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Petitioner: COMMISSIONER INLAND REVENUE, ZONE-III VS Respondent: Messrs IGI INSURANCE JUDGMENT
Court Name: Sindh High Court Judge(s): Zulfiqar Ahmad Khan, Munib Akhtar Title:COMMISSIONER INLAND REVENUE, ZONE-III vs Messrs IGI INSURANCE
JUDGMENT
Reported As: 2018 PTD 114 Result: Order accordingly Judgment JUDGMENT MUNIB AKHTAR, J.---This reference application has been filed by the Department impugning the order of the Tribunal dated 08.10.2012. The questions of law said by the Department to arise out of the impugned order (as amended by learned counsel vide statement dated 01.11.2013) are as follows:-- (1)Whether in the facts and circumstances of the case, the learned Tribunal was justified in law that the impugned share transactions with associated companies and pressed as a claim of an exempt capital gain of Rs, 7,081,205,000/- under Rule 6A of the Fourth Schedule to the Income Tax Ordinance, 2001 ("2001 Ordinance") did not constitute, for the tax year 2007, a tax avoidance scheme under section 109 read with Rule 5(b) of the said Fourth Schedule? (2)Whether in the facts and circumstances of the case, the learned Tribunal was correct in holding that for the tax year 2007, the taxpayer had correctly imputed income in accordance with the dictates of the Fourth Schedule to the 2001 Ordinance read with the principles laid down by the Supreme Court in Central Insurance Co. and others v. Central Board of Revenue and others 1993 SCM R 1232? (3)Whether in the facts and circumstances of the case, the learned Tribunal was justified in law to hold that the Fourth Schedule to the 2001 Ordinance being a special provision overrode the provisions of section 67, which was therefore not applicable in the case of an insurance business? (In this judgment, "Department" is used interchangeably with the term that appears in the statute, "Commissioner", unless otherwise indicated.) 2. The respondent taxpayer is a company engaged in non-life insurance business. The present
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dispute relates to the tax year 2007, which for the taxpayer corresponded to the income/financial period 01.01.2006 to 31.12.2006. The principal issues, which have required a lengthy and detailed consideration, are encapsulated in essentially the first question (to which the second is but ancillary), and we are essentially concerned with these. The third question can be dealt with swiftly and briefly (see para.92 below). 3. By way of broad overview, the dispute that requires resolution can be stated as follows. The Department sought to amend the taxpayer's income tax return by applying section 109 of the 2001 Ordinance to certain share transactions undertaken during the aforementioned financial period. These transactions involved the sale and repurchase of certain blocks of shares held by the taxpayer in 10 listed companies. Section 109, as explained in more detail below, is what is known as GAAR, i,e, a "general anti-[tax] avoidance rule". Since the taxpayer is an insurance company its income is computed according to certain special rules, by reason of section 99 read with the Fourth Schedule to the 2001 Ordinance. By applying. section 109, the Department sought to re- characterize the share transactions as an appreciation of investment within the meaning of Rule 5(b) of the Fourth Schedule, and thereby bring the appreciation to tax. The taxpayer resisted the Department's claim by arguing firstly, that section 109 did not apply at all to insurance companies as their incomes are determined according to the special rules (which have the effect of excluding this section), secondly, that the share transactions enjoyed the benefit of Rule 6A of the Fourth Schedule that was then in force (and was an exemption provision) and thirdly, that on any view of the matter Rule 5(b) did not in any case apply to the facts and circumstances at hand. 4. Learned counsel for the Department submitted that in its return filed for the tax year 2007 (which was a deemed assessm ent order under section 120) the taxpayer showed capital gains on the disposal of shares in the amount of Rs, 7,081,1205,000/-. It was claimed by the taxpayer that these gains were exempt by reason of Rule 6A of the Fourth Schedule. The taxpayer's case had been selected for audit and further inquiry revealed that the taxpayer had held a total of 22,899,792 shares in ten blue chip listed associated companies which were sold in 63 transactions between July 2006 and December 2006. All of these transactions were routed through the taxpayer's associated brokerage house. What was peculiar about these transactions was that in each case, the taxpayer repurchased the shares almost immediately, within a period of 24 to 72 hours. Thus, in all the, taxpayer entered into 126 transactions, being essentially back-to-back sales/repurchases, the result of which was that its share portfolio (as presently relevant) did not change at all. These shares were held by the taxpayer as shares not ordinarily intended for trading purposes, had been held for considerable periods, and were carried in the taxpayer's accounts/books on cost (i,e,, acquired value) basis. The market value of the shares subsequently rose considerably, and at the time that the transactions at hand were entered into was many times greater than the acquired value. Thus, in each transaction when the shares were ostensibly sold, the taxpayer recorded a capital gain. However, when they were almost immediately reacquired, they reappeared in its books at the (now much higher) "acquisition" value. Learned counsel submitted that these were sham transactions and "wash sales" without any real or substantive content or purpose. There was never any intent to dispose off the shares. Rather, the aim was to enjoy the benefit of the increase in market value without having to pay tax on the gain. The taxpayer was not entitled to the benefit of Rule 6A, since the shares were not, and never intended to be, disposed off. The Department therefore treated the transactions as a tax avoidance scheme within the meaning of section 109. It re-characterized the transactions as an appreciation in investment within the meaning of Rule 5(b) of the Fourth Schedule and brought to the gains to tax accordingly. 5. Learned counsel submitted that all 126 transactions had been routed through a sister concern (i,e,, the group brokerage house) and were quite contrary to the taxpayer's past practice. Thus, although there had been disposals of shares in the previous years (and of other shares even
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during the calendar year 2006), the magnitude was many times lower and there had then been no reacquisition. In the facts and circumstances at hand, the relevant shares had been almost immediately reacquired, which showed that there was never at all any real intent to dispose them off. 6. Learned counsel further submitted that section 109 was a wholly new provision and had no equivalent in the earlier legislation, i,e,, the Income Tax Act, 1922 ("1922 Act") or the Income Tax Ordinance, 1979 ("1979 Ordinance"). It had made a fundamental change in the law applicable to tax avoidance. It was a "general" anti-tax avoidance provision, i,e,, a GAAR. Learned counsel linked the section to other sections, such as sections 4 and 37 and submitted that it applied across the board and throughout the 2001 Ordinance. It was submitted that no doubt the determination of income of insurance companies was subject to the special rules contained in the Fourth Schedule, as provided for in section 99. In fact, this had always been the case, and special rules had also applied to insurance companies in the 1922 Act and the 1979 Ordinance. However, there was a significant difference. In the two predecessor laws, there had been non-obstante clauses, which had overridden the other provisions of the statute. Neither section 99 nor the Fourth Schedule however contained any non-obstante clause. Thus, the law had been materially altered. Section 109 was a provision that applied for determination of liability to tax "under" the 2001 Ordinance, i,e,, applied generally across the whole of the statute, and that obviously included the Fourth Schedule. Thus, the combined effect of the absence of a non-obstante clause in section 99 and the scope of section 109 was that the latter applied even to the special rules set out in the Fourth Schedule. 7. Referring to Rule 5(b), learned counsel submitted that it had two components, one relating to deductions and the other to additions. It was only the latter that was relevant in the present context. It provided that "any sums taken credit for in the accounts on account of appreciation, or gains on the realization of investments shall be treated as part of the profits and gains". In the present case, the "investments" (i,e,, the shares subjected to the 126 transactions referred to above) had not been "realized" since the shares had been almost immediately reacquired after each "sale" transaction. But, and this was precisely the purpose behind the transactions, after the re- acquisition of the shares at the higher value, the accounts reflected the "appreciation" in the investments. The attempt to shield the transactions from tax by purported recourse to Rule 6A was a patently impermissible device to avoid tax. The Department was fully justified in applying section 109 in the facts and circumstances of the case. The increase in value was not a capital gain protected by Rule 6A, but an appreciation to be added in terms of Rule 5(b), and the taxpayer was liable to pay tax accordingly. 8. Learned counsel analyzed in some detail the specific parts of section 109, highlighting its various components, and the terms used therein. Learned counsel also made extensive reference to other jurisdictions (such as Canada, New Zealand, Australia, South Africa and Belgium) where the tax legislation also contained a GAAR provision and to the judicial interpretation and application of those provisions. Reference was also made to other jurisdictions (principally the United Kingdom and the USA) where there was no GAAR provision, but the courts had developed detailed rules, concepts and principles relating to tax avoidance schemes and measures. 9. Learned counsel submitted that the facts and circumstances at hand brought the case squarely within the scope of clauses (a) and (c) of section 109. It was submitted (with reference to clause (c)) that the facts showed that the "form" of the share transactions did not reflect the "substance" thereof. Even if the "form" was a "sale" of the shares (which, as claimed by the taxpayer, resulted in it obtaining the benefit of Rule 6A) the "substance" was materially different. The almost immediate and back-to-back reacquisition of the shares, repeated more than five dozen times, wholly negated the claim as to "sale". The substance was to enjoy the benefit of the appreciation in value without any exposure or liability to tax. Since one of the main purposes of the transactions was to
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avoid tax, they also constituted a "scheme" for tax avoidance within the scope of clause (a). Learned counsel submitted that the learned Appellate Tribunal had erred in its understanding and application of sections 99 and 109 and the Fourth Schedule. The questions raised ought to have been answered in favour of the Department and against the taxpayer. 10.Learned counsel for the taxpayer strongly controverted the case sought to be made by the Department. Learned counsel submitted that insurance companies placed the shares held by them in different categories, which included shares "held to maturity", "available for sale" and "held for trading". It was only the shares in the last category that were part of the active trading portfolio. These were shares held on short-term basis. All the shares that were relevant for present purposes were held in the middle category, i,e,, "available for sale". These were shares held on a long term basis and were not part of the, active trading portfolio. However, they could be sold off from time to time and/or as and when any (special or specific) need or occasion arose. Referring in detail to the relevant sections of the Insurance Ordinance, 2000 and the rules framed thereunder, learned counsel submitted that the law required the shares "available for sale" be held in the insurance company's books at cost, or the acquisition value. Learned counsel emphasized that this was a mandatory requirement, which bound all insurance companies. If the market value of the shares "available for sale" was higher, it had to be disclosed in the notes, but it could not otherwise appear as such in the accounts. 11.Learned counsel submitted that all the share transactions at hand were genuine bona fide transactions. The respondent sold off the shares, and since the market value was much greater than the acquisition value, made a .substantial capital gain on each transaction. It was a sale transaction both in law and substantive effect and hence the respondent was entitled to the benefit of Rule 6A. The respondent was also perfectly entitled in law to reacquire the shares, which it did in each case. It was emphasized that in each case, the shares moved from the respondent's CDC account to that of the broker and vice versa on reacquisition, and funds flowed correspondingly. All applicable taxes were paid on the transactions. Thus, they could not be characterized as sham transactions, or those that had any effect other than what was reflected on the face of it. In other words, learned counsel contended that the form and the substance were the same. Referring to the show-cause notice that was issued for purposes of amending the assessm ent, learned counsel submitted that there was no allegation therein of any collusion or other malfeasance in respect of the sale/repurchase transactions. Furthermore, it was submitted, the tax turn (i,e,, deemed assessm ent order) could only be amended if there was "definite information", and there was none such in the facts and circumstances of the case. 12.Learned counsel submitted that section 109 had no application since the income of insurance companies was admittedly determined in terms of the special drules contained in the Fourth Schedule. This had always been the case. Learned counsel submitted that it was well settled that the "one unit" or "one basket" concept applied to insurance companies and the Department had to take the profits and gains as laid out in the accounts submitted by the companies to the insurance regulator. It could not go behind such accounts. The general or ordinary provisions of the 2001 Ordinance did not apply. The tax liability had to be worked out strictly and only within the framework of the special rules (as contained in the Schedule), and not otherwise. This had also been the position under the 1922 Act and the 19,79 Ordinance and reference was made to many of the cases decided under those statutes. Learned counsel also relied, in particular, on a decision of a learned Division Bench of this Court reported as Commissioner (Lena! Inland Revenue v. EFU General Insurance Ltd. 2011 PTD 2042 in which section 99 and the Fourth Schedule had been considered. Learned counsel submitted that the learned Division Bench had held that exactly the same position obtained under these provisions as had been the case under the previous statutes. It had been held that the lack of a non-obstante clause was of no moment. The "one unit" or "one
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basket" concept continued to apply, and in the same terms as under the predecessor legislation. Thus, section 109 did not and could not apply to the case of an insurance company. 13.Referring to Rule 5(b), learned counsel submitted that the respondent did not at all take credit in its accounts for any "appreciation" in the "investments". At all times, its books showed the value of the investments at the acquisition cost, as was required by law. When the shares were sold, that generated a capital gain, which was duly recorded in the books but was exempt from tax by reason of Rule 6A. When the shares were reacquired, the books showed the acquisition value. It was of course the case that this value was (much) higher than the one recorded previously, but learned counsel emphasized that the re-acquisition was a separate transaction in its own right, which was recorded, and had to be regarded for all purposes, as such. It was submitted that these were not back-to-back transactions as was being claimed. Rather, there were separate share transactions, each of which had to be recorded and dealt with, both in law and in fact, on its own terms. The linkage sought to be established by the Department was spurious and impermissible. Referring to section 109, learned counsel submitted that there was never any tax liability on the respondent and hence there could be no question of the respondent needing, and therefore acting, to "avoid" the same. Thus, on any view of the matter, there could be no application of section 109 to the facts and circumstances of the case at hand. Learned counsel for the Department exercised his right of reply. 14.At the conclusion of the hearing, we had asked learned counsel to file written synopses and both filed detailed submissions, running in each case to around 40 pages of closely argued material. We would like to record our appreciation of the very fine synopses that were filed, and acknowledge the valuable assistance that we derived from the same. Both synopses merited, and repaid, close and careful study and we would like to note that it would have been all the more difficult to give judgment in this Reference without the very welcome assistance provided by learned counsel in this manner. 15.We have heard learned counsel as above, considered the case law and material relied upon and written synopses filed on behalf of the parties. As will become clear as this judgment progresses, we have referred to and relied on a large mass of material, both in terms of case law and statutory provisions. Much of that material is from jurisdictions other than our own. For ease of reference the material (including from our own jurisdiction) is, in the case of the statutory provisions set out, and in respect of the case law referenced, in an Annex to the judgment. The Annex also contains a comparative table setting out the relevant provisions of the 1922 Act, the 1979 Ordinance and the 2001 Ordinance. The short form manner in which cases are cited below is also stated in the Annex and since many of the Pakistani cases are printed in more than one law report, an attempt has been made to refer to all citations in the Annex. (Cases cited only once are generally not referenced in the Annex.) 16.The first question is whether section 109 can at all apply in view of, and in relation to, the special rules that govern the determination of the profits and gains of insurance companies. If, as submitted by learned counsel for the taxpayer, this question is answered in the negative then the Department's case must necessarily fail at the outset. Learned counsel for the Department of course seeks an answer in the affirmative. We begin consideration of this question by examining the cases relied upon by learned counsel for the taxpayer. 17.The first case, decided under the 1922 Act; is Commissioner of Income Tax, Central, Karachi v. Alpha Insurance Co. Ltd. and another PLD 1981 SC 293 ("Alpha Insurance"). (The relevant provisions of the 1922 Act are set out in the comparative table given in the Annex.) The facts were that the insurance companies (the judgment disposed off more than one appeal) filed tax returns which showed certain management expenses. There was no dispute that such expenses were expenses within the meaning of section 10. However, the expenses shown were in excess of what was permissible under rules framed under the Insurance Act, 1938 ("1938 Act"). The Income Tax Officer
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(ITO) disallowed the expenses in excess of the limit prescribed under the 1938 Act. Upon appeal by the taxpayer, the Department failed to satisfy the Appellate Tribunal and then, on reference made by the Department, the High Court that this was, in law, the correct approach. The Department's appeal to the Supreme Court also failed. As regards the First Schedule, it was observed as follows: "The First Schedule of the Income-tax Act takes over and governs the computation of the profits and Gains of Insurance Business and is exhaustive of the subject" (pg. 296). It was observed that the 1938 Act and the rules framed under it required the balance sheet submitted to the Controller of Insurance (i,e,, the insurance regulator) by insurance companies to set out the management expenses in full as actually incurred, regardless of whether they exceeded the prescribed limit. However, it was also noted that the Controller had the power to condone any excess over the prescribed limit. As regards the jurisdiction of the ITO, it was held as follows 298-99):-- "10. The jurisdiction of the Income-tax Officer under rule 6 of the First Schedule to the Income-tax Act is confined to the taking of the profits and gains of any business of insurance other than life insurance "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." This presents the Assessing Authority with a fait accompli, over which he exercises no control. If the law requires such excess to be excluded from the balance-sheet the Assessing Authority cannot reintroduce it. If the law, as in these cases requires such expenses to be included in the balance-sheet, the Assessing Authority cannot exclude it on any principle not made a part of the First Schedule to the Income-tax Act. This brings us back to the starting point, namely, that the Income tax Officer has no power to do anything not contained in the First Schedule to the Income-tax Act." It was also held as follows (pg. 300): "12. The next question concerns the third part of the argument of the learned counsel for the appellant that the excess in management expense involves contravention of law, and any expenses incurred in contravention of law cannot qualify as expense "wholly and exclusively for the purpose of such business." A power has been expressly conferred on the Assessing Authority under rule 6 of the First Schedule of the Income-tax Act to readjust the balance disclosed in the Annual Accounts by excluding therefrom expenditure other than that "which may under the provisions of section 10" of the Income-tax Act "be allowed for in computing the profits and gains of a business." TO this extent alone and on a finding that the expense could not qualify as a legitimate deduction under section 10, it could be excluded from the balance sheet. None of the authorities have held it to be an expense other than that admissible under section 10. On the contrary, the findings proceed on. the assumption that such an expenditure, even though in excess, was "wholly and exclusively for the purpose of such business." Section 40-C [of the 1938 Act] itself shows that the prohibition is not absolute and the expenses dealt with therein and limited thereby would ordinarily, and by and large, be expenses incurred wholly and exclusively for that business." Thus, the Supreme Court held that in the facts and circumstances before it, the jurisdiction of the ITO was confined only to determining whether an expense appearing in the balance sheet presented to the Controller was an expense within the meaning of section 10. If so, then the ITO had to accept the profits and gains disclosed in such balance sheet as it stood. It was outside his jurisdiction to consider whether any part of such expense was beyond the scope of the 1938 Act or its rules or impermissible in terms thereof. Finally, while concluding it was interalia observed as follows (pg. 301, emphasis supplied):-- "14. Our conclusions therefore are that: (i) the rules contained in the First Schedule to the Income-tax Act completely, exhaustively and to the exclusion of every other provision not expressly incorporated, govern the computation of the Profits and Gains of insurance business, ...." 18.We pause to respectfully note that if the facts and circumstances of Alpha Insurance were to
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recur under the 2001 Ordinance, the Commissioner would have the jurisdiction to exclude the excess. This is so because clause (c) of Rule 5 of the Fourth Schedule now expressly provides that any deduction by way of expense, allowance etc. in excess of any limit laid down in the Insurance Ordinance, 2000 is to be excluded unless such excess has been allowed by the regulator (now the SECP) and is incurred in deriving income liable to tax. In fact, this provision was also to be found in the corresponding rule under the 1979 Ordinance. 19.The next case is also a Supreme Court decision, Commissioner, of Income Tax, Zone A…
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