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Petitioner: Messrs Army Welfare Trust, Rawalpindi VS Respondent: Commissioner of Income Tax
Court Name: Islamabad High Court Judge(s): Mohsin Akhtar Kayani, Babar Sattar Title: Messrs Army Welfare Trust, Rawalpindi vs Commissioner of Income Tax Case No.: Tax Reference No.50 of 2005 and I.T.R. No.4 of 2009 Date of Judgment:2022-04-07 Reported As: 2023 PTD 351 Result: Order accordingly
JUDGMENT
JUDGMENT BABAR SATTAR, J. Through this judgment, we will decide tax references listed in Annexure-A attached hereto. The questions of law proposed for our consideration in the references listed in Annexure-A have been amalgamated with the assistance of the learned counsel for the taxpayer (i.e. Army Welfare Trust) and the tax department. The questions so proposed have been listed in Annexure-B. Seeking guidance from the law laid down by the August Supreme Court in Octavius Steel Company, Ltd. v. The Commissioner of Income Tax, Dacca (PLD 1960 SC 371), we find it to be in the interest of clarity that we reformulate the questions proposed for our consideration, in order to squarely address the underlying legal issues, as follows: 1. Whether income derived by the projects of Army Welfare Trust (AWT) is to be treated as diverted income by virtue of overriding title of the Welfare and Rehabilitation Directorate of Pakistan Army (WARD) and consequently not to be treated as income of AWT chargeable to tax in its hands? 2. What is the status of AWT being a society registered under the Societies Registration Act, 1860, and whether it is to be treated as a trust under the Income Tax Ordinance, 1979 ("Ordinance of 1979") and whether it is to be treated as a company under section 2(16)(bb) of the Ordinance of 1979, which could attract provisions of section 80D of the Ordinance of 1979, and whether AWT qualifies as a company under section 80(2) (b)(v) of the Income Tax Ordinance, 2001 ("Ordinance of 2001") rendering it liable to minimum tax under section 113 of the said Ordinance? 3. If the income of the AWT is not to be treated as income to be diverted to WARD by virtue of overriding title, would such income qualify for exemption under clause 62(1) of Part I of the Second Schedule to the Ordinance of 1979 and clause 58(2)(i) of Part I of the Second Schedule of the Ordinance of 2001 for purposes of the Ordinance of 2001. In order to seek exemption under clause
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62(1) of Part I of the Second Schedule to the Ordinance of 1979 and clause 58(2)(i) of Part I of Second Schedule to the Ordinance of 2001, does AWT need to discharge the onus of establishing the "quantum of income expended" on welfare activities or would setting aside income for welfare activates suffice to seek exemption under the clauses of the Ordinance of 1979 and the Ordinance of 2001? 4. Whether the interest income is to be treated as "income from business" under section 15 of the Ordinance of 1979 or under section 11 of the Ordinance of 2001, or whether such income is to be treated as "income from other sources" for purposes of the said sections? 5. Whether in relation to assessing the income from Blue Lagoon project of AWT, the tax department was justified in applying a gross profit rate of 30% without furnishing reasons for applying such rate or otherwise identifying any defects in the return submitted by AWT on the basis of applying a lesser gross profit rate to the revenue generated? 6. Whether AWT was entitled to deduction in lieu of bad debt under section 23(1)(x) of the Ordinance of 1979. 2. A perusal of the questions summarized in Annexure-B reflects that there are certain other questions framed for our consideration as well. But after review of the judgments of the learned Tribunal we are of the view that no other questions of law emanate from the said judgments from which the references have arisen and consequently the additional questions listed in Annexure-B have not been included in the reformulated questions listed above. 3. Army Welfare Trust ("AWT") was initially registered as a society under the Societies Registration Act, 1860, with the name of Army Welfare Projects Fund and a certificate of registration was issued dated 13.10.1971. Its name was subsequently changed to Army Welfare Trust pursuant to the permission granted on 13.10.1974. 4. The basic legal question in the references being decided is the status of AWT for purposes of the Ordinance of 1979 and the Ordinance of 2001, as some references relate to tax years to which the Ordinance of 1979 is applicable and others relate to tax years to which the Ordinance of 2001 is applicable. 5. AWT has taken the position that it has no real income as all of its income is diverted to WARD by virtue of overriding title over such income. The Tax Department refused to acknowledge the concept of diversion of income and assessed the income received by AWT in its own hands. The Commissioner (Appeals) by order dated 04.10.2000 held that AWT qualified as a company under section 2(16) of the Ordinance of 1979 in view of the fact that AWT had filed returns with the status of a company up until 1995-1996. The Commissioner (Appeals) further held that AWT was a juristic person with distinct legal personality and could claim an exemption under clause 62(1) of Part I of the Second Schedule to the Ordinance of 1979 to the extent that it expended income chargeable to tax under the head of income from business as required by such clause. The Commissioner (Appeals) did not allow the interest income from investments placed in bank accounts to be treated as income from business and held that such income was to be treated as income from other sources. The learned Tribunal by order dated 24.03.2003 after discussing all the case law cited by AWT and considering the arguments on behalf of AWT and the Tax Department held that diversion of income on the basis of overriding title was not a concept recognized under the Ordinance of 1979. It observed that the basis being claimed by AWT for attributing overriding title over AWT's income to WARD was a letter dated 02.05.1999 issued by the Adjutant General Branch of GHQ directing AWT to transfer its entire income to WARD and that such letter would at best be treated as an administrative instruction to AWT and could create no overriding title in favour of WARD over the property of AWT or the income produced by such property. It held that the income received by AWT was to be treated as AWT's income for purposes of section 11 of the Ordinance of 1979 liable to tax in the hands of AWT. On the question of legal status of AWT, the learned Tribunal
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held that given that AWT was a society it could not be treated as a trust under section 2(16)(bb) of the Ordinance of 1979 and was liable to be treated as an association of persons and would not be subject to minimum tax under section 80D of the Ordinance of 1979 for purposes of minimum tax. It held that the income of AWT was exempt to the extent of clause 62(1) of Part I of the Second Schedule to the Ordinance of 1979. But it was for the assessee to establish that the income from business was actually expended for welfare activities. It further held that the interest income generated by funds parked in bank accounts was to be regarded as income from business under section 22 of the Ordinance of 1979 as opposed to income from other sources. In a separate order the learned Tribunal held that the adjustment for bad debts was to be disallowed for purposes of section 23(1)(x) of the Ordinance of 1979 as AWT had not written off such debt in its books and accounts for which it was seeking adjustment. In holding that income of AWT was to be taxed in its own hands and not to be treated as the income of WARD, the learned Tribunal also took in account clause 9 of Part H of the Second Schedule to the Ordinance of 1979 which identifies AWT and provides that, "so much of the income [of AWT] chargeable under the head income from business or profession as is not exempt under clause (62) of Part I, shall be charged to tax at the rate of 20% of such income". The learned Tribunal opined that as the legislature had provided an explicit provision for application of reduced tax rate to the income of AWT from business to the extent that such income was not exempt under clause 62(1) of Part I of the Second Schedule to the Ordinance of 1979, the legislative intent was explicit that the income of AWT was liable to tax in its own hands and further that AWT's income from business was also liable to exemption under clause 62(1) of Part I of the Second Schedule to the Ordinance of 1979. Against such findings, the AWT as well as the Tax Department filed cross references. 6. Learned counsel for AWT took the Court through the history of creation of AWT and how the seed money for registration of AWT as a society had been provided by Pakistan Army. He submitted that not every sort of income was taxable under section 11 of the Ordinance of 1979 but only such income that "accrues" to a person and when the income in the hands of an assessee was not its own income, such income could not be offered for taxation as income of such assessee. He submitted that income received by AWT was immediately diverted to WARD and that AWT had no power to employ such income as it pleased and that it was WARD that employed the income in welfare activities. His basic argument was that the income being treated by tax authorities as AWT's income was not AWT's real income as AWT had no control over such income. And consequently such income should be regarded as the income of WARD and not that of AWT due to WARD's overriding title over such come due to which it was diverted to WARD. 7. Learned counsel for FBR submitted that pursuant to the provisions of the Ordinance of 1979 and the Ordinance of 2001 fruits of one tree could not be attributed to another tree. That AWT was a juridical person and a taxpayer being a society registered under the Societies Registration Act, 1860, and was liable to sue in its own name and was consequently taxed as a legal entity. That AWT was a large commercial empire carrying business and other commercial activities and could not be exempt from taxation merely because it was transferring its income to WAD, which was then using it in welfare activities. He submitted that Indian judgments cited by the learned counsel for the applicant were of binding on this Court, and even if they were deemed to have persuasive value, the concept of diversion of income explained therein was not applicable to the facts of the instant case. He submitted that the basic question to be considered in determining whether income of a taxpayer had been diverted by virtue of overriding title was whether such income was diverted before or after reaching the taxpayer. And the jurisprudence produced in India suggested that in the event that a charge was created against the property whose income was liable to tax by overriding title, such income was to be excluded from the income of the taxpayer as such income never reached the taxpayer by virtue of being diverted. But that in the instant case there
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was no overriding title in favour of WARD as the income generated by assets and projects was being received by AWT and had subsequently been transferred to WARD on the basis of administrative instructions issued by the Adjutant General Branch of GHQ, which instructions were being abided by as a matter of policy and not as a matter of law. He submitted that AWT was liable to be treated as a company as has been held by the learned Lahore High Court in Commissioner Inland Revenue v. Multan Educational Trust (2014 PTD 402). That a society registered under the Societies Act was an entity incorporated under the Societies Act and fell within the definition of a company under the Ordinance of 1979 and the Ordinance of 2001. He further submitted that the question whether or not bad debts were to be adjusted under section 23(1)(x) of the Ordinance of 1979 had been correctly determined by the learned Tribunal, as pursuant to section 23(1)(x) such debt had to be written off within the books and accounts of the taxpayer and found to be irrecoverable by the Deputy Commissioner undertaking the assessment of taxpayer and in the instant case it had been found that AWT had not written off such debts in its books as bad debt. The crux of the arguments of the learned counsel for, the Department was that in view of Article 165-A of the Constitution there was no question regarding the competence of the Parliament to impose tax on an entity established by or under a federal law and owned or controlled either directly or indirectly by the Federal Government, and that in exercise of such authority the Ordinance of 1979 as well as the Ordinance of 2001 created no overarching exemption for the income of welfare institutions owned or controlled by the Federal Government. And that in view of the scheme of the Ordinance of 1979 as well as the Ordinance of 2001, irrespective of the ultimate destination of the income generated by an entity owned or controlled by the Federal Government, the income was taxable in the hands of an entity that it received. He submitted that AWT was a juristic person and there was no room to lift its veil of incorporation as a society and bold that the income being generated through assets owned and vested in such society was not liable to tax despite having been received by such taxpayer. Diversion of Income through overriding title. 8. The concept of diversion of income due to overriding title doctrine has not been recognized in the jurisprudence produced in relation to the Ordinance of 1979 or the Ordinance of 2001. The pillar judgment in India was Indian Supreme Court's decision in The Commissioner of Income Tax v. Shri Sitaldas Tirathdas (1961 AIR 728), wherein it interpreted the decision of the Privy Council in Bejoy Singh Dudhuria v. The Commissioner of Income Tax (1933)1 ITR 135), where the stepmother of the Raja had brought a suit for maintenance and a compromise deed was passed under which the stepmother was to be paid a certain amount which was treated as a charge on the properties in the hands of the Raja and thus not part of his income. In Shri Sitaldas, it was held that: "There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation w pay another a portion of one's own income, which has been 'received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable." 9. In Associated Power Company Ltd. v. Commissioner of Income Tax (1996 AIR 894), the Indian Supreme Court reiterated the test laid down in Shri Sitaldas and held that, "the doctrine applies when, by reason of art over-riding title or obligation, income is diverted and never reaches the person in whose hands it is sought to be assessed."
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10. Perusal of Indian Jurisprudence on the concept of overriding title leading to diversion of income reflects that it has largely evolved in the context of attributing income of property of Joint Hindu Family i.e. in determining to whom belongs the title of the joint property or income produced by such property. The concept has no application when comes to the income of a trust or society or a charitable institution. The constituent documents of such entity constrain its ability to determine freely how the income is to be used once it reaches the entity. In other words, the entity is not free and autonomous to use it as it pleases. Its constituent documents determine how the income is to be employed or even who all would be the beneficiaries of such income. But such constraint does not transform the income of the welfare entity (whether constituted as a section 42 company or a trust or a society) into that of the beneficiaries. Once the income reaches the entity (i.e. the taxpayer), it qualifies as income under sections 2(24) and 11 of the Ordinance of 1979 and sections 2(29), 9 and 10 of the Ordinance of 2001, and the manner in which such income is to be employed is a question of its utilization and not that of overriding title. The income that reaches a taxpayer or accrues to it, notwithstanding the manner of its utilization, remains income in the hands of the taxpayer and is to be taxed as such. 11. The Ordinance of 1979 or the Ordinance of 2001 does not recognize the idea that "real income" of a taxpayer may be a subset of his "income", and that it is only the real income that is to be offered up for taxation. What qualifies as "income" under the Ordinance of 1979 or the Ordinance of 2001 is the income liable to tax in the hands of the taxpayer who is in the receipt of such income. An example of overriding title would be income from joint property, which, even if received by one co- owner, would be received as income of the other co-owners to the extent of their respective shares, and would not be taxed as income of the receiving co-owner. The issue of attribution of income from property can be complex in the context of a Hindu Undivided Family that is taxed as a person, which is where jurisprudence on the question of diversion of income through overriding title has developed in Indian. The concept is however not attracted at all in the present case. WARD is neither a legal person, nor has any title to the income of AWT or any overriding title to the assets of AWT. The Chairman of the Governing Body of AWT is the Adjutant General of Pakistan Army. If the Adjutant General has issued instructions to AWT as to how to the employ and expend its income, such administrative instructions neither create a legally binding obligation for AWT nor create any title in favour of the organizational set-up to whom such income is to be handed over for use i.e. WARD in the instant case. 12. The relevant provisions of the Ordinance of 1979 and the Ordinance of 2001 that define income to be offered for tax are as follows: Income Tax Ordinance, 1979 2. Definitions.-1n this Ordinance, unless the context otherwise requires, - (24) "income includes- (a) any income, profits or gains, from whatever source derived, chargeable to tax under any provision of this Ordinance under any head specified in section 15; (b) any loss of such income, profits or gains; (c) any sum deemed to be income, or income accruing or arising or received in Pakistan under any provision of this Ordinance, but does not include, in the case of a shareholder of a domestic company, the amount representing the face value of any bonus shares or the amount of any bonus declared, issued or paid by the company to its share-holders with a view to increasing its paid-up share-capital; and (d) in the case of shareholder of a domestic company, the amount representing the face value of any bonus shares or the amount of any bonus declared, issued or paid by the company to its shareholders with a view to increasing its paid-up share capital,
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11. Scope of total income.- (1) Subject to the provisions of this Ordinance, the total income, in relation to any assessment year, or a person, - (a) who is a resident, includes all income from whatever source derived, which - (i) is received, or is deemed to be received, in Pakistan in the income year by, or on behalf of, such person; or (ii) accrues or arises, or is deemed to accrue or arise, to him in Pakistan during such year; or (iii) accrues or arises to him outside Pakistan during such year; (b) who is a non-resident, includes all income from whatever source derived, which (i) is received, or is deemed to be received, in Pakistan in the income year by, or on behalf of, such person; or (ii) accrues or arises, or is deemed to accrue or arise, to him in Pakistan during such year. (2) Notwithstanding anything contained in subsection (1), where any amount consisting of either the whole or a part of any income has been included in the total income of a person on the basis that it has accrued or arisen, or is deemed to have accrued or arisen, to him in any year, it shall not be included again in his total income on the basis that it is received, or is deemed to be received, by him in Pakistan in any other year. Income Tax Ordinance, 2001 2. Definitions.-- In this Ordinance, unless there is anything repugnant in the subject or context - (29) "income'' includes any amount chargeable to tax under this Ordinance, any amount subject to collection or deduction of tax under sections 148, 150, 152(1), 153, 154, 156, 156A, 233, subsection (5) of section 234 and any amount treated as income under any provision of this Ordinance] and any loss of income; 9. Taxable income.--The taxable income of a person for a tax year shall be the total income under clause (a) of section 10 of the person for the year reduced (but not below zero) by the total of any deductible allowances under Part IX of this Chapter of the person for the year. 10. 'Total Income.-- The total income of a person for a tax year shall be the sum of the (a) person's income under all heads of income for the year; and 4 (b) person's income exempt from tax under any of the provisions of this Ordinance. 13. The provisions of the Ordinance of 1979 very clearly define total income as the income "received by or on behalf of a taxpayer". Likewise, sections 9 and 10 of the Ordinance of 2001 when read together with section 18(1)(a) that define income from business, include in the income of an entity from business, "the profits and gains of any business carried on". Neither the Ordinance of 1979 nor the Ordinance of 201 create any room for diversion of income through overriding title as both these tax codes also include deeming provisions which further explain how the income is to be treated even where there could be confusion regarding the person to whom the income accrues. But there is no need to get into any further discussion regarding deeming provisions as in the instant case AWT is a society and its assets and projects admittedly produce revenue and income from assets, and projects vested in AWT as a juristic person. Further, the income in question is the income actually received by AWT and does not include any funds that are diverted to any other person or entity by virtue of overriding title prior to receipt of such funds by AWT. AWT's claim that WARD has overriding title over the entire income of AWT is based on an administrative instruction issued by the Adjutant General Branch of Pakistan Army. Merely because the Adjutant General who oversees WARD is also the Chair of the Governing Body of AWT and has issued administrative instructions in compliance with which AWT transfers all of its income to WARD for being employed in welfare activities creates no overriding title for WARD, which is not a legal person in any event. In other words, the AWT is under no legal obligation to transfer its entire income to WARD due to legal necessity. But even in the event that the constituent documents of AWT stated that the entire income of AWT would be employed in welfare activities through another organization such as
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WARD, such arrangement for utilization of the income of AWT would still not create any overriding title in favour of WARD over the properties and income of AWT. To the extent that AWT receives income generated by assets and projects owned by AWT, such income would be liable to tax in the hands of AWT. Legal Status of AWT and its entitlement to tax exemption 14. The definition of company as provided under section 2(16) of the Ordinance of 1979 is as follows: 2. Definitions.-In this Ordinance, unless the context otherwise requires, - (16) "company" means- (a) company as defined in the Companies Act, 1913 (VII of 1913); or (b) a body corporate formed by or under any law for the time being in force; or (bb) a trust formed by or under any law for the time being in force; or (d) a body corporate incorporated by or under the law of a country outside Pakistan relating to incorporation of companies; or (cc) a modaraba as defined in the Modaraba Companies and Modarabas (Floatation and Control) Ordinance, 1980 (XXXI of 1980); (d) the Government of a Province; (e) a foreign association, whether incorporated or not which the Central Board of Revenue may, be general or special order, declare to be company for the purposes of this Ordinance for such assessment year or years (whether commencing before, on or after the first day of July, 1979)…
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