Income Tax Ordinance (XXXI of 1979)---

----Fourth Sched. R. 5(a) [as amended by Finance Ordinance (XXV of 1980)] & S.26---Provision for taxation, gratuity and civil commotion made by an insurance company could be disallowed under R.5(a) of the Fourth Schedule, Income Tax Ordinance, 1979, as amended by Finance Ordinance, 1980.

The amendment in Rule 5(a) of Income Tax Ordinance, 1979 has altered the previous law. There is no anomaly or ambiguity in the term "any reserve or provision for any expenditure" in the amended rule. "Reserve" and "provision for any expenditure" are different items. Accordingly, if any reserve is created or any provision for expenditure has been made by an assessee general insurance company, which is not deductible in computing income chargeable under the head "income from business or provision", the assessing officer, under the Income Tax Ordinance, is required to disallow such amount.

Finality attaches to the accounts submitted by the assessee insurance company under the Insurance Act to the Controller of Insurance but jurisdiction now vests in the Income-tax assessing authorities to exclude expenditure, reserve and provision for expenditure which is not permissible under section 26 of the Ordinance in view of rule 5(a) of the Fourth Schedule to the Ordinance, as amended by Finance Ordinance, 1980.

Commissioner of Income-tax v. Phoenix Assurance Co. Limited 1991 PTD 1028; Habib Insurance Company Limited v. Commissioner of Income-tax PLD 1985 SC 109 and Commissioner of Income-tax v. Alpha Insurance Company Limited PLD 1981 SC 1028 ref.

M.G. Hassan for Applicant.

Nasrullah Awan for Respondent.

Date of hearing: 5th May, 1992.

JUDGMENT

NASIR ASLAM ZAHID, J: --This consolidated judgment will dispose of the following four Income-tax cases, in which the parties are the same--the applicant being M/s. Home Insurance Company Limited and respondent is Commissioner of Income-tax, Companies Rang III, Karachi -- but the assessment years are different:-

(i) I.T.C. No. 4'7/91--assessment year 1980-81;

(ii) I.T.C. No.48/91--assessment year 1981-82;

(iii) I.T.C. No.49/91--assessment year 1982-83;

(vi) I.T.C. No.50/91--assessment year 1983-84.

We heard the arguments of Mr. M.G. Hassan, learned counsel for the applicant/assessee and Mr. Nasrullah Awan, learned counsel for the Department.

2. The applicant is an insurance company engaged in general insurance business and, for the assessment year 1980-81 (I.T.C. No.47/91), declared a net income of Rs.7,25,165. However, while computing total income of the applicant, the Assessing Officer disallowed the provision of Rs.10,32,470 for taxation, provision for gratuity amounting to Rs.70,529 and the provision for civil commotion amounting to Rs.49,153.

For the assessment year 1981-82, the applicant declared a net income f Rs.7,91,602. However, the Assessing Officer disallowed the provision for taxation amounting to Rs.11,35,530 and the provision for gratuity amounting to Rs.81,511.

For the assessment year 1982-83, the applicant declared a net income of Rs.5,61,871 but the Assessing Officer disallowed the provision for taxation amounting to Rs.9,10,000 and the provision for gratuity amounting to Rs.1,23,116.

For the assessment year 1983-84, the applicant declared a net income of Rs.4,78,994 but the Assessing Officer disallowed the provision for taxation amounting to Rs.17,54,296.

3.Being aggrieved, the applicant preferred appeals before the Commissioner of Income-tax (Appeals) contending that the provision for taxation gratuity and civil commotion could not be disallowed under rule 5(a) of the Fourth Schedule to the Income-tax Ordinance, 1979. The Commissioner did not agree with the contention of the applicant and confirmed the orders of the Income-tax Officer. The applicant then preferred second appeals before the learned Income-tax Appellate Tribunal, which appeals were also dismissed and the orders passed by the Assessing Officer were confirmed on the ground that the disallowances were covered by the amendment made by the Finance Ordinance, 1980 in Rule 5(a) of the Fourth Schedule to the Income-tax Ordinance, 1979.

4. The applicant then filed applications before the Tribunal for reference of questions to this Court under section 136(1) of the Income-tax Ordinance but the Appellate Tribunal refused the request of the applicant on the ground that no questions of law arose out of the orders passed by the Tribunal. In the circumstances, for the aforesaid four assessment years in question, present separate applications being I.T.Cs. Nos.47, 48, 49 and 50 of 1991 have been filed by the applicant under section 136(2) of the Income-tax Ordinance, 1979, submitting that questions of law do arise out of the orders of the Tribunal which require opinion of this Court.

5. In these applications, a question of law does arise for consideration and opinion by this Court and it is that whether the Tribunal was right in holding that on the facts and in the circumstances of the cases, the provisions for taxation, gratuity and civil commotion made as aforesaid were liable to be disallowed under rule 5(a) of the Fourth Schedule to the Income-tax Ordinance, 1979, as amended by the Finance Ordinance, 1980.

6. When the Income-tax Act,. 1922, was in force, rules for the computation of the profits and gains of insurance business were contained in the First Schedule to the Income-tax Act. Reference in this regard may be made to section 10(7) of the Act which read as follows:---

"Notwithstanding anything to the contrary contained in sections 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the First Schedule to this Act."

The relevant rule for the purpose of these reference applications was rule 6(1) of the First Schedule to the Act, 1922, which is reproduced here:---

"6.(1) The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938, to be furnished to the Controller of Insurance after adjusting such balance so as to exclude from it any expenditure, other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business. Profits and losses on the realisation of investments and depreciation and appreciation of the value of investments shall be dealt with as provided in rule 3 for the business of life insurance."

It would be noticed from a perusal of rule 6(1) of the First Schedule to the Income-tax Act that adjustment under the said provision could be made only as regards any "expenditure" which is not allowable under section 10 of the Act. The question as to the extent of jurisdiction of the Income-tax Officers to question the accounts submitted by the assessee Insurance Companies under the Insurance Act to the Controller of Insurance had come up for consideration before this Court as well as the Supreme Court in respect of the cases covered by the Income-tax Act and the latest decision of the Supreme Court in that regard is given in the case of Commissioner of Income-tax v. Phoenix Assurance Co. Limited 1991 PTD 1028. The question for consideration before the Supreme Court was whether on the facts and in the circumstances of that case of the assessee insurance company, the Tribunal was justified in deleting the provision for taxation from the income of the assessee. Sindh High Court, by its decision dated 8-10-1983, decided the question in the affirmative in favour of the insurance company. The Department took the matter in appeal before the Supreme Court. With reference to the relevant facts and the applicable provisions including rule 6(1) of the First Schedule to the Income-tax Act, 1922 and earlier decisions of the High Court and also of the Supreme Court, Mr. Justice Zaffar Hussain Mirza (as he then was) summarised the legal position as follows:---

"Leave to appeal was granted in these appeals to consider the question, inter alia, whether on the facts and circumstances of the case, the High Court was justified in holding that the reserve for taxation was not expenditure and therefore, Rule 6 of the First Schedule of the Income Tax Act, 1922 was not applicable to the case.

Before the High Court it was urged on behalf of the Commissioner of Income Tax that the provision for taxation reserve in the accounts submitted by the assessee to the Controller of Insurance having been shown on the expenditure side it had to be treated as an expenditure and therefore, under Rule 6 of the First Schedule to the Income Tax Act, 1922 (hereinafter referred to as -the Act), the Income Tax Officer was entitled to examine it for the purpose of adjustment of the balance of profits and gains. This contention' was repelled by the learned Judges for the reasons that appear from the extract of the impugned judgment cited hereinbefore. The learned Judges relied on Commissioner, Income Tax v. Alpha Insurance Company Limited PLD 1981 SC 293 to come to the conclusion that the accounts submitted under the Insurance Act are binding on the Income Tax Officer as a fait accompli and accordingly the limited power vesting in the Assessing Officer is to exclude only items which are in the nature of `expenditure' which are not allowable under section 10(2) of the Act, but since taxation reserve was not expenditure the conclusion was drawn that it was beyond the power of the Assessing Officer to invoke the provisions of section 10(2) and add back the reserve to the balance of profits for the purpose of putting it to tax. In 'reaching this conclusion the learned Judges relied on an earlier judgment of the Sindh High Court in I.T.C. No. 326 of 1974 dated 30th August, 1982. In the last mentioned case the question whether provision for taxation constitutes expenditure within the meaning of Rule 6(1) of the First Schedule to the Act, was considered. In that case, the learned Judges in turn relied on a decision of the same High Court in I.T.C. Reference No.221 of 1972 (Commissioner of Income-tax v. New Jubilee Insurance Company Limited, dated 24th February, 1982). In the latter case the term `expenditure' was interpreted, by following Indian Molasses Co. v. Commissioner of Income-tax (1959) 37 ITC 66. The Court held that `expenditure' connotes `paying out or away' of money which is the primary meaning of the term. In other words, `expenditure' means `paid out or away' and is something which has gone irretrievably. The conclusion reached by the Court in the first mentioned case (I.T.C. No.326 of 1974) was recorded as under:-

"In our view, provision for taxation or taxation reserve cannot be equated with `expenditure' which is something which has already been incurred or something which has already been paid out and which has gone irretrievably. In essence provision for taxation or taxation reserve remains a reserve and is not an expenditure.

In support of the present appeals Mr. Shaik Haider proceeded to urge that taxation reserve as provided in the accounts of the assessee, cannot be treated as expenditure even though it may be mentioned on the debit side. In support of this contention learned counsel also placed reliance on the Indian Molasses Co. (Private) Ltd. v. The Commissioner of Income-tax, West Bengal AIR 1959 SC 1049, so far as the connotation and meaning of the term `expenditure' is concerned. It was argued that the return filed by the assessee was not in accordance with Regulation 1 Part I of the Second Schedule to the Insurance Act, 1938. Therefore, according to the learned counsel such a reserve cannot be deducted from the profit, nor did the Insurance Act authorise such deduction. In order to appreciate the contention of the learned counsel it will be convenient to refer to the relevant part of Rule 6 of the First Schedule to the Act which runs as follows:---

6. (1) The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938, to be furnished to the Controller of Insurance after adjusting such balance so as to exclude from it any expenditure, other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business.

In the case of Alpha Insurance Company Limited (supra), this Court had occasion to consider the scope and effect of Rule 6 of the First Schedule, in relation to the accounts submitted by the Insurance Company engaged in insurance business other than life insurance, before the Controller for Insurance for the purpose of assessment of income-tax. The question raised in that case was whether the Insurance Company was entitled to show in its accounts on the debit side management expenses exceeding the ceiling prescribed by the Insurance Rules framed under Insurance Act, 1938. The Court, inter alia, held that the Assessing Officer could not add back in the accounts even though such excess was in violation of the Insurance Rules. This conclusion was expressed in the following words:---

(i) the rules contained in the First Schedule to the Income Tax Act completely, exhaustively and to the exclusion of every other provision not expressly incorporated, govern the computation of the profits and gains of insurance business.

(iii) the power of the Assessing Authority under first part of Rule 6(ibid) to readjust the balance of the profits disclosed by the annual accounts required to be furnished under the Insurance Act, 1938 is restricted to `exclude from it any expenditure, other than expenditure' which may ,under the provisions of section 10 of the Income-tax Act be allowed for in computing the profits and gains of a business. The Assessing Authority has to apply an independent mind uncontrolled by Insurance Act arrive at such a readjustment."

In reaching these conclusions, it was observed:---

"The jurisdiction of the Income-tax Officer under Rule 6 of the First Schedule to the Income-tax Act is confined to the taking of the profits and gains of any business of insurance other than life insurance to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 to be furnished to the Controller of Insurance. This presents the Assessing Authority with a fait accompli, over which he exercises no control. If the law requires such excess to be excluded from the balance-sheet the Assessing Authority cannot re-introduce it. If the law, as in these cases, requires such expenses to be included in the balance-sheet, the Assessing Authority cannot exclude it on any principle not made a part of the First Schedule to the Income Tax Act. This brings us back to the starting point, namely, that the Income Tax Officer has "no power to do anything not contained in the First Schedule to the Income Tax Act.

To this extent alone and on a finding that the expense could not qualify as a legitimate deduction under section 10, it could be excluded from the balance-sheet."

In Habib Insurance Co. Ltd. v. Commissioner of Income Tax (Central), Karachi PLD 1985 SC 109 once again this Court reiterated the proposition on the ground that under subsection (7) of section 10 of the Act, the computation of tax has to take place, in respect of profits and gains of non-life insurance business, in accordance with the First Schedule, the provisions of which are self-contained and complete. In that case also it was urged that in Revenue cases the Court has to look at the substance of the things and not at the manner in which the account was stated but it was observed that this broad proposition is controlled by the First Schedule and it was emphasised that the completeness and importance of accounts prescribed under the Insurance Act for a Company carrying on business of insurance, even for purposes of Income-tax is apparent from the relevant provisions of the Insurance Act. In this connection, reference was made to section 21 of the Insurance Act which authorise the Controller of Insurance to get further information about the returns, to examine the books of accounts, to decline to accept returns unless defect is removed. Reference was also made to section 22 which authorises the Controller to order re-evaluation.

From the authoritative pronouncements of this Court, the law seems to be settled that finality attaches to the accounts submitted by the assessee insurance company under the Insurance Act to the Controller of Insurance, and the limited jurisdiction vesting in the Income Tax Officer is only to exclude expenditure from the balance of profits in such accounts which is not permissible under section 10 of the Act. Under subsection (7) of section 10 of the Act the profits and gains of any business of Insurance and the tax payable thereon, is required to be computed in accordance with the rules contained in the First Schedule to the Act. However, it is important to note, that the enacting part of this subsection is subjected to the non obstante clause excluding the application of section 8, 9, 10, 12 or 18 of the Act. Therefore, it is quite apparent that the main provisions with regard to computation of profits and gains in the Act have been excluded including section 10. It is only by virtue of Rule 6 of the First Schedule that section 10 has been brought back for the limited purpose of adding back expenditure not permissible under that section. Therefore, the Income Tax Officer, in the face of these statutory provisions, is not competent to upset the integrity of the accounts submitted by the assessee under the insurance Act, by applying the ordinary rules for computation of profits and gains and for assessment of tax thereon, in the light of provisions of the Income Tax Act in respect of the income in regard to the head `business'. The contention of the learned counsel, therefore, that the return filed by the assessee was not in accordance with Regulation Part 1 of the Second Schedule to the Insurance Act is untenable. Similarly his submission that `reserve' cannot become expenditure even though it may be mentioned on the debit side, because the money is hot paid out irretrievably, is also irrelevant. On the contrary if the item in question did not in substance and essence constitute expenditure, it would be out of the power of the Income Tax Officer to apply the provisions of Rule 6 to exclude and add back the same to the balance of profits in order to bring it within the tax net.

In this connection also we may refer to another argument of the learned counsel for the Revenue that income-tax even if paid cannot be deducted as an expenditure for the purpose of determining the taxable income. This argument also is contrary to the above-said principle that the jurisdiction of the Income Tax Officer extended to expenditure, whereas in the present case admittedly the two items in question were amounts appropriated to taxation reserve and therefore by the test adopted by learned counsel with reference to the case of Indian Molasses Company Limited (supra) they were not amounts of expenditure in so far as they were not sums already paid so that it can be said that they were irretrievably paid out or any.

We may mention that Mr. Muhammad Dawood Khan, who was at the relevant time Inspecting Assistant Commissioner, Range-II, Companies Zone III, Karachi (now Commissioner Wealth Tax) was also allowed to address us. He submitted that nowhere in the insurance Act is a taxation reserve deductible from the profit. The object of the provision of a reserve, according to him, is to set apart a sum for some purpose so that the same is not touched or distributed. He has also referred to the re-enacted Income Tax Ordinance, 1979, where the language in Rule 5 of the Forth Schedule has been modified so as to clearly provide for exclusion from balance of profits to the annual accounts furnished to the Controller of Insurance by saying `any expenditure or allowance of any reserve or provision for any expenditure. .So far as the last contention is concerned the change in language in the re-enacted law, on the contrary, indicated that reserve was not originally included in the `expenditure' and therefore, both terms have been used in the dispensation in order to extend the scope of the provisions to cover reserves also. However, we have already given other reasons for not subscribing to this submission, namely, that as held in Alpha Insurance Company Limited (supra) the accounts submitted under the Insurance Act are complete and their authenticity and integrity cannot be questioned by the Income Tax Officer, with reference to any provisions of the Insurance Act. In this connection, we may further point out that an examination of the provisions of the Insurance Act would reveal that the same makes detailed provisions to ensure the true evaluation of assets and the determination of the true balance of profits of an insurance business so that Rule of the First Schedule to the Act has to be construed in the background of those provisions."

7. However, in the present 4 cases, rule 6(1) of the First Schedule to the Income-tax Act is not applicable as the Income-tax Act has been repealed and the relevant rules for computation of the profits and gains of insurance companies, are contained in the Fourth Schedule to the Income-tax Ordinance, 1979. Reference may also be made to section 26(a) of the Income-tax Ordinance which provides that, notwithstanding anything contained in the Ordinance, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the Fourth Schedule. In Fourth Schedule to the Income-tax Ordinance, the relevant rule is Rule 5, which, as amended by the Finance Ordinance, 1980 reads as follows:----

"5. General insurance. The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts required under the Insurance Act, 1938 (IV of 1938) to be furnished to the Controller of Insurance, subject to the following adjustments, namely:---

(a) any expenditure or allowance or any reserve or provision for anv expenditure or the amount of any tax deducted at source from any dividends or interest received, which is not deductible in computing the income chargeable under the head "Income from business or profession" shall be excluded;

(b) any amount either written off or taken to reserve to meet depreciation or loss on the realisation, of investments shall be allowed as a deduction and any sums taken credit for in the accounts on account of appreciation, or gains on the realisation, of investments shall be treated as part of the profits and gains:

Provided that the Income Tax Officer is satisfied about the reasonableness of the amount written off or taken to reserve in the accounts to meet depreciation, or loss on the realisation, of investments, as the case may be:"

It may be observed here that the words underlined in sub-rule (a) Were inserted by the Finance Ordinance, 1980 and prior to such amendment, the relevant words were only "expenditure or allowance". The words "any reserve or provision for any expenditure or the amount of any tax deducted at source from any dividends or interest received" were inserted by the Finance Ordinance, 1980.

8. According to Mr. M.G. Hassan, the law laid down by the previous decisions of this Court and by the Supreme Court in the case of Habib Insurance Company Limited v. Commissioner of Income-tax PLD 1985 SC 109 and in the case of Commissioner of Income-tax v. Alpha Insurance Company Limited PLD 1981 SC 1028 and in the latest decision of the Supreme Court to the case of Phoenix Assurance Company Limited 1991 PTD 1028 supports the contention of the applicant and the provisions for taxation, gratuity and civil commotion made by the applicant could not be disallowed by Income-tax authorities additionally for the reason that the accounts of the applicant insurance company had been approved by the Controller of Insurance.

9. We may observe that the aforesaid decisions related to assessments of the concerned insurance companies by the assessing authorities under the repealed Income-tax Act, 1922, and, as observed earlier, rules for computing the profits and gains of any business of insurance were contained in the First Schedule to the Act. However, the present four cases relate to assessment years 1980-81 to 1983-84. Provisions of the repealed Income-tax Act, 1922, are admittedly not applicable to such assessments. These assessments are governed by Income-tax Ordinance, 1979, and as has been noticed, rules for computation of profits and gains of insurance business are now contained in the Fourth Schedule to the Income-tax Ordinance as provided by section 26(a) of the Ordinance. The relevant rule relating to general insurance business is rule 5(a), which, prior to its amendment by the Finance Ordinance, 1980, only referred to adjustment in regard to "expenditure or allowance". Before its amendment, rule 5(a) was more or less similar to rule 6(1) of the First Schedule to the repealed Income-tax Act. However, by the amendment made through the Finance Ordinance, 1980, the words "any reserve or provision for any expenditure" etc. have been added after the words "any expenditure or allowance" in rule 5(a).

Mr. M.G. Hassan, learned counsel for the applicant/assessee admitted that, for all the four assessment years in question, amended rule 5(a) is applicable. His contention was that the amendment in rule 5(a) by the Finance Ordinance of 1980 has not made any difference in the legal position and the Income-tax assessing authorities are still not entitled under the law to disallow any amount on account of reserve or provision made for a 'contingency which had not arisen and for which expenditure is still to be incurred. Learned counsel emphasised the importance of the distinction made in the reported decisions between "reserve" and "expenditure". According to the learned counsel,, it is ,row well-settled that a reserve cannot be equated with expenditure as reserve is a provision for some amount to be expended or for some future expenditure whereas expenditure signifies the amount already expended.

10. We are not impressed by the contention of the learned counsel for the applicant/assessee that no change has occurred in the law. In our view, the amendment in rule 5(a) has altered the previous law. We find no anomaly or ambiguity in the term "any reserve or provision for any expenditure" in the amended rule. According to us, "reserve" and "provision for any expenditure" are different items. Accordingly, if any reserve is created or any provision for expenditure has been made by an assessee general insurance company which is not deduct-able in computing income chargeable under the head "income from business or provision", the assessing officer, under the Income Tax Ordinance, A is required to disallow such amount.

11. In the case of Phoenix Assurance Co. Limited, Supreme Court has declared that finality attaches to the accounts submitted by the assessee insurance company under the Insurance Act to the Controller of Insurance and the limited jurisdiction vesting in the Income-tax Officer is only to exclude the expenditure from the balance of profits in such account which is not permissible under section 10 of the Act. As has been observed, the. aforesaid principle was enunciated on the basis of section 10(7) of the repealed Income-tax Act read with First Schedule to the Act in which the rules for computation of profits and gains of insurance business were contained and in rules 6(1) thereof the words "reserve or provision for expenditure" did not find place. Now the rules are contained in the Fourth Schedule to the Income-tax Ordinance, 1979. Still finality attaches to the accounts submitted by the assessee insurance company under the Insurance Act to the Controller of Insurance but jurisdiction now vests in the Income-tax assessing authorities to exclude expenditure, reserve and provision for expenditure which is not permissible under section 26 of the Ordinance in view of rule 5(a) of the Fourth Schedule to the Ordinance, as amended by Finance Ordinance, 1980.

12. In our opinion, the Tribunal was right in confirming the orders of the Income-tax Officer disallowing the aforesaid provisions for taxation, gratuity and civil commotion in view of the amended rule 5(a) of the Fourth Schedule to the Income-tax Ordinance. The questions referred in these 4 income-tax cases arc answered accordingly:

There shall be no order as to costs.

M.B.A./H-319/K Reference answered.