Per Inam Ellahi Shaikh, Accountant Member; Mian Abdul Khaliq, Judicial Member agreeing---

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

-----Third Sched. cl. 5---Depreciation---Assessee, a limited company engaged in its business of manufacturing and vending of tin containers---Factory of the assessee was situated at M while the Head Office was in K---Assessee during the relevant year purchased machinery which was not such as needed installation by way of fixing on the ground or attachment with any other fixed machine (etc.) but were portable units which could be installed for commissioning into service simply by plugging like a computer or such like equipment---Said machines were purchased at K and after obtaining possession it was thought expedient by assessee that the staff members who were to operate should be called for training so that in case of difficulty the manufacturer (who also were in K) could be consulted and called in for necessary guidance---Concerned staff members were thus brought on tour to K from M for which usual TA./DA. was paid debiting the accounts to which no exception was taken by the Assessing Officer by way of disallowance---Held, machines in question could be treated as installed for the purposes of Third Sched. to the Ordinance but the same could not be treated as having been used for the purpose of assessee's business as it was used for training of the staff and therefore assessee was not entitled to the depreciation on the machinery in question.

In re: S. Muhammad Din 1979 PTD 538; In re: Challipali Sugar Mills (1973) 98 ITR 167 and In re: Simco Metres Ltd. (1978) 111 ITR 113 (Mad.) distinguished.

Per A. A. Zuberi, Accountant Member (Minority view)--

In re: Meer Muhammad Ali (1964) 10 Tax 262; In re: Shahemilon Steamship Co. Ltd. 1971 PTD 429; In re: S. Muhammad Din 1979 PTD 538; In re: Challapalli Sugar Mill (1975) 98 ITR 167 and In re: Simco Metres Ltd (1978) 111 ITR 113 ref.

G. M. Gangat, CA. for Appellant. Qudrat Ullah, D.R. for Respondent.

Date of hearing: 5th March, 1991.

ORDER

A. A. ZUBERI (ACCOUNTANT MEMBER).--This appeal has been filed at the instance of a company who act as manufacturers and vendors of tin contain. The appeal impugned order dated 15-5-1985 passed by the learned Commissioner of Income Tax (Appeals Zone-I) Lahore in respect of the assessment year 1983-84.

The learned counsel for the appellant give-up his objections raised as Nos.1 and 2 in the "grounds of appeal" and confines his arguments to agitate against disallowance of initial a normal depreciation on newly acquired machinery.

It was explained by Mr.G.M.Gangat (FCA), the learned counsel that although the factory of the appellant is situated in Multan the Head-Office is in Karachi. During the income year the appellant purchased machinery for seam welding and another machine for stretch forming. On these depreciation was claimed (initial normal) which the assessing officer disallowed at an aggregated amount of Rs.1,57,500 and the learned Commissioner maintained the treatment in appeal. The learned counsel submitted that the reason assigned by the assessing officer to disallow the claim was that machines were neither installed in the factory nor operated in the income year. When a notice was served by the assessing officer upon the appellant, it was explained that the machines were not such as needed installation by way of fixing on the ground or attachment with any other fixed machinery (etc.) These were portable units which could be installed for commissioning into service simply by plugging like a computer or such like equipment. The machines were purchased at Karachi and after obtaining possession it was thought expedient that the staff members who were to operate these should be called for training so that in case of difficulty the manufacturers (who also were in Karachi) could be consulted (and called in) for necessary guidance. For this purpose, the concerned staff members were brought on tour to Karachi for which usual TA/DA was paid debiting the accounts to which no exception was taken by the assessing officer by way of any disallowances. Therefore, the objection as respect the installation was not based on correct appreciation of fact. Moreover, the objection that the machinery was not `used' during the income year was also not correct inasmuch as the three units of machinery were operated for training purposes and thus put to `use' by the appellant. The learned counsel, Mr.G.M. Gangat, referred to Rule 5 of the Third Schedule of the Income Tax Ordinance which prescribes initial depreciation (inter alia) for machinery and plant installed in Pakistan. It was canvassed that in the appellant's case commercial production had already commenced and the new machinery in question was acquired subsequently and, therefore, what was relevant was its `use' for the first time for the purpose of business. It was asserted by Mr. Gangat with vehemence that the training of staff on a machine was as much as a `use' for the purposes of business as its use for the purpose of production. The learned DR on his turn insisted that as the factory was situated in Multan, the machinery could not used in the Head Office at Karachi and any training away from the could not be charaterized as the "purpose" of the business. The learned insisted that it was incumbent on the appellant to prove that they acquired, installed and also used the machinery in such manner as participated in the production process. Unless that was done, the learned DR asserted, the machinery could not be said to have been used for the first time for the purposes of business during the income year.

After hearing the rival arguments from the two sides we are of the view that what clinches the issue is whether the `use' of the machinery for the purposes of training can be characterised as its use " for the purposes of business". As it is, we see no difficulty to hold that the machinery as purchased by the appellant is to be treated as "installed in Pakistan" for the purpose of allowing depreciation. For forming this view benefit is drawn from a decision from the Supreme Court of India In re: Meer Muhammad Ali (1964) 10 Tax 262 where it was held:--

"Installed did not necessarily mean fixed in position but was used in the sense of induct or introduce or placing the apparatus in position for service or use."

Moreover, the learneded Judge of the Karachi High Court rules In re: Shahemilon Steamship Co. Ltd. (1971 PTD 429) the expression "installed" is unqualified. Our finding, therefore, is that the machinery (i.e.) machinery for seam welding and another for stretch forming is to be treated "installed in Pakistan" for the purpose of depreciation allowance under the third schedule to the Income Tax Ordinance.

Another issue warranting adjudication is: whether the two machines (as above) acquired by the appellant were used for purposes of the business carried on by the appellant. Here we may with advantage refer to a ruling by the Lahore High Court In re: S. Muhammad Din:

"The machinery which earns depreciation has a known functional utility. Such functional utility is related to the business carried on by the owner or possessor of it. Any arrangement whereby such machinery or plant is not used at all or used in a manner not consistent with its functional existence would not be used for the purpose of business Therefore, any use of the machinery which is not consistent with the functional utility and existence or is not related to the earning of the profit by making use of the machinery as such, would not entitle the owner thereof to claim depreciation."

This Tribunal also has ruled in several decisions that the `use' of an asset denotes both passive as well as active use.

Judging on the criterion laid down by the learned Judges we feel persuaded that the `use' of the machinery by the appellant was consistent with the functional utility (and existence) hence "for the purposes of business" though it may not have resulted in the earning of the profit for the income year under consideration. At this stage it may be of advantage to look into (rather in detail) the basis on which the depreciation is ordinarily admissible. It is nearly always with reference to the cost of the asset' acquired during the income year (as in the case of the appellant) and thereafter on the WDV. Now, clause (b) of sub-rule (7) of Rule 8 of the Third Schedule deals with "case of other assets------acquired in the income year" to prescribe depreciation on "the actual cost thereof to the assessee". This quite naturally leads us to examine what the term "actual cost" suggests moreso when it has not been defined in the Ordinance which makes it all the more necessary to consider the elements of the cost of an assets in the context of the Income Tax Ordinance for the purpose of allowance of depreciation. Coming directly to Machinery and Plant, the obvious items to be aggregated are: the price paid for the asset, import duties (if any) the dock charges, freight, carriage-cost to transport the asset to the side, installation cost and similar other charges. These still may leave out certain items for which no obvious answer may be possible such as, in the process of installation, even before an Assessee commences his business, he may have to run an office thus incurring expenses on establishment, may enter into technical know-how agreement for installation and/or loan may have to be raised and interest paid thereon, and so on and so forth. What is to be done in regard to such expense According to well-recognized principles of Accountancy, all such expenses can be classified, as under:--

(1) Expenses directly relatable to acquisition of the assets (price of the assets; interest on loan taken for purchase etc.).

(2) Expenses required to bring the machinery to the site its installation and making it ready for use.

(3) Expenses incurred to enable the use of the asset.

(4) Expenses necessarily incurred even if the asset is finally not installed or commissioned for use.

So far as the first category of expenditure is concerned, there is no dispute that the price paid is certainly the principal element of cost. But, what about the loan taken to acquire the assets? Going a little further, what about the cost incurred to take such a loan? For example, when a loan is taken from a financial institution, there arises the unavoidable requirement of considerable documentation, entailing substantial expenditure. How are these to be treated for the purposes of determining the cost? The answer on these puzzling issues is available in Supreme Court of India decision In re: Challapalli Sugar Mill (1975) 98 ITR 167 where it is observed:

"It would appear from the above that the accepted Accountancy rule for determining the cost of fixed assets is to include ail expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of the production on such borrowed money can be capitalised and added to the cost of the fixed -assets which have been created as a result of such expenditure. The above rule of Accountancy should in our view, be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary."

(Here underlined for emphasis)

Applying the above test, it emerges that when assistance is obtained for guidance or know-how the expenditure incurred in this behalf is clearly for the purpose of bringing the asset (in the case in hand the machinery) into existence and to put it into working condition, the same is to be aggregated to work out the "actual cost" thus entitling the owner to depreciation thereon. This view gets further support from a decision of Indian jurisdiction In re: Simco Metres Ltd. (1978) 111 ITR 113 (Mad.) where treatment of indirect expenses vis-a-vis determination of the "actual cost" for purposes of depreciation, came up for consideration. The expenses in this case were: 1-Managing Agency remuneration; 2. Rent and lighting; 3. Audit fees; 4. Law charges; 5. Directors fees; 6. Advertisements; 7. Interest and banking charges; 8. Filing fees; 9. Technical staff training expenses; 10. Technical know-how fees; which the learned Judges held as proper additions to the capital cost having been incurred to bring the assets into existence and to put these in working condition.

On a foregoing survey of facts and circumstances as also the case law, both from the Pakistan and Indian jurisdiction; we hold; the machinery purchased by the appellant was "installed in Pakistan during the income year and was "used by the assessee for the first time for the purpose of business." Therefore, the appellant is without doubt entitled either to claim depreciation by capitalising, inter alia, the expenses on technical training of the staff; or to claim direct deduction as was preferred by them. Since the assessing officer has not in any way interfered with .the claim for incidental charges such as TA and DA paid to the staff for training it looks more justifiable and in consonance with facts and circumstances of the present case that instead of capitalising the entire expense, those already admitted by the assessing officer be left undisturbed and whatever element of `actual cost' has been capitalised in the Appellant's books of accounts be allowed to be tapered off in the form of depreciation, as already claimed. The appeal SUCCEEDS in consequence.

INAM ELLAHI SHEIKH (ACCOUNTANT MEMBER).-- I have carefully perused the above elaborate order written by my learned brother the Accountant Member (Mr. A.A.Zuberi). Whereas I agree with his finding that the machinery in question could be treated as installed for the purposes of the Third Schedule to the Ordinance, I am unable to subscribe to his view that it could be treated as having been used for the purpose of assessee's business since it was used for training of staff. The assessee's contention is that the use of machinery for training of staff is equated to the use of the same for business purpose. My learned brother, the AM, has reproduced an extract from for a ruling of the Lahore High Court In re: S. Muhammad Din (1979 PTD 538) wherein the term "used" for the purpose of business has been elaborated. I would like to reproduce hereunder the last sentence of the same extract, which, in my view, goes against the contention of the assessee:

"Therefore, any use of the machinery which is not consistent with the functional utility and existence or is not related to the earning or the profit by making use of the machinery as such, would not entitle the owner thereof to claim depreciation."

2. The assessee has not claimed before us that training of its own staff was a part of its business activities. My learned brother, the Accountant Member, has then proceeded to discuss the elements of cost, which is to be considered for the purpose of allowance of depreciation. My learned brother the Accountant Member has reproduced an observation of the Supreme Court of India In re: Challipalli Sugar Mills (1973) 98 ITR 167 wherein it was held "interest incurred before the commencement of the production on such borrowed money can be capitalised and added to the cost of fixed assets which have been created as a result of such expenditure". My learned brother, the Accountant Member, also referred to another ruling of Indian jurisdiction In re: Simco Metres Ltd. (1978) 111 ITR 113 (Mad.) wherein certain indirect expenses including those on technical staff training could be capitalised. Thus, my learned brother concluded that the machinery in question was used by the assessee for the first time for the purpose of business. My learned brother also held that the assessee was either entitled to capitalise the travelling and other related cost of the staff for such training and claim depreciation thereon or to claim such expenses as a straight deduction. However, the question before us was not as to what was the cost or WDV but the question was whether the machinery, having been used for training of staff, could be said to have been used for the purpose of business of the assessee. Nowhere it has been pleaded before us or before the departmental officials that imparting training to its staff was one of the objects of the company as per its memorandum of association. In the absence of any such plea. I am inclined to follow the ruling of the Lahore High Court In re: S. Muhammad Din (supra) wherein the criterion for determining the use has been clearly laid down.

3. It may be useful to summarise the facts of the case and the discussion of the High Court in the case of S. Muhammad Din (supra). The assessee was the owner of an Ice Factory at Rawalpindi and, during the relevant periods, he entered into a pool arrangement with the owners of other similar factories whereby he was required to keep his plant in readiness for use but was not to run it independently unless called upon to do so. Thus the factory was not run during this period at all and the assessee received a sum of Rs.11,000 as his share. The assessee's claim of depreciation on such plant and machinery, which was kept in readiness for use was refused by the assessing officer but the AAC as well as the Tribunal allowed this claim. The learned Judges of the High Court, however, after examining a number of conflicting decisions on this issue, disallowed this claim after discussing the matter in the following manner:

"In view of the conflicting decisions has to be examined afresh. The relief under consideration is in the form of depreciation of machinery etc. The machinery which earns depreciation has a known functional utility. Such functional utility is related to the business carried on by the owner or possessor of it. Any arrangement whereby such machinery or plant is not used at all or used in a manner not consistent with its functional existence would not be a use for the purpose of business. An agreement not to use the machinery at all cannot be said to be use of the machinery for the purpose of the business though the agreement as such may yield income. It is not the actual depreciation of the machinery which entitles the owner thereof to claim depreciation. Similarly it is not the mere accrual of income while possessed of such machinery that entitles one to depreciation. It is the use of the machinery which does. In the given case before us the agreement amounts to one of not using the machinery and money was made by such an agreement. It cannot be said that making money by any means is the business relatable to the machinery or plant owned by the assessee. Therefore any use of the machinery which is not consistent with its functional utility and existence is not related to the a trnin of profits by making, use of the machine as such would not entitle the owner thereof to clam depreciation.

(Emphasis added)

4. In view of my discussion made above I hold that the assessee was not entitled to the depreciation on the machinery in question as, in my humble view, the use of machinery, in the circumstances of this case, could not be equated with the use for the purpose of its business. The appeal should be dismissed.

MIAN ABDUL KHALIQ (JUDICIAL MEMBER). --After going through the proposed orders of my learned brothers, I feel fully persuaded to agree with the reasons, discussion and conclusion arrived at by my learned brother Mr. Inam Ellahi Sheikh, Accountant Member.

CONCLUSION

As per majority decision, the assessee's appeal being devoid of any merits is dismissed.

M.BA./1248/T

Appeal dismissed.