Al Wakeelo
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Petitioner: Messrs MND EXPLORATION AND PRODUCTION LTD. and others VS Respondent: C.I.R., L.T.U., ISLAMABAD and others
Court Name: Appellate Tribunal Inland Revenue Judge(s):Javed Iqbal, Nazir Ahmad, Muhammad Ashraf, Abdul Rauf, Muhammad
Jahandar Title:Messrs MND EXPLORATION AND PRODUCTION LTD. and others vs C.I.R., L.T.U., ISLAMABAD and others Case No.:I.T.As. Nos.433 to 436(IB), 137(IB), 440 to 443(IB) of 2008, 311, 312(IB), 297(KB), 298(IB), 115(KB), 116(KB), 117(IB), 1944(KB) of 2007 and 545(KB), 1305 to 1309(KB) of 2006, 1086(KB) of 2005, 18(KB), 19(KB) of 2011, and M.A. (A.G.) No.137 of 2009 Date of Judgment:2011-06-13 Reported As: 2012 P.C.T.L.R. 610, 2012 PTD (Trib.) 581 Result: Order accordingly Judgment ORDER The questions posed for determination before the larger bench are the application of tax rate and payments to Government of Pakistan by Oil and Exploration Companies and the manner of calculation of depletion allowance to the E&P companies. During pendency of the instant appeals memorandum of understanding was executed on 26-3-2010 between the E&P Companies [Pakistan Petroleum Exploration and Production Companies Association (PPEPCA)] and F.B.R. Through its member policy (direct taxes) on all matters including the aggregate of taxes on income and other payments to government and the depletion allowance which are the subject of dispute before the bench. On the issue of depletion allowance previously the full bench of the Appellate Tribunal Inland Revenue in the case of PIR KOH gas company had given its judgment. Thereafter full bench was constituted to resolve the issue of tax rate and payments to GOP, subsequently it was converted into larger bench to decide the issue of manner of calculation of depletion allowance in addition to tax rate. In the earlier judgment of the full bench it is held that the transportation, gathering, processing and other charges specifically mentioned in Rule 2(K) of the 1986 Rules and the sales tax, Excise duty and Royalty the Government of Pakistan levies which are not specifically mentioned in Rule 2(k) are to be excluded from the gross receipts for the purpose of the depletion allowance.
---
## Page 2
Now the aforementioned judgment is sub-judice before the Hon'ble High Court. The MOU signed by the member F.B.R. And PPEPCA, which as per the counsels of the E&P Companies was to be implemented by the F.B.R. Whereas the DR stated that the MOU provide only a framework for understanding and it was never a binding agreement, hence its implications are not relevant to the instant appeals. The learned DR also referred the clause 10 of the MOU, which states that in case of any dispute over the MOU, parties are free to pursue their legal course. We are persuaded to agree with the contention of the UDR, the matter relating to MOU has neither been raised through the grounds of appeals nor does it arise from the orders of the officers below which are subject of the present appeals, while also this Tribunal is not a proper forum to resolve the disputes arising out of MOU It has no legal status as it has neither been codified as law by the legislative body nor has been A notified by the subordinate legislation, rather it was a memo of understanding between the E&P Companies and member FBR, During course of hearing of appeals, it was pointed out on behalf of department that some of the E&P Companies have also filed writ petitions on the matter of implementation of MOU, in this way matter is also sub-judice before the Hon'ble High Court and yet is pending for adjudication. Arguments tendered on behalf of the E& P companies: The dispute on account of calculation of tax rate has arisen because as per the contention of E&P Companies, the Petroleum Concession Agreement is binding on Government of Pakistan and has got sanctity under Rule-4 of Part-I of Fifth Schedule to the Ordinance, 1979. In majority of the taxation articles, it has been stated that 'payments' to Government shall be limited to 55 percent of profit and gains. Accordingly in case of almost all petroleum companies in Pakistan tax rate that is provided in the respective PCAs, has been applied on the profits and gains prior to deduction of payments to Govt. Tax department is misapplying the provisions and principles laid down in the PCAs. The gist of the misapplication is that taxation officers are reading the terms 'profit and gains' and 'profit and gains before deduction of royalty' as being synonymous, which is a fundamental error on the part of the department. The words "prior to deduction of payments to Government" are not contained in PCAs in the sentence 'containing the rate. The brief reasons of their incorrectness by tax department as per the view of L/ARs of E&P Companies are as follows:-- Clause 2 of the Schedule to the Mining Act specifies that the rate within the range of 50 to 55 per cent is to be applied on the `profits and gains prior to deduction of payments to Government'. This provision is not the rate of tax, it provides the ceiling and the floor within which, range of the rate can be fixed by the government. This clause is being misconstrued since this clause also provides that the limit of payments to Government shall be fixed in the permit/license PCA. Oil and Gas Development Corporation of Pakistan (OGDCL), Government Holdings Pakistan Limited (GHPL) and Pakistan Petroleum Limited (PPL) are voluntarily paying to the Government at 55 percent. This fact is not correct since OGDCL, which have several PCAs making payment to Government at 'average rates' (e.g. 52.0428 and 53.2564. This is not as per.Any law or PCA. PPL has paid to the Government at 50 percent since past few years.] The tax department has contended that Circular No.2 of 1974 dated May 14, 1974 issued by the Federal Board of Revenue [F.B.R.] is no longer effective but this contention of the tax department is incorrect since F.B.R. Has not withdrawn this Circular. The crux of the arguments of E&P Companies representatives was that: (a) Each PCA contains a rate. Some PCA's state that this rate has to be either on: Profit and gains; or Profit and gains prior to deduction of payments to Government
---
## Page 3
(b) The amount payable to Government arrived at in the above manner needs to be compared with the following amount calculated under the Fifth Schedule to the Ordinance, 1979. Profit and gains prior to deduction of payments to Government. (c) Higher of A or B is payable to the Government. There is nothing in the Mining Act, petroleum policy or any concession agreement that is different from the aforesaid principle and the same has been accepted by the FBR through circular of 1974. Departmental Arguments: On behalf of the department it was stated that schedule to Mining Act, 1948 was inserted through amendment in 1976, which clearly set out an upper cap at 55% and floor at 50% of the profit or gains "before deduction of payments", to Govt. Of Pakistan The Ordinance, if allows for any limit to be set in PCA, the same limit can not be more or less than the limit provided in the Mining Act, 1948, but in each case it must be "before the deduction of payments" to the government. The PCA is dependent and is subject to section 4 of Mining Act, while the last Para of each PCA in its taxation clause also describe the same. No PCA can be in breach of mandatory law. Section 4 of Mining Act, 1948 provides "that any rule made under this Act and any order made under such rule shall have effect notwithstanding any thing inconsistent therewith contained in any enactment or any instrument having effect by virtue of enactment other than this Act". The E&P Companies from ambiguous wordings of PCA have tried to introduce a new category of rate which is 55% of profit and gains (after royalty) which is not envisaged in the Mining Act, 1948. Any basis if provided in PCA is against the mandate of law, the law of Mining Act shall prevail. If the arguments of ARs are accepted, then the "55% "after royalty" will always be lower than 50% (before. Royalty). Therefore there is no rationale in stating 55% (after royalty) in PCA. The PCA also provide the minimum rate of 50% of profit or gains, (before royalty). Mathematically 55% limit (after royalty) will always be lower than 50% limit (before deduction of royalty), unless the rate of royalty is reduced from 12.5% to a lower rate, which is legally not possible as the rate of royalty at 12.5% is fixed under the law. Rate of payments and taxes as per Mining Act, 1948 range from 50% to 55% but rate shall always be based on (profit and gains (before deduction' of royalty). If the PCA - impliedly provides the rate of 55% of Profit and gains and does not further expressly state (before deduction of royalty,) it does not mean that such rate will be applied on profit and gains (after deduction of royalty). On account of the PCAs of Tajal Adhi, Kandkat and Magarani, it was stated by the E&P companies that the rate of tax at 55% (before royalty) is stated to be applicable to the above PCAs, whereas in other PCAs no such sentence containing the rate has been recorded, therefore in all other cases rate of 55% of profits and gains (after royalty) will be applied. In its reply it was stated by the departmental representatives that if the above plea of the E&P companies is accepted then the rate will always be lower than 50% of profit and gains (before royalty) and then the statement regarding 55% limit (after deduction of royalty) becomes redundant, While the conflict under this special system of taxation is to be resolved as per the provisions of Mining Act under the arbitration clause of the PCA. It was also pointed out on behalf of the Revenue that there are different types of PCAs and in certain PCAs there are other are irrationalities too, therefore any interpretation to the wording of PCA would not be appropriate. Regarding the F.B.R. Circular No.2 of 1974, the L/DR stated that it is not applicable because of subsequent amendment in 1976 by virtue of which circular has become redundant, Mining Act of 1948 is the governing law which shall prevail over any other inconsistent provision contained in any PCA or circular. Before amendment in 1976 the Mining Act, 1948, was silent about the computation of limit, therefore F.B.R. As per its understanding of any particular PCA interpreted a manner of calculation which was applicable at that time in the absence of any provision in the statute. In 1976. "Regulation of Mines and Oil Fields and Mineral Development (Government Control) (Amendment) Ordinance was promulgated whereby schedule to the Mining Act was inserted along with other amendments. Para 2 of the
---
## Page 4
schedule to the Mining Act clearly indicates that both 55% and 50% limit should be computed on profits and gains before royalty. The C.B.R. Circular No.2 of 1974 was issued on 14th May 1974, law was amended in 1976 and after the amendment in law, aforementioned circular has become redundant, as circular cannot stand in conflict with the law. As per amendment in 1985 depletion allowance is to be added back for computing the limit. The E & P companies are not applying the stipulation of Circular No.2 of 1974 by not adding back the depletion allowance towards profit or gain with the plea that after amendment in 1985 depletion allowance is not required to be added back, while on the other hand are applying the rate of tax deducting the royalty which is contrary to amendment in law. If the argument is taken by taxpayer that the law of adding back of depletion allowance was changed subsequently (in 1985), so the Circular to that extent is not applicable,. Then there is also an argument that the Mining Act was also changed in 1976, therefore the Circular is also not applicable in respect of computing 55% limit (after deduction of royalty). It is also settled principle that FBR is not empowered to interpret the law. The instructions issued by FBR only in nature of administrative matters are binding on the tax officers. This concept has very well been explained by the Supreme Court of Pakistan in the case of Central Insurance. The Federal Government is entitled to prescribe the aggregate of payment of taxes on income and other payments to Government within provided limit only. The taxation officers were correct in applying the ceiling of 55% of profits and gains (before deduction of royalty), as this is the only. Basis envisaged in law for applying the rate. The Mining Act, 1948 does not allow providing any rate (50%, 52/5 & 55%) on profits (after deduction of royalty). All the rates are applicable on profit and gains (before deduction of royalty). The E&P Companies were required to pay tax as per PCA provided it is not in conflict with the Act. The Federal Government, no doubt is entitled to prescribe tax within the limit of. 50% - 55% but whatever rate is prescribed within the provided limit, it should be before deduction of royalty. There exists no confusion and there is no miscalculation of tax payable. In fact E&P Companies are calculating tax payable by ignoring the fact that Act shall prevail over the PCA and after amendment in the Act, the circular and its calculation is not applicable. It was mandatory on E&P Companies to calculate tax as per schedule of Mining Act and not to calculate tax according to circular. On account of "royalty" as an allowable expense for computing profits and gains there was no contrary provision to that effect in the law prior to 2001, E&P Companies' view is totally unreasonable and not based on correct interpretation of law. How payments and a levy to the Government is to be allowed as an expenditure, when it being part of 'payment to the Government' and it is adjustable as credit against the tax liability. Notwithstanding to that the amendment made through Finance Act, 2001 and FBR's Circular No.5 of 2001 has removed the doubt. As a result of the change in petroleum policy in 2001, whereby royalty is no more treated as 'payment to the Government', its deduction was consequently allowed as an expenditure. It is therefore clear that previously (for PCA singed before 2001 (which are under dispute), royalty was not an allowable expenditure for the purpose of computing 'profits and gains'. It was also stated by the L/DR that subsequent amendment or substitution of provision of law do not affect any provision of law, rather the amendment and substitution further clarify and supports the stance of the department that royalty is not an allowable expenditure and rate by the Govt. Of Pakistan is to be fixed between the range of 55% to 50% (before the deduction of royalty). The rate of 50% before the deduction is not disputed by the E&P companies. We have heard the arguments of the rival parties, perused the relevant law and the PCAs on the subject. The issue of calculation of tax rate has arisen because of the broad types of Petroleum Concession Agreements by the E&P Companies with the Govt. Of Pakistan which as per the Authorized Representatives of E&P Companies have different implications, whereas departmental
---
## Page 5
point of view was that the implications thereof should be the same in the light of the provision of Mines and Oil Field and Mineral Development Act, 1948 (Act of 1948) read with the amendments brought out in Act in 1976. In certain PCAs where the rate of 55% is not expressly stated to be applicable on profit & gains before royalty, E&P companies are contending that rate of 55% in such cases is applicable on profit and gains (after royalty). The activities for exploration, prospecting, mining and production of petroleum are regulated by a Federal Statute viz. Regulation of Mines and Oil-Fields and Mineral Development (Government Control) Act, 1948 (Mining Act) and the Rules made pursuant thereto. The companies engaged in this line of business are assessable under special system as per the provision contained in Part-I of the 5th schedule to the Income Ordinance, 1979. Entities engaged in these activities enter into Petroleum Concession Agreements (PCAs) with the President of Pakistan. This is special system through which the sum of payments to government and taxes on income are determined, this system operates through combined reading of following:-- (1) Mining Act (read with the Rules) (2) Petroleum Concession Agreement (PCA) (3) Part I of Fifth Schedule to the 1979 Ordinance History and historical development of the above provisions is as follows:-- Through Finance Act, 1956 section 10(8) was inserted in the Income Tax Act, 1922, in consequence of which 2nd schedule was also inserted to provide separate basis for computing profits or gains and tax payable there on. Rule 4(1) of the second schedule to the 1922 Act was inserted in 1956, which provides: "The sum of payments and taxes to the government on income in respect of profit or gains derived from their business to which the provisions of this schedule apply for any year of assessment shall equal to one-half of the profit and gains derived from the said business or part of business before deduction of payments to government and the additional allowance .Referred to in rule 3." Through Finance Ordinance, 1969 Rule 4(1) was substituted as to provide that sum of payments and taxes on income shall be as provided for in the agreement with the government subject to condition that, such sum shall not be less than 50% of profit or gains before deduction of royalty and depletion allowance at that time called as additional allowance. (Now called as depletion allowance). Circular-3 of income tax was issued after the finance Ordinance, 1969 to explain the amendments made in 1969 through these amendments three important changes were made in the 2nd Schedule under which the income of the companies engaged in the production of oil etc. Is computed. Rule 4(1) as amended in 1969, now exists in similar form in the fifth schedule to the Income Ordinance, 1979, except for amendments in 1985 to the effect that 50% minimum limit was to be computed at that time on profit or gains before royalty and depletion allowance and now such minimum limit is computed at profit or gains before royalty, the and back of depletion allowance was deleted in 1985. In 1994 petroleum policy was introduced. Before November 2nd 1976, there was no limit or rate provided in the Mining Act, 1948. Through amendment in Ordinance, 1976 sections 3A, 3B and Schedule was inserted in the Mining Act, 1948. Till that time tax and payments made to the government by such companies taken together have not to exceed 50% of profits or gains derived before deduction of payments to the government and depletion allowance at time called as additional allowance. The law now provides that this percentage can be increased subject to an agreement between the government and oil producing companies.
---
## Page 6
From the above changes and development of law, it transpire that for the first time through Finance Act, 1969, the tax as provided in PCA were given legal sanction as prior to changes as granted in 1969, the income tax law of Pakistan did not recognize the sanctity of any rates given in the PCA. The lower the limit of 50% of profit .And gains before the deduction of royalty in 1969 and there after through a proviso in Rule 4(1) to the schedule of Mining Act was in fact legislation by way of abundant caution for setting up a floor for taxation of E&P companies, so that if any PCA envisaged the rate below 50% before deduction of royalty then such rate should not prevail, this was in fact bringing it in harmony with section 3B of the Mining Act. After amendment in Mining Act, 1976, the legal status of PCA has been determined through section 2 of the regulations of Mines and Oil Fields and Mineral Development Act, 1948. This section empowers Government to make rules, which provide for the following:-- Section 2 of the Mining Act 1948 reads as under: It is hereby declared through the expediently in the public interest that (appropriate government) shall have power to make rules to provide, for all or any of the following matters namely:- (i) (ii) (i.e) ........................... (iv) The determination of rate and conditions subject to which royalties, rent and taxes shall be paid by licensee, lessee and guarantees of mining concession. Section 2 (4) of Mining Act provided powers to the authorities for signing of PCA. (v) ........................................ (vi) ........................................ (vii) ........................................ (viii).......................................... Further sections 3A and 3B were inserted in the Mining Act, 1948 vide Finance Act, 1976 in a manner to restrict the scope of powers provided under section 2(4) of the Mining Act to the extent of schedule inserted whereby method of computation of income, rate of royalty, basis of computing royalty on the well head value and taxes on income were provided with maximum and minimum limit together with the method of computing payments to the federal government including taxes on income Prior to 1976 there was no limit or rate provided in the Mining Act, 1948, through amendment in 1976, besides of sections 3A and 3B, schedule was also inserted in the Mining Act, 1948 the concessions provided as per section 3B and the schedule include; (i) Freezing of tax law. (ii) Rate of royalty. (i.e) Limit of aggregate of payment to government. (iv) Exemption of tax for foreign expenditure. .(v) ............................. (vi) ................... Rule-1 of schedule freezes the applicability of Income Tax Law on the date of signing of PCA. Thus any amendment in the income tax law after effective date of PCA is not applicable to taxation matters of that particular PCA. In all cases, which are subject of instant appeals, PCAs were executed prior to 1995, as per freezing clause of agreements Ordinance, 1979 is applicable, to which protection has also been given vide section 239(10) of Ordinance, 2001. Rules 2 and 3 of the schedule to the Mining Act, 1948, relating to fixation of limit of aggregate since 1976 states as under:-- "Royalty shall be charged at a fixed rate of 12-1/2 percent of the well-head value and shall form part of the sum of payments to the Federal Government and taxes on income which shall neither be more than 55 percent nor less than 50 percent of the profits or gains before deduction of 'payments to the Government' referred to in clause (5) of rule 6 of part I of Fifth Schedule to the Ordinance, hereinafter referred to as the said Schedule". Rule-4 of the 5th Schedule of Income Tax Ordinance, 1979 prescribes limitation payments to Government and taxes: (1) "The aggregate of the taxes on income and other payments to the Government in respect the profits and gains derived from an undertaking to which this Part applies for any assessment year shall not exceed the limits provided for in the agreement:
---
## Page 7
Provided that the said aggregate shall not be less than fifty percent of the profits or gains derived from the said undertaking before the deduction of the payment to the Government". From bare reading of law, with Rule 4 of the fifth schedule to the Ordinance, 1979, point seems very much clear without any shadow of doubt:-- (1) Under section 4 of the Mining Act, 1948 no other Act or Rule can override the provision of Mining Act, 1948; therefore neither the Income Tax Ordinance nor a PCA or Rule can over ride provision of Mining Act; if there is conflict. (2) The royalty is chargeable at the rate of 12.5% of the well-head value and it has to form the part of the payments to the government. (3) The controlling law unambiguously prescribes the minimum and the maximum thresholds and states that payments to government including taxes on income shall neither be more than 55% or less than 50% of the profits and gains. (4) Lastly and most importantly, the law prescribes that for the purpose of determination of aggregate sum of payments to the government and tax the profits and gains have to be taken "before the deduction of payments to government including royalty. The 1948 Act set out upper limit 55% of the profits and gains before deduction of payments to the Government. The Income Tax Ordinance, 1979 provides only limit be that as provided in the PCA. The 1979 Ordinance allows for any limit to be set in a PCA, the same can not be more or less than the limits provided in the Mining Act, 1948 i.e. 55% and 50% of profits or gains before deduction of royalty. For this purpose the 1948 Act also provides limit of profit and gains "before deduction of payments to the Government". In this way in the light of aforementioned provision of law contained in the Mining Act and 1979 Ordinance, Government is bound to execute an agreement accordingly, whereas no agreement can be in breach of a mandatory provision of law. From the above it is evident that PCA provide a limit or an applicable rate of 55% of profits and gains, and a lower limit of 50% of profit and gains, which will be amount payable. The lower…
Read the unabridged text and precedent citation network on Al Wakeelo Legal Research Platform.