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Petitioner: COMMISSIONER OF INCOME TAX (LEGAL), ISLAMABAD VS Respondent: Messrs ASKARI COMMERCIAL BANK LIMITED, RAWALPINDI
Court Name: Islamabad High Court Judge(s): Athar Minallah, Miangul Hassan Aurangzeb Title:COMMISSIONER OF INCOME TAX (LEGAL), ISLAMABAD vs Messrs ASKARI
COMMERCIAL BANK LIMITED, RAWALPINDI Case No.: I.T.R.A. No. 71 of 2008 Date of Judgment:2018-03-13 Reported As: 2018 PTD 1089 Result: Order accordingly Judgment ORDER ATHAR MINALLAH, J.---Through this consolidated judgment, we shall decide the Income Tax References listed in Annexure 'A' attached hereto. With the consent of the learned counsel for the parties, the questions of law which have arisen from the judgments rendered by the learned Tribunal were formulated and have been articulated in Annexure B'. The Tax References have been divided into two categories i.e. Category 'A' and Category B'. The Category 'A' References have been filed by the Department and the respondents therein are financial institutions, individually referred to as 'Banking Company' defined under clause (vii) of section 2 of the Income Tax Ordinance, 2001 (hereinafter referred to as the 'Ordinance of 2001'). The set of References in Category 'B' have been filed by one of the Banking Companies. The Banking Companies hereinafter will be referred to as the 'Banks'. 2. The facts, in brief, are that the Banks are, inter alia, engaged in the business of attracting resources from customers and offering financing to others. The Banks are assessees and regularly file tax returns. Assessm ent orders were passed by the concerned Assessment Officers and these Tax References stem from the judgments rendered by the learned Tribunal. During the course of business the Banks, inter alia, invest in 'securities offered by the Federal Government which are issued under the Public Debt Act, 1944 (hereinafter referred to as the 'Act of 1944'). The interest on such securities is paid and received according to the terms and conditions which are prescribed under the relevant rules framed in the exercise of powers conferred under section 28 of the Act of 1944 e.g. S.R.O. 735(1)/2000, dated 12-09-2000. The controversy between the Department and the Banks is whether the interest on Government securities is required to be offered for taxation on
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accrual or cash basis. In some of the References an interpretation of the Income Tax Ordinance, 1979 (hereinafter referred to as the 'Ordinance of 1979') is involved while in others the relevant provisions of the Ordinance of 2001 are the subject of interpretation. The second question which we are required to answer is regarding the treatment of non-performing loans or bad debts i.e. when and under what circumstances loans or debts are allowed to be treated as admissible expense. The third question of law relates to taxation of the loan which a Bank advances to its employees at concessional rates i.e. its status in the context of section 24(i) of the Ordinance of 1979. The Department had also proposed questions of law relating to interest credited to a suspense account. However, the learned counsel for the Banks drew our attention to the order dated 21-02- 2017, passed by the august Supreme Court in Civil Appeal No.08/2017 titled 'Deputy Commissioner Income Tax v. M/s. Habib Bank AG Zurich' in support of their contention that this issue stood settled on the basis of the letter/instructions, dated 23-11-2005, which has been explicitly mentioned in the aforementioned order. This statement was not contested before us on behalf of the Department and, therefore, the Tax References to the extent of the questions relating to interest credited to a suspense account are disposed of in similar terms as the august Supreme Court had disposed of the appeal vide order dated 21-02-2017. Moreover, the questions of law in respect of profit and loss expenses were also proposed by the Department in some of the References but have not been pressed and, therefore, we need not consider or answer the same. As noted above, we will be answering questions of law which have been proposed for our consideration and are mentioned in Annexure 'B'. 3. The learned counsel for the Department have argued that; the interest on, securities under the Ordinance of 1979 was governed under section 17(1) and its method of accounting was described under section 32 ibid; the interest derived from securities was required to be offered for tax on accrual and not on cash basis; this was further reaffirmed under the repealing statute i.e. the Ordinance of 2001, particularly sections 34 and 32 ibid; the Banks are under an obligation to account for income relating to Government securities on accrual basis as it falls under the head 'income from business'; the Banks adopt a mercantile system of accounting and, therefore, they were and continue to be under an obligation to offer interest on securities for the purposes of chargeability of income tax on accrual basis; under section 23(1)(x) of the Ordinance of 1979, the assessing officer was exclusively empowered to ascertain whether the loan had become irrecoverable otherwise deduction was not permissible by the Banks on their own; mere bad debts/non-performing loans cannot be claimed as expense; the claim regarding admissibility of bad debts/non-performing loans as expense was and continues to be restricted to such loans which become irrecoverable; the assessee cannot claim adjustment of the loan as an expense unless it has become irrecoverable; the question of whether bad debts have become irrecoverable involves objective and factual determination; if it is a secured loan then it cannot be treated as irrecoverable under the Ordinance of 2001; section 29 regulates taxation in relation to Bad Debts; neither under the Ordinance of 1979 nor the Ordinance of 2001 concessional loans , given by the Banks to its employees were exempt to the extent of difference in the rate of interest; such loans attract section 24(i) of the Ordinance of 1979; section 25 of the Ordinance of 1979 and section 13 of the Ordinance of 2001 prescribes guidelines for the purposes of determination of perquisites. 4. The arguments advanced by the learned counsel who have appeared on behalf of the Banks may be summarized as; the question regarding taxation of interest on securities i.e. on accrual or receipt basis stands settled in the light of the judgment of the august Supreme Court rendered in the case of ' Commissioner of Income Tax v. Habib Bank Limited and ANZ Grindlays Bank PLC' [2014 SCM R 1557]; the Banks adopt hybrid accounting system and, therefore, interest is required to be offered for the purposes of taxation when it is actually received and not on accrual basis; the learned Tribunal has consistently held in several judgments that under section 34(2) read with
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section 32 of the Ordinance of 2001 the Banks become entitled to interest on the date of its actual receipt and not before i.e. on accrual basis; section 32 of the Ordinance of 1979 provides that profit and gains of a person shall be charged on the basis of method of accounting which is regularly employed by the assessee; a person becomes entitled to receive interest when it has become due i.e. when the payment is actually received; section 17 of the Ordinance of 1979 explicitly provided that interest from securities were liable to be taxed on receivable basis; the expression 'receivable' has not been defined under' the Ordinance of 1979; under section 22 of the Act of 1944 a person is not entitled to claim interest in respect of any period which has lapsed after the earliest date on which demand could have been made for the payment of amount due thereon and thus the entitlement is reckoned from the date when the interest is actually received; the mere recording of receipts or expenses in the financial statement is not by itself sufficient to make such receipts or expenses chargeable to tax; reliance has been placed on 'Messrs MCB Bank Ltd. v. Commissioner Inland Revenue' [2014 PTD 1874]; the concessional loans given to the employees do not attract section 24(i) of the Ordinance of 1979. 5. The learned, counsel have been 'heard and the record perused with their able assistance. 16. As noted above, we have been called upon to answer questions of law relating to three issues. The tax years regarding which respective assessment orders were passed inevitably requires an interpretation of the Ordinance, 2001 and the repealed Ordinance of 1979. It would, therefore, be apt to discuss each issue separately. A. Tax treatment of interest on Government Securities, Whether Banks were/are obliged to offer income for purposes of chargeability of tax on accrual or actual receipt basis. 7. The Ordinance of 1979 was repealed by the Ordinance of 2001. The expression 'Banking Company' was defined under section 2(10) of the repealed Ordinance of 1979 and now under section 2(7) of the Ordinance of 2001. The Banks fall within the ambit of the said expression. Before surveying the relevant provisions of the two aforementioned statutes, it would be beneficial to briefly examine the methods employed for accounting purposes. Accounting methods consist of rules and guidelines regarding the keeping of financial records and reports. The two basic methods used for record keeping are 'cash basis' and 'accrual basis'. The method known as on 'accrual basis' is also referred to as the 'mercantile system' of accounting. Under the accounting method, also termed as on 'cash basis', income is recorded in the accounts in a tax year when it is actually received while on the other hand under the 'accrual basis' of accounting, income is recorded when it is earned rather than its actual receipt. In other words, in the case of the accounting method described as on 'accrual basis' or 'mercantile system', the transactions are recorded regardless of the period when the amount of revenue or income is actually received. There is also another category of accounting method which is referred Lo as the 'hybrid system'. The latter is a combination of 'cash' and 'accrual' basis of accounting. The distinguishing factor between 'cash' and 'accrual' methods of accounting is the timing when revenues and expenses are recorded in the Books of Accounts. Under the method of accounting termed as on 'cash basis', revenues for the purposes of determining income is recognized when cash is actually received. It does not recognize receivables or amounts payable. On the other hand, under the accounting method of 'accrual basis', income and expenses are recorded in the books of accounts when they are earned, notwithstanding the timing of actual receipt. This difference in the two accounting methods is crucial for the levy and charge of tax. In a nut shell, the income of an assessee which/who employs the method of accounting known as on 'accrual basis', is offered for chargeability of tax in the tax year when it is earned and recorded as such in the accounts. Likewise, in the case of 'cash basis' of accounting method the income is recorded when the revenues are actually received and, therefore, it becomes chargeable to tax in the corresponding tax year. These two methods are internationally recognized and uniform accounting systems used for recording transactions, determining profit
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and loss and consequently offering income for taxation purposes. Generally small businesses and individuals employ the 'cash basis' accounting method while large business entities adopt the method on 'accrual basis'. In case of the 'cash basis' accounting an assessee is not under an obligation to record income before it is actually received while 'accrual basis' requires that income is declared and recorded in the books of accounts when it becomes receivable regardless of its actual payment. It is noted that the International Financial Reporting Standards are based on accrual based accounting. The Banks prepare and publish their accounts on accrual basis. The legislature, while enacting the Ordinance of 1979 or the Ordinance of 2001, as the case may be, appears to have been cognizant of the accounting methodology recognized and followed globally. This will become obvious from the survey of the two statutes discussed in the paragraphs which are to follow. 8. The relevant provisions under the Ordinance of 1979, which requires our attention and deals with taxation of interest on securities, are sections 17(1) and 32 ibid. Section 17(1) describes the categories of income which are chargeable under the head interest on securities and it, inter alia, includes interest on securities of the Federal Government or Provincial Government receivable by an assessee in any income year. Section 32 expressly provides the method of accounting, inter alia, for the purposes of section 17. It explicitly provides that income, profits and gains shall be computed in accordance with the method of accounting regularly employed by the assessee. The Ordinance of 1979, for the purposes of computing income, profit and gains in the context of section 17, had left the selection of the method of accounting to the assesee. Thelatter, therefore, could either adopt cash or accrual basis of accounting method unless the then Central Board of Revenue (renamed as Federal Board of Revenue), in the exercise of powers vested under subsection (2) of section 32, had prescribed the form and manner for maintaining the accounts through a general or special order. In the event that an assessee had not regularly employed one of the accounting methods, the Deputy Commissioner was vested with power under subsection (3) of section 32 to compute income in such manner as the latter thought fit. In the present References, subsections (2) and (3) are not relevant because on the factual side it has been explicitly determined by the lower forums that . the Banks had regularly employed the mercantile or in other words the accounting method on 'accrual basis. This is also implicit from the arguments made before us on behalf of the Banks. The learned counsel for the Banks have strenuously argued that the expression 'receivable' used in section 17(1)(a) of the Ordinance of 1979 is crucial. The said expression was not defined under the Ordinance of 1979. The Black's Law Dictionary Eighth Edition defines the expression 'receivable' as follows.- receivable, adj. 1. Capable of being admitted or accepted <receivable evidence > . 2. Awaiting receipt of payment <accounts receivable > . 3. Subject to a call for payment <a note receivable > . receivable, n. An amount owed, esp. by business's customer. See account receivable under ACCOUNT. unrealized receivable. An amount earned but not yet received. Unrealized receivables have no income-tax basis for cash-basis taxpayers. [Caws: Internal Revenue - 3931, 3935.] 9. It is obvious from the above dictionary meaning of the expression "receivable that by no stretch of the imagination can it be construed as involving actual receipt of income. Moreover, under the A International Accounting Standards, 'receivable' is distinct from actual receipt of income. It is the settled law of interpretation of a statute that provisions are required to be read in its context. In the case of a taxing statute the Court has to look to the clear words since there is no question of any intendment, nor is there any presumption or equity about tax. Nothing can be read or implied in the taxing statute. It is also a settled rule of interpretation that in order to discover the legislative intent the statute has to be read as a whole. We therefore hold that the timing for offering income for taxation purposes relating to interest on securities under the Ordinance of 1979 was solely
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dependent on the method of accounting which was regularly employed by the Banks. If the method of accounting termed as on 'cash basis' was employed then income was required to be recorded in the books of account in the tax year when the interest or part thereof was actually received. In the case of the instant References, on the factual side, it stands determined that the Banks were regularly following and had adopted the mercantile, or in other words the 'accrual basis' of accounting method. This was never contested by the Banks. Moreover, it is not the case of the latter that income from interest was recorded in the accounts on the basis of actual receipt nor that the recording of income in the books of accounts was based on the method of accounting known as on 'cash basis'. We have carefully gone through the judgment of the august Supreme Court rendered in the case titled 'Commissioner of Income Tax v. Habib Bank Limited and ANZ Grindlays Bank PLC' [2014 SCM R 1557] and we feel that our above interpretation stands fortified. In the facts before the august Supreme Court, the respondent Banks had adopted the method of accounting which was hybrid while in the instant tax References the method employed was mercantile or on accrual basis. The august Supreme Court has affirmed in the said judgment that the regularly adopted method of accounting by an assessee will inevitably determine the tax liability in the case of interest on securities. As the interest on securities were not recorded in the accounts of the Bank on 'cash basis' i.e. when actually received or paid, therefore, the relevant tax year was when they were shown or recorded in the accounts as receivable or earned. 10. Now we shall advert to the relevant provisions of the Ordinance of 2001. In the case of the said statute the relevant provisions relating to the Banks in this regard are sections 18(2), 32, 33, 34 and 100 A read with the Seventh Schedule. Section 18(2) provides that any profit on debt derived by a person, where the latter's business is to derive such income, shall be chargeable to tax under the head 'Income from Business' and not under the head 'Income from other sources'. Subsection (1) of section 32 provides that, subject to the Ordinance of 2001, a person's income chargeable to tax shall be computed in accordance with the method of accounting regularly employed by such person. Subsection (2) further provides that, subject to subsection (3), a company shall account for income chargeable to tax under the head 'Income from Business' on accrual basis, while other persons may account for such income-on cash or accrual basis. Subsection (3) of section 32 empowers the Board to prescribe that any class of persons shall account for income chargeable to tax under the head income from business on a cash or accrual basis. Subsection (4) of section 32 makes it mandatory for a person to apply in writing for a change in the person's method of accounting and the ,Commissioner may, by order in writing, approve such an application but only if satisfied that the change is necessary to clearly reflect the persons income chargeable to tax under the head income from Business. Subsection (5) of section 32 provides that if a person's method of accounting has changed, then such person shall make adjustments to items of income, deduction or credit or to any other items affected by the change so that no item is omitted and that no item is taken into account more than once. Section 33 explains that a person accounting for income chargeable to tax under the head 'Income from Business' on cash basis shall derive income when it is received and shall incur expenditure when it is paid. Likewise subsection (1) of section 34 describes that a person's accounting for income chargeable to tax under the head income from business on accrual basis shall derive income when it is due to the person and shall incur expenditure when it is payable by the latter. Subsection (2) of section 34 unambiguously provides that, subject to the Ordinance of 2001, an amount shall be due to a person when the latter becomes entitled to receive it even if the time for discharge of the entitlement is postponed or the amount is payable by installments. Section 100 A of the Ordinance of 2001 was inserted through the Finance Act 2007 which was assented to on 30-06-2007. The said provision explicitly provides that income, profits and gains of any Banking Company defined in clause (7) of section 2 and the tax payable thereon shall be computed in accordance with the rules prescribed in the Seventh
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Schedule. However, the provision of section 100 A was explicitly made applicable to the profits and gains of the Banking Companies relevant to the tax year 2009 and onwards, as explicitly provided under section (2) ibid. The relevant expressions in the context of the controversy at hand are 'Banking Company', 'Company', 'Financial Institution', and 'person' which are defined under sections 2(7), 2(12), 2(24) and 2(42) of the Ordinance of 2001 respectively. 11. The expressions 'due' and 'entitled' are crucial for the adjudication of these Tax References, since a great deal of emphasis has been laid by the learned counsel and the learned Tribunal has also interpreted the expression 'entitled' as meaning the actual receipt of interest by the Bank. The expression 'due' used in subsection (1) of section 34 has been explained in subsection (2) and it is essentially in the context of the method of accounting referred to as on 'accrual basis'. Subsection (2) of section 34 provides, that subject to the Ordinance of 2001, an amount shall be due to a person when the latter becomes entitled to receive it even if the time for, discharge of the entitlement is postponed or the amount is payable by installments. The expression 'entitled' has not been defined under the Ordinance of 2009. The said expression is defined in various dictionaries. The Burton's Legal Thesaurus, Fifth Edition defines the expression 'entitled' as follows:-- "ENTITLED. Adjective, allowed, authorized, deserved, deserving, desirable, due, earned, eligible, empowered, fit, having the right, justified, labeled, legalized, licensed, merited, ordained, permitted, privileged, qualified, sanctioned, suitable, warranted, worthy" Advanced Law Lexicon Volume II (Reprint 2009):-- Entitled. Having a title to. "The word 'entitled' in Art. 5(4) [of the European Convention on Human Rights] connotes an enforceable right." R. (D.) v. Secretary of State for the Home Department, (2003) 1 WLR 1315, 1327 QBD per STANLEY- BURNTON J. (Stroud, 6th Edn., 2000, Supplement 2003) SEE ALSO (1) 'ABSOLUTELY ENTITLED'; (2) 'ACTUALLY ENTITLED'; (3) 'BENEFICIALLY ENTITLED', (4) 'PERSON ENTITLED'. Entitled as of right. Having a title as a matter of his right. Entitled as of right to practice. The phrase 'entitled as of right to practice' is an emphatic affirmation of a, right to plead and to act independently of the will or discretion of any other person. Asvini Kumar chuse v. Arbinda Bose, AIR 1952 SC 369, 377. (S. 2 Supreme Court Advocates (Practice in High Court) Act (18 of 1951)). Entitled consumer. "ENTITLED CONSUMER" means a person in a cantonment who is paid from the Defence Services Estimates and is authorized by general or special order of the Central Government to receive a supply of water for domestic purposes from the Military Engineer Services or the Public Works Department on such terms and conditions as may be specified in the order. [Cantonments Act (2 of 1924), s. 2(xic). "Entitled to" as applied to estates generally embraces every interest of eyed kind which the party in question has any title to whatever, whether it be an estate or interest in possession, in remainder or reversion, either vested or contingent. (Wilton v. Colvin, 3 Drew. 617). "ENTITLED TO" "SEIZED", "POSSESSED OF". The word "seized", or "possessed of", or "entitled to", are generally used to mean the same thing and very frequently occur in Settlements and wills, and other instruments where undefined property is dealt with by general words. Entitled to act. The following persons shall be deemed persons "ENTITLED TO ACT" as and to the extent hereinafter provided (that is to say)-- Trustees for other persons beneficially interested shall be deemed the persons entitled to act with reference to any such case, and that to the same extent as the persons beneficially interested could have acted it free from disability. A married woman, in cases to which the English law is applicable, shall be deemed to the person so entitled to act and whether of full age or not, to the same extent as if she were unmarried and of
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full age; and The guardian of minors and the committees or managers of lunatics or idiots shall be deemed respectively the persons so entitled to act, to the same extent as the minors, lunatics or idiots themselves, if free from disability, could have acted: Provided that - (i) no person shall be deemed "entitled to act" whose interest in the subject-matter shall be shown to the satisfaction of the Collector or Court to be adverse to the interest of the person interested for whom he would otherwise be entitled to act; (ii) in every such case the person interested may appear by a next friend or, in…
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