Per Farhat Ali Khan, Chairman; agreeing with A.A. Zuberi, Accountant Member---

Income Tax Ordinance (XXXI of 1979)---

----Second Sched. C1.125---Interpretation of C1.125---Exemption under C1.125 when available ---Assessee, a private limited company deriving income from manufacturing and export of garments and from local sale of cloth--Profits and gains of the company for the purpose of exemption were to be restricted to the profits and gains derived either from sale of manufactured garments or sale of those things which were either incidental to or had been produced in the manufacturing process of the garments.

The exemption is available under clause 125 of the Second SO the Income Tax Ordinance, 1979 to the profits and gains of that industrial undertaking which is firstly set up between the 1st day of July, 1978 and 30th day of June, 1991 and secondly, which is engaged in the manufacture of garments from cloth manufactured in Pakistan and, thirdly, it is owned by a company which is managed by a company having its registered office in Pakistan and which is registered under the Companies Act of 1913. The opening part of Second Schedule speaks of the conditions and extent of the exemption. The opening part of the aforesaid Second Schedule does not lay down four categories under which the income is exempt under the Second Schedule. It rather refers to the persons or classes of persons who may have income or classes of income, which falls under any of the clauses given in Second Schedule subject to the conditions and to the extent specified in each clause. Since the clauses of Second Schedule are dealing with exemption regarding various types of incomes or classes of income which have been granted exemption in the hands of persons or classes of persons, the words income or classes of income or persons or classes of persons have been mentioned. The exemption, however, is subject to the conditions and to the extent as specified in each clause. Clause 125 does not grant exemption to all profits and gains of an industrial undertaking derived from whatever source, provided it has primary business of manufacturing of garments. Aforesaid clause 125 does not talk of primary or secondary business. It grants exemption to those profits and gains which are derived by an assessee who is engaged in the manufacture of garments. Nevertheless, it would not be correct interpretation of law to include the profits and gains derived from "the activity which is ancillary or subsidiary to the main exempt business". The emphasis under clause 125 appears to be on the expression "manufacture of garments" for the purposes of exemption and not in the least on "the business of an industrial undertaking". It is to be kept in mind that the clause begins with the profits and gains of an industrial undertaking but the second paragraph applies the exemption to an industrial un-detaching, which is engaged in the manufacture of garments. Ordinarily only those profits and gains would fall within the ambit of exemption granted to an industrial undertaking under this clause which are obtained on sale of manufactured garments or those things which are either incidental to or are produced in manufacturing process of the garments. Under the facts and circumstances of the case widening of the exemption to those profits and gains which are ancillary or subsidiary to the manufacturing process would not be justified as the provisions of an exemption are to be strictly interpreted.

Per A.A. Zuberi (Accountant Member).

1987 PTD 479; 1987 PTD 182; 1983 PTD 108; 1991 PTD 207; 1991 PTD 178 and 1988 PTD 157 ref.

Per Abrar Hussain Naqvi (Judicial Member) (Minority view).

Liaquat Chaudhry, D.R. for Appellant. Zia H. Rizvi for Respondent. Date of hearing: 28th January, 1991.

JUDGMENT

ABRAR HUSSAIN NAOVI (JUDICIAL MEMBER).---This is a departmental appeal against a private Limited Company deriving income from manufacturing and export of garments and from local sale of cloth. The appeal relates to the assessment year 1988-89.

2. Brief facts of the case under which this appeal arises are that the assessee declared his sales and receipts under various heads are as under:--

The net income declared by the assessee was at Rs.4, 68,140. The assessee claimed exemption of its entire income under clause 125 of the Second Schedule of the Income-tax Ordinance. The I.T.O. accepted the income from export sales as well as from the local sales of garments. The assessing officer disallowed the claim of exemption of income from local sales of cloth as well as from stitching charges. The I.T.O. disallowed the claim of exemption on the ground that only that part of the income is exempt which relates to the garments manufactured from Pakistani cloth. Since the sale of cloth does not involve manufacturing therefore the income from sale of cloth could not be exempt under the aforesaid clause. Similarly the stitching charges were held? not to be a manufacturing process, and therefore, it was also held not to be exempt under the aforesaid clause. On appeal the learned C.I.T.(A) after giving detailed reasons held that so far as the stitching income was concerned that involved manufacturing as stitching included processes such as washing, cutting, stitching, pressing, fixing buttons `kaj' and packing. The learned C.I.T.(A) further held that the I.T.O. was not correct in saying that the processes mentioned above had not been undertaken by the assessee. According to the learned C.I.T.(A) he examined the record and found that the process stated above had been undertaken by the assessee in stitching which was reflected in the assessee's manufacturing account details of which were furnished to the panel. He further found that in the manufacturing account the assessee had claimed expenses on packing material at Rs.3,72,060, on stitching material at Rs.16,61,928, on raising charges at Rs.1,21,695, mending charges at Rs.25,565, washing expenses at Rs.57,764, stitching charges paid to labour at Rs.13,48,292,pressing charges at Rs.1,32,697 and the calendaring charges at Rs.32,915. The panel's objection that the amount of Rs.3,00,000 received from M/s. United Textile was for stitching of bed covers was also found to be incorrect and the learned C.I.T.(A) found that in fact these charges were received for stitching kitchen Aprons. He further found that there was nothing on record to indicate what charges were on account of bed covers. The learned C.I.T.(A) further found that the panel's finding that the assessee did not own the pressing machinery was also incorrect and the press was found to be declared by the assessee in the details of machinery and factory equipments. The learned C.I.T.(A) after reproducing the detailed arguments of the assessee that the process of stitching was the manufacturing process finally concluded that the process of cutting, sizing, stitching and sewing, pressing, kaj and buttons and the tailoring in regard to the cloth supplied by the other parties amounted to and constituted manufacturing of garments within the meaning of clause 125 of the Second Schedule. On the basis of these reasoning and findings the learned C.I.T.(A) accepted the assessee's appeal and held the assessee's entire income as exempt under clause 125 of the Second Schedule of the Income-tax Ordinance. The department has come up in appeal against this order of the learned C.I.T.(A).

3. The learned D.R. argued the case with vehemence and insisted that the finding of the learned C.I.T.(A) was incorrect. It was contended that the sale of cloth could not be said to be part of manufacturing process and therefore the learned C.I.T.(A) was wrong in holding that income from sale of cloth could be exempt under clause 125 of the Second Schedule. In regard to the stitching charges as well the learned D.R. contended that this could not be included in the manufacturing process, and therefore, could not be held to be exempt under the aforesaid clause. The contention of the learned D.R. was that only that part of the income of an industrial undertaking was exempt which was derived by an assessee from manufacturing of garments. Since no manufacturing was involved in stitching charges the income could not be held to be exempt. On the other hand the learned counsel for the assessee supported the order of the learned C.I.T.(A). In regard to the sale of cloth it was explained, as before the C.I.T.(A) that this was an incidental income inasmuch as during the manufacturing process some of the defective cloth as well as the cut-pieces could not be used for the garments particularly in exports, and therefore, the income from this sale of cloth was incidental to the manufacturing of garments. In regard to the stitching charges, again the learned counsel for the assessee repeated the same arguments as before the learned C.I.T.(A) that it included processes enumerated above, and therefore, this amounted to manufacturing of garments. It was further argued by the learned counsel for the assessee that clause 125 of the Second Schedule is applicable to an industrial undertaking and thus the actual factum of manufacturing is irrelevant. According to the learned counsel clause 125 exempts the profits and gains derived by an assessee from an industrial undertaking engaged in the manufacturing of garments from cloth: According to him the assessee fulfilled all the conditions laid down in clause 125 of the Second Schedule, and therefore, its entire income was exempt.

4. We have examined the rival arguments and have gone through the impugned order. So far as the sale of cloth is concerned notwithstanding the various arguments advanced by the learned C.I.T. (A) as well as by the learned counsel for the assessee and whatever reasoning may be for the sale of cloth of the assessee which may be genuinely made by the assessee, the sale of cloth cannot be said to be manufacturing of garments. It is true that this may be an incidental income which may be a bye-product out 'of the manufacturing of garments. Still the sale of cloth could not amount to manufacturing of garments. As regards the stitching charges the learned C.I.T.(A) has given detailed reasons and has controverted all the objections of the panel to establish that in earning stitching income manufacturing process was involved such as washing, cutting, stitching, pressing, fixing buttons, kaj and packing. The learned C.I.T.(A) has given relevant figures of expenses which were incurred by the assessee which have already been reproduced above. The learned D.R. has not been able to controvert the finding. However, to our mind the question as to whether the stitching charges amounted to manufacturing of garment or not is beside the point and irrelevant for the purpose of exempting income under clause 125 of the Second Schedule of the Ordinance. Clause 125 is reproduced below for ready reference:--

"Profits and gains declared 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 manufacturing 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."

5. From the perusal of the above clause and simplifying this clause it would read that profits and gains derived by an assessee from an industrial undertaking set up between various dates are exempt if such an assessee is engaged in the manufacturing of garments from cloth manufactured in Pakistan and such an undertaking is owned and managed by a Company formed and registered under the Companies Act having its registered office in Pakistan. It may be noted here that the Second Schedule starts with the following words "Income or classes of income, or persons or classes of persons, enumerated below shall be exempt from tax, subject to the conditions and to the extent specified hereunder." This means that there are four categories under which the income is exempt under the Second Schedule namely:--

(i)? income;??????

(ii) classes of income;

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(iii) persons;

(iv) classes of persons:

6. Under clause 125 it is the income of an industrial undertaking which is exempt. T he only conditions in order to qualify for exemption are:--

(i). It should be engaged in the manufacturing of garments from cloth manufactured in Pakistan.

(ii). It should be ovens and managed by a Company having its registered office in Pakistan.

Admittedly, the assessee has derived profits and gains from an industrial undertaking set up between the dates mentioned in the clause. It is also admitted that the assessee is engaged in the manufacturing of garments from cloth manufactured in Pakistan. There is also no dispute that the industrial undertaking is owned and managed by a Company formed and registered under the Companies Act having its registered office in Pakistan. All the conditions having been fulfilled by the assessee the question as to whether a part of the assessee's income was out of the manufacturing of garments or not is absolutely beside the question. It has not been provided by the clause that only that part of the income of an industrial undertaking is exempt which is derived from manufacturing of garments. On the contrary the entire income of an industrial undertaking is exempt if it is engaged in the manufacturing of garments. It, therefore, follows that if an industrial undertaking is engaged in the manufacturing of garments then its entire income is exempt under the aforesaid clause. In other words once it is established that the assessee fulfilled all the conditions mentioned in clause 125 then the profits and gains derived by an assessee from an industrial undertaking whose primary business is manufacturing of garments, all profits and gains derived even from other business would be exempt. The exemption provided by clause 125 is not to the particular kind of income but to an `industrial undertaking'. If the intention of the Legislature was to exempt only that part of income which is derived from manufacturing of garments the wording would have been different. The wording for instance could have been "profits and gains derived by an industrial undertaking from the manufacturing of garments" Since, such wording has not been used by the Legislature it cannot be read into clause 125 of the Second Schedule. This clause exempts the entire income of an industrial undertaking engaged in the manufacturing of garments, and therefore cannot be restricted to income only from the manufacturing of garments.

7. For the foregoing reasons we see no merit in the appeal of the department not only for the reasoning advanced by the learned C.I.T. (A) but also for the reason that the assessee fulfilled all the conditions given in clause 125. The assessee being an industrial undertaking admittedly engaged in the manufacturing of garments its entire income is exempt for a period of five years beginning with the month in which the undertaking is set up or the commercial production was commenced whichever was later. As a result the appeal of the department is dismissed.

A. A. ZUBERI (ACCOUNTANT MEMBER).--With profound respect of my learned brother, the Judicial Member, I have formed an opinion different from the one expressed by him in the proposed order. I am of the view that exemption at clause 125 of the Second Schedule to the Income Tax Ordinance, is (i) in respect of profits and gains; (ii) derived by an assessee; (iii) from an industrial undertaking; (iv) having the status of the company; and (v) carrying on the manufacture of garments from cloth made in Pakistan. Therefore in the present case only that part of the income would be exempt as represents `profits and gains' from the manufacture of garments out of cloth made in Pakistan. It is not necessary that the manufacturing of garments should be by the assessee themselves and for them alone. They may manufacture the garments for then selves, for others, or may just receive charges for manufacturing these from others; for which the Pakistan-made cloth may have been supplied by the client or may have been secured by the Assessee themselves. This view was expressed by this Tribunal more than a decade ago and was upheld by the Karachi High Court in 1987 PTD 479 National Spinning Mills Ltd. and 1987 PTD 182 Mekram Fisheries Ltd. in both of which the learned Judges benefited from the opinion expressed by the highest judicial forum of the realm In re: H. Nizam Din & Sons 1983 PTD 108.

With the aforementioned legal position in mind, I am of the view that the addition in respect of "stitching charges" may well be described as profits and gains derived from the activity of the manufacturing of garments (kitchen aprons) but not the simple "sale of cloth". The sale of cloth simpliciter, unless it is established that it represented defective pieces (or useless cut-pieces) would not fall under business activity of ancillary or subsidiary nature of an undertake, mainly engaged in the manufacture of garments. The sale of cloth at Rs.186,082 is substantial representing over 10% of exports of garments at Rs.1,815,G37 and unless conclusively established, these sales cannot be treated as mere disposal of defective cloth or unusable cut-pieces. For this conclusion I draw strength from decisions reported as 1991 PTD 207-Hussain Sugar Mills Limited and 1991 PTD 178-N:W.F.P. Forest Development Corporation. It is true in the former case the exemption notification specifically mentioned about the claimant to be "engaged exclusively in the business .... " yet the provisions of an exemption are to be interpreted strictly leaving no room for intendment. If any authority is needed one may refer to 1988 PTD 157 In re: Lutfi & Co. (Pakistan) Ltd. Therefore, unless the claimant is able to positively prove that the activity is ancillary or subsidiary to the main exempt business their onus would not stand fully discharged hence it would be erroneous to declare the entire claim as exempt under clause 125 of the Second Schedule to the Income Tax Ordinance. To sum up: my conclusion is that though `stitching charges' may be treated ancillary or subsidiary to the industrial activity of manufacture of garments, the "sale of cloth" can hardly be so characterised.

ORDER OF THE BENCH

As the two of us, the learned J.M. and A.M. have a difference of opinion, it is proposed that the Chairman may exercise his authority under section 133(7) of the Ordinance to refer the following point for resolution by a Third Member:

"Whether on the facts and in the circumstances of the case, the exemption claimed by the respondent/assessee as per clause 125 of the Second Schedule is--

(i) available in respect of the entire income of the industrial undertaking and `cannot be restricted to the income from the manufacture of garments' (view by learned J.M.) OR

(ii) it is confined to such `profits and gains' as arise from the' manufacture of garments from cloth manufactured in Pakistan." (view by learned A.M.).

FARHAT ALI KHAN (CHAIRMAN).--This appeal has been placed before me to resolve the controversy which has arisen between the learned Judicial Member and the learned Accountant Member. I am thus required to answer the following questions:

"Whether on the facts and in the circumstances of the case, the exemption claimed by the respondent/assessee as per clause 125 of the Second Schedule is:

(i) Available in respect of the entire income of the industrial undertaking and cannot be restricted to the income from the manufacture of garments' (view by learned J.M.) OR

(ii) it is confined to such `profits and gains' as arise from the `manufacture of garments' from cloth manufactured in Pakistan (view by learned A.M.)"

FARHAT ALI KHAN (CHAIRMAN):- This appeal has been placed Before answering aforesaid question let me firstly recapitulate the facts which have been found out by both the officers below.

Firstly, it is admitted position that the assessee (hereinafter referred to as "the respondent") derived its income from the following sources and his sales and receipts have been shown against them:--

From perusal of the assessment order it appears that the Chairman of the Panel exercising his power as an assessing officer came to the conclusion that the sale of cloth worth Rs.1,49,525 was not exempt under clause 125 of Second Schedule of the Income-tax Ordinance, hence he added the profit of Rs.10,793,72 to the total income. This figure he arrived at after deducting purchase price of Rs.1,39,331 from the sale price of Rs.1,49,525. Let me mention here that according to him cloth totalling 14,232 meters was sold at the rate of Rs.10.50 whereas it was purchased at an average price of Rs.9.79 per meter. It is also clear from assessment order that the learned Chairman of the Panel has granted exemption to the sale of defective cloth, such as cut?-pieces and rags, taking them to be part of manufacturing process exempt under clause 125 of the Second Schedule of the Income-tax Ordinance. From personal of the proposed order of the learned Judicial Member it appears that the cloth was locally sold at an amount of Rs.1,86,082. It is thus clear that the learned Chairman of the Panel has granted exemption to sale of defective cloth worth Rs.36,557 treating it to be part of manufacturing process and thus exempt under clause 125 of the Second Schedule of the Income-tax Ordinance. On the other hand, the learned C.I.T.(A) has disposed of the issue relating to exemption of sale of local cloth with the following observation:--

"As regards the Panel's observation that defective cloth sold fetched more price than average purchase rate, it is pointed out that the cloth was purchased in bulk in million meters at lower rates on wholesale basis, whereas the defective cloth sold in cut-pieces was still much cheaper than the prevailing market price. Further, the sale of cloth is integral and inseparable part of the manufacturing of garments because the cut-pieces and defective cloth is bound to come in heavy turnover and large scale production and moreso when the appellant was engaged in the manufacture of export and high quality of garments so that the defective cloth could not be used for the manufacture of garments and had no alternative but to be sold in the local market at cut-piece rates."

Thus, it is clear from this observation that the learned C.I.T.(A) has not taken note of the fact that the learned panel of the Chairman has granted exemption to the sale of defective cloth taking it to be part of the manufacturing process whereas the profit on sale of cloth in original form has been charged to tax. With this background let me now turn to the proposed orders of my learned brother, which have given rise to the questions before me.

In paragraph 4 at page 5 the learned Judicial Member has made the following observation:--

"We have examined the rival arguments and have- gone through the impugned order. So far as the sale of cloth is concerned, not?withstanding the various arguments advanced by the learned C.I.T.(A) as well as by the learned counsel for the assessee and whatever reasoning may be for the sale of cloth of the assessee which may be genuinely made by the assessee, the sale of cloth cannot be said to be manufacturing of garments. It is true that this may be an incidental income which may be a bye-product out of the manufacturing of garments. Still the sale of cloth could not amount to manufacturing of garments."

However, after analysing the provision of clause 125 the learned Judicial Member has made the following observation:--

"It has not been provided by the clause that only that part of the income of an industrial undertaking is exempt which is derived from manufacturing of garments. On the contrary the entire income of an industrial undertaking is exempt if it is engaged in the manufacturing of garments. It, therefore, follows that if an industrial undertaking is engaged in the manufacturing of garments then its entire income is exempt under the aforesaid clause. In other words, once it is established that the assessee fulfilled all the conditions mentioned in clause 125 then the profits and gains derived by an assessee from an industrial undertaking whose primary business is of manufacturing of garments, all profits and gains derived even from other business would be exempt."

At page 8 the learned J.M. has remarked:--

"If the intention of the legislature was to exempt only that part of income which is derived from manufacturing of garments the wording would have been different. The wording could have been "profits and gains derived by an industrial undertaking from the manufacturing of garments."

Thus, it is clear that the learned Judicial Member has firstly held that the sale of cloth cannot be said to be manufacturing of garments. Secondly, he has held that the entire income of an undertaking would be exempt whatever be its source if its primary business is manufacturing of garments.

On the other hand, the learned Accountant Member has observed at page 9 as under:--

"The sale of cloth simpliciter, unless it is established that it represented defective pieces (or useless cut-pieces) would not fall under business activity of ancillary or

subsidiary nature of an undertaking mainly engaged in the manufacture of garments."

The learned Accountant Member has also cited several decisions in support of his conclusion.

After careful consideration of the respective views of my learned brothers, I have come to the conclusion that the conclusion arrived at by my learned brother, the Accountant Member, is correct. In my humble opinion, the exemption is available under clause 125 of the Second Schedule of the Income Tax Ordinance to the profits and gains of that industrial undertaking which is firstly set up between the 1st day of July, 1978 and 30th day of June, 1991 and, secondly, which is engaged in the manufacture of garments from cloth manufactured in Pakistan and, thirdly, it is owned by a company which is managed by a company having its registered office in Pakistan and which is registered under the Companies Act of 1913. To my mind, the opening parts of Second Schedule speak of the conditions and extent of the exemption and I have given above the conditions and extent of such exemption, which emerge out of aforesaid clause 125. In my humble opinion the opening part of the aforesaid Second Schedule does not lay down the four categories under which the income is exempt under the Second Schedule as has been pointed out by my learned brother, the Judicial Member. It rather refers to the persons or classes of persons who may have income or classes of income which fall under any of the clauses given in Second Schedule subject to the conditions and to the extent specified in each clause. Since the clauses of Seconds Schedule are dealing with exemptions regarding various types of incomes or classes of incomes which have been granted exemption, in the hands of persons or classes of persons, the words "incomes or classes of incomes or persons or classes of persons" have been mentioned. The exemption, however, is subject to the conditions and to the extent as specified in each clause. In my humble opinion, aforesaid clause 125 does not grant exemption to all profits and gains of an industrial undertaking derived from whatever source, provided it has primary business of manufacturing of garments. Aforesaid clause 125 does not talk of primary or secondary business. As pointed out earlier, it grants exemption to and gains which are derived by an assessee who is engaged in the manufacture of garments. Nevertheless, let me also mention here that it would not be correct interpretation of law to include the profits and gains derived from "the activity which is ancillary or subsidiary to the main exempt business." Let me mention here that under aforesaid clause 125 the emphasis appears to be on the expression "manufacture of garments for the purposes of exemption and not in the least on" the business of an industrial undertaking". It is to be kept in mind that the clause begins with the profits and gains of an industrial undertaking but the second paragraph applies the exemption to an industrial undertaking which is engaged in the manufacture of garments. I am, therefore, of the humble opinion that ordinarily only those profits and gains would fall within the ambit of exemption granted to an industrial undertaking under this clause which are obtained on sale of manufactured garments or those things which are either incidental to or are produced in manufacturing process of the garments. I humbly feel that under the facts and circumstances of this appeal widening of the exemption to those profits and gains which are ancillary or subsidiary to the manufacturing process would not be justifiable as my learned brother the Accountant Member, has himself observed that the provisions of an exemption are to be strictly interpreted.

In view of discussion made above; my answer to both parts of the question is that profits and gains of the respondents under clause 125 of the Second Schedule are to be restricted to the profits and gains derived either from sale of manufactured garments or sale of those things which are either incidental to or have been produced in the manufacturing process of the garments.

Since I have agreed with the learned Accountant Member, the departmental appeal stands allowed to the extent of addition of profit of Rs.10,193,72 to the total income on account of profit earned on sale of cloth.

The appeal stands disposed of accordingly.

M.BA./1249/T ???????????

Order accordingly.