary and had claimed exempt under Clause (103A), Part I of Second Schedule to the Ordinance. It was submitted that the learned CIR(A) was of the view that for availing exemption under the said Clause (103A), the condition laid down in section 59AA were to be "first complied with before invoking this clause". It was argued that in their opinion the learned CIR(A) misdirected himself in ascribing meanings to the statute which was not intended by the legislature. Had legislature intended to make compliance to the requirements of section 59AA precondition to the availing of the benefit under clause (103A), it would have said it in so many words. It was, therefore, contended that this not being the position, the word "entitle" signifies that any company which is entitled under section 59AA can avail the benefit of said clause.

3. The Learned AR further contended that it is worth noting that the word of 'entitled' is used in the section and the word of opting is not used. If the wholly owned group companies are 'entitled' for group taxation then the dividend income would be exempt. Opting for group taxation or filing of an irrevocable option is not the requirement as per the clause 103 A, Part-I of Second Schedule. Going to that extent would make the said clause (103A) redundant since in a situation where option is made and the assessment/return is made on the consolidated basis, the payment of dividend will become meaningless since it would be an internal movement of money within one taxable unit lacking the elements of a transaction. It was further argued that it is against the basic principles of interpretation to ascribe a meaning/interpretation to a legal provision that would render it redundant. The Department's interpretation which was adopted by the learned CIR(A) was therefore against the principles of interpretation of statutes.

4. The DR reiterated the Department's stance taken in the amended assessment and maintained that entitlement would only arise upon if the taxpayer opts to file a consolidated return along with its 100% owned subsidiaries.

5. We have heard to the rival arguments of both the sides and perused the record and the statutes. After considering all the facts and circumstances we are of the opinion that the appellant's view holds weight especially since the stance taken by the Department would essentially mean that two or more qualifying companies of the group opt to file a consolidated return as one tax entity. Due to consolidated accounts their internal transactions would become nullity since one cannot trade with one's ownself. This would lead to payment of dividend becoming an entry in the same book in which the money will move from the P&L account to the retained earnings or appropriation for payment to the shareholders of the parent company and the step of payment of dividend from subsidiary to the parent company will get simply eliminated. In that situation there will be no need ever of applying the said clause (103A). We therefore accept the appellant view on this issue and accordingly direct that the inter-corporate dividend received by the appellant be treated as exempt.

6. In support of the ground regarding disallowance of the of long term financial charges on the monies borrowed for the expansion of the appellant's business, it was argued that the learned CIR(A) misdirected, himself by not allowing deduction of the financial cost of the funds borrowed for the expansion of the existing business while the income earned on deposit of the same funds was taxed during the year. It was further argued that the learned Commissioner deviated from the already decided legal principles in cases of the higher forums cited as 2000 PTD 2906, 1997 PTD 43 (Trib.) and 1997 PTD 1454 (Trib.) in which, the superior appellate forums have held that in case of borrowing cost for expansion of an existing business it would be a deductible expense and not a capital expense. It was also argued that the action of the learned CIR(A) is not only inconsistent with the case-laws but also within the same transaction as while he has disallowed current deduction of the financial charges on the borrowed funds for the expansion purposes he has allowed taxation of the income from those borrowed funds to be taxed as revenue receipt. If receipts were current on the same ground the financial expenses on the same funds, which are just opposite of those receipts, should also be treated, as revenue expenses.

7. The DR argued that since the financial expenses are related to the finds borrowed for the expansion project and which has still to be commissioned as mentioned on pages 12 and 13 of the amendment assessment order therefore, those are pre-operation expenses and shall be made part of the capital value of the underlying assets.

8. We have heard to the rival arguments of the two sides and have perused the impugned order as well. We find that the learned CIR(A) has dealt with the issue in detail on the factual plane and have found some fault with the figures of the underlying amounts in various parts of the annual statements of the appellant. On that basis he has concluded that allowing the long term financial expenses would tantamount to double deduction. He has however not dwelt upon the legal basis of the allowing or disallowing the said financial charges as current expenditures. In line with the ratio of the cases-laws cited by the learned ARs of the taxpayer we tend to agree with the legal principle that financial charges on expansion of an existing business are allowable as revenue expenses but as elaborated by the learned CIR(A) in his order there seems to be some inconsistency between the figures in the computation sheet filed by the taxpayer with the original assessment/return and the annual accounts, which makes it difficult to determine the quantum of the allowable current expense. It goes without saying that in case of capitalization the taxpayer would be allowed to take depreciation on those capitalized values and recover those expenses over time. We therefore, uphold the essence of the order of the learned CIR(A) the issue and direct the parties to draw up the tax depreciation table for the year anew and allow the admissible depreciation as per law. Regarding earning on the deposit of those funds we find that being "Income from Other Sources" will get taxed as a separate block and cannot be let to be net off against the financial expenses, which do not relate to that head of income.

9. On the issue of prorating certain expenses on the account of allocation to dividend and exempt income we direct to follow our order, in another appeal (I.T.A. No. 260/KB of 2010), in the taxpayer's own case.

10. In support of the ground regarding disallowance of expenses incurred on supply of gas and electricity to the on-site residential colony maintained by the appellant for its employees, the AR argued that the said colony is integral part of the factor set up and if the residential colony element is taken off the Organizational structure, there would hardly be any possibility of running the factory even for a single day since the manufacturing process is such that it has to be run round the clock and because of production of ammonia gas during the manufacturing process it is imperative that strict mechanical and human watch is kept to avoid any industrial accident, which may lead to catastrophic outcomes. He also argued that since there is no city within the reasonable distance of the factory, it becomes doubly necessary that such a residential colony is maintained on site. He also argued that in the appellant's other factory, located near Port Qasim, Karachi there is no such colony maintained since none is required as workers can live in nearby communities. The learned A.R argued that the appellant contention throughout the process has been that it has not provided electricity, and gas to the employees but to its owned, managed and maintained residential units there employees live as licensees only during their tenure at the factory. He concluded that it being the business, need of the appellant expenses incurred on maintaining it should be allowed because if it taken out of the equation, there would he no business and no consequent tax on the appellant's income.

11. The learned DR however emphasized that expenditure involved constitute perquisites and rightly taxed by the Taxation Officer.

12. We have considered the arguments advanced by the learned AR and learned DR and basis of disallowance by the Taxation Officer and later confirmation by the learned CIR(A). The authorities below have disallowed the expense amounting to Rs.11.8 million treating it as part of the perquisites and invoked section 13 and on that basis disallowed it under section 21(c) as reportedly tax was not withheld on that part of the concerned employees salaries. The appellant contention exclude the expense from purview of perquisites, that it has not provided electricity and gas to the employees but to its owned, managed and maintained residential units where employees live as licensees only during their tenure at the factory. Under these circumstances, therefore, when verifiability of expense is not disputed, in determining that whether an underlying expense was deductible, the cardinal principle of business necessity should be applied. On that count we feel that this relatively insignificant amount of Rs.11.8 million should have been allowed by the Department in the first place since it is very likely that without an onsite residential colony a chemical factory handling hazardous material would cease to do business. In the similar other facilities also we have noted that similar residential colonies are part of the factory organization. We, therefore, annul the orders of the two officers below and direct to allow the same amount of Rs.11.8 million as business related on account of business expediency.

13. The last ground relates to disallowance of initial depreciation on computer software used in the business computers. The taxpayer's argument is that these programs are part and parcel of the hardware and the benefit of the hardware cannot be utilized without these softwares. On the other hand DR pointed out that those programs were separately purchased as shown in the body of the order and that the taxpayer should have amortised those expenses over the useful life of the softwares which in his opinion was 10 years.

14. We have heard to the rival arguments of both the parties and have perused the case record. Our finding are as under.

15. Interestingly the Department has allowed depreciation but not the initial allowance, which seems incomprehensible. There is no dispute about the expense being an allowable business expense and we feel the ends of justice would be met appropriately and, in conformity with the Ordinance if the expense is amortised under section 24 with normal useful life of 3 years in case of computer softwares and therefore, we so direct.

16. In the Departmental appeal (I.T.A. No. 162/KB of 2010) the 2 ground taken are as under:-- "(a) That the Learned Commissioner (Appeal-I) Inland Revenue has erred in deleting the disallow and made on the adjustment of loss of the subsidiary company. (b) That the Learned Commissioner (Appeals-I) Inland Revenue has erred in deleting the addition of Rs.53,059,000 made on account of catalyst depreciation.".

17. Arguing in support of the ground the DR maintained that the taxpayer did not fulfill the conditions for becoming eligible for offsetting its income against losses from its subsidiary Messrs Engro Foods Limited. Referring from the body of the order he enumerated the conditions and contended that the taxpayer did not fit in the criteria for making use of the Group Relief as provided in section 59B of the Ordinance. He further argued that the Learned Commissioner Appeal was not justified in directing that the taxpayer be allowed to use Group Relief and offset its income against its subsidiary's losses. His argument rested on three alleged shortcomings on the part of the taxpayer:-- (a) That the taxpayer is engaged in the trading as part of its business activity and is therefore hit by clause (b) of subsection (2) of section 59B; (b) That the taxpayer was not designated by the SECP as required under clause (g) of the said subsection (2); and (c) That cash was not paid to the loss surrendering company by the time of filing of return.

18. Arguing on behalf of the respondent taxpayer the AR, relying on the report of the task force formed on the issue of introducing the group taxation in the country, argued that the basic purpose of the introduction of the concept of Group Relief in the country was to encourage corporate capitalization to promote industrial activity. Usually in the initial years of the businesses, companies suffer business and tax losses in great sums. Allowing qualifying associates to offset their incomes against the losses of their associated companies would fast forward the utilization of the tax loss by the new companies which would sell the loss and get cash against it from the income offsetting company. In the absence of such a provision in law the loss making company would wait for many years to let the company earn profits and then get them offset against brought forward losses from earlier years.

19. Regarding "trading" controversy it has been argued that as clear from the task force recommendations the trading losses were to be discouraged to be offset since they would not contribute to promoting industrial investment rather they would promote trading at the cost of the industrialization. Therefore surrendering of trading losses was excluded through insertion of the said clause (b) into the legal framework. Therefore if the surrendering company was a trading company, it was barred from availing group relief.

20. Regarding designation by the SECP it was argued, by AR on behalf of the Taxpayer Company that a citizen cannot be deprived of his legal rights particularly those enshrined in a law if a governmental authority has yet to frame some mechanism of implementing it. By insertion into law and coming into force of that law the right becomes available to the citizenry irrespective of the fact that some administrative or procedural mechanisms are yet to be put in place. In this context reliance was made on the ratio adopted by the Hon'ble superior judiciary in State of Bombay v. United Motors (India) Ltd. (AIR 1953 SC 252) and His Holiness Sri-la-Sri Ambalavana Pandara Sannathi Avergal v. Commissioner Hindu Religious and Charitable Endowments, Madras (1980) 93 LW 224).

21. Regarding the time of transfer of funds to loss surrendering company it has been argued that there is no time limit prescribed in the statutes and that the Department cannot put the words into mouth of the legislature. If there was to be a time limit that must have been put into the law by the legislature and there being none it was between the two associated companies to decide as to when it should occur.

22. The AR also argued that the learned Taxation Officer has misinterpreted the law in passing the amendment assessment order and that the learned CIR(A) has rightly allowed the taxpayer to offset its income against its subsidiary's losses. Therefore, order of the CIR(A) shall be maintained.

23. We have heard the rival arguments of both the parties, have perused the case record. Our findings are as under:

24. We have noted that learned CIR(A) has dwelt upon the issue in detail discussing the facts and legal aspects of the case to reach his conclusion. It would be in the fitness of things to reproduce from his order the relevant part, which reads

"Keeping the two points of views in consideration, it is seen that emphasis, of the department is on the fact that since the holding company is also engaged in trading, therefore, the benefit of group relief cannot be extended, and consequently the loss of subsidiary company cannot be adjusted in view of the department clause (b) of subsection (2) of section 59B is to be interpreted as depicting that either of the two companies i.e., whether the holding company or the subsidiary company, if engaged in trading, then benefit of group relief cannot be availed." The appellant on the other hand pleaded that the group relief cannot be denied because in its view if the company availing relief is not doing trading then it cannot be denied relief. In order to examine the substance and objective of clause (b) of subsection (2) of section 595 of the Ordinance, it would be appropriate to look at the language of clauses (2)(b), which reads as:-- (2) the loss surrendered by the subsidiary company may be claimed by the holding company or a subsidiary company for set off against its income under the head "income from Business" in the tax year and the following two tax years subject to the following conditions, namely (b) A company within the group engaged in the business of trading shall not be entitled to avail group relief. The above clause is one of the conditions with regard to setting-off of loss surrendered by the subsidiary company against the business income of the holding company. The correct appreciation of this clause would be to read the clause in proper context, the clause is placing emphasis on the words entitled to avail group relict, which clearly refers to the company asking for relief under the scheme. The beneficiary in the case is the subsidiary company and it is applying for relief to improve its economic viability, therefore, what the law envisages is that the circumstances and the constitutions of the said subsidiary company should be such that it is not engaged in trading business. It is trite law that legal provision in a statute should always be applied with reference to the context and subject in which a particular expression is used and no indiscriminate application of a particular expression be allowed. The Taxation Officer's argument that the words used in the clause under reference include both the holding company and the subsidiary company are not supported grammatically or factually and he has tried to extend the intended meaning without taking into consideration the subject and context of section 59B. Section 59B as referred above and as substituted by Finance Act, 2007, aims at regulating and imposing certain conditions for the holding and subsidiary companies to obtain benefit of Group Relief. The purpose of group relief by way of allowing holding company with certain conditions, to set-off losses is to provide benefit to the subsidiary company having unabsorbed losses effecting its economic viability. The conditionality attached relate to the holding company as well as the subsidiary company. It is to be noted that where it is intended to refer the condition to the holding company, it has been specifically mentioned such as in clause 59B(2)(c) and when reference is made to the group companies it is depict in clauses (a), (d) and (g), similarly in rest of the clauses the reference is specifically made or in context to the subsidiary company as is evident from clauses (h), (e) and (f). It is, therefore, important that the context of each clauses be read with the provision of section 59B, before arriving at a decision. If the context is ignored then the true intent of the legislation would be defeated and the application of the law would suffer redundancy which cannot be attributed to the legislature. The offshoot of the discussion supra would be that the clause (b) of subsection (2) is to be read in its context to the intent and provision of section 59B whereby it clearly emerges that the phrase "A Company" refers to the company within the group soughting relief under the scheme of group relief and it would be the company surrendering its losses to the holding company for gaining the relevant benefit. The losses in the situation are to be allowed against the income of the holding company, therefore, the real beneficiary is the subsidiary company availing benefit and it has been restricted through this clause that the loss being surrendered by it should not be a trading loss because under this eventuality the subsidiary company will not be entitled for group relief." Regarding the requirement of the designation by the SECP, the Learned AR observed as under:-- "The Securities and Exchange Commission of Pakistan has made regulations regarding registration of Group Companies vide S.R.O. No. 1307(I)/2008 dated 31-12-2008. The rules framed by the SECP cannot act in isolation and need to examine. Section 8 of the SECP (Group Companies Registration Regulations, 2008) relates to the filing of application for availing of tax relief under sections 59AA and 59B of the Income Tax Ordinance, 2001. Subsection (1) of the said section categorically refers to the fact that holding company may apply to the Commission for the purpose of availing group relief. The said subsection is furnished below for reference:-- "The holding company within a Group may apply to the Commissioner for designation of the Group for purpose of availing tax relief under sections 59AA and 59B of the Income Tax Ordinance, 2001. In pursuance of above the appellant was required to apply to the commission for designation of the group for purpose of availing tax relief. The learned AR of the appellant referred to a letter issued by SECP addressed to the D.G., LTU, specifying that regulations are in the process of formulation and ECPL has applied to the commission for requisite designation. FBR would examine the issue of designation after formal issuance of regulations and grant of its approval or otherwise in due course of time. But the said approval for designation was never issued. The appellant, therefore, complied with the requirement by applying to the commission for required designation but the commission failed to respond. It may also be pointed out that sections 59AA and 59B of the Ordinance are independent section for application within their domain." The Rules framed by the SECP cannot be relied upon particularly when they are in conflict with the substance of the provisions of law. The rules of SECP cannot be made basis for depriving the appellant from availing relief which is enshrined in the provisions of section 59B of the Income Tax Ordinance, 2001."

26. We feel that the learned CIR(A) has dealt with the issue appropriately and according to the legal principles, therefore, no interference of this forum on this count is warranted since it is clear from the circumstances leading to the introduction of the concept of Group Relief in the country the legislature sought to introduce provisions which would allow early utilization of losses that industrial concerns usually suffer in the early years of their lives. This would promote investment in the industrial sector. However the legislature did not want the same facility for the trading concerns since it would promote relatively low-risk trading and discourage investment in the industrial enterprises being relatively higher risk area. In the instant case the beneficiary of the Group Relief is the loss surrendering company since it in a way sold its loss for cash and the loss buying company paid exactly the same amount to the loss surrendering as loss buying company would have paid to the tax authorities had it not offset its income against the loss of its subsidiary. We therefore decline to interfere with the order of the CIR(A) on the issue. We would however add that enjoying of a legal right cannot be left to the governmental authorities as in this case SECP was to make some procedures. As we understand from the perusal of record and analysis of the arguments the need for SECP designation seems to arise from the fact that it keeps the record of the shareholding of different persons and institutions in a company and could confirm about that fact and on that basis determine whether there is a "group" relationship between and among the companies if they seek to avail the tax benefits under sections 59AA and 59B. Other than that there seems to be no need for making the SECP part of the framework. In the instant case it is undisputed that the Holding Company (respondent in the instant appeal) holds 100% shares of the subsidiary against the requirement of 75% under section 59B. Therefore the designation by SECP was mere formality. However in a situation where such shareholding was not so clear, the SECP designation can become a stumbling block in the way of availing the facility. Another aspect of the designation is that now the Department shall ensure through SECP that such required holding continues for the required period in future. On the transfer of cash to the loss surrendering company, we agree with the argument of the AR and are of the view that when there is no time frame given in the statutes, none can be imposed by the Department.

27. The next ground relates to allowing by the learned CIR(A) expense on account of use of catalyst. The DR argued that the taxpayer cannot take the expense twice once through depreciation and again by debiting the Stores and Spares account. The AR in return contends that the DR is not fully in picture about the nature of deduction claimed and its adjudication at the lower levels. It is contended that the addition in the Taxation officer's order was made on the same basis but when the matter went before the learned CIR(A) and it was explained before him that according to the accounting principles the accounting depreciation was taken on the underlying, asset as it has useful life of more than one accounting period. But in accordance with the earlier Departmental practice it was added back in the computation as inadmissible expense and debited to Stores and Spares account. The learned CIR(A) advised the Taxation Officer to verify the contention of the taxpayer after going through the accounts and computation after which the matter was decided by the learned CIR(A) in favour of the taxpayer.

28. Undisputedly the underlying expense is a business expense and must be allowed to the taxpayer either through depreciation allowance or through direct deduction according to the law. Since the deduction is in line with the earlier practice of the Department itself, it should be allowed. However, it should be ensured that it is not allowed twice because of depreciation deduction controversy. We therefore, feel no need to interfere in the determination made by the learned CIR(A).

29. Third appeal I.T.A. No 259/KB of 2010 covers two issues also raised in the taxpayers Appeal 144/KB discussed in earlier paras of this order line with those decisions it is directed that on proration of certain expenses on account of allocation to exempt income and dividend income and disallowance of expenses incurred an supply of gas and electricity to the onsite residential colony the decisions made in the said ITA 144 be followed.

30. The above three cross appeals are disposed as given hereinabove. H.B.T./32/Tax(Trib.) Order accordingly.