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Petitioner: COMMISSIONER OF INCOME-TAX (CENTRAL), KARACHI VS Respondent: MESSRS HABIB INSURANCE Co. LTD., KARACHIHonorable Justice Dorab PatelGhias Muhammad, Attorney-General,A. K Brohi, Ali Athar
1969 P T D 317
1969 P T D 317
[Karachi (Pakistan)]
Before Qadeeruddin Ahmad and Dorab Patel, JJ
COMMISSIONER OF INCOME‑TAX (CENTRAL), KARACHI
versus
MESSRS HABIB INSURANCE Co. LTD., KARACHI
Civil Reference No. 89 of 1959, decided on 19th December 1968.
(a) Insurance Act (IV of 1938)-----
---- S. 2(9)(b)‑Business of insurance‑"Insurer"‑Definition‑Act does not prohibit an insurer from carrying on non‑insurance business‑Companies Act (VII of 1913), S. 8(2)‑Income‑tax Act (XI of 1922), S. 10(7).
(b) Insurance Act (IV of 1938)-----
---- Ss. 11, 15 & 17‑Insurer carrying on "non‑insurance business"‑Separate accounts have to be prepared by him for such business.
(c) Income‑tax Act (XI of 1922)------
---- S. 2(4)‑"Business" Definition ‑ Purchase and sale of shares ‑ When constitute "business of investment".
In order to constitute a business, there must be a continuous exercise of activity for the purpose of gain. This element of continuity is essential to constitute a business of investment. The reason for this condition is that in modern society people no longer hold their savings in gold or cash but are encouraged to invest their savings in property and securities, yet a man who invests his savings in buying a property would not be said to be carrying on a business if he lets out the property on rent, nor would a person who has purchased shares out of his savings be said to carry on business merely because he derives income from his investments. If, however, he regularly bays and sells property or shares, so as to make profit out of the fluctuations in the prices of property or shares, then it would be said that he was carrying on the business of investment ; there is thus a fundamental distinction between the business of investment; and the purchase and sale of investments by a person. Even occasional speculation in shares does not amount to carrying on a business ; therefore, a person, who buys property or shares and retains them for a long period of time, would not be considered to be carrying on the business of investment.
Commentary on Income‑tax by Sir Jamshedjee Kanga and Mr. Palkhiwala, 4th Edn., p. 31 ; Swadeshi Bima Company v. Commissioner of Income‑tax 26 I T R 530 ; Grainger & Son v. William Lane Gough 1896 L R A C 325 ; Californian Copper Syndicate v. Harris 5 Tax Cas. 159 and Re : A. Debtor (1936) 1 Chan. 327 ref.
(d) Company-------
----‑Memorandum of limited liability company containing "primary object" ‑ Construction ‑ Other clauses in Memorandum to be understood as ancillary to main object of Company.
Palmer's Company Law, 12th Edn., p. 88 ref.
(e) Income‑tax Act (XI of 1922)-----
----- S. 10(7) read with First Sched. rr. 3 & 6‑Words "other cossets" in r. 3‑Held, include `'immovable property".
(f) Income‑tax Act (XI of 1922)-----
----- S. 10(7) read with First Sched.‑Computation of profits and gain of insurance business No distinction drawn by S. 10 between insurers‑Argument that only income of mutual insurance associations can be calculated according to rules of Schedule ‑ Held, cannot be accepted.
(g) Income‑tax Act (XI of 1922)------
--- S. 66(1) read with First Sched., rr. 3 & 6 ‑ Question as formulated presupposing valid existence of rr. 3 & 6 Plea that rr. 3 & 6 were illegal raised before High Court‑Held, not within ambit of question referred.
Sutlej Cotton Mills v. Commissioner of Income‑tax P L D 1965 S C 443 and State of Utter Pradesh v. Lal A I R 1957 S C 912 distinguished.
(h) Income‑tax Act (XI of 1922)------
------ S. 2(6‑C) and First Sched., rr. 3 & 6 --`Income"‑Definition‑Word to be construed to widest possible manner‑Includes capital gains on application of investments as provided in rr. 3 & 6 even though such gains not realised.
Navinchandra Mafar Lal v. Commissioner of Income‑tax AIR 1955 S C 58 ref.
Ghias Muhammad, Attorney‑General with S. A. Nusrat and Haider Pirzada for Appellant.
A. K Brohi, Ali Athar, Bhojani, Rafiqul Haq (Dacca) and Khalid Anwar for Respondent.
Dates of hearing : 23rd to 26th, 29th to 31st January, 1st and 2nd February 1968.
JUDGMENT
DORAB PATEL, J.‑This is a reference by the Income‑tax Appellate Tribunal, Karachi under section 66(1) of the Income‑tax Act, 1922.
2. The assessee is the Habib Insurance Company Limited (hereafter called the Company). The Company was incorporated in Bombay as a public limited company in 1943, with an authorised capital of Rs. 1 crore, and a paid‑up capital of Rs. 25 lakhs. The purposes for which the company was incorporated are set out in clause 3 of the Memorandum of Association of the Company. The following are the clauses of the Memorandum, which have been cited as relevant to this reference :
"(r) To purchase, take on lease or in exchange, hire, or otherwise acquire, any real and personal property, and any rights or privileges which the Company may think necessary or convenient for the purposes of its business.
(s) To construct, maintain and alter any buildings or works, necessary or convenient for the purposes of the Company.
(t) To appropriate any party or parts of the property of the Company for the purposes of and to build and let or sell shops, offices and other places of business.
(u) To sell, improve, manage, develop, exchange, lease, mortgage, dispose of, turn to account or otherwise deal with all or any part of the property and rights of the Company.
(v) To invest and deal with the moneys of the Company not immediately required in such manner as may from time to time be determined.
* * * * * * * * * * *
(aa) To promote any company or companies for the purpose of acquiring all or any of the property, rights, and liabilities of this Company or for any other purpose which may seem directly or indirectly calculated to benefit this Company.
(bb) To sell or dispose of the undertaking of the Company or any part thereof for such consideration as the Company may think fit, and in, particular for shares, debentures or securities of any other company having objects altogether or in part similar to those of this Company.
(cc) To carry on any other business which may seem to the Company capable of being conveniently carried on in connection with the above, or calculated directly or indirectly to enhance the value of or render profitable any of the Company's property or rights or be conducive to its interests."
The primary object of the Company was to carry on the business of insurance. Immediately on incorporation the Company commenced fire insurance, and a few months thereafter, it began life and other insurance businesses.
3. The questions which are to be determined in this reference arise out of certain investments made by the Company in 1943 and 1944. In 1943, the Company purchased 8 immovable properties in Bombay for a sum of Rs. 10,47,100 and 10,000 Preference Shares and 461 Ordinary Shares from the Habib Bank Ltd. (a sister concern of the Company) at a
total cost of Rs. 5,37,250 in round figures. In 1944, it purchased another immovable property in Bombay, thereby increasing its investments in immovable property to Rs. 11,99,652. As a result of the conversion of the Preference Shares of the Habib Bank into Ordinary Shares, the Company's investment in Habib Bank shares was increased in 1946 by Rs. 2 lakhs to Rs. 7,37,250. In the year 1949, the book value of two of the said immovable properties was shown to have appreciated by Rs. 1,59,954, and one immovable property was sold with an additional profit of Rs. 76,462. In 1950, another immovable property was sold at a profit of Rs. 10,360, and the remaining immovable properties were shown in the books as having appreciated in value by Rs. 5 lakhs. The value of the shares of the Habib Bank had appreciated by Rs. 32,85,000. Thus the appreciation and surplus realisation in 1949 was Rs. 2,36,416, and the book appreciation in 1950 was Rs. 37,85,000. These amounts were shown in the Company's balance‑sheet of 1949 and 1950 respectively.
4. Consequently, the Income‑tax Officer treated the said amount of Rs. 2,36,416 vide his order dated the 14th of March 1955 for the assessment year 1950‑51, as income of the Company's insurance business under the provisions of rules 3 and 6 of the Schedule to the Income‑tax Act. Similarly, he treated the book appreciation of Rs. 37,85,000 as income of the Company's insurance business for the assessment year 1951‑52, vide his order dated the 29th of March 1956. The Company disputed its liability to tax on the said amounts. The contention of the Company throughout has been that these investments were made directly out of the share capital of the Company, and that they were not shown in the revenue accounts of its insurance business. Moreover, it was argued, since the investments were made in the course of investment business of the Company, it was not liable to be taxed on the said accounts, as income of insurance business. The Income‑tax Officer rejected the contentions of the Company. According to him, the entry of the aforesaid amounts of Rs. 2,36,416 and of Rs. 37,85,000 in the balance‑sheet of the Company amounted to appropriation of the said amounts to non‑life insurance business of the Company within the meaning of rule 3 of the First Schedule of the Act, therefore taxable as such.
5. The Company appealed against the said orders to the Appellate Assistant Commissioner, who by a single order dated the 16th November 1957 rejected them. Thereafter, the Company filed an appeal before the Income‑tax Tribunal, which was dismissed by the order of the Tribunal dated the 4th November 1958. Finally, the Company asked for a reference of the case to this Court, and the present reference has been made to this Court.
6. The question framed by Tribunal under section 66(1) of the Income‑tax Act is as follows
`Whether, in the facts and circumstances of the case, the Tribunal is correct in holding that (a) the appreciation in the book value of the investments and (b) realisations in respect of properties sold during the relevant years of accounts, were chargeable to tax under the provisions of section 10(7) of the Income‑tax Act, read with rules 3 and 6 of the rules set out in the First Schedule to the said Act ?"
The question thus formulated holds good with respect to both the assessment years 1950‑51 and 1951‑52, and is of general, importance to Insurance Companies.
7. Mr. Brohi submitted that, although the primary object of the Company is to carry on the business of insurance, it was entitled under its Memorandum of Association to carry on the business of investment, and that the above‑mentioned surplus realisation and book appreciation (hereafter called the said credits) arose out of investments made by the Company in the course of its business of investment and not of insurance. Thus, he argued, the Tribunal has erred in taxing the said credits as income from the insurance business of the Company merely on the ground that the Company has shown the said credits in its balance‑sheet. In order to appreciate this contention, it is necessary to examine the relevant provision of the Income‑tax Act, 1922.
8. Under section 3 of the Income‑tax Act, 1922, income‑tax is payable by an assessee on its income for the previous year. Section 10 enacts that tax shall be payable by an assessee on the profits and gains on any business, profession or vocation carried on by him. But subsection (7) of section 10 provides as follows :
"Notwithstanding anything to the contrary contained in section 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with rules contained in the First Schedule of this Act."
Rule 1 of the First Schedule enacts that when any person carries on life insurance business, the profits and gains of such person from that business shall be computed separately from his income, profits or gains accrued from any other business. Rule 2 prescribes the manner of determining the profits and gains of life insurance business and is not relevant because in this case, the Department has held that the surplus realisation and book appreciation of the investments were appropriated by the Company to non‑life insurance business. Rule 3 is mentioned in rule 6, which is relevant, but rules 4 and 5 are irrelevant to the present inquiry. Rule 6 runs as follows :‑
"6(1). The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 to be furnished to the Controller of Insurance after adjusting such balance so as to exclude from it any expenditure, other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business. Profits and losses on the realisation of the investments, and depreciation and appreciation of the value of investments shall be dealt with as provided in rule 3 for the business of life insurance."
The relevant part of rule 3 is as follows :
"* * * * * * * *
In computing the surplus for the purpose of rule 2 :‑
(b) any amount either written off or reserved in the accounts or through the actuarial valuation balance‑sheet to meet depreciation of or loss on the realisation of securities or other assets, shall be allowed as a deduction, and any sums taken credit for in the accounts or actuarial valuation balance‑sheet on account of appreciation of or gains on the realisation of the securities or other assets shall be included in the surplus."
9. The rules have created a special definition of income in order to meet the exigencies of the business of insurance. Although no profits may be earned by an insurer, if he appropriates an investment made by him and credits appreciation in his accounts, tax becomes payable on such appreciation.
10. The contention of the Attorney‑General has been that if an insurer credits in his balance‑sheet the appreciation that is accrued on such investment tax is attracted on such appreciation, irrespective of the source of the investment. We are not able to accept this contention, because section 10(7) of the Income‑tax Act clearly states that it is only the profits and gains of the business of insurance which are taxable in the manner provided in the First Schedule ; therefore we have to determine the meaning of the expression "business of insurance", but before doing this, we have to decide whether the Insurance Act, 1938 permits an insurer to carry on non‑insurance business, because Mr. Brohi submitted that an insurer was free under the Insurance Act, 1938, to carry on non‑insurance business, but the Attorney‑General submitted that an insurer could carry on insurance business only. Both counsel have addressed us at great length on this aspect of the case.
11. The Attorney‑General advanced five arguments in support of his submission. Firstly, according to him, the provisions of section 11 and section 14 of the Insurance Act, 1938 eliminate the possibility of an insurer keeping any accounts or account books except those of the business of insurance. Secondly, since the provisions of section 33 of this Act empower the Controller of Insurance to issue orders and directions to an insurer, the Controller was empowered to prohibit non‑insurance business. Thirdly, he submitted that section 58 of the Act empowers the Controller of Insurance to order partial winding up of the business of the insurer. The Companies Act does not contain any provision empowering any authority to give directions to a Company as to how the business of the Company is to be run. In view of this inconsistency between the Companies Act, 1913 and the Insurance Act, 1938, the Attorney‑General submitted, the relevant provisions of the Companies Act had beet repeated for purposes of the business of insurance. Fourthly, he submitted that if an insurer was allowed to carry on non‑insurance business, this could endanger the safety of the policy holders and thus defeat the provisions of the Insurance Act. Finally, he argued that it was an admitted fact that no other company in Pakistan had combined non‑insurance business with insurance business, which fact proved that no insurer could carry on non‑insurance business under the Insurance Act, 1938.
12. On the other hand, Mr. Brohi submitted that an insurer is required to show his non‑insurance business in Forms A and B, which he is required to prepare under section 11 of the Insurance Act. Secondly, Mr. Brohi pointed out that in subsection (2) of section 8 of the Companies Act, 1913 an insurer is defined as "any person who carried on the business of insurance with any other business". and argued that this definition recognises the right of an insurer to carry on non‑insurance business, although subsection (9)(b) of section 2 of the Insurance Act defines an insurer as "any individual or body corporate .carrying on the business of insurance". Counsel submitted that the definition of insurance given in the Companies Act, 1913 was not affected by the definition of an insurer given in the Insurance Act, nor did the said Act anywhere prohibit an insurer from doing non‑insurance business, therefore, according to counsel, the Insurance Act permitted an insurer to carry on non‑insurance business. Thirdly, as to the contention of the Attorney General that the interest of policy holders would be endangered if an insurer was allowed to carry on non‑insurance business, Mr. Brohi pointed out that since the Controller of Insurance was entitled under section 33 of the Insurance Act to investigate the affairs of an insurer and to give such directions and orders to the insurer as he thought fit, the Controller had sufficient powers under the Act to protect the interest of policy holders against any danger caused by non‑insurance business of the insurer. Fourthly, Mr. Brohi relied on the judgment of the Allahabad High Court in the Swadeshi Bima Company v. The Commissioner of Income‑tax (26 I T R 530) in which that Court held that under the Insurance Act, 1938 an insurer could carry on non‑insurance business along with his insurance business. Lastly, Mr. Brohi pointed out that the Insurance Act, 1938 had been amended in India, so as to empower the Controller of Insurance to prohibit an insurer from carrying on insurance business. This amendment, Mr. Brohi argued, proved that before the amendment an insurer was entitled under the Insurance Act, 1938 to carry on non‑insurance business.
13. We have examined the provisions of sections 10, 11 and 14 of the Insurance Act, 1938. The contention of the Attorney‑General that the provisions of sections 10 and 11 relate to the maintenance by an insured of accounts of various classes of insurance business only is obviously correct. The provisions of section 14 do require an insurer to keep registers of all of his business, but these registers relate only to the business of insurance. But merely from these provisions it is not possible to infer that the Insurance Act, 1938 has taken away the right of an insurer to carry on non‑insurance business. The definition of an insurer under the Companies Act, 1913, which we have quoted above, clearly recognises the right of an insurer to carry on non‑insurance business. This definition has not been altered or modified by the definition of an insurer in section 2(9) (b) of the Insurance Act, 1938, nor is there any provision in the Insurance Act prohibiting an insurer from carrying on non‑insurance business. We have also referred to the Manual prepared by the Income‑tax Department and found at page 249 that this Manual also recognises the right of an insurer to carry on non‑insurance business. We, therefore, agree with the finding of the Tribunal that the Insurance Act, 1938 does not prohibit an insurer from carrying on non‑insurance business.
14. But absence of prohibition does not mean that the Insurance Act has provided any practical method for keeping the accounts of the non‑insurance business of an insurer. An examination of the account forms set out in the Schedules of the Insurance Act, 1938, which an insurer is required to prepare under section 11 of the said Act, shows that the accounts required to be kept under the Act relate only to the business of insurance.
15. Section 11 of the Insurance Act requires an insurer to prepare a balance‑sheet according to the above‑mentioned Form A, a profit and loss account according to the above mentioned Form B, except when the insurer carries on only one class of insurance business. In respect of each class of insurance business, the insurer has to keep a separate account of receipts and payments, and has also to prepare a revenue account for each class of business in accordance with the forms set forth in the Third Schedule of the Act applicable to the class of business carried on. Form D is the form of revenue account for life insurance business, and Form F is the form of revenue account for all, fire, marine and all other class of insurance business. The insurer has also to prepare other forms, which need not be considered here.
16. Let us now consider whether, as contended by Mr. Brohi, an insurer can declare the profits of his non‑insurance business in From B. Form B is as follows
Form B
Form of Profit and Loss Account.
Profit and Loss Account of For the year ended 19
Rs. A. P.
Rs. A. P.
Central Taxes on the insurer's Profits (not applicable to any particular Fund or Account)
Interest, Dividends and Rents(not applicable to any particular Fund or Account) ... Rs. Less ..Income‑tax thereon Rs.
Expenses of Manage ment (not applicable to any particular Fund or Account)*
Profit on realisation of Investments (not credited to Reserves or any particular Fund or Account).
Loss on Realisation of investments (not charged Reserves or any particular Fund or Account) ...
Appreciation of Investments to (not credited to Reserves or any particular Fund or Account ...
Depreciation of Investments (not charged Reserves or any particular Fund or Account)
Profit transferred from to Revenue Accounts (details to be given) ...
Loss transferred from Revenue Accounts (details to be given).
Transfer Fees ...
Other expenditure (to be specified)
Other Income (to be specified) ...
Balance for the year Carried to Appropriation Account ...
Balance being loss for the year carried to Appropriation Account ...
*If any sum has been deducted from this item and entered on the assets side of the balance‑sheet, the amount must be shown separately.
An insurer is required to prepare Form B only if he carries on more than one class of insurance business. If he carries on only one class of insurance business, the revenue form account enables him to supply all the information appertaining to that class of insurance business. Thus if he is carrying on life insurance business, Form D will enable him to show all the claims under life insurance policies, the liabilities thereon, all expenses of management, including commission to agents, salaries, director's fees, etc. The form will also enable him to show the balance of the life insurance fund, the premiums earned, "interest, dividend and rents," all other income, and finally the amount of profit or loss transferred from that revenue account to the profit and loss account. Similarly, Form F enables the insurer to supply the same information for other classes of insurance business. We may note here that this form requires that "interest, dividends and rents," reserves for unexpired risks, other reserves, and the amount of profits or loss transferred from the said revenue account to the profit and loss account be shown in it. Now the fourth entry in the right hand column of the Form B refers to "profits transferred from revenue account". It refers to the profits transferred from the revenue accounts D and F of the various classes of insurance business carried on by an insurer. This Form does not contain any other entry for declaring profits by the insurer. Since the revenue accounts relate only to the business of insurance, it is impossible for an insurer to declare the profits of the non‑insurance business in Form B.
18. But Mr. Brohi argued that certain entries in Form B support his contention that in this form an insurer can declare the profits of his non‑insurance business. He referred to the entries which relate to assets "not credited to reserves or to any particular fund or account." For instance the first entry in the right hand column of Form B states
"Interest, dividend and rents (not applicable to any particular Fund or Account)."
Counsel contended that this entry relates to income derived from the non‑insurance business of an insurer. Similarly, the second and third entries in the right hand column of Form B, are as follows
"Profits on realisation of investment (not credited to reserves or any particular Fund or Account).…
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