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

----S.13(l)(b)---Addition---Purchases and sales can only .be rejected and an estimated figure taken if they are not verifiable.

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

----S.13(1)(b)---Addition---Where purchases were not recorded and neither appeared in the purchase account nor in the stock register, the Assessing Officer had to prove through evidence that purchases had been suppressed and not by a general observation.

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

----S.13(1)(b)---Addition---When purchases are verifiable the addition to the sales can only be made to the extent of addition made in gross profit by virtue of application of G.P. rate and sales to be estimated had to be based on this principle and feasibility report of an industry for obtaining loan submitted to the bank had no sanctity as far as this principle was concerned.

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

----S.13(1)(b)---Addition---Even if there was a discrepancy between the hypothecated stocks with bank and those shown by the assessee in his books yet no adverse inference could be drawn.

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

----S.13(1)(b)----Assessee, an industrial concern---Project figures for Industrial Development Bank of Pakistan had been relied upon by Assessing Officer for estimating sales which were more hypothecated than even the hypothecation figures given to a bank for the stock pledged---Effect---Held, when preparing a feasibility report for obtaining a loan for setting up a new industry from a financial institution suitable figures were adopted so that the granting of the loan was facilitated and it would be fantastic to say that production was going to confirm the projected figures in the feasibility report without taking into account the facts of the case during the year under consideration.

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

----S.13(1)(b)---Addition---Separate addition will only be made if it is over and above the intangible addition made in the trading account and in case the intangible addition in the trading account is more than that figure, no separate addition will be made.

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

----Third Sched. paras. 5 & 8(7)---Initial depreciation---All cost incurred on the machinery through erection or by payment of interest etc. has to be added to the value of the asset---All such cost is added to the value of asset before the production is started and that is why all such expenses are capitalized under the same head of asset or class of asset---Cost of assets as laid down in Third Sched., para. 8(7) of the Ordinance, means actual cost of the asset to the assessee including all such expenses incurred by the assessee in erecting machinery and capitalised by him.

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

-----Third Sched., paras 5 & 8 (7)---Depreciation has to be allowed on the rates. prescribed even if the factory has worked for one day during the year-- Depreciation has to be given in the year in which commercial production is commenced when it is later than the year of creation or installation or the year in which it is used by the assessee for the first time for the purpose of his business or profession---Depreciation has to be considered from the date of start of commercial production---Any cost incurred on the machinery through erection or by payment of interest etc. has to be added to the value of the asset and as far as assessee is concerned all this adds to the cost of the asset before allowed in the P & L account and it is never taken as covered by G.P. rate, when books of accounts of assessee show that and entries in the sales register confirm the trial production period vis-a-vis the commercial production period.

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

----Third Sched., paras. 5 & 8(7)---Initial depreciation---All expenses incurred before the start of commercial 'production have to be capitalised and the initial depreciation has also to be given on them.

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

----Third Sched., paras. 5 & 8(7)---Initial depreciation---Preliminary expenses have to be capitalised and in addition to normal depreciation initial depreciation has also to be given.

Ali Bin Abdul Qadeer, Ch. Muhammad Sadiq and Ch. Salman Bashir for Appellant.

S. Roomi Shah, D.R. for Respondent.

Date of hearing: 7th January, 1992.

ORDER

The appellant is a Private Limited Company engaged in the manufacture and sale of galvanised wire. Appeal has been filed for the' assessment year 1989-90.

2. The facts of the case are that the assessee returned a loss of Rs.59,24,440 whereas it was assessed at Rs.2.3,27,562 (loss). It is the first year of business. The trading account results are as under:

3. The assessee has initially contested the rejection of accounts. It was claimed that the purchases are all verifiable and the G.P. rate declared is quite reasonable as compared to similar other cases and so the declared trading account results should have been accepted. It was emphasised that purchases had only been made from two well known parties i.e. M/s. Hashoo Steel Industries Karachi and M/s. Brother Steel, Lahore and sales were made through only one party i.e. M/s. National Steel Company. Without going into the merit of the claim of the assessee he decided first of all to consider on what grounds the I.T.O. had rejected the accounts. The I.T.O. has admitted in his order that the sale, have been made to one party i.e. M/s. National Steel Company, 10-Azeem Street, Nishtar Road, Lahore, but observed that it is a sister concern of the assessee-company and is a proprietary concern of one of the Directors Mr. Pervaiz Manzoor who is the son of Managing Director of the assessee-company. In response to notice under section 144(c) sales of Rs.21,22,760 were confirmed by M/s. National Steel Company against declared sales of Rs.20,68,360 by the assessee. When confronted on the difference, it was explained that it relates to the sales of trial production period. All the same the I.T.O. further observed that it being a sister concern owned by the Director the verifiability remains unreliable. From this observation it is quite obvious that further sales by M/s. National Steel Company were not verifiable. But what we have failed to understand is how the un-verifiability of sales of a sister concern can affect the sales of the parent company when they have all been made through the sister concern. May be the I.T.O. was of the view that the creation of M/s. National Steel Company was just a ploy to conceal the fact of un-verifiability of all sales. Further elaboration of this point will be made subsequently in this order when the other defects have been discussed.

4. Second objection raised was that purchases were declared to have been made from two parties only as mentioned before. A notice was issued under section 144(c) to both the parties and it was found that as far as M/S. Hashoo Steel Industries, Karachi are concerned they had shown sales to the assessee al 123 tons for a value of Rs.12,65,600 whereas the assessee company had declared purchases of 101 tons for a value of Rs.10,43,400 thus resulting in a difference of Rs.2,22,200 which was sought to be added by the assessing officer under section 13(1)(b) of the Income-Tax Ordinance. Whereas M/s. Brother Steel had shown that Rs.7,888 were payable to the assessee-company. The balance-sheet of the assessee does not show any receivable from M/s. Brothers Steel which, according to the assessing officer, indicated that the assessee had suppressed this asset in its balance-sheet. A second point noted by the I.T.O. was that in the books of the assessee company a pay order Rs.56,000 has been shown which was deposited with Brothers Steel on 12-10-1988 for which no charges for pay order have been shown in the books meaning thereby that in fact it is cash payment. From all this the assessing officer arrived at the following conclusions:

(1) That the books of accounts arc not reliable.

(2) That the assessee has been making cash purchases from other parties as well which have not been recorded in the books of accounts.

This position renders the declared version of purchases totally unverifiable.

3. G.P. rate declared at 21.78% is also low keeping in view the fact that in its feasibility report the assessee has shown G.P, margin at 36.37% and even otherwise normally G.P. rate applied in parallel cases is 30% (Reference N.T. No.07-O1-1714855).

4. Infeasibility report presented to the IDBP, for obtaining loan following projections of production capacity and financial operation of the project were given by the assessee:---

PRODUCTION CAPACITY 1500 TON PER YEAR (Rs. in 000)

PROFITABILITY RATIO (%)

It was further observed by the I.T.O. that against the above projection presented before IDBP, the assessee had shown a pathetic picture of his business to the Income Tax Department which does not bear any proportion with the above-referred position. Another defect mentioned by the I.T.O was that the assessee had highly inflated the cost of its assets in order to claim maximum as claim of depreciation. Certain references given in his order do support his contention at page 3 of the assessment order. The I.T.O. further observed that these examples are only illustrative and not exhaustive. Keeping all these defects in view the I.T.O. estimated the sales at Rs.1,00,00,000 and subjected them to a G.P. rate of 30%. Addition under section 13(1)(b) for alleged suppressed purchases from M/s. Hashoo Steel Industries, Karachi with the approval of the IAC at Rs.2,21,200. In addition to the above, another addition was made under section 13(1)(b) with the approval of the IAC at Rs.7,888 for the discrepancy in the balance-sheet not showing the amount receivable 'from M/s. Brothers Steel Ltd. Lahore. Depreciation was also recalculated by adopting new values of assets and certain addbacks were made in the P&L account. The assessee feels aggrieved against all these.

5. The learned A.R. of the assessee contended that as far as discrepancy in purchases from M/s. Hashoo Steel is concerned a clarification was given by M/s. Hashoo Steel Industries which is placed on record. According to this clarification/affidavit Mr. MA. Ghausi, Finance Manager M/s. Hashoo Steel Industries Ltd. Chamber of Commerce Building, Talpur Road, Karachi confirmed that their company had made sales to the tune of Rs.l0,43,400 in the assessment year 1989-90 i.e. 1-1-1988 to 31-12-1988 to the assessee and not Rs.12,65,600 as shown inadvertently in the ledger account. The sales made on. 19-3-1988 and 27-3-1988 amounting to Rs.1,11,100 in both cases pertaining to invoices Nos. 1545 and 1560 respectively issued by their company were wrongly inadvertently recorded in the ledger account of the assessee. This mistake was claimed to be through oversight and these sales were actually made to Mr. Jabbar, 58-Motan Das Market, Karachi who is a broker. It was further confirmed in the affidavit that the statement made in letter No.HS/S/GX/1233, dated 12-9-1990 addressed to the assessee and copy endorsed to the Income Tax Officer, Circle Companies XV, Lahore was that given by their company. It was further confirmed in this affidavit that the above statement was the factual position in respect of M/s. Pakistan Wire Products (Pvt.) Ltd. i.e. the assessee. It was vehemently stressed by the learned A.R. of the assessee that the assessee could not be penalised for any entries made by the suppliers inadvertently as admitted by them. If the I.T.O. was not satisfied with this affidavit the only way open to him was to make further enquiries from Mr. Jabbar of 58-Motan Das Market, Karachi which the I.T.O. had failed to do. So no adverse inference can he drawn as far as this discrepancy noted by the I.T.O. is concerned. As far as the discrepancy in the balance-sheet about amount payable to M/s. Brothers Steel, Lahore is concerned, no plausible explanation for the same was given but that can justify only the addition under section 13(1)(b) and has nothing to do with the rejection of account because the quantum of purchases from that company has not been objected to. The learned A.R. of the assessee was very bitter about the remarks given by the, I.T.O. that cash purchases from other parties as we have been made which have not been recorded in the books of accounts. He maintained this remark to be capricious, without any foundation and uncalled for because no evidence was given in support of any suppression of purchases. We are of the view that this remark of the I.T.O. is based on surmise and conjecture and cannot be justified in the absence of any evidence.

6. Coming to the G.P. rate declared at 21.78% and applied at 30% and the references to the parallel cases, assessee referred to another two cases where the G.P. rate applied and declared was much lower for example in NTN-10-02-82567231 Karachi, the G.P. rate declared was 8.38 % and the case has been finalised by making an ad hoc addition of Rs.25,000 only when the sales declared was Rs.82,97,786. It was claimed that even if the G.P. rate had been enhanced by 1%o the resulting addition could have been Rs.82,978 which means that the declared G.P. rate in this case has been enhanced nominally by 3% only i.e. the emerging G.P. rate is less than even 9%. Reference was also made to a case at NTN-07-11-171.1061 wherein the G.P. rate had been declared at only 14.45%. The assessee was not sure about the G.P. rate applied but it was insisted that it was less than the rate declared by the assessee. Coming to the cases referred to by the I.T.O. in support of the application of G.P. rate at 30% it was claimed that it was the case of United Wire produced where electricity consumed had been shown at Rs.11,02,861 whereas the sale had only been declared at Rs.29,98,548. The I.T.O. had estimated the sales in that case at Rs.40,00,000 and subjected it to a G.P. rate of 30%. It was pointed out that the assessee had shown electricity consumed for whole the year at Rs.3,29,558 whereas the sales declared were Rs.20,68,360, i.e. almost at 7 times of the electricity consumed whereas in the case quoted by the I.T.O. the sales declared were even less than 3 times and those estimated at less than 4 times. So it was insisted that the I.T.O. was not justified in depending on that case in respect of application of G.P. rate when the sales declared and assessed were so ridiculously low vis-a-vis the power consumed as compared to the assessee. It was argued that in that case sales had been suppressed drastically enabling the assessee to declare a higher G.P. rate. In conclusion it was argued that when such a heavy suppression of sales is there the quoted case was not on all fours with the assessee and so that case could not be relied upon for application of G.P. rate. It was insisted that inference if any had to be drawn both from sales and rate and when the sales declared by the assessee vis-a-vis power consumption were much better than the case quoted partial application' of G.P. rate while ignoring the sales did not meet the ends of justice. It was further argued that the I.T.O. had also not considered sum from some valid facts when applying the G.P. rate such as that this was a new unit and the people running the affairs never had any experience of any industry before. Another important fact was that the factory was situated at Sheikhupura Road which was flooded during the rainy season. It was claimed that the labourers were also unskilled mostly and so there was some problem in production as far as the first year was concerned. Marketing of goods produced was also a major bottle-neck.

7. It appears from the order of the I.T.O. that the main thing which influenced his thinking was projection of production capacity and financial operations submitted to the IDBP, when obtaining the loan. The learned C.I.T.(A) has also mainly depended upon this when confirming the estimate of sales by the I.T.O: and the application of G.P. rate. The learned A.R. of the assessee claimed that the feasibility report could not be made a basis for estimating sales and applying G.P. rate for this year because the figures given to the IDBP are only projections and have nothing to do with the realities of the year under consideration. No doubt the projected figure for the first year is Rs.1,54,15,000, for the second year Rs.1,95,88,000 and still higher figure for 3rd and 4th year. The main argument of the learned A.R. was that the projection figures arc usually inflated to facilitate the obtaining of the loan. No doubt the experts of the 1DBP are associated with the feasibility report yet it was stressed that the main idea between the whole thing was to facilitate the asking and grant of the loan. It was claimed that feasibility report not only gives the projection for the sales and G.P. rate but also gives estimate for obtaining profit, pre-tax profit and after tax profit and lays down a schedule of payment. It was maintained by the assessee that if all the projections had been achieved there must not have been any difficulty in discharging the loan as specified in the schedule. But the same was not the position. The assessee was also not paying the loan back to 1DBP as per the schedule which showed that the projection figures had not been achieved. The learned D.R. on the other hand insisted that the projected figures are not in a vacuum. According to him they are based on market facts and arc made in a scientific way following laid down principles. In theory this argument of the learned D.R. seems to be very plausible but what is going to happen in future cannot be prophesied before hand and working in a year has to be seen in the light of the facts of the year. In rebuttal of argument of the learned D.R., the learned A.R. of the assessee insisted that he had shown sales at Rs.90,00,000 in next year and at Rs.1,00,00,000 subsequent to that year. From this he tried to convey that if the assessee had the habit of concealing sale so drastically as apparent from the sale, estimated and those declared by the assessee he could easily do so in the subsequent years also. The very fact that progressive increase is being shown means that the assessee had been quite honest and straight forward. Leaving side this controversy the ITO when passing his order was expected to base his finding on certain well-established principles and precepts. For example purchases and sales can only be rejected and an estimated figure taken if they are not verifiable. Although the ITO has not mentioned in his order yet the learned CIT(A) has referred that the assessee has maintained no stock register or production record. The assessee conceded to this but the learned A.R. of the assessee maintained that the maintenance of production record is not a business practice and the non-maintenance of stock register could only be taken as a defect if it can be proved that the assessee either suppressed any purchases sales. The learned A.R. was quite emphatic in saying that no defect in purchases and sales had been found and so the absence of stock register has no consequence. The learned D.R. on the other hand argued that the non maintenance of stock register can help an assessee in suppressing both purchases and sales because they cannot be co-related with each other. We fail to understand this argument of the learned D.R. as far as the purchases are concerned. May be the non-maintenance of stock register can help an assessee in suppressing some of the sales because no co-relation can be established between the material consumed represented by purchases and sales in this case but as far as the purchases are concerned if they are not recorded, they will appear neither in the purchase account nor in the stock register. In such an eventually the ITO has to prove through evidence that purchases have been suppressed and not by a general observation as done by the ITO in his order. It is worthwhile to mention here that the ITO issued a letter to the assessee on 5-9-19911 wherein it had been conveyed that sales of Rs.40,00,000 will be adopted and G.P. rate will be applied at 25%.

8. To sum up the whole discussion we are inclined to conclude that the suppression of purchases has not been established by the I.T.O. So tile purchases are verifiable. It is a well known established principle justified by accounting principles that when purchases are verifiable, the addition of the sales can only be made to the extent of addition made in Gross Profit by virtue of application of G.P. rate. The sales to be estimated have to be based on this principle and the feasibility report has no sanctity as far as this principle is concerned. It has been held in many cases by the Tribunal that even if there is a discrepancy between the hypothecated stocks with bank and those shown by the assessee in his books yet no adverse inference can be drawn because usually people give higher hypothecated figures for stock to enjoy a higher loan facility. Here in this case project figures for IDBP had been relied upon for estimating sales which are more hypothecated than even the hypothecation figures given to a bank for the stock pledged because in the later case a definite base i.e. stock available with the assessee is there whereas in a feasibility report even such a base is not there and all figures are just projected figures. Every one knows very well that when preparing a feasibility report for obtaining a loan for setting up a new industry from a financial institution suitable figures are adopted so that the granting of the loan is facilitated. It will be fantastic to say that production is going to confirm the projected figures in the feasibility report without taking into account the facts of the case during the year under consideration.

9. Coming to the application of G.P. rate the assessee has successfully distinguished the case quoted by the I.T.O. in his support yet the case of the assessee is also distinguishable from the cases quoted by the assessee because the G.P. rate declared by the assessee is much higher than those in cases quoted by the assessee. Keeping in view all the facts of the case in their totality we are of the view that the application of G.P. rate at 25% will be quite reasonable which is usually applied in the cases of manufacturers. Consequently the I.T.O. is directed to apply a G.P. rate of 25%. He is further directed to make the addition in declared sales to the extent of addition in gross profit by the application of G.P. rate at 25% against that declared by the assessee at 21.78%.

10. The next issue is about the additions made under section 13(1)(6). The addition made at Rs.2,22,200 for suppressed purchases from M/s. Hashoo Steel Industries stand deleted as the discrepancy has been explained by the Hashoo Industries. The addition made at Rs.7,888 for discrepancy in the' balance-sheet as far as the amount receivable from M/s. Brothers Steel, Lahore is concerned is maintained with the observation that a separate addition will only be made if it is over and above the intangible addition made in the trading account. In case the intangible addition in the trading account is more than this figure, no separate addition will be made.

11. Coming to the alteration of values of assets when allowing depreciation it was contended by the assessee that he had capitalised expenses on interest, wages, and electricity amounting to Rs.16,12,750 incurred before the assessee went into actual production excluding trial production period. It was asserted by the learned A.R. of the assessee that as they stand added to the cost of the machinery under well established accounting principles initial depreciation should have been also allowed on them whereas the ITO has not done so. In para. 5 of the 3rd Schedule of the Income Tax Ordinance, 1979 it has been laid down under the head `Initial Depreciation' that "where any building has been newly erected, or any machinery or plant has been installed, in Pakistan .., further depreciation allowance in respect of the year of erection or installation or the year in which such building, machinery or plant is used by the assessee for the first time for the purposes of his business or profession or the year in which commercial production is commenced, whichever is the later, shall be allowed at the specified rates". When giving the rates in the Schedule have been mentioned as so many per cent of the written down value. It has been further laid down in relevant part of sub-para. 7 of para 8 under the head definitions that written down values means "where the asset, or class of assets, was acquired in the income year the actual cost thereof to the assessee". So what is important to be considered is actual cost to the assessee. The ITO seems to be of the opinion that actual cost means only the cost of the purchases of the assets and does not include interest, wages or other expenses incurred during the trial production or before the start of the commercial production. As discussed before initial depreciation has to be given in the year in which commercial production is commenced when it is later than the year of erection or installation or the year in which it is used by the assessee for the first time for the purposes of his business or profession. From this it is quite clear that the depreciation has to be considered from the date of start of commercial production. It is according to the well established accounting principle that any cost incurred on the machinery through erection or by payment of interest etc. has to be added to the value of the asset and as far as the assessee is concerned all this adds to the cost of the asset before the production is started and this is why all such expenses are capitalised under the same head of asset or class of assets. So we are of the opinion that the cost of asset as laid down in para. 8 sub para. 7 containing the term actual cost to the assessee includes all such expenses incurred by the assessee and capitalised by him so the I.T.O. is directed to allow the initial depreciation also on these costs represented by an amount of Rs.16,12,750.

12. As far as the changing of the price of the assets is concerned, the I.T.O. has reduced the price of the Charade car to Rs.1,00,000 from Rs.2,00,000 by saying that the price of the car has been inflated in spite of the fact that it was supported by a purchase receipt. The I.T.O. when not accepting the value of the price declared by the assessee took the plea that the reply of the assessee about supporting purchase receipt is not tenable in the presence of Bill of Entry of Charade car purchased during the same period. The assessee insisted that the bill of entry has nothing to do with the price prevalent in the market and the price could not be reduced without making any enquiry from the seller. The I.T.O. is directed to make enquiry from seller and if the sale price is acknowledged to be true by him should be accepted. The I.T.O. has reduced the value of assets under the head electrical installation and plant and machinery by Rs.10,00,000. The assessee had shown the value of plant and machinery and electrical installation at Rs.1,32,81,790. The I.T.O. reduced the value by Rs.10,00,000. It was pointed out by the learned counsel for the assessee, which was supported by the books of account, that out of this investment of Rs.1,32,81,790 local purchases to the tune of only Rs.11,00,000 have been made. Obviously the reduction in the value by Rs.10,00,000 is not justified because the amount could be reduced only out of the local purchases keeping in view the element ofun-verifiability. It was further asserted by the learned counsel that reduction at Rs.10,00,000 had been made after quoting a few instance of the small amounts. This contention of the learned counsel is quite weighty but at the same time it has to be kept in mind that the assessing officer has written in his order that these are some of the instances quoted. Keeping in mind all local purchases at about Rs.11,00,000. We are of the considered opinion that the reduction in the value of assets by Rs.10,00,000 cannot be justified by any stretch of imagination. The same is reduced to. Rs.2,00,000 in view of the facts of the case.

13. The assessee had capitalised expenses of Rs.1,91,203 for the period of trial production on account of electricity, Chemicals, Oil and Lubricants, Wages and M.S. Red material etc. The I.T.O. disallowed this capitalization for the reasons that:

(a) The assessment is being made for whole of the period in which the factory worked.

(b) It is covered by G.P. rate.

(c) The contention of the assessee that the factory remained in trial production for a period of 3 months is not acceptable.

14. As far as the first two objections are concerned, these are not tenable because the depreciation has to be allowed on the rates prescribed even if the factory has worked for one day during the year. Depreciation is allowed in the P & L Account and it is never taken as covered by G.P. rate. The books of accounts of the assessee show that and entries in the sales register confirm the trial production period vis-a-vis the commercial production period. We have already given a finding that all expenses incurred before the start of commercial production have to be capitalized and the initial depreciation has also to be given on them. So the I.T.O. is directed to give both the normal and. initial depreciation on this amount of Rs.1,91,203.

15. The only addback made by the I.T.O. in the P & L Account is the amount of Rs. 11,360 which has been claimed as preliminary expenses. The I.T.O. has treated it in the nature of capital expenses and disallowed the same with the observation that depreciation on normal rate will be admissible on the

same. We have already given a finding that such expenses have to be capitalized and in addition to normal depreciation initial depreciation had also to be given.

16. As a result the appeal stands disposed of as discussed above.

M.B.A./1527/T Order accordingly.