Al Wakeelo
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Petitioner: ROYAL INSURANCE PLC., KARACHI VS Respondent: I.T.O. COS, CIR A-5, KARACHI -87, 3530/KB
Court Name: Income Tax Appellate Tribunal Judge(s): Muhammad Mujeebullah Siddiqui, Alvi Abdul Rahim Title:ROYAL INSURANCE PLC., KARACHI vs I.T.O. COS, CIR A-5, KARACHI -87,
3530/KB Case No.:I.-TAs. Nos. 595/KB to 603/KB 1970/KB, of 1986-87, 3530/KB to 3533/KB and 2067/KB 1987-88 and No, 4785/KB, 4786/KB, 4787/KB of 1986-87, 48/KB of 1988-89 Date of Judgment:1989-05-02 Reported As: 1989 PTD (Trib.) 1263 Result: Order accordingly Judgment ORDER ' ALVI ABDUL RAHIM (ACCOUNTANT MEMBER).--The Royal Insurance (Public) Company, hereinafter referred to as the appellant, has filed appeals in respect of various years. As they involve common issues we have decided to adjudicate them through this consolidated order in respect of all the years. 2. However, before we proceed to discuss various common issues we may decide the appeals in respect of assessm ent years 1968-69 and 1969-70 which are of a different nature. The original assessm ents for the two years were set aside by this Tribunal for re-examination of the case as per some directions. While giving effect to Tribunal's decision, the I.T.O. Did not allow deduction for provision for taxation amounting to Rs,57,409 and Rs,74,380 for the two years. The appellant filed appeals before the learned CIT (A). Before the appeals could be taken up for hearing, the ITO rectified his order and allowed the two sums of money. At the time of hearing before the learned CIT (A) the appellant submitted prayer for withdrawing the appeals as the cause of grievance had been removed by the I.T.O. The learned CIT (A) did not entertain this request. As per his order, under consideration, he has directed that the two sums of money should not be deducted. 3. Now we take up the ground of appeal which is common for the years 1976-77 to 1987-88. The learned CIT (A) has held that taxes deducted at source (i.e, under section 18 of the repealed Income Tax Act, 1922 and under section 50 of the now operative Income Tax Ordinance, 1979) are not to be deducted from gross receipts to arrive at taxable profits of the appellant. For assessment
---
## Page 2
years 1976-77 to 1979-80 the tax deducted at source from interest and dividend income was held to be inadmissible while provisions made for taxation in respect of other types of income was held to be admissible. For subsequent years (viz 1980-81 to 1987-88) the tax deducted at source as well as provision made for such deductions as well as for tax on other types of income have been held to be inadmissible because of an amendment made in Rule 5(a) of the Fourth schedule vide Finance Ordinance of 1980. 4. The main argument of Mr. Mansoor Ahmed Khan, the learned counsel for the appellant, is that the ITO has no power to disallow income tax deducted at source, advance tax deposited by the appellant or provision made by the appellant for any tax liability arising on income earned during the year. According to him the tax on income, whether paid or provided for is neither an item of expenditure nor any allowance. According to him this amount is claimed by an insurance company because Form B requires that it should be shown in the debit side of Form B of the Second Schedule to the Insurance Act. This form contains Profit and Loss Account to be submitted to Controller of Insurance. In other words the insurance company is fulfilling its statutory requirement by claiming the amount of tax in his Profit and Loss Account. As the company is not claiming it as an expenditure the I.T.O. Has no jurisdiction to disallow it because Rule 5(a) and the corresponding provision in the repealed Insurance Act, 1922 permits the ITO to disallow items of expenditure which are inadmissible. Continuing the argument he submitted that the amendment made in 1980 in Rule 5(a) has made no difference insofar as admissibility of tax on income is concerned because, after amendment, the I.T.O. Has been given powers to disallow inadmissible reserves or provision for any expenditure. Mr. Khan submitted that the Insurance companies do not claim taxes on income because it is of an expenditure or provision for an expenditure. They claim them because Form B of the Second Schedule to the Insurance Act, 1938 requires so. The learned counsel then explained the accounting procedure adopted by the appellant to record tax payment transactions. He stated that the appellant creates provision for taxation at the beginning of the year and as and when any tax bill is received the payment is made by adjusting the provision created for this purpose. From this he concluded that the appellant does not make any claim in his Profit and Loss Account for tax actually paid; on the contrary it claims the provision made for taxation. He then cited the Sindh High Court decision in Reference Application I.T.C. No, 272 of 1974 dated 30-8-1982. It was held in this case that the I.T.O. Cannot disallow any provision for taxation which appears in the Profit and Loss Account of an insurance company in respect of assessment years 1969-70 and 1970-71. He further submitted that section 24 (a) of the Income Tax Ordinance and section 10 (4) of the repealed Act talk about tax PAID It says that tax PAID shall not be allowed as expenditure. From this he concluded that taxes which are payable can be claimed by insurance companies. Mr. MA. Khan also objected to disallowance of tax deducted at source by invoking provisions of section 10 (4) of the repealed Income Tax Act, 1922. He maintained that the I.T.O. Can disallow only those expenses which are inadmissible as per povisions of section 10 (2) of the said Act. According to him provisions of section 10 (4) cannot be invoked by the I.T.O. 5. Mr. Yousuf Sharih, the learned D.R., defended the orders passed by the I.T.O. And the learned C.I.T. (A). He drew our attention to various recent decisions of this Tribunal whereby it has been held that taxes deducted at source are not allowable while the provision for taxes is allowable (till assessm ent year 1979-80) as held by the Hon'ble Sindh High Court in the New Jubilee Insurance Company case (I.T.C. No, 272 of 1974 dated 30-8-1982). The learned D.R. Also submitted that provision for taxation is not allowable even for earlier years upto 1979-80. It is for this reason that the department has taken up the matter to the Supreme Court. He is of the view that the amendment made in Rule 5 (b) in 1980 is of a clarificatory nature. According to him provision for taxation is inadmissible even if we ignore the amendment made in Rule 5 (b). He submitted that
---
## Page 3
even if there was any doubt about inadmissibility of provision for taxation it has been removed by the amendment made in 1980. 6. We have pondered over the issue of admissibility of tax on income as deduction from gross receipts in the case of insurance companies for quite some time. We will, therefore, like to discuss the matter in a some what detailed manner. It is mentioned in section 10 (4) of the repealed Income Tax Act and section 24 (a) of the now operative Income Tax Ordinance, 1979, that any tax levied on the profit of any business shall not be allowed as a deductible expenditure from gross receipts for calculating taxable income. There exists a controversy as to whether these provisions of law are applicable in the case of insurance companies. This is because income of insurance companies is computed in a manner different from the method of computing income adopted for other types of business activities. Taxable income of insurance companies is computed as per provisions contained in the Fourth Schedule to the Income Tax Ordinance which has been made in pursuance of section 26 (a) of the Income Tax Ordinance. In the repealed Income Tax Act, 1922 the provisions were contained in section 10 (7) and the First Schedule to the Income Tax Act. But for an amendment made in 1980 which we will discuss later on, the provisions in the two statutes are similar. According to section 26 (a), the profits and gains of insurance business and the tax payable thereon is to be computed in accordance with the rules contained in the Fourth Schedule. Section 26 (a) is reproduced below:-- " 26 (a) The profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the Fourth Schedule ; " ' Rule 5 of the Fourth Schedule deals with General Insurance Business. This is relevant for our purposes because the appellant-company is earning income from this source. Rule 5 (a), as it stood before amendment in 1980, is reproduced below :-- " 5 General insurance, The profits and gains of any business of insurance other than life insurance shall be taken to be balance of the profits disclosed by the annual accounts required under the Insurance Act, 1938 (IV of 1938), to be furnished to the Controller of Insurance, subject to the following adjustments, namely:-- (a) any expenditure or allowance which is not deductible in computing the income chargeable under the head " income from business or profession" shall be excluded." ' In 1980, Rule 5 (a) was amended. The amended subrule is as under: "5 (a) any expenditure or allowance or any reserve or provision for any expenditure, or the amount of any tax deducted at source from any dividend or interest received which is not deductible in computing the income chargeable under the head "income from business or profession" shall be excluded ; " 7. While examining cases of insurance companies the I.T.O. Disallowed taxes on income, whether they were on account of deductions at source or a provision was created for tax liability. This was done by invoking the provisions contained in section 10 (4) of the Income Tax Act. The matter was agitated before superior Law Courts and ultimately it was held by the Sindh High Court that provision made for taxation could not be disallowed by the I.-T.O. Because the relevant rule governing computation of income of insurance companies, authorised the I.T.O. To disallow only the expenditure or the allowance which is inadmissible. In other words if an insurance company claims a provision for any expenditure which is inadmissible, the I.-T.O. Had to allow it because he was competent to disallow inadmissible expenditure only. It was held that a provision for taxation is not an expenditure; therefore, the I.-T.O. Has no power to disallow the provision for taxation. The Department has taken up the matter to the Supreme Court. Then an amendment was made in Rule 5 (a) to empower the I.-T.O. To disallow any reserve or provision for any expenditure which is not admissible and also to disallow the amount of tax deducted at source from any dividend or interest. Following the decision of Hon'ble High Court this Tribunal, in its recent decisions, has been
---
## Page 4
holding that till the assessm ent year 1979-80 provisions for taxation cannot be disallowed by the I.- T.O. Though the amount of tax deducted at source can be disallowed because it is not a provision for taxation but actual paymant of tax. 8. Before we proceed further we have to ascertain the nature of tax on income. Mr. Mansoor Ahmed Khan has stated that it is not an item of business expenditure. According to him it is a part of income which is set apart for making a liability. He concluded that as tax on income is not an item of exenditure it cannot be disallowed. On querry as to why should the tax on income be deducted from gross receipts if it is not spent as an expenditure to earn it he stated that the same is deductible because an insurance company is required vide Form B of the Second Schedule to the Insurance Act to claim it as a deduction. Let us see what does accountancy, the language of businessm en, say on the subject. In Pakistan tax on income as well as provision for taxation is always shown in the Profit and Loss Account. As a matter of fact we follow the practice prevailing in England and other countries. Spicer and Pegler's Book-Keeping and Accounts , a standard text- book on the subject, is quoted below :-- "(m) Treatment of taxation in the accounts of companies : ' The amount of the charge for United Kingdom corporation tax (together with a note of the amount it would have been but double taxation relief), the amount of the charge for United Kingdom income-tax, and the amount of overseas taxation on profits, income and (so far as charged to revenue capital gains, must be respectively disclosed in the Profit and Loss) Account. It is also necessary to disclose by way of note (if not otherwise shown) the basis on which these charges (other than in respect of capital gains) are computed, and any special circumstances which affect liability in respect of taxation of profits, income or capital gains for the financial year, or which will affect it in succeeding years [Schedule 8 to Companies Act 1948, as amended, paragraphs 12 (c), 14 (3) and (3A)1. ' In the Balance Sheet or by way of note or report annexed thereto: (a) If a sum set aside for the purpose of its being used to prevent undue fluctuations in charges for taxation has been used during the financial year for another purpose the amount thereof and the fact that it has been so used (para. 11 (8A). (b) If an amount is set aside for the purpose of its being used to prevent undue fluctuations in charges for taxation, it shall be stated (para. 7A). ' Corporation tax and income tax are the two principal taxes affecting company records: company profits are subject to corporation tax; companies must deduct, and account to the Inland Revenue for income tax at the standard rate when paying dividends and annual charges; companies normally receive their investment income after income tax has been deducted. Corporation tax. ' The charge for corporation tax shown in the Profit and Loss Account is based on profits for the year; the rate of tax, e.g. 45 per cent. At which the charge has been computed must be shown inset. If the rate of corporation tax is not known for the whole or part of the period covered by the accounts, the latest known rate should be used and disclosed. Over provisions and under provisions for corporation tax in previous years will be added to, or substracted from, as appropriate, the profits brought forward from previous years in the Profit and Loss Appropriation Account." ' accounts has also been examined by the International Accounting Standards Committee (IASC). It has issued International accounting Standard No, 12 on the subject of "Accounting for taxes on Income". This IAS has been circulated by Pakistan Institute of Chartered Accountants. Paras 33 and 34 of IAS 12 are reproduced below:- "Financial Statement Presentation
---
## Page 5
33. Taxes on income are generally accounted for as tax expense in the determination of net income of the enterprise. However, in some circumstances in which the effect of a transaction is charged or credited directly to shareholders' interests, the related tax effect of the transaction is accounted for and disclosed in the same manner so that the taxes may be directly related to the item to which they apply. 34. The tax expense related to accounting income from the ordinary activities of the enterprise is usually presented as a separate item in the income statement. The tax attributable to an unusual item is included with that item because it directly relates to it. Disclosure is made of this related tax amount." 10. The practice of Accountancy in Pakistan as well as the above-mentioned two quotations leave no doubt in our mind that tax on income is treated as expense incurred for the purpose of earning income. They are, therefore, debited to Profit and Loss Account and not reflected in the Profit and Loss Appropriation, which shows application of income for different purposes. Though taxes on income are business expenses they are not allowed as admissible deduction because of provisions of sections 10(4) of the repealed Income Tax Act and section 26(a) of the Ordinance, 1979. The debit entry in the Profit and Loss Account of an insurance company (viz. Form T') in respect of taxes on income is, therefore, not an abnormality required by law in the cases of insurance companies only. Taxes on income are shown as debit entry in the Profit and Loss Account of every company which earns income from any source. The ITO, has, therefore, to consider taxes on income as expenses to earn income and not as some statutory requirement of law as maintained by Mr. Mansoor Ahmed Khan. As taxes on income fall in the category of expenses the ITO can invoke provisions of Rule 5(a) of the Fourth Schedule-. 11. During the course of his arguments the learned counsel for the appellant stated that the ITO can disallow taxes which are claimed on the basis of actual payment but he cannot disallow a claim on account of provision made for taxation. In support he cited the decisions of Hon'ble Sindh High Court and also drew our attention to the word "paid" used by section 24 (a) of the Income Tax Ordinance, 1979. There is no doubt that this subsection say that the taxes paid are inadmissible expenses. However, Explanation (b) to section 23 (1) states that the expression 'paid' as used in 18, 23, 24, and 31 means actually paid or incurred according to method of accounting upon the basis of which income is computed. Part (b) of the Explanation to section 23 is reproduced below:-- "Explanation : (a)................................................................................................................ (b) the expression "paid", as used in this section and sections 18, 24, and 31, means actually paid or incurred according to the method of accounting upon the basis of which the income is computed." ' It is clear from above that the argument of the learned counsel, in so far as it refers to the language of the section 24 (a) of the Income Tax Ordinance is not convincing. As far as the New Jubilee Insurance Company case (Reference Application I.-T.O. No,272 of 1974) cited by Mr. MA.Khan is concerned the ruling is binding till assessment year 1979-80. For 1980-81 and onwards the I.-T.O. Can disallow taxes actually paid as well as the provision for taxation because Rule 5 (a) has been modified to read as under:" "5 (a) any expenditure or allowance or any reserve or provision for any expenditure, or the amount of any tax deducted at source from any dividends or interest received which is not deductible in computing the income chargeable under the head "income from business or profession" shall be excluded:" ' Before this amendment the I.-T.O. Could disallow the "expenditure" and not any "provision for taxation". The amendment in 1980 has made the New Jubilee Insurance Co. Case inapplicable for assessm ent years 1980-81 and onwards. We may also mention here that the appeal, on this issue, for assessm ent years 1980-81 and 1981-82 cannot be entertained because in these years the I.T.O.
---
## Page 6
Did not disallow any claim made by the appellant. The I.-T.O. Accepted income declared by the appellant under the Self Assessm ent Scheme. As no disallowance was made by the I.-T.O. The learned C.I.T.(A) has erred in mentioning in his order that disallowance on account of provision for taxation is in order. 12. The learned C.I.T. (A)'s finding about taxes deducted at source in assessment years 1976-77 to 1979-80 has been challenged by Mr.MA. Khan on the ground that taxes on income are inadmissible as per provisions of subsection (4) of section 10 and not as per subsection (2) of section 10. According to him the I.-T.O. Can disallow only those items of expenditure which are inadmissible as per provisions of section 10 (2). The argument is not convincing. Rule 6 (1) of the First Schedule to the repealed Income Tax Act speaks about inadmissilbility as per section 10. In other words inadmissibility is not restricted to provisions of subsection (2) or to any other subsection. The provisions of the entire section 10 can be invoked by the I.-T.O. Rule 6 (1) is reproduced below : "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 business. Profits and losses on the realisation of 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." 13. Before parting with this issue we may also examine the types of taxes on income and see if a provision can be created in respect of every type of tax due under the Income Tax Ordinance. Taxes on income are paid in the following four manners : (a) Tax is deducted by withholding agent from any taxable receipt as soon as the taxable receipt comes into the hands of a taxpayer. (b) Advance tax is deposited under section 53 of the Income Tax Ordinance in four specified dates, namely, 15th September, 15th December, 15th March and 15th June of each fmancial year. (c) Tax is deposited under section 54 ; and (d) Tax is deposited in response to notice of demand issued under section 85. ' As far as the tax deducted at source in pursuance of section 50 and advance tax deposited under section 53 are concernd, they are deducted and paid as soon as the liability for the same arises. In other words, there is no time lag between the accrual of tax liability under section 50 and section 53 and payment of the liability. Therefore, question of creating a provision for payments under section 50 and 53 does not arise. As far as tax due under section 54 is concerned, a provision has to be made because tax has to be paid after income is earned. Therefore, in the books of accounts for the relevant year the liability for such tax can be claimed in the form of provision for tax only. The last category of tax is the one which is due under a demand notice issued by the I.-T.O. Under section 85. This demand is in respect of a liability which can never be envisaged by a taxpayer during the year when income is being earned. No provision can be created in respect of this liability because this liability does not arise on account of income declared by an assessee. It arises only when the I.-T.O. Enhances the declared income. It is clear from this discussion that provision for taxation is made for tax due under section 54 and not in respect of tax due under sections 50, 53, and 85. The finding of the Hon'ble High Court in the case of New Jubilee Insurance Co is, therefore, binding in respect of provision made for tax due under section 54. If an assessee makes provision for taxes due under section 50, 53 or 85 this will not be governed by the New Jubilee Insurance Company's case. The nature of the transaction does not depend on the name given to it by a taxpayer. The nature of a transaction has to be ascertained from its facts. The provisions of law discussed above calearly show that question of creating provision for taxes due under section 50 and 53 does not arise because there is no time lag between the date on which tax liabilities under
---
## Page 7
these sections arise and the payment of these liabilities. Tax liability under section 85 cannot be envisaged; therefore, no provision can be created for the same. Even if it is envisaged it cannot be quantified with any degree of accuracy. It is for this reason that this Tribunal has been holding that tax deducted at source from dividends income and interest income received by an insurance company are inadmissible expenses and are not governed by the decision in the New Jubilee Insurance case. 14. In the light of discussion in the preceding paras we hold that tax deducted at source from interest and dividend has been rightly disallowed by the I.-T.O. And the learned C.I.T. (A) in assessm ent years 1976-77, 1977-78, 1978-79 and 1979-80. In view of amendment made in Rule 5 (a) in 1980, the I.-T.O. And the learned C.I.T. (A) have rightly held for assessment years 1982-83 to 1987- 88 that neither taxes withheld from interest and dividend income nor provision made for taxation is admissible to the appellant. The appeals on this issue fail. The appeals for 1980-81 and 1981-82 are misconceived because I.-T.O. Has not disallowed any claim. The I.-T.O. Has accepted the declared income. Even if the I.-T.O. Had disallowed provision for taxation, the action would have been justified on account of amendment in Rule 5 (a) . SURCHARGE (ASSESSMENT YEARS 1977-78 TO 19'41-82: 15. The second common issue is in respect of surcharge levied for assessment years 1977-78 to 1981-82. The appellant has objected to the finding of the learned C.I.T. (A) to the effect that the difference between income…
Read the unabridged text and precedent citation network on Al Wakeelo Legal Research Platform.