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Petitioner: Messrs CRESOX (PVT.) LTD. VS Respondent: C.I.R., ZONE-IV, LTU, KARACHI
Court Name: Appellate Tribunal Inland Revenue Judge(s): Muhammad Jawed Zakaria, Faheem-ul-Haq Khan Title: Messrs CRESOX (PVT.) LTD. vs C.I.R., ZONE-IV, LTU, KARACHI Case No.: I.T.A. No,293/KB of 2012 Date of Judgment:2013-10-31 Reported As: 2017 PTD (Trib.) 1416 Result: Case remanded
Judgment ORDER MUHAMAMD JAWED ZAKARIA (JUDICAL MEMBER).---Through this appeal the Appellant has challenged the validity of the impugned order No,761 dated 15.3.2012 passed by the learned Commissioner Inland Revenue (Appeals-I), Karachi. The Appellant has assailed the following grounds of appeal:-- "1. The order of the Commissioner Inland Revenue (Appeals) is bad in law and on facts of the ease. 2. The Commissioner Inland Revenue (Appeals) erred in confirming that the exercise of jurisdiction by the Additional Commissioner under Section 122(5A) of the Income Tax Ordinance, 2001 was valid. 3. The Commissioner Inland Revenue (Appeals) erred in confirming invocation of sections 108/109 of the Income Tax Ordinance, 2001 in respect of advance against equity amounting to Rs: 152,699,400/- and receivable on account of renovation and reconstruction of building and land owned by subsidiary at Rs,96,782,859/-. 4. The Commissioner Inland Revenue (Appeals) erred in confirming computation of deemed interest income Ct 10% on advance against equity at Rs,152,699,400 and on receivable on account of renovation and reconstruction of building and land owned by subsidiary at Rs,96,782,859/- by treating such amounts as loan and charging tax on such deemed interest income. 5. Without prejudice to ground No,4 the Commissioner Inland Revenue .(Appeals) erred in remanding the case to Additional Commissioner for allowing proportionate financial expenses instead of directing to allow such expenses. 6. The Commissioner Inland Revenue (Appeals) has erred, rather was extremely unjustified, in commenting that "filing of rectification application for allowing proportionate expenses against
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notional interest income computed by the Additional Commissioner under sections 108/109 ipso factor confirms that AR has impliedly accepted the addition made under sections 108/109 in principle as the filing of rectification application presupposes that invocation of sections 108/109 by AC1R was correct." 2. Brief facts of the case as gathered from the arguments of the parties, record of the case as well as from impugned orders are that the Appellant is a private limited company incorporated in Pakistan under the Companies Ordinance, 1984 with registered office in Lahore, Punjab and manufacturing facilities located at Manghopir Road SITE Karachi. The company entered into a joint venture with effect from 16 April, 1998 with Renfro Corporation USA, one of the largest socks manufacturing company in USA for manufacturing and-export of socks to USA. The company's main source of income is export proceeds realized from export of socks. The entire income of the appellant company falls under final tax regime for which statement of final taxation under section 115 (4) has been filed. During the current year the company also earned an amount of Rs, 600,802 as profit / mark-up on bank deposits which has been declared under normal tax regime. However, no deduction in respect of any expense whatsoever has been claimed by the company. The appellant had. a wholly owned subsidiary namely Elite Textile Mills (Private) Limited (Elite Textile) which was incorporated in 1951 as a listed company and was quoted on the Karachi and Islamabad Stock Exchanges. Elite Textile was, however, delisted from Karachi and Islamabad Stock Exchanges in 2004 and convened into private limited company. The registered office of Elite Textile was situated at Karachi and its principal business was manufacture and sale of yarn. Elite Textile ceased all its production activities from 1 September 1997 and disposed of all its plant and machinery and a portion of land and building. During financial year 2004-2005 Renfro Crescent purchased entire shares of Elite Textile and since the Elite Textile is its wholly owned subsidiary. As Elite Textile was in yarn manufacturing business and Renfro Crescent was in the business of manufacturing socks for which yarn is the basic raw material, the purpose of acquiring Elite Textile was to revive Elite Textile to achieve synergies in business for both companies. However, as any revival plan of Elite Textile could not be worked out, the owners decided to merge Elite Textile in to Renfro Crescent. The Scheme of Merger of Elite Textile into Renfro Crescent was approved in Board of Directors meeting of both companies held on 17 December 2010 and the scheme was approved in Extra Ordinary General Meeting of shareholders of both companies held on 7 January 2011. Joint application for sanction of merger . Was filed before Lahore High Court on 25 January 2011 and the Scheme of merger was sanctioned by the Honourable High Court on 19 April, 2011. When entire shares of Elite Textile were taken over by Renfro Crescent, Renfro Crescent injected a sum of Rs, 180.142 million in Elite Textile. The Additional Commissioner Inland Revenue by taking recourse to section 122(5A) of the Income Tax Ordinance, 2001 treating the deenied assessment erroneous and prejudicial to the interest of revenue and declared income was revised by adding markup income of Rs, 24,505,0001= by re-characterising under sections 108/109 of the Income Tax Ordinance, 2001 in respect of advance against equity amounting to Rs,152,699,400/- receivable on account of renovation and re-construction of building and land owned by subsidiary at Rs,96,782,852/ =. Being aggrieved and dissatisfied from the order of the ACIR the appellant preferred an appeal before the CIR(A) who vide order mentioned supra confirmed the treatment under sections 108/109 of the Income Tax Ordinance, 2001. Hence the instant appeal before this Tribunal on the above- mentioned grounds. 3. On the grounds of appeal the learned counsel for the appellant vehemently submitted that when entire shares of Elite Textile were taken over by Renfro Crescent. Renfro Crescent injected a sum of Rs,180.142 million in Elite Textile. The break-up of this amount is given in Note No, 5 of audited accounts of Renfro Crescent for the year ended on 30 June 2005. They submitted financial statement which revels as under:--
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2005 2004 Rupees Rupees Cost of 1,932,000 shares of Elite Textile Mills 27,442,850 - Limited Advance against equity/share capital 152,699,400 ----- 180,142,250 ------- 4. The learned counsel explained that aforesaid amount of Rs,152.699 million was shown in the audited account of both Renfro Crescent and Elite Textile as "Advance against equity / share capital". During the same year i,e, 2004-2005, shares of Rs, 180.142 million were issued by Renfro Crescent against cash and further shares of Rs,180.142 million were issued to JV partner Renfro Crescent Corporation USA for consideration other than cash. It reflected in Note No,11 of audited accounts of Renfro Crescent for the year ended on 30 June, 2005. The learned AR furnished the same which is being reproduced below:- 2005 2004 2005 2004 Number of shares Rupees Rupees 18,014,227 2 Ordinary shares of Rs.10 each issued for cash Ordinary shares of Rs.10 each issued for consideration other than cash180,142,270
180,142,25020 18,014,225 - 36,028,452 2 360,284,520 20 5. The Learned AR pointed out that the source of investment of Rs,180.142 million in Elite Textile was through equity investment in Renfro Crescent and not from borrowed funds. 6. They contended that the land and building owned by Elite Textile was being used by Renfro Crescent, Renfro Crescent made payments on account of renovations and construction of factory land and building during the years 2005-2006 to 2009-2010 which accumulated to Rs, 96.78 million upto 30 June 2010. The Learned ARs, Pointed out that the said amount is reflected in Note No, 10 to the audited accounts of Renfro Crescent for the year ended on 30 June 2010 as follows:-- 2010 2009 Rupees Rupees 10. ADVANCE, DEPOSITS PREPAYMENTS AND OTHER RECEIVABLIES Other receivables Other10.1 96,782,859 87,933,850 7. The Learned AR went on to argue that the above amount, represents receivable from Elite Textile Mills (Private) Limited amounting to Rs, 96.78 million (2009: Rs, 87.93 million) on account of renovations and constructions on factory land and building which is owned by subsidiary. The aforesaid amount of Rs, 96.78 million was shown as "Receivable from Elite Textile" in the audited accounts of Renfro Crescent and "Payable to Renfro Crescent" in audited accounts of Elite Textile. 8. The ARs further vehemently argued that if business of Elite Textile would have been revived, shares would have been issued and advance against equity/share capital of Rs, 152.699 million would have been adjusted against shares issued. Similarly, Elite Textile would have paid the amount of Rs, 96.78 million due to Renfro Crescent. However, as contended by AR, the entities were ultimately merged, the advance against equity/share capital of Rs, 152.699 million and the amount
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of Rs,96.78 million receivable by Renfro Crescent and payable by Elite Textile on account of renovations and construction of *tory land and building were squared off/adjusted in the books of the respective companies, the learned AR out that these are as reflected in Note No, 1.1.2 of audited accounts of Renfro Crescent for the year ended on 30 June 2011. 9. The ARs, of the appellant contended that the learned ACIR has treated Advance against equity / share capital of Rs, 152.699 million and receivable of Rs, 96.78 million on account of renovations and construction of factory land and building as "loan" given by Renfro Crescent to Elite Textile and computed deemed/notional mark-up income on these amounts @ 10% on the ground that Renfro Crescent had borrowed funds and the borrowed funds were utilized to make the aforesaid payments to Elite Textile or on behalf of Elite Textile. 10. The learned ARs drew our attention to the contents of show cause notice-and operating paragraphs of the assessm ent order which are reproduced below for ready reference. (a) Notice under section 122(9): "Subject: Notice under section 122(9) for amendment of assessment under section 122(5A) of the Income Tax Ordinance, 2001 for tax year 2010 Kindly refer to above and the return filed on 30-12-2010 declaring exports of Rs, 2.203(B) and Normal Tax Regime (NTR) income of Rs, 600,802 which is deemed assessment as per fiction of law under section 120 of Income Tax Ordinance. As per record the deemed order has not been amended and still holds the field. (If the return is revised or any amendment has been made please bring it to my notice and record). As per record you have advanced Rs, 152.699 (M) against equity to the related party M/s. Elite Textile Mills (Pvt.) Ltd., but shares have not been issued for long (Note 6 to the audited accounts) from the said company (Rs, 87.933 (M) as on 30-06-2009 and Rs, 96.782 (M) as on 30-06-2010) which is in fact receivable on account of Renovation and Construction on factory land and building (Note No, 10.1 to the A/c). As per Note # 30 to the A/c you are using land and building of wholly owned subsidiary i,e, Messrs Elite Textile Mills (Pvt.) Ltd., without any consideration. As you have borrowed funds and incurring huge borrowing cost (Rs, 69 (M) in the current year and Rs, 62 (M) in the preceding year). Therefore, the amount advanced to the related party and expenses incurred on construction and Renovation are not without cost. Similarly use of the premises of the subsidiary can't be considered as a right. Non-charging of cost of finances by you and non-charging of rent by the sister concern are transactions which are not on Arm's Length principle. As you have been declaring income from exports which is taxable under PTR except Markup income therefore any income from funds utilized by the related party i,e, Markup by you would have resulted in Taxable Income chargeable under NTR. Whereas any charge of Rent would not have benefited you as your income from business is taxable under PTR but it would have resulted in income to the subsidiary which would have been taxable at a fixed rate. Thus non-charging of markup by you and rent by subsidiary are part of tax avoidance scheme requiring recharacterization under sections 108/109 rendering the deemed order as erroneous in so far as prejudicial to the interest of revenue liable to action under section 122(5A) of the Income Tax Ordinance, 2001. Therefore, I intend to amend the deemed order by charging markup 010% on the basis of markup rate prevailing in this period. 1 will apply the rate on the balance sheet figures. If you have any objection to the aforementioned treatment and working please furnish the same. You may rely on any documents including A/cs or books of A/cs in this regard. This is an opportunity of being heard as per Section 122 (9). Proforma notice under Rule 68 is enclosed." (b) Operating paras of order under section 122 (5A)
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In the light of the above there is no iota of doubt that advance against equity and cost of renovation and construction are in fact interest free advances to the subsidiary and are controlled transactions entered into in a tax avoiding scheme requiring recharacterization under section 108 read with ,109 of the Income Tax Ordinance. Taxpayer was confronted for application of 10% interest rate for recharacterising and making the transaction in accordance with arm's length principle. The taxpayer was confronted for lower rate application in the presence of internal uncontrolled transactions at a higher rate. Transaction between the taxpayer and the financial institutions are internal comparables of CUT where loan has been acquired at KIBOR plus 2% to 3% markup rate which works out to 14% to 16%. The rational of lower rate application is wholly owned character of the subsidiary where investment is 100% secure therefore lower rate is being applied for giving margin of security of investment. As there is no movement in the amount reflected as advance against equity therefore markup 6 10% on the same works out to Rs, 15.269(m). The amount considered as loan on renovation and construction shows opening balance of Rs, 87.933(m) and closing balance of Rs, 96.782(m) therefore average balance of the balance sheet figures comes to Rs, 92.358(m) and markup @ 10% comes to Rs, 9.236(m). Thus total income from these recharacterized transactions is Rs . 24. 505 (m). 11. The ARs,, of the Appellant vehemently contested the vires of sections 108 and 109. Both of the learned counsel argued that:- That ACIR has invoked Sections 108 and 109 simultaneously. As both provisions of law are independent they cannot be invoked simultaneously. If both sections are invoked simultaneously, one of the two sections becomes redundant and redundancy cannot be attributed to law. The ACIR should have been very clear as to which section can be invoked in a given situation. Whereas, in the instant case, that none of the sections can be invoked. That Section 108 cannot be invoked because it empowers the Commissioner to distribute, (b) apportion or (c) allocate the following: Income Deductions Tax credit The learned A.Rs, further argued that in this case there is neither any "income" not "tax credit" which needs distribution, apportionment or allocation. However, as the ACIR mentioned in his notice that the company has incurred huge borrowing cost, therefore, he has apparently tried to contend that as part of the borrowed funds were given to subsidiary without charging any interest, therefore, proportionate borrowing cost should be allocated to subsidiary instead of claiming the entire borrowing cost by parent company. But, as the AR contended, the ACIR has missed the point that for this purpose the borrowing cost must have been claimed as a deduction by the appellant company. Whereas the admitted fact is that entire income of the appellant company was from exports and taxed under final tax regime and deduction of any expense or cost was neither claimed nor allowed to the company. 12. The learned AR next-submitted that section 108 is applicable to actual transactions i,e, where some actual income is earned or actual tax deductions or tax credits have been claimed. Under section 108 the Commissioner is empowered to either distribute or apportion or allocate actual income declared or actual tax deductions or tax credits claimed by the taxpayer between associates. It does not empower the Commissioner to work out deemed income. As the power to work out deemed income is not available under section 108, the question of distributing, apportioning or allocating such deemed income between associates does not arise. In this case no
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mark-up income was earned by the appellant from its subsidiary. Similarly, no interest/mark-up on borrowing was claimed as an admissible deduction due to taxation of appellant under final tax regime. Further, no tax credit was claimed by the appellant. Therefore the question of distributing, allocating or apportioning any income or deductions or tax credit does not arise and there is no room to invoke section 108 in this case. 13. The learned A.R. Further vehemently contended that Section 109 cannot be invoked because the parameters as envisaged and prerequisite of section 109 are not fulfilled which are that the Commissioner may: (a) recharacterise a transaction or an element of a transaction that was entered into as part of a tax avoidance scheme. (b) Disregard a transaction that does not have substantial economic effect. (c) recharacterise a transaction where the form of the transaction does not reflect the substance. For this purpose, "tax avoidance scheme" means any transaction where one of the main purposes of a person in entering into th transaction is the avoidance or reduction of any person's liability to tax under the Income Tax Ot.Dinance, 2001. 14. Reverting back to the facts of the case the learned counsel submitted that in this case, the purpose of giving advance against equity / share capital to subsidiary and recording the cost of renovations and construction of factory land and building as receivable from subsidiary was not to avoid tax but was a business necessity i,e, to either revive the subsidiary or to merge it and this fact is proved by actual merger of the subsidiary. 15. The Learned AR urged that on the basis of the facts of the case explained above the following positions emerges:-- (a) the form of the transactions i,e, advance against equity and recording of receivable on account of renovations and construction cost of factory land and building reflect the substance of the transactions; and (b) both the aforesaid transactions i,e, advance against equity and recording of receivable on account of renovations and construction cost of factory land and building have substantial economic effect. 16. The AR stated that the above transactions were the business necessity of the parent and subsidiary in view of the dormant status of the subsidiary and pending revival or merger of subsidiary. 17. Referring to section 109, the learned AR argued that provisions of section 109 cannot be invoked to a valid and legally permissible transaction. In this regard, the AR of the appellant has relied on the order of this Tribunal in I.T.A. No, 391/KB of 2007 vide order dated 30 October 2009. Relevant extracts from the order are reproduced below:-- "The Taxation Officer has invoked provisions of section 85 (Associates), section 108 (Transaction between Associates) and section 109 (Recharaterisation of income and deduction) of Income Tax Ordinance, 2001 to make addition under section 111 of Income Tax Ordinance, 2001. In our opinion, the action of the Taxation Officer is unfair and unjustified. A valid and legally permissible transaction cannot be hit by the provisions of section 109 of Income Tax Ordinance, 2001. If the logic of the Taxation Officer is to be followed, then any loan from Cresox (Pvt.) Ltd. v. CIR, Zone-IV, LTU any relative, say a loan from father to son, or from mother to son, or from husband to while etc. Will be discarded by the Department under section 109 of Income Tax Ordinance, 2001. The Taxation Officer can under garb of section 109 of Income Tax Ordinance, 2001 doubt, question and can disregard the Hiba (Gift). There can be no end to challenges from the Taxation Officer and taxpayer will seriously suffer from heavy handedness of Taxation Officer. In this case what is to be seen is that whether the fronds pass from one individual to another, was banking channels used for fund transfer and is it corroborated through bank statement. If the answers to these questions
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are in affirmative, which they are in this case under appeal then it is not for the Taxation Officer to disregard and disbelieve a bona fide loan in our eastern cultural environment and disregard a loan from family relative, or friend. In view of the above facts and discussion, we hold that the order of learned CIT(A) does not warrant for any interference, hence the departmental appeal fails". 18. The AR also relied on another order of this Tribunal reported as 03 PTD (Trib.) 116. Relevant extracts from the order are reproduced low:-- "We have heard the learned representatives of both the sides and have also gone through the record of the case as well as case-laws cited at bar. It is obvious from the facts of the case that the transaction of sale and repurchase have taken place resulting in actual realization of capital gain which had accumulated over the years for the reason of increase in market prices of the shares over the appellant 's cost of purchase. The veracity of these transactions has not been doubted by the taxation officer in his order. In fact on page 24 of the order, the taxation officer has observed that all elements of the transactions existed in this case including sale consideration, movement of funds, delivery of shares in CDC accounts, deduction of tax and CVT on the transactions. We respectfully feel that the submissions made by the learned DR on veracity of the transactions do not merit consideration. In our view tax avoidance can only be done where a taxpayer has more than one modes of carrying out a particular transaction which result in different tax liabilities for each mode." 19. The learned counsel by placing reliance on the judgment of Hon'ble Supreme Court of Pakistan reported as PLD 1992 SC 562 = 992 PTD 954 in the case of Pakistan Industrial Engineering Agencies Limited, argued that the Department cannot dictate the taxpayer how to do business or how to utilize its funds. If the taxpayer enters in certain transactions for business purposes by adopting legal modes, and one of the main purpose of entering into such transactions is not avoidance or reduction of tax liability, then even if such transaction results in some tax benefit, it cannot be considered as a "tax avoidance scheme". Hon'ble Supreme Court of Pakistan has very aptly and categorically laid down this principle in the aforesaid judgment in the following words:- "An assessee is entitled to manage his own affairs to the best of his benefit even by adopting legal modes which may result in reduction of tax and the same if covered by the provisions of law cannot be challenged on the ground of prudence, advisability or business practice. 20. The AR argued that the ACIR has computed deemed / notional interest income in this case but he has not cited any provision of law under which such deemed/notional interest income can be charged to tax. Currently, there is only one provision in Income Tax Ordinance, 2001 for determining deemed/notional interest income in the case of employees which is subsection (7) of section 13. Apart from this, there is no provision in Income Tax Ordinance, 2001 which permits determination of deemed/notional interest income. While explaining further the AR submitted that there was a provision i,e, Section 12(7) in Repealed Income Tax Ordinance, 1979 for determining deemed / notional interest income on all types of interest free loans except loans advanced to employees in accordance with the terms and conditions of employment and persons exempted by notification in the official Gazette but even that subsection was made inapplicable for assessment year, 1985- 86 onwards and no similar provision (except section 13(7) pertaining to loans to employees) exist in the Income Tax Ordinance, 2001. The AR further submitted that the courts have always held that any deemed/notional income cannot be determined without the availability of a specific enabling provision / charging section in law. The AR cited the cases reported as PLD 1997 SC 582 = 1997 PTD 1555 (Ellahi Cotton Mills Limited), Hon'ble…
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