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Petitioner: Assessee VS Respondent: Department
Court Name: Income Tax Appellate Tribunal Judge(s):Muhammad Mujeebullah Siddiqui, Rasheed Ahmed Sheikh, Hamidullah
Malik Title: Assessee vs Department Case No.: I.T.As. Nos. 905/IB, 906/IB of 1991 Date of Judgment:1997-07-10 Reported As: PTCL 1998 CL. 286 Result: Order accordingly. Judgment ORDER MUHAMMAD MUJIBULLAH SIDDIQUI, (CHAIRMAN). -1. This Full Bench has been constituted to consider the following main questions:- (i) Whether L.P.G, produced by O.G.D.C. And Occidental of Pakistan falls within the definition of petroleum as defined in Rule 6(6) of Part 1 of the 5th Schedule to the Income Tax Ordinance, 1979. (ii) If L.P.G, comes within the purview of petroleum whether the income derived from the sale of L.P.G, is to be assessed under the provisions contained in 5th Schedule read with section 26 (b) of the Income-tax Ordinance, 1979. 2. The subsidiary questions relate to the setting OF of losses of L.P.G, business against petroleum income and admissibility of depletion allowance on production of L.P.G, also. 3. The naim point for consideration by this Full Bench is whether L.P.G, falls within the purview of petroleum as defined in Rule 6(6), Part 1 of the 5th Schedule to the Income Tax Ordinance, 1979. 4. We have heard Mr. Khalid Majeed, F.C.A., learned representative for the appellant and Mr. Abdul Jalil, learned representative for the department. Mr. Nasim Zaffar I.T.P, was also present at the time of hearing of appeals and on our request he has also assisted as on the point in issue. The common facts before us are that the O.G.D.C., M/s. Occidental of Pakistan Inc. (a non-resident foreign company), Messrs Pakistan Oil Fields Limited (not a party to the proceedings before us) a private limited company and Occidental of Pakistan Inc. a non-resident company derived income from production mid sale of crude oil, natural gas and liquified petroleum gas (L.P.G ) and are engaged in exploration, production and drilling as well under agreement with the Government of Pakistan through President of Pakistan. So far the business relating to crude oil and natural gas is
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concerned there is no dispute that the income from these sources is assessable under 5th Schedule to the Income Tax Ordinance, 1979. However, a perusal of record shows that a It of confusion is prevailing on the point if the business from sale of L.P.G, is a business other than petroleum business. The dispute and confusion has arisen on the interpretation, if L.P.G, falls within the purview of petroleum as defined in Rule 6(6) of Part 1 of 5th Schedule to the Income Tax Ordinance, 1979 or is refined petroleum product. The decision on subsidiary issues depends on the decision on this point. A perusal of record produced by the learned representatives for the parties shows that while framing assessm ent order in respect of M/s. Pakistan Oil Field Limited, Rawalpindi (N.T.N. 02-01-0200241) for the assessment year 1985-86 the assessing officer found that two separate accounts were maintained first under the head oil and gas and the second under liquified petroleum gas. Profit was declared under the head oil and gas, whereas loss was declared under the head L.P.G. Depletion allowance was claimed at 15% on gross receipts and was restricted to 50% of the profit declared under the head oil and gas without taking loss of L.P.G, from the profit on oil and gas. The assessing officer observed that the assessee should have deducted loss of L.P.G, from the profit of oil and gas and depletion allowance should have been restricted tb 50% of the resultant profit. The assessee in its reply contended that it has two lines of business one relates to oil and gas activities and other relates to L.P.G, plant. The A.R, of the assessee explained that L.P.G, comes under the definition of "refined petroleum products" and income/loss from L.P.G, is not assessable under the 5th Schedule to the Income-tax Ordinance, 1979. They further explained that due to this reason loss declared under the head L.P.G, was not deducted from the profit declared under the head oil and gas for restricting the depletion allowance to 50% of the profit declared. The assessing officer ultimately held as follows:- "A detailed correspondence was made and discussions were held with the assessee company regarding the taxability of L.P.G, as per 5th Schedule and the interpretation of well head value. There is thus a difference of opinion between the assessee and the department about the meaning and implication of the well head value as well as the treatment with the L.P.G. The assessee is producing crude oil and natural gas from its different wells. As the natural gas produced by the assessee is very rich in Hydrocarbons specially Propane and Butane which can be separated. It has set up a Plant at the well-head for extraction of L.P.G. (Propane and Butane) from the Natural Gas produced from different wells. The assessee has contended that the loss from the production and sale of L.P.G., for calculating of depletion allowance, cannot be adjusted against the profit from the sale of crude oil and natural gas. It has been claimed that the production of natural gas is a business activity, which is not covered by the Schedule. In view of the above facts and perusal of Pakistan Petroleum Production Rules, 1949 it is concluded that the contention of the assessee regarding adjustment of depletion allowance is not acceptable, as in the case of the assessee, the business activity with regard to production and sale of L.P.G, is to be considered for the calculation of depletion allowance. This conclusion is based simply on the fact that the assessee (by employing only mechanical process) separates and liquifies certain gases out of the natural gas obtained from the wells and sells them separately. This process of separation which is established at the well head site is employed before the sale of any product to any other agency is part of the well head production process of the assessee and its profits/loss from this activity is profit/loss of the assessee from the exploration and production of petroleum, which is to be computed under Part 1 of the 5th Schedule. This conclusion is further strengthened from the definition of well head value given in the Pakistan Petroleum Production Rule, 1949. The assessee claim is based on the argument that L.P.(j. As produced by it, is a refined petroleum product and as per definition of petroleum given is sub-rule (6) of Rule 6 of the 5th Schedule, Profit from production and sale of L.P.G, are not to be computed under the 5th Schedule. This interpretation of definition of petroleum does not appear to be correct because of the
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understanding that L.P.G, is not a refined petroleum product as is being obtained by the assessee. The assessee is only separating different gases by employing a mechanical process. As a result of this process, the sale of gas, after extraction of Propane and Butane, to Sui Northern Gas Pipelines, Company is reduced. If L.P.G, had not been extracted from the natural gas, the quantity of gas sold to the gas company in terms of volume would have been resulting in more sales and more profit. On questioning the petroleum Engineer Mr. Rizvi it was learnt that the natural gas which was left after extraction of Propane and Butane (LPG) and which is supplied to Sui Northern, can also be liquified, by employing a very sophisticated and expensive process. If the assessee had employed such process, the production of natural gas of the assessee would have become nil. In such an eventuality the sale of natural gas would have been totally eliminated from the accounts of the assessee, which were to be considered for computation of income under the 5th Schedule. This does not seem to be the purpose and spirit of the legal provisions enacted for determining profits from the exploration and production of petroleum. However, the expert personnel of the company do not agree with this interpretation of the issue. They stated that since separate L.P.G, plant, has been installed for processing the natural gas in accordance with the specification of S.N.G.P.L. And A.R.L., the income/loss computed under the head L.P.G, should not be adjusted against income/loss computed under the head oil and gas. To elaborate the exact process of separation and lignification of natural gas, the representatives of the assessee company further explained that after drilling the crude oil and gas on the well head the gas oil and water are separated through well head separator. Gas being lighter escaped through the top portion of the well head separator, water being heavier is drained from the bottom and oil is taken out from the middle. Some of the oil is then again separated from the gas in the form of casing-head spirit and then gas is taken through pipeline to a storage tank of L.P.G, plant. The temperature of gas in the plant is reduced up to minus 120F. As a result of lower temperature two gases namely Propane and Butane get liquified to become liquified petroleum gas. Other contents of gas get separated from L.P.G. L.P.G, is sold to marketing companies while remaining gas is sold to D.N.G.P. Ltd. He has, therefore, contended that loss from L.P.G, being a refined petroleum having no effect upon the sales of gas is not assessable as per 5th Schedule which should not be taken into account for depletion allowance. He has further submitted that under the head 'gas' value of total gas produced has been given as per price fixed by the Government at the well head before its bifurcation into L.P.G, on other gas sold to S.N.G.P. However on the advice and explanation of the experts of the company, the plea of the assessee company in this regard is accepted and the declared, version that L.P.G, may not be accounted for depletion allowance is accepted subject of action under section 156/65." 5. A perusal of the above finding shows that in the year 1985-86 while computing assessment in respect Pakistan Oil Field Limited, the contention on behalf of department was that the L.P.G, was not a refined petroleum product and was, therefore, included within the expression 'petroleum' as defined in Rule 6(6) of Part 1 of 5th Schedule to the Income Tax Ordinance, 1979 and the assessing officer was insisting that the income, profits and gains from the L.P.G, business is liable to be assessed under 5th Schedule to the Income Tax Ordinance, 1979 which the contention on behalf of the experts of the Pakistan Oil Field Ltd. Was that L.P.G, was refined petroleum product and, therefore, the profit from production and sale of L.P.G, was not to be computed under the 5th Schedule. It is very interesting to note that in the assessment order for the assessment year 1988- 89 in respect of O.G.D.C. Which is subject-matter of the present appeals (I.T.A. No. 905/IB of 1991-92) the positions taken by the two parties were diametrically opposed. The assessing officer has observed that, "assessee gross receipts include receipts from sale of L.P.G, which is a separate business and not assessable under the 5th Schedule". A notice was issued to the assessee asking as to why the profit/loss arising from sale of L.P.G, should not be treated as a separate business
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from its main business of exploration and production of the petroleum in Pakistan and assessed accordingly. The exact reply given on behalf of assessee has not been incorporated in the assessm ent order. However, the assessing officer has observed that the assessee has taken pains to technically establish that L.P.G, is not a product distinct from natural gas. This contention has not been accepted by the assessing officer and he has held as follows:- "It is to be pointed out that definition given in the Fifth Schedule of the Income Tax Ordinance, 1979 is so specific and clear that no external help is required to interpret its wording reproduced below:- Petroleum means crude oil, natural gas and casing-head petroleum spirit as defined in the Pakistan Petroleum (Production) Rules, 1949 but does not include refine petroleum products. As is evident from the above, this definition is restrictive and nothing can be added to it or included in it. The very fact that a separate technology is operated through independent extensive plant to convert natural gas into L.P.G, itself establishes the distinction involved. For the sake of convenience it would be appropriate to elaborate the exact process of separation and lignification of natural gas. It is to be pointed out that after drilling the crude oil and gas on the well head, the gas, oil and water are separated through well head separate. Gas being lighter escapes through the top portion of the well head separate, water being heavier, is drained from the bottom and oil I taken out from the middle. Some of the oil is then again separated from the gas in the form casing head spirits and then gas is taken through pipelines to a storage tank or L.P.G. Plant. The temperature of gas in this plant is reduced up to 120F. As a result of lower temperature two gases Propane and Butane get liquified to become liquified petroleum gas. Other contents of gas get separated from L.P.G. L.P.G, is sold to marketing companies. Needless to point out that although the law-makers have included oil, natural gas and casing head petroleum spirit in the definition of petroleum but have not included liquified petroleum gas deliberately. It may be mentioned that losses of L.P.G, could not be set OF against the business of drilling of oil find gas etc. A plain reading of the words 'Profits and gain of such undertaking shall be computed separately from his income, profits or gains from any other business, if any carried on by him clearly indicates that the business of exploration and production of oil and natural gas has to be segregated from other business income of the assessee. It also becomes obvious from plain reading of section 26(b) that the segregation is not only confined to the computation of income but it is operative right up to the point of calculation of tax. This can only be possible if losses' of other business carried on by the assessee are not allowed to be set OF against die profits of petroleum activities. Section 26 which begins with the words 'notwithstanding anything contained in this Ordinance' and Fifth Schedule lays down specific exception to the general principles." 6. The same treatment was given in the assessment orders for the assessment years 1989-90 and 1990-91. However, two different treatments were given at the first appellate stage while deciding first appeals for the assessm ent years 1988-89 and 1989-90 the learned C.I.T.(A), Islamabad vide his order dated 5-12-1991 held as follows:-- "The appellant's income in respect of sale of L.P.G, was considered by the I.T.O, not to be determinable in the light of provision of the 5th Schedule. It may be observed here that income, in respect of extraction has been made assessable under the 5th Schedule in accordance with the provisions contained in section 26(b) of the Ordinance. While discussing the merits of the case the assessing officer held that since L.P.G, was covered by the terms 'refined petroleum products' in sub-rule (6) of Rule 6 of the 5th Schedule, the income arising from this source was assessable under section 23 of the Income Tax Ordinance and not under the rules contained in the 5th Schedule. The learned A.R. Is not satisfied with the reasoning of the I.T.O, and contended that L.P.G, formed as much part of the petroleum products defined in the 5th Schedule, as crude oil, natural gas and casing-head petroleum spirit. In this respect reference has been made to Pakistan Petroleum Production Rules, 1949 in which the term 'natural gas' has been defined as 'gas obtained
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from bore-holes and well and consisting primarily of hydro carbons'. Again the Pakistan Petroleum (Refining, Blending and Marketing) Rules, 1971 have defined petroleum products to means 21 products of different kinds named therein but none of these includes liquid petroleum gas as a petroleum product. The learned A.R. Contended that whatever L.P.G, may mean, it certainly does not mean a refined petroleum product as contained in the 5th Schedule. In his lengthy written arguments it has been urged by the learned A.R. That L.P.G, was part of crude oil of natural gas and, consequently, income therefrom was assessable in the light of the 5th Schedule. I find myself in agreement with the arguments of the learned A.R. And would consequently, direct the I.T.O, to assess income from sale of L.P.G, along with income from sale of crude oil and natural gas." 7. Against a similar finding another CIT(A), Islamabad vide his order dated 17-10-1993 in respect of assessm ent year 1990-91 rejected the contention of. Assessee by placing reliance on the order of this Tribunal in I.T.As. Nos. 1742, 1743, 443 and 444 Islamabad Bench dated 5-12-1991 and held that the L.P.Q. Business should not be treated as part of business exploration and production of petroleum for computing income under 5th Schedule. 8. In the case of Occidental of Pakistan Limited in respect of assessment years 1989-90, 1990-91, 1991-92, 1992-93 and 1993-94, it was held by the assessing officer that L.P.G, business does not form part of the business of exploration and production of the petroleum and is not assessable under the provision of 5th Schedule to the Income Tax Ordinance, 1979. The assessing officer in this behalf referred to assessm ent order for the charge year 1988-89 and maintaining thereof by the learned C.I.T.(A), Rawalpindi vide his order dated 26-3-1990. The assessing officer further observed that, "the method whereby the assessee included profit from L.P.G, business in profit from business of exploration and production of petroleum was not correct". He further observed that "it would not be out of place to mention here that the provision of section 26(b) override any other provision of the Income Tax Ordinance and it states that profit and gains from exploration and production of petroleum and the tax payable thereon shall be computed in accordance with the rules contained in para. 1 of the 5th Schedule. Since, while assessing the profit and gains from the business of exploration and production of petroleum one cannot be go beyond the ambit of Part 1 of 5th Schedule, the set OF of losses of other business would amount to altering the very nature of the income assessable under 5th Schedule and thereby distort the method provided in the said Schedule for computation of assessee tax liability". 9. The assessing officer further observed that in view of detailed discussion in the assessment order for the charge years 1986-87, 1987-88 and 1988-89 the fact that L.P.G, and petroleum business are distinct and separate stands established. The learned C.I.T.(A) by placing reliance on the first appellate order for the assessm ent years 1986-87 to 1988-89 maintained the finding that the profit from sale of L.P.G, was not assessable under 5th Schedule, while placing reliance on the same order held that the assessee was entitled to claim set OF of the loss from L.P.G, business against the business of production and sale of petroleum assessed under 5th Schedule to the Income Tax Ordinance, 197$. The department is in appeal in the assessment years 1989-90 and 1990-91 assailing the finding for adjustment of loss in L.P.G, account against profits and gains from business of production and sale of petroleum while assessee is in appeal against the finding that L.P.G, business is separate from business of exploration and thus is not assessable under 5th Schedule. 10. The main order in favour- of department at first appellate stage is in the case of M/s. Occidental of Pakistan Inc. In respect of assessment years 1987-88 and 1988-89, dated 26-03-1990. The contention was raised before the learned C.I.T.(A) on behalf of assessee that the provisions contained in Concession Agreement to the effect that separation of hydrocarbons (other than Methane) from gas in liquid form shall be treated as crude oil will override the provisions contained in the Fifth Schedule to the Income Tax Ordinance, 1979. The contention was not accepted. The
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learned CJ.T.(A) after referring the contention and with reference to chemical composition of natural gas held that L.P.G, cannot be deemed to be petroleum as it is natural crude oil nor natural gas or casing head petroleum spirit and therefore, provisions of Fifth Schedule to the Income Tax Ordinance, 1979 is not applicable. For the sake of convenience the finding of learned C.I.T.(A) in the case of Occidental of Pakistan Inc. For the assessment year 1987-88 is reproduced below:- "The appellant has challenged the action of the ITO/Panel and prays that the L.P.G, business should be treated as a part of the business of exploration and production of petroleum assessable under the Fifth Schedule. The AR submitted the following arguments in support of his contentions:-- (a) Under Rule 6(6) of Part 1 of the Fifth Schedule to- the Income Tax Ordinance, 1979, 'Petroleum' 'has been defined to mean 'crude oil, natural gas and casing-head petroleum spirit as defined in the Pakistan Petroleum (Production) Rules, 1949 but does not include refined petroleum products'. This definition is also given at clause 1.18 of Article 1 of the North Potwar Petroleum Concession Agreement. ) (b) According to the Pakistan Petroleum Production Rules. 1949. Crude oil, natural gas and casing- head petroleum have been defined as under: ~ " Crude oil' means oil in its natural state before the same has been refined or otherwise treated, but excluding water and foreign substance. "Natural gas' means gas obtained from bore-holes and wells and consisting primarily of hydrocarbons. "Casing-head petroleum spirit' means any liquid hydro-carbons obtained from natural gas (before crude oil from which it is derived has been measured for royalty) by separation or by any chemical or physical-process. (c) Under the Liquified Petroleum Gas (Production and Distribution) Rules 1971 "liquified petroleum Gas' has been defined to mean hydrocarbons mainly consisting of Propane and Butane mixed or unmixed whether with or without gases which are vapours at room temperature and pressure but can be liquified on slight compression. (d) "Gas' has also been defined under the Natural Gas Rules. 1960 to means natural unmixed and natural gas mixed with artificial gas and includes all other fluid hydrocarbons not defined as oil. (e) L.P.G, as per its definition given above, is also casing head petroleum spirit, being liquid hydrocarbon obtained from natural gas by separation or by any chemical or physical process, while it has not been included in schedule or petroleum products referred to above. (f) In this regard, the definition of 'natural gas' given in clause 1.15 of Article 1 of North Potwar Petroleum Concession Agreement again confirms that hydrocarbons other than Methane are to be treated as crude oil. (g) Clause 7.5(c) of Articles VII of the North Potwar Petroleum Concession Agreement is reproduced below which clearly states that all hydrocarbons other than methane, like for instance Butane and Propane, if extracted, are to be considered as crude oil. "The provisions of this agreement shall not restrict the rights of the parties to remove any hydrocarbons other than methane (CH4) from gas. Such other hydrocarbons, if extracted, shall be considered as crude oil under the other clauses of this Agreement and not as gas under this clause." In nutshell, the contention of the A.R. Is that L.P.G, is included alternatively in the terms 'crude oil', 'natural gas' or 'casing-head petroleum spirit' as per their definitions given above. Hence income from L.P.G, business is liable to be computed under the Fifth Schedule. The A. R.'s reliance on the provisions of North Potwar Concession Agreement in support of his contention that separation of hydrocarbons (other than Methane) from gas in liquid form, shall be treated as 'crude oil' is of no help to him because the provisions of the said agreement cannot override the provisions of the Fifth Schedule. The agreement may define crude oil and natural gas
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differently for the specific purposes of the agreement which could be calculation of royalty or some other purpose. However, for tax purposes, provisions (including definitions) of the Fifth Schedule shall prevail. L.P.G, cannot be treated as a 'casing-head petroleum spirit' for the simple reason that the chemical formula of both the products are totally different. Whereas chemical formula of 'casing-head petroleum spirit' is C.5 plus that of L.P.G., which is the combination of Propane and Butane gases in 60:40 percentage, is totally different. Moreover, 'casing-head petroleum spirit' is obtained from natural gas before crude oil from which…
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