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Petitioner: Pakistan Mercantile Exchange Limited VS Respondent: Commissioner Inland Revenue - Zone 1
Court Name: Sindh High Court Judge(s): Muhammad Ali Mazhar, Agha Faisal Title:Pakistan Mercantile Exchange Limited vs Commissioner Inland Revenue -
Zone 1 Case No.: ITRA 198 of 2011 Date of Judgment:2019-02-12 Reported As: PTCL 2019 CL. 298, 2019 PTD 1463, 2019 SHC 46 Result: N/A Judgment Agha Faisal , J: The sole question framed by the Court for determination herein was recorded vide the Order dated 13.10.2014 in the following terms: "Whether the amount deposited by its Members with the Applicant, as security deposit can be treated as its income?" 2. The facts, demonstrated before in reliance upon the record arrayed on file and pertinent to the present controversy , are encapsulated herein below: I. The applicant, being the Pakistan Mercantile Exchange Limited [formerly National Commodity Exchange Limited] ("Exchange "), has established and regulates the first commodities / futures exchange in Pakistan. In order to trade on the Exchange a broker must apply to become a member . During the Tax Year 2003 membership was governed by the Membership Rules 2002 ("Rules 2002 ") and the General Regulations of the National Commodities Exchange Limited 2003 ("Regulations 2003 "). In 2007, these were replaced by the General Regulations of the National Commodities Exchange Limited 2007 (" Regulations 2007 "). II. Rule 2 (Chapter 3) of the Rules 2002 empowered the board of directors of the Exchange ("Board ") to regulate the membership of the Exchange in terms delineated herein below: "The Board shall have power to establish categories of membership and to attach different rights, benefits, obligations and liabilities to each categ ory established. Such categories may, for example, include Specific Membership which would authorize the Member to trade only in one specific commodity authorized or Universal membership which would entitle the Member to trade in all commodities on the Exchange. In addition to such categorization, the Board my allow a Member to be active, which will mean that the Member will be allowed to trade on the Exchange as a broker subject to payment of Clearing House Deposit. The Board may from time to time,
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prescribed different fees payable for different categories of Membership and processing applications and for such other matters as the Board may in its discretion consider appropriate." III. The Board, through a resolution dated 23.09.2002 ("Resolution "), stipulated that each person applying for membership had to pay an entrance fee of Rs. 250,000 and a refundable security deposit of Rs. 750,000. The Resolution provided that the security deposit is refundable to a member when he resigns, subject to receipt of a new security deposit from an incoming member . Rule 94(a) of the Rules 2002 provided that the security deposit is to be used to meet any loss or liability of a member / broker who defaults. Rule 94(b) further provided that the Exchange had a lien over the security deposit. IV. Rules 2002 and Regulations 2003 were superseded by Regulations 2007. Regulation 12.12 of Regulations 2007 provided that security deposit is to be refunded to a person when he ceases to be a broker/member even if he does not transfer his membership. Furthermore, under Regulations 2007 the refundable security deposit becomes part of the Settlement Guarante e Fund ("Fund ") and as per Regulation 12.6.1 this fund is used to meet any loss or liability arising out of default of a member/broker . Regulation 12.7 provided that whenever a broker defaults the Exchange may utilize any monies lying to the credit of the broker to fulfill these obligations. Regulation 12.15 of the Regulations 2007 (similar to Rule 94(b) of the Rules 2002) provided that the Exchange shall have a lien over all amounts deposited by a broker towards the security deposit. V. The issue reportedly arose on 31.12.2003, when the Exchange filed its original return for the tax year 2003, which was revised and re-filed on 30.12.2004. On 24.12.2008, the Exchange received a notice under Section 122(5A) of the Income Tax Ordinance 2001 ("Ordinance ") expressing the taxation officer's intention to treat the security deposits paid by its members as the Exchange's income. On 31.01.2009 the taxation officer amended the assessment order , taxing the security deposits as the Exchange's income. The operative constituent of the aforesaid order is reproduced herein below: "All these positions establish that the receipts earned by the taxpayers are not a security deposit but in fact income. It contains all the attributes of an income as the source is definite, some sort of regularity is there, the control over the money lies with the company the company is sole beneficiary of the profit arising from investment. The company can forfeit the money with no fault of the outgoing member so there is consistency of the source. The company has not refund the amount but it is the incoming member which in fact makes the payment for the outgoing members. Further as held by the Apex Court (1997) 76 Tax 5 (S.C.Pak) it is actual as well as constructive receipt. All this indicates that the amount shown as security deposit is in fact income in the hand of the taxpayer liable to be taxed. The further amended order for the subject Tax Year 2003 being erroneous in so far as prejudicial to the interest of revenue is therefore, hereby further amended u/s 122(4)(5A) to charge the income earned but declared as security deposits. The computation is as under ." VI. The Exchange challenged the aforesaid order before the Commissioner Appeals and on 23.04.2009 the appellate forum upheld the order of the taxation of ficer in terms as follows: "Adverting to the facts of the case, the core issue involved is taxing membership fee claimed as security deposit payable by incoming member to the appellant company. It is an admitted fact that the said amount or fee is refundable in the vent of going out of member subject to condition if the same is deposited by incoming member, if any. However, this amount is not refundable to the outgoing member unless the incoming member pays the same amount, therefore the appellant keep the said amount for an indefinite period. Obviously the appellant utilizes this amount to earn profit, which is further reinvested. Hence this activity of the appellant constitutes income from investment of so called security deposit. In view of the facts that the security deposits claim is in fact one time membership fee but classified as membership fee and security deposit payable by every incoming member, the investment/fee deposited is not refundable as and when required by the depositor on his will rather the members have no control on its utility and depositor is not beneficiary of the said investment/fee. Therefore, it can be safely concluded that for all practical purposes the appellant is vested with rights to hold the said investment and enjoys sale discretion for its
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utilization. Hence it establishes that so-called security deposits are nothing but income of the appellant and not liability. In view of the above facts and discussion , the action of the Taxation Officer in treating the deposits liability claim as income of the appellant is found legally correct, hence confirmed. The appeal fails to succeed. " VII. The Exchange filed an appeal before Appellate Tribunal Inland Revenue, which remanded the matter back to the Commissioner Appeals vide Order dated 01.08.2009. On 17.10.2009 the Commissioner Appeals, instead of deciding the case, remanded it further to the taxation officer for de novo proceedings. The Exchange filed an appeal before Appellate Tribunal Inland Revenue against order of Commissioner Appeals, however, the same was dismissed on 13.08.2010. A separate Income Tax Reference application is pending against the aforesaid order of the Appellate Tribunal Inland Revenue. VIII. Notwithstanding the foregoing, the taxation officer proceeded with matter and on 21.10.2010 passed an order holding that the security deposits receive d by the Exchange are in fact income. The relevant portion of the said order is reproduced herein below: "All these positions establish that the receipts earned by the taxpayers are not a security deposit but in fact income. It contains all the attributes of an income as the source is definite, some sort of regularity is there, the control over the money lies with the company; the company is the sole beneficiary of the profit arising from investment. The company can forfeit the money with no fault of the outgoing member so there is consistency of the source. The company has not to refund the amount but it is the incoming member which in fact makes the payment for the outgoing members. Further as held by the Apex Court (1997) 76 Tax 5 (S.C. Pak) it is actual as well as constructive receipt. All this indicates that the mount shown as security deposit is in fact income in the hand of the taxpayer liable to be taxed. " IX. The Exchange challenged the order before the Commissioner Appeals who upheld the same on 18.05.201 1. It is relevant to reproduce the essential constituent of the cited order: "Now it raises the question what about the amount shown as a long term liability by the appellant in the audited accounts. I am deeply concerned that by declaring a revenue receipt in the balance sheet as a liability does not change its character. As held earlier that the appellant shall be maintaining these deposits and even in the event of quitting of a member, is not liable to make any refund but it is the incoming member which deposits the same amount. In this context to claim this amount as a liability by the appellant, it cannot be presumed that the same are subject to certain conditions. If so, the receipts shown as a liability is nothing except misclassification of receipt. The above view is further strengthened from the fact that the amount could be forfeited when there is no incoming member to take the place of the outgoing member . It is observed that no security deposits could be forfeited by the receiver . In the instant case the appellant is blowing hot and cold in the same breath. On the one hand the appellant is claiming the mount as security deposit but on the other hand it has been expressly declared with so much right to forfeit the amount with no fault on part of the depositor . This, beyond any shadow of doubt, establishes the fact that as soon as the deposits are received by the appellant from incoming member it becomes owner of the said deposit and thus the same constitute income of the appellant. Further it is a definite source in the shape of membership fee and has direct nexus between the receipt and source, which once received is never payable by the appellant. In view of the above discussion, I feel no hesitation to hold that the receipts earned by the appellant are not a security deposit but the same is income and the amount shown as security deposit is in fact income of the appellant and liable to be taxed. " X. The Exchange filed appeal before the Appellate Tribunal Inland Revenue, wherein the earlier order was upheld on 04.06.201 1 in the following terms: "We have heard the learned counsel for both the parties and have gone through the relevant orders. As already mentioned earlier that the sole issue involved in the present case is determination of nature of security deposit made by the incoming members of the Exchange. There is no denying the fat that these are only refundable as and
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when incoming members deposit the same amount this leads to the irresistible conclusion that once an amount stands deposited with the appellant, the same remains intact till such time that until/unless outgoing/defaulting members brings in a new member to replace him, then he could ask for refund for his own deposit It is pertinent to note that the incoming member deposits the same amount with the appellant. During the arguments it was conceded by the learned A.R. that amount deposited stands forfeited if there is no incoming members, meaning thereby that the depositor/member has no control over the money deposited but it is the company which has exclusive control over the depositor s money . Therefore, whatever is deposited to the appellant as security deposit, it is the income of the appellant and same is not refundable, and this practice goes on and on. Impliedly , the incoming member has to pay the outgoing member and not to the appellant. As regards showing he said amount/security deposit as a long term liability in the accounts, we have no hesita tion in making observation that the balance sheet does not change its character . It is admitted position that the appellant is not under any obligation to refund the deposited amount to a quitting member but the same is to be paid by the incoming member , hence, in the circumstances, the claim of the appellant that the said amount is a liability , is a fallacy , rather tantamount to hoodwinking the department by miss-describing the said amount. With regard to the arguments of the learned A.R. that the security deposit is used to compensate the parties in case of default member of NECL, Perusal of both the orders show that no evidence of such use has been produced before the Taxation Officer. Even otherwise, despite repeated reminders by the department the appellant did not cooperate with the authorities to ascertain real acts with regard to this aspect of the case. The learned A.R. has not been able to persuade us to warrant our indulgence which is hereby upheld. As a result of above discussion, appeal of the taxpayer is dismissed being devoid of any force." XI. Being aggrieved by the impugned pronouncement of the learned Appellate Tribunal Inland Revenue, the applicant preferred the present proceedings. 3. Barrister Almani laid out the case for the applicant and argued that security deposit could not be treated as income. It was argued that the Order passed by the Appellate Tribunal Inland Reve nue was dissonant with the law as it unreasonably concluded that the security deposit was income of the Exchange and liable to be taxed. It was argued that the said order is bad in law since it ignored evidence showing that the Exchange refunds the security deposit to persons who cease to be members; it failed to appreciate that since no member has defaulted as yet it is impossible for the Exchange to produce evidence of using a security deposit to settle the obligations of a member in case of default and reference can only be made to the Regulations 2007; it ignored the Regulations 2007 which clearly set out that the security deposit is to be used to fulfill the obligations of a broker who defaults and provide that the Exchange only has a lien over the security deposits; it failed to consider that on occasion when person s membership was cancelled due to contra vention of the rules and his security deposit forfeited in such case, the Exchange has accepted and declared the same as income and paid tax thereon. It was submitted that an amount which is not income and has none of the characteristics of income cannot be treated as income even by operation of law since the Constitution limits the taxing power of the Federal Government to the ordinary definition of income. In this regard the learned counsel drew attention to Article 142 of the Constitution read with Entry 47 of the Federal Legislative List. Learned counsel for the applicant cited the authorities of Habib Bank Limited vs. Liquidator National Construction Co. reported as 2017 CLC 17 ("Habib Bank "), Umar vs. S.A. Rana reported as PLD 1957 Karachi 760 ("Umar "), CIT vs. Madurai Soft Drinks Ltd. reported as 2005 276 ITR 607 ("Madurai 2"), S.Sahakari Sakhar Karkhana Ltd vs. CIT reported as 2004 270 ITR 1 ("S. Sahakari "), CIT vs. Madurai Soft Drinks Ltd. reported as 2000 241 ITR 229 ("Madurai 1",) CIT vs. Trichur Kuri Syndicate reported as 1995 211 ITR 365 ("Trichur Kuri"), CIT vs. Goyal Gases Ltd reported as 1991 188 ITR 216 ("Goyal Gases ") CIT vs. Bijli Cotton reported as 1979 116 ITR 60 ("Bijli Cotton ") CIT vs. Sanderson & Morgans reported as 1970 75 ITR 433, ("Sanderson "), Upper India Sugar Exchange Ltd. vs. CIT reported as 1969 72 ITR 331 ("Upper India ") Agra Bullion Exchange Ltd vs. CIT- reported as 1961 41 ITR 472 ("Agra Bullion "). Lakhsmanier & Sons vs. CIT reported as 1953 23 ITR 202 ("Lakhsmanier '), Samina Shaukat vs. CIT reported as PLD 1981 SC 85 at 91A ("Samina '), Pakistan Industrial Development Bank vs. Pakistan reported as 1992 PTD 576 ("PIDB '), Elahi Cotton Mills vs. FOP reported as PLD 1997 SC 582 ("Elahi Cotton '), Punjab Small Industries v CIT reported as 2001 PTD 2282? ?
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("Punjab Small ') and contended that placing reliance thereupon the question of law before the Court may be answered in the negative and in favour of the Exchange, hence, denoting that refundable members security deposit cannot be treated as its income. 4. Mr. Shahid Ali, Advocate for Tax Department, controverted the arguments advanced on behalf of the applicant and submitted that there was no merit to the present reference application and the same may be dismissed forthwith. It was submitted that the security deposits lying with the applicant are an integral constituent of its membership pricing structure and that it was a settled law that mere accounting treatment does not affect the taxable character of a receipt. It was further contended that the so called liability is subject to forfeiture if the outgoing member does not bring in a new member with the same deposit or even resigns. In ordinary course, the enjoyment of cash flow for the applicant remains the same. In was submitted that security deposits when they are in the nature of trading receipts and are meant to ensure adjustment of mutual obligations fall within the ambit of taxable income. Learned counsel for the applicant cited the authorities of Badri Narayan Balakishan vs. Commissioner of Income Tax reported as 1965 57 ITR 752 AP ("Badri Narayan "), K.M.S Lakshmanier and Sons vs. Commissioner of Income Tax reported as AIR 1953 SC 145 ("Lakhmanier ") and Punjab Distilling Industries Limited vs. the Commissioner of Income Tax reported as 1959 AIR 346 ("Punjab Distilling ") in order to bulwark his submission that the impugned order passed by the learned Appellate Tribunal Inland Revenue was in due consonance with the law and merited no interference in the present proceedings. 5. We have considered the arguments ably advanced by the respective learned counsel and have also appreciated the case law placed before us. The controversy for us to address has been distilled to constitute the question framed herein, as reflected by the Order dated 13.10.2014, being whether the amount deposited by the members with the Exchange, as security deposit, could be treated as its income. 6. Prior to deliberating upon the submissions of the learned counsel it may be pertinent to record that during the course of the final hearing a query was raised by us with regard to the treatment under the Ordinance with respect to amounts deposited as security in respect of tenancy relationships of immovable property and whether the said situation would be analogous with the present controversy. Barrister Almani submitted that an analogy could be drawn with respect to a security deposit received by a landlord from his tenant, which is refundable at the end of the tenancy if not utilized for repairing any damage to the property by the tenant or is otherwise forfeited under the tenancy agreement. It was demonstrated that Section 15(2) of the Ordinance, which relates to income from property, specifically provides that "rent", which is taxable under Section 15(1), includes "any forfeited deposit". So it was deduced that a deposit, unless it is forfeited, cannot be taxed as income. Per learned counsel the same principle applied to the security deposited with the Exchange by its members. It was thus argued that since the security deposit is refundable, it is clear that the said amount does not belong to the Exchange and cannot be considered its income. Mr. Shahid Ali Advocate had accepted that the two scenarios were analogous, during the course of the hearing, and expressly stated that the in tenancy situations the security deposit is not ordinarily treated as income by virtue of it being refundable, however, the said stance was reconsidered in the written arguments that were submitted subsequently. It was stated in the written arguments that provisions of Section 16 of the Ordinance, even with a different context, still fortified the respondents stance that security deposits can be taxed if they are in the nature of revenue receipts and mere fact that they are shown as long term liability did not extinguish their taxable character and in such regard reliance was squarely placed upon section 16(1) of the Ordinance. 7. Barrister Almani had cited case law to illuminate three propositions of law; a lien is a right in a person to retain which is in his possession but belongs to another till certain conditions are satisfied; that income ordinarily connotes a periodical monetary return with relative actual or expected regularity; and that a security deposit cannot be considered as income. 8. A Division bench judgment of this Cour t in Habib Bank and an earlier Single Bench judgment of this Court in the case of Umar had been relied upon to demarcate the concept of lien. Umar , authored by Wahiduddin Ahmed, J (as he was then), defined a lien as a right in one man to retain that which is in his possession, but belongs to another , till certain demands of the person in possession are satisfied. The subsequent Division Bench judgment in the case? ?
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of Habib Bank reiterated the definition enunciated earlier and maintained the verbiage enunciated earlier . The learned counsel for the respondent did not make any submissions to controve rt or distinguish the argument advanced or authority cited in respect hereof. 9. The argument that income connoted a regular periodical return was bolstered by the authority of Samina, PIDB, Elahi Cotton and Punjab Small. Samina is a decision of the honorable Supreme Court wherein it is observed that the term income generally and ordinarily it connotes a periodical monetary return, coming in with some sort of regularity, or expected regularity, from a definite source. PIDB is another pronouncement of the honorable Supreme Court wherein it is maintained that prior to charging tax an assesse must be shown to have received income or it has arisen and accrued or deemed to be so under a statute. Any amount which is not an income cannot be subjected to tax. The august bench relied upon Corpus Juris Secundum, Volume 89, at page 731, wherein it was observed that income for any given period of time is the amount of gain so derived during the designated period. That which is not income cannot be made taxable by calling it income. Elahi Cotton and Punjab Small were also employed to reiterate the ratio gleaned as above. Once again the learned counsel for the respondent did not make dispel or distinguish the argument advanced or authority cited in respect hereof. 10. The crux of the argument, advanced on behalf of the respondent relevant hereto and as featured in the judgments of the fori under consideration herein, was that since the security deposit of a member of the Exchange was non-refundable till such time as the same was not replaced by an incoming member , therefore, the said amount was income and could not be treated in any other manner . It is in this context that it was implied that the security deposit was not a lien and further that it was not amenable to the definition of income being propagated by the applicant, even though such a definition was not exhaustive even by account of the authority cited in such regard. 11. It is an admitted fact that vide the Resolution the Board had designated that security deposit is refundable to a member upon resignation subject to receipt of a replacement security deposit from the incoming / replacing member. However, it is also clear that the said Resolution stood superseded by the prescriptions of the Regulations 2007 wherein it was provided that the security deposit is to be refunded to a person when he ceases to be a member even if he does not transfer his membership; the refundable security deposit becomes part of the Fund and this Fund is used to meet any loss or liability arising out of default of a member/broker; that whenever a broker defaults the Exchange may utilize any monies lying to the credit of the broker to fulfill these obligations; the Exchange shall have a lien over all amounts deposited by a broker towards the security deposit. Therefore, it becomes apparent that the entire premise of the respondent, justifying the treatment of the security deposit as income, fails post Regulations 2007. 12.…
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