Income Tax Ordinance (XXXI of 1979)----

----Second Schedule, Clause 125 & S.48(2)---Exemption---Clause 125 of second Schedule of the Ordinance is independent of S.48(2) of the Ordinance and said clause need not be read with S.48(2) to grant exemption under clause 125---Where the two conditions laid down in clause 125 of the Second Schedule had been met with, assessee's income was to be treated as exempt.

Agha Faqir Muhammad for Appellant (in ITA No.101/HQ of 1988 89).

Syed Humayun Zaidi, D.R. for Respondent (in ITA No. 101/HQ of 1988-89).

Syed Humayun Zaidi, D.R. for Appellant (in ITA No. 447/KB of 1991-92 and ITA No. 7157/KB of 1992-93).

Agha Faqir Muhammad, Advocate for Respondent (in ITA No. 447/KB of 1991-92 and ITA No. 7157/KB of 1992-93).

Date of hearing: 10th August, 1992.

ORDER

NASIM SABIR SYED (ACCOUNTANT MEMBER).---The assessee is a manufacturer of garments. Appeal has been filed by the assessee for the assessment year 1987-88 and by the department. for the years 1989-90 and 1990-91. They stand disposed of as below:---

ASSESSMENT YEAR 1987-88

The only grievances of the assessee are that the ITO erred in law not to treat the income of the appellant exempt under clause 125 of the 2nd Schedule alongwith certain objections to the P&L addition. Coming to the objection raised against not holding the income of the appellant exempt under the clause 125 of the 2nd Schedule, the facts of the case are that according to the learned A.R. of the assessee it was a newly-set up industrial undertaking which met both the conditions for grant of exemption under clause 125 of the 2nd Schedule. Those two conditions are as under:--

"(a) Engaged in the manufacture of garments from cloth manufactured in Pakistan.

(b) Owned and managed by a company formed and registered under the Companies Ordinance, 1984, having its registered office in Pakistan."

It was insisted that as the assessee filled both these conditions the exemption should have been granted. There is no dispute about the fact that both these conditions are fulfilled. The reason given by the ITO for not granting of the exemption was that according to him the assessee had taken over the assets of M/s. Aishama International a registered firm which were being assessed to tax in Circle-4, West Zone, Karachi having partners which are now the Directors in the assessee-company. On the other hand, the learned A.R. of the assessee insisted that the I.T.O. has failed to appreciate that the assessee being an artificial juridical person had independent identity from that of the registered firm and there was no provision under any law that the partners of a firm could not float a company as its Directors. To supplement this claim and in response to a query raised by us it was further clarified that even the premises of the two entities i.e. the firm and the company were different because the premises of the assessee were Plot No.98 Malir Industrial Area whereas those of the registered firm was Plot 94 in the same area and the two plots being not contiguous it could not be said that the company and firm were working at the same premises. It was further asserted that the registered firm was still working and none of its assets were taken over by the assessee. The learned A.R. even went to the extent of saying that even if something had been purchased from the firm that did not mean that the company lost its identity and got merged with the firm. It was further maintained that the very fact that the assessment of the assessee had been made separately from that of the firm as a limited company showed that the ITO was conscious of the fact that the two concerns have independent identities. All these arguments of the learned A.R. are very forceful and supported by the legal provisions on the subject. Another reason given by the ITO was that the exemption under clause 125 has been given understandably to the new industrial undertakings which have been set up with totally new set up and having plant and machinery which was not in use in Pakistan at any time before the commencement of the new business. The relevant provisions of clause 125 read as under:---

"125 a --

Profits and gains derived by an assessee from an industrial undertaking set up between the first day of July, 1978, and the thirtieth day of June, 1988 both days inclusive, for a period of five years beginning with the month in which the undertaking is set up or the commercial production is commenced, whichever is the later.

The exemption under this clause shall apply to an industrial undertaking which is:--

(a) engaged in the manufacture of garments from cloth manufactured in Pakistan; and

(b) owned and managed by a company formed and registered under the Companies Act, 1913 (VII of 1913), having its registered office in Pakistan.

From plain reading of this it is quite obvious that this clause talks only of an industrial undertaking set up between a certain period and nothing else but for 3 the two conditions given in sub-clauses (a) & (b).

3. We fail to understand as to how the ITO was of the opinion that the plant and machinery was to be such that was not in use in Pakistan at any time before the commencement of this type of concern. May be he was mixing up the requirements of some other clause of 2nd Schedule with this clause. A careful perusal of the order of the ITO showed that he was of the opinion that the industrial undertaking for the purpose of this clause has been defined under section 48(2) of the Income Tax Ordinance which puts up the restriction that such industrial undertaking is not formed by the splitting up or the reconstruction or reconstitution of business already in existence or by transfer to a new business of arty machinery or plant used in a business which was being carried on in Pakistan in any time before the commencement of the new business. The learned A.R. of the assessee vehemently stressed that section 40(2) of the Income Tax Ordinance had nothing to do when this exemption clause in 2nd Schedule of Income Tax Ordinance. Section 48 essentially talks about exemption from tax of newly-established undertakings. It was insisted by the A.R. of the assessee that this was a general exemption clause which had nothing to do with the 2nd Schedule. It was asserted that the clause 125 talked only of the exemption granted to the garment industry and this being a special provision the general provision of section 48 could not be applied to it. The learned D.R., on the other hand, argued that this section had been introduced to safeguard the interest of the revenue against unscrupulous person who were likely to deprive the State of its legitimate revenue by manipulating things in a way which were against the spirit of the law. He insisted that this was the case of an assessee who had already enjoyed exemption under clause 125 in the case of the firm and had now created a legal fiction to extend the benefit for another five years although the same family was running the firm and the company. It was pointed out by the D.R. that two brothers who were the Directors in the company were the partners in the firm and the new two Directors were just mother and father who were "dummy" Directors and were not associated with the actual business of the assessee. According to learned D.R. it was not a newly-established industrial undertaking as defined under section 48 and so exemption was rightly disallowed because according to him when it is said in clause 125 that the profits and gains have to be from an industrial undertaking set up between certain dates it means that it has to be a newly-established undertaking and so clause 125 has to be applied read with section 48 of the Income Tax Ordinance. We feel that the reproduction here of the relevant provisions of section 48 will help in understanding the matter in a better perspective. These provisions are as under:--

"48. Exemption from tax of newer-established industrial undertaking-s.--M Subject to the provisions of this section, there shall be exempt from the tax payable under this Ordinance so much of the profits and gains derived by assessee from an industrial undertaking, to which this section applies, as does not exceed an amount computed with reference to the capital employed in the undertaking as hereinafter provided.

(2) This section applies to an industrial undertaking (hereinafter referred to as the "said undertaking") which fulfils the following conditions, namely:---

(a) that it is an undertaking engaged in the manufacture of goods or materials, or the subjection of goods or materials to any such process, ship-building and navigation, or the generation, transformation, conversion, transmission, distribution or supply of electrical energy or hydraulic power; or

(b) that it is an industrial undertaking which is approved by the Central Board of Revenue for the purposes of this section;

(c) that it is set up by a Pakistani company in the. areas specified in clauses (119), (120), (121) and (122) of the Second Schedule or in an industrial estate approved by the Central Board of Revenue and located in the territories of Pakistan (excluding Talukas of Karachi and Hyderabad, and Tehsils of Faisalabad and Lahore and such adjoining areas of Lahore Tehsil as may be notified in this behalf of the Federal Government);

(d) that it employs ten or more workers and involves the use of electrical energy or any other form of energy which is mechanically transmitted and is not generated by human or animal agency, or twenty or more workers and does not involve the use of electrical energy or any other form of energy which is mechanically transmitted;

(e) that it is not formed by the splitting up or the reconstruction or reconstitution of business already in existence or by transfer to a new business of any machinery or plant used in a business which was being carried on in Pakistan at any time before the commencement of the new business; and

(f) that it has commenced commercial production at any time between the first day of July, 1975 and the thirtieth day of June, 1988 (both dates inclusive)."

4. The learned Authorised Representative of the assessee insisted that according to his understanding this section had nothing to do with clause 125 but even if some distorted interpretation suggested that it has to be read with clause 125 then this suggestion is legally untenable. According to him S.48 was applicable in cases of specific industries such as ship-building and navigation or the generation, transformation, conversion, transmission, distribution or supply of electrical

energy or hydraulic power with attached conditionalities the most important of which was that this has to be an undertaking which is approved by the Central Board of Revenue for the purposes of this section. This means this bestows special powers on the Central Board of Revenue to grant exemption of profit from taxation upto a certain limit in the case of specialised industries the limit being 10% of the capital employed in the said undertaking as per S.48(3). It was stressed that clause 125 exempted the whole of the profits from garment industry and so it had nothing to do with this section. Secondly it was argued that this section applied to such specific industrial undertakings which had commenced commercial production at any Time between the first day of July 1975 and 30th day of June, 1978. Whereas in clause 125 the exemption starts from first day of July 1978 indicating thereby that it was an independent provision to encourage the manufacture of readymade garments both for exports and local consumption. After considering all these things in detail we have reached the conclusion that clause 125 of Second Schedule is independent of section 48(2) of the Income Tax Ordinance and clause 125 has not to be read with that section to grant an exemption under that clause. We further observe that both the conditionalities laid down in clause 125 have been met with. So that ITO is directed to treat the income of the assessee as exempt. We will further like to clarify that even if clause 125 talked of a new business set up it has nowhere been laid down that second-hand machinery cannot be used by it. The assessee has denied that any machinery or assets were purchased from the firm yet it is of no material difference because the company being an independent artificial juridical person could buy machinery or assets from anywhere including the firm in which two of the active directors of the company were partners.

PROFIT AND LOSS ADDBACKS

5. The add-back under the head telephone is reduced to 15% of the claim. Rest of the add-backs maintained by the CIT(A) are quite reasonable and call for no interference. Similar is the position about addition made under the head Cartage expenses, Printing and Stationery, entertainment expenses, Misc. expenses and Govt. taxes.

6. In the next ground the assessee has contested the ad hoc addition of Rs.2,00,000. Rejection of accounts has not been challenged. The ad hoc addition made is rather on the higher side keeping in view the GP rate declared by the assessee which is 13% with exports at Rs.23,38,651 and local sales at Rs.1,94,308. The same stands reduced to Rs.1,00,000.

7. This disposes of appeal as above.

ASSESSMENT YEARS 1989-90 AND 1990-91.

8. The department is only aggrieved about the grant of exemption by the learned CIT(A) to the income of the assessee under clause 125 of the Second Schedule of Income Tax Ordinance. Keeping in view the appeal order for 1987-88 this finding of the learned CIT(A) stands confirmed and calls for no interference.

9. Both the appeals of the department stand rejected.

M.B.A./1731/T