Al Wakeelo
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Petitioner: Commissioner Of Income Tax, Karachi VS Respondent: M/S. Gelcaps (Pvt) Ltd., Karachi
Court Name: Sindh High Court Judge(s): Muhammad Mujeebullah Siddiqui, S. A. Sarwana Title: Commissioner Of Income Tax, Karachi vs M/S. Gelcaps (Pvt) Ltd., Karachi Case No.: I.T.R. No. 58 of 1992 and I.T.C. No. 226 of 1991 Date of Judgment:2003-04-10 Reported As: PTCL 2009 CL. 493 Result: Reference answered
JUDGMENT
JUDGMENT MR. JUSTICE MUHAMMAD MUJEEBULLAH SIDDIQUL-(1). The question of law in both the above cases is common, therefore, both the cases are being disposed of by. This single consolidated judgment. 2. In I.T.R. 58 of 1992, the learned Income Tax Appellate Tribunal (hereinafter referred to as ITAT) has referred the following question of law for our opinion:- "Whether on the facts and circumstances of the case the Income Tax Appellate Tribunal was justified in directing the adjustment of Profit earned on PLS time Deposit against interest payable on borrowed capital, and capitalize the balance." 3. The facts giving rise to the above question are that during the assessm ent year 1988-89 the respondent/assessee was setting up a factory. No production or business was carried on. The assessee filed, return of total income declaring nil income. The organization and development expenditure amounting to Rs. 80,46,674 was capitalized after deducting the profit earned on PLS time Deposit. The Assessing Officer did not accept the treatment and held that the interest incurred on loan for establishing industrial undertaking is to be capitalized and there is no provision for reducing the capital expense by adjusting it against the income from other sources. He further held that the amount of interests earned by assessee is taxable under section 30 of the Income Tax Ordinance, 1979 and consequently the profit/interest amounting to Rs. 5,54,701 was subjected to tax as income from other sources. The First Appeal preferred by the assessee was dismissed. The assessee preferred second appeal before the ITAT. The Tribunal while placing reliance on its earlier decision reported as 1988 PTD (Trib.) 369, accepted the appeal and directed the Assessing Officer to allow capitalization of the amount representing the difference of the interest paid and the interest received. The Department feeling aggrieved submitted reference application and fee learned ITAT,
---
## Page 2
after citing the following passage from the earlier decision of ITAT, reported as 1988 PTD (Trib.) 369, referred the question reproduced earlier:- "Now, if we examine the facts of these appeals from the point of commercial expediency, it appears that the appellant had to pay interest on the borrowed loan. He therefore, had two choices; either he could . Have kept the money in its safe and capitalized the interest paid, or should have earned some interest on the unutilized money and then capitalized the difference obtained after deduction of the interest earned from interest paid, in either case he could have minimized its liability whereas in the former case it would not have done so. As a businessman of ordinary intelligence and common prudence it adopted the second method and it is indeed the method of commercial expediency. At the time when it was minimizing its interest liability it " might not have known that its adventure would ultimately fail to see the day of commencement of production as it ultimately happened. Let us point out that as per statement of Mr. Faruq Ali, the appellant has not gone in production till today and this fact further shows the commercial foresight of the appellant and its financial advisers as they minimized their losses by depositing the balance money on interest. We are, therefore, of the considered view that the appellant rightly invested the balance money in fixed deposits and earned interest thereon so that its losses could be minimized. This is, in our judgment, best example of commercial expediency. We are, therefore, of the view that the interest income of the appellant earned under the facts and circumstances of these appeals was an income from business and, as such, it was rightly set of against the interest payable before the balance was capitalized for the simple reason that it was an expenditure admissible under section 23(l)(vii) of the Income Tax Ordinance. Let us point out that under the facts and circumstances of these, appeals the loan was obtained for business of earning interest as well as for business of earning income from manufacturing liquid sugar. Hence file interest expenditure in proportion to interest income has been deducted and the balance has been capitalized." 4. The relevant facts giving rise to I.T.C. No. 226 of 1991 are that the respondent filed return of income for the assessment year 1987- 88 declaring nil income. The assessee being a company was in the process of establishing a factory and the expenses were capitalized. The Assessing Officer, on examination of accounts found that an amount of Rs. 2,07,935 were paid to Messrs Union Bank of Middle East while an amount of Rs. 1,91,269 was received from Union Bank of Middle East as interest on fixed deposit. Difference of these two amounts were transferred to Paper Plant machinery account. The assessee was called upon to show as to why the interest received should not be subjected to tax as income from other sources. The assessee contended that it did not earn profit on fixed deposit but had reduced the cost of machinery by way of adjusting Rs. 1,91,269 against Rs. 2,07,935 by reducing interest charged on loans for investment in machinery and the difference of Rs. 16,666 was capitalized. The Assessing Officer, did not accept the contention and subject to the interest earned on F.D.R. At Rs. 1,91,269 as income from other sources. The assessee preferred First Appeal contending that the method was adopted by way of business expediency and the Assessing Officer has no jurisdiction to interfere with the manner in which business is conducted by an assessee. The learned A.A.C. Did not accept the contention and the appeal was dismissed. The assessee preferred Second Appeal before the ITAT and the learned ITAT allowed the appeal by placing reliance on its earlier decision reported as 1988 PTD (Trib.) 369. 5. The Department being aggrieved submitted reference application proposing following question of law:- "Whether on the facts and circumstances of the case the learned Tribunal was justified in upholding the action of the appellant in capitalising the difference of the interest paid and interest received amounting to Rs. 16,666 and not charging the tax on the amount of interest earned on FDR of Rs. 1,91,269 under the head income from other sources." 6. The reference application was rejected
---
## Page 3
and consequently, the department submitted application under section 136(2) of the Income Tax Ordinance, 1979 before this Court and the reference application was admitted to regular hearing to consider the question of law proposed by the Department. 7. We have heard Mr. Nasrullah Awan, learned counsel for the applicants in both the reference applications and Mr. Hisamuddin learned counsel for the respondent in ITR 58/92. Nobody has appeared on behalf of respondent in ITC 226/91. Mr. Nasrullah Awan, has vehemently assailed the finding of ITAT in the judgment reported as 1988 PTD (Trib.) 369, his contention is that, in the above cited judgment, learned Tribunal has seriously erred in holding that in pre-production period the assessee earned income from business and further fell in error that the assessee rightly set of the income so earned against the interest payable before the balance was capitalized for the similar reason that it was an expenditure admissible under section 23(l)(vii) of the Income Tax Ordinance. He has submitted that the finding contained in the Tribunal's order reported as 1988 PTD (Trib.) 369, is contradictory in terms as the learned Tribunal has approved the capitalization of interest which means that it was a pre-production period and the assessee has not commenced its business, while on the other hand, it has held that the interest earned on deposits was a business income. He has further contended that even if it is accepted for the sake of argument that the interest earned on deposits is income from business then the entire business income is not to be allowed as expenditure and that too in the form of capitalization of the interest paid at the borrowed capital at a stage when the business has not taken of. He has submitted that the learned ITAT, has not considered the judgment cited by it in real perspective and consequently, has fallen in error. 8. On the other hand, Mr. Hisamuddin, learned counsel for the respondent in ITR 58/92, has fully supported the view of the ITAT held in the judgment reported as 1988 PTD (Trib.) 369. 9. We have carefully considered the contentions raised by the learned Advocates for the parties and the relevant law on the question under consideration. 10. The learned Tribunal while deciding the issue under consideration in both the cases mainly placed reliance on an earlier Division Bench judgment of the Tribunal reported as 1988 PTD (Trib.) 369. It is, therefore, necessary to recapitulate the relevant facts in the above cited judgment of die Tribunal. In the said case, the assessee, a company, incorporated in July, 1980, had filed return for the assessm ent years, 1982-83 to 1985-86 declaring nil income. The Assessing Officer, while processing the return found that the assessee company was floated with paid up capital of Rs. 35,000 divided into 7000 shares of Rs. 5 each for the purposes of setting-up industry for manufacturing of liquid sugar. For this purpose it had also borrowed loan. A part of the borrowed loan was spent on the under construction project and the balance was kept in banks on fixed deposits. Interest income was earned which was deducted from the amount of interest paid on the borrowed capital and the balance interest paid on the borrowed capital was capitalized. Admittedly the assessee had not gone in operation in the relevant assessment years. The Assessing Officer did not accept the treatment and held that the amount of interest derived from fixed deposits was income from other sources and taxed accordingly. In the above situation, a Division Bench of the learned Tribunal held as follows:- "Now, if we examine the facts of these appeals from the point of commercial expediency, it appears that the appellant had to pay interests on the borrowed loan. He, therefore, had two choices; either he could have kept the money in its safe and capitalised the interest paid, or should have earned some interest on the unutilized money and then capitalize the difference obtained after deduction of the interest earned from interest paid. In either case he could have capitalized the interest paid. In the later case, however, he could have minimized its liability whereas in the former case it would not have done so. As a businessm an of ordinary intelligence and common prudence it adopted the second method and it is indeed the method of commercial expediency. At the time when it was minimizing its interest liability it might not have known that its adventure would ultimately fail to
---
## Page 4
see the day of commencement of production as it ultimately happed. Let us point out that as per statement of Mr. F.A. The appellant has not gone in production till today and this fact further shows the commercial foresight of the appellant and its financial advisers as they minimized their losses by depositing the balance money on interest. We are, therefore, of the considered view that the appellant rightly invested the balance of money in fixed deposits and earned interest thereon so that its losses could be minimized. This is, in our judgment, best example of commercial expediency. We are, therefore, of the view that the interest income of the appellant earned under the facts and circumstances of these appeals was an income from business, and as such, it was rightly set of against the interest payable before the balance was capitalized for the simple reason that it was an expenditure admissible under section 23(l)(vii) of the Income Tax Ordinance. Let us point out that under the facts and circumstances of these appeals die loan was obtained for business of earning interest as well as for business of earning income from manufacturing liquid sugar. Hence the interest expenditure in proportion to interest income has been deducted and the balance has been capitalised. Thus, in view of discussion made above, we allow these appeals and hold that interest income was not chargeable to tax as income from other sources. We also direct the 1TO to allow deduction of interest earned from interest payable." 11. The learned Division Bench of the Tribunal gave the above finding by placing reliance on the judgment of Supreme Court of India in the case of Eastern Investment Ltd. v. CTT (1951) 20ITR 1 (SC India). 12. The facts in the case of Eastern Investment Ltd. Were that an investment company was formed for acquiring, holding and otherwise dealing with shares and Government securities which belonged to C. The share capital of the company was 250 lacs and the majority of its shares, including 50,000 ordinary shares of the face value of Rs. 5,000 .n , was held by C and the rest was held by the nominees of C.C died and S was appointed administrator of his estate. S held the 50,000 ordinary shares in that capacity. Money was needed by the executors of C and accordingly S entered into an agreement with the assessee under which the assessee agreed to reduce its share capital by Rs. 50 lacs by taking over from S the 50,000 shares at Rs. 100 a share and S on his part agreed to forego cash payment and to receive instead debentures of the face value of Rs. 50 lacs carrying interest at 5 per cent, per annum "redeemable at the option of the registered holder at any times". The sanction of the High Court was obtained in due course and the agreement was carried -out by the parties. The transaction was not challenged on the ground of fraud. The Income-tax Authorities, the Appellate Tribunal and the Calcutta High Court took the view that in computing the income of the assessee the interest paid on these debentures could not be deducted under section 12(2) of the Indian Income Tax Act, 1922, on the ground (a) that it was not expenditure incurred for the purpose of earning the income, profits and gains of the assessee and (b) that even if it was so, it was at any rate not expenditure incurred solely for that purpose. 13. The Supreme Court of India, under the facts and circumstances supra, found no relevance to the core issue, in the arguments that (1) the conversion did not, in any way, disturb the holding of the investments of the company; (2) or interfere with the earning of its income; (3) or it had the effect of diminishing its taxable income; (4) or that there was complete identity of person between the person whose shares, were sold and the person who took the debentures and whole the transaction resulted in considerable benefit to him; (5) or whether the transaction could be brought within the functions of an investment company; (6) or that the capital of the company could have been reduced in other ways; (7) or that the company had, at the time, sufficient liquid resources to effect the reduction of capital desired and so it was not necessary to resort this process. The Court held that as long as the transaction is not challenged as a fraud, and since there is no even an allegation of fraud, the test for present purposes is neither whether the other party benefited, nor indeed whether this was a prudent transaction which resulted in ultimate gain
---
## Page 5
to the appellant, but whether it was properly entered into as a part of the appellant s legitimate commercial undertaking in order, indirectly, to facilitate the carrying on of its business. Finally it was held:- "On a full review of the facts it is clear that this transaction was voluntarily entered into, in order, indirectly, to facilitate the carrying on the business of the company and was made on the ground of commercial expediency. It therefore, falls within &e purview of section 12(2) of the Income Tax Act, 1922, before its amendment in 1939." 14. A perusal of the above facts and the findings of the Supreme Court of India shows, that the issue under consideration was pertaining to nature of expenditure incurred incidental to business under the law. The ground of commercial expediency was not considered in the context of the nature of income accrued to the assessee. The learned Tribunal further placed reliance on the judgments reported in 36LTR 329, 29 LTR 696, 46 LTR 511, 49ITR 127 and (1978) 115 ITR 519. In all these cases the facts were similar to the Eastern Investment Ltd. 15. The other case on which the learned Division Bench of the Tribunal placed reliance was, Motilal Hirabhai Spinning and. Weaving Mills Ltd. v. CTT (1978) 113 ITR 173 (Gujarat High Court). 16. The relevant facts in the case of Motilal Hirabhai Spinning and Weaving Mills Ltd., (Supra) were that the assessee was running a textile mill. Subsequently, it discontinued business and derived income from property and interest on deposits. The assessee used to deposit the excess funds available with it with various parties and declare up to assessment year, 1969-70, interest income under the head "Income from other sources". Subsequently, in the assessment year in dispute, the interest income was derived from loans advanced to five parties and scrutiny of the accounts of those parties revealed that there was no frequency of advances made to those parties and the transactions were mainly in the nature of deposits. No borrowal was affected by- the assessee in the assessm ent year under consideration nor in any of the earlier years to earn interest by lending money to the various parties and only surplus finds which were available to the company were advanced to eam interest. The pattern of advances had also varied from year to year, and in some years, monies were invested in banks while in others monies were placed either in fixed deposit or in Sharafi account with certain companies. The assessee claimed that the income was under the head 'business'. The Income Tax Officer and the Appellate Assistant Commissioner, did not accept the claim of the assessee. The Tribunal, however, upheld the assessee's claim on the grounds that the articles of association of the company authorized the company to invest and deal with the moneys of the company in such manner as may from time to time be thought necessary and to land, deposit or advance money, securities and property to such persons, firms or companies limited or otherwise and on such terms as may seem expedient and in particular to customers and sellers and other having dealings with the company. The proceedings of the meetings of the board of directors showed that the directors were regulating the advances to be made to various parties and that they decided not only upon the amounts to be advanced but also the rate of interest to be charged depending upon the exigencies of the situation. The Tribunal also found that there was a systematic activity of advancing monies to various parties. 17. At the instance of the revenue, the Tribunal referred the following question of law arising out of its order for the opinion of the Gujarat High Court:-- "Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the income derived by the assessee company from deposits and loans is 'income from business' and not 'income from other sources'. The Gujarat High Court finally held that, the last part of clause (25) of the articles of association of the company referred to advances being made in particular to customers and . Sellers and others having dealing with the company. The last part could not be read as controlling the first part. The objects of the company, having regard to the language in which they were couched, authorized
---
## Page 6
the company to make advances not only to customers and sellers but also to any "persons, firms or companies" as the assessee company thought proper. The proceedings of the board of directors revealed that the directors were regulating the advances. They treated it as a part of the activity which the company had to undertake. The Tribunal rightly applied the relevant tests, namely, volume, frequency, continuity and regularity of the transactions in reaching the conclusion that the activities of the assessee giving advances constituted business. The interest earned by the assessee on the advances made by it was assessable as income from business. We further find that the ratio of the decision of Gujarat High Court supra is that in taxing statutes the word "business" is used in the sense of an occupation or profession which occupies the time, attention and labour of a person normally with the object of making profit. In order to infer from a course of transactions that the person intended thereby to carry on business, ordinarily the characteristics of volume, frequency, continuity and regularity indicating an intention to continue the activity of carrying on the transactions must exist. But no single test is decisive of the intention to carry on business. In the light of all the circumstances an inference that a person desires to carry on business may be raised. 18. From the facts of the case narrated above and the judgment of the Gujarat High Court, we find that the learned members of the bench who decided the judgment reported as 1988 PTD (Trib.) 369, failed to consider that the facts in cited case were entirely different and distinguishable. The ratio of the judgment by the Gujarat High Court was not attracted. On the contrary, the Gujarat High Court held that profits and gains from business are earned normally through devotion of time, attention and labour of person undertaking an intention to continue the activity which, in the case before the Gujarat High Court was manifested from the deliberated decisions of the board meetings to make advances to various parties at the rate warranted by the situation and expressly provided in the articles of the memorandum. No such activity was shown in the case reported as 1988 PTD (Trib.) 369 and in the two cases under consideration before us. 19. The learned Bench, thereafter, considered the ratio of decisions relied upon by the learned D.R. And observed that in CTT v. United Wire Ropes Ltd. (1980) 121 ITR 762 (Bom. H.C.), Bengal and Assam Investors v. CIT (1976) 33 Tax 8 (S.C. The.) and CTT v. Liquidators Khulna Bagerhat PLD 1962 SC 128 it is held that, where surplus funds either out of share capital or borrowed capital are deposited in banks, the interest accrued thereon, and, where investment of such funds in shares is made simply to earn dividends, the interest and/or dividend, so derived, are income from other sources. The learned Bench further observed that the ratio of decision in Trace Cable Co. Ltd. v. CIT (1969) 72 ITR 503, is that if a person carries on any business other than a business of banking or dealing in money, deposits surplus funds in a bank and receives interest thereon, it cannot be contended that it is income from business nor can it be contended that, where pending commencement of business any expenses are incurred by a company connected with the running of its affairs, such expenditure is incurred for earning interest on deposits of surplus funds in bank. The learned Bench further noted that in United Commercial Bank Ltd. v. CIT (1975) 32 ITR 688, relied Upon by the learned D.R., the Supreme Court of India has held that interest on securities held by the bank is part of its banking business income. 20. However, the learned Bench, in our view, seems to have been influenced by the ratio of decisions in California Copper Syndicate Ltd. v. Haris, Surveyor of Taxes 5 TC 159, Mazagaon Dock Ltd. v. CIT (1958) 34 ITR 368 (S.C. The.) and Bandengwers Ltd. v. Clarke (1935) 31 LTR (Eagles case) 17 which are not relevant, either in context or in content. It has escaped the attention of the learned Bench that to earn interest on "investment" is distinct from earning interest on "deposit". Thus, the learned Bench has arrived at the fallacious conclusion that earning of interest by the appellant, who had obtained loan for setting up a liquid sugar manufacturing factory, and who would have been manufacturing liquid sugar when it might have started the production, is also to be deemed
---
## Page 7
an income from business on the principle of commercial expediency. 21. Under the scheme of law contained in the Income Tax Ordinance, 1979, the sections 9 and 10 provide that tax specified therein shall be charged, levied and paid for each assessment year, in respect of total income of the income year, of every person at the rate or…
Read the unabridged text and precedent citation network on Al Wakeelo Legal Research Platform.