ITAS.NOS.1374/KB OF 1992-93 AND 1796/KB OF 1993-94, DECIDED ON 14TH SEPTEMBER, 1994. VS ITAS.NOS.1374/KB OF 1992-93 AND 1796/KB OF 1993-94, DECIDED ON 14TH SEPTEMBER, 1994.
1995 P T D (Trib.) 299
[Income-tax Appellate Tribunal Pakistan]
Present: Muhammad Mujibullah Siddiqui, Chairman and A.S.K Sheerani, Accountant Member
ITAs.Nos.1374/KB of 1992-93 and 1796/KB of 1993-94, decided on /01/.
th
September, 1994. Per A.S.K. Sheerani, Accountant Member; Muhammad Mujeebullah Siddiqui, Chairman agreeing--
(a) Income Tax Ordinance (XXXI of 1979)---
----S. 79---Addition ---Transaction with non-resident principal---Conditions laid down in S.79, Income Tax Ordinance, 1979 enumerated.
To tax the income from transactions with non-resident the following conditions, as laid down in section 79, have to be fulfilled:--
(i) That there should be business relationship between a resident and non-resident.
(ii) There must be close connection between them (of Principal and Agent).
(iii) The course of business is so arranged that it---
(a) produced to the resident no profit, or
(b) less than ordinary profits, which might be expected to arise in that business.
1988 PTD 447 fol.
(b) Income Tax Ordinance (XXXI of 1979)---
----S. 79 & 62---Addition---Transaction with non-resident principal---Income Tax Officer had discussed at length in the assessment order that by purchasing raw material at a higher cost from its parent company, assessee had shown less profit than ordinary profit which would have been earned as raw material was available at a much lower price' in the open market and assessee was not compelled to buy said material from a particular source---Business relationship and close connection had been established between the non-resident and the assessee beyond any doubt---Income Tax Officer, while determining the amount of profit which may reasonably be deemed to accrue to the assessee, had given opportunity to the assessee to explain various points---Notices under S.62, Income Tax Ordinance, 1979 were issued to the assessee by Income Tax Officer and sufficient opportunity was allowed to explain the position-- Contents of notice issued under S.62, Income Tax Ordinance, 1979 and the explanation submitted by the assessee had been incorporated in the assessment order---Points relating to business relationship between the assessee and non resident had been discussed by .the Income Tax Officer in the assessment order---Close connection between the non-resident and assessee had been tried to be established by the Income Tax Officer and ordinary profit which could have been earned by the company in view of rates of raw material had also been discussed---Amount of addition made under S. 79, Income Tax Ordinance, 1979 had been worked out by the Income Tax Officer on the basis ,of the rate available with him in case of a parallel case of an importer whose NTM had been incorporated in the assessment order---Income-tax Commissioner, held, rightly confirmed the addition made by the Income-tax Officer in circumstances.
Per Muhammad Mujibullah Siddiqui, Chairman agreeing with A.S.K. Sheerani, Accountant Member--
(c) Income-tax---
----Profit---Purchases can generate profit.
I.T.O. v. Beecham Pakistan Limited 1988 PTD (Trib.) 447; C.I.T. v. Pfizer Laboratories Limited 1989 PTD 612; C.I.T. v. Glaxo Laboratories Ltd. 1991 PTD 393 and Glaxo Laboratories v. C:I.T. Karachi Civil Appeal No.237-K of 1991 ref.
(d) Income Tax, Ordinance (XXXI of 1979)---
---S. 79 [as stood before amended by Finance Act (VII of 1992)]---Addition-- Transaction with non-resident principal---Applicability of S. 79, Income Tax Ordinance, 1979--- Conditions.
(e) Income Tax Ordinance (XXXI of 1979)----
---S. 79---Addition---Transaction with non-resident principal---If the profit of the year is higher in comparison with the earlier year S. 79, Income Tax Ordinance, 1979 still can be applied with object of taxing deemed profit based on legal fiction.
I.T.O. v. Beecham Pakistan Limited 1988 PTD (Trib.) 447 fol.
(f) Income Tax Ordinance (XXXI of 1979)---
----S. 79---Addition---Transaction with non-resident principal---Applicability of S.79, Income Tax Ordinance, 1979---Income determined under S. 79, Income Tax Ordinance, 1979, is the deemed income which is always a fiction of law and acceptance or rejection of accounts has nothing to do with the applicability of S.79---Provision of S. 79, Income Tax Ordinance, 1979 is a deeming provision and thus by fiction of law a profit which is expected to arise in the business is to be determined by the Income-tax Officer which has been diverted because of close connection between the resident and non-resident by arranging the course of business in such a manner which depletes the profit.
(g) Income Tax Ordinance (XXXI of 1979)---
---S. 79---Transaction with non-resident principal---Application of S. 79-- Declaration of reasonable gross profit rate is not a ground for non-application of S.79.
(h) Income Tax Ordinance (XXXI of 1979)---
----S. 79---Addition---Transaction with non-resident principal---Where the business connection between the resident and the non-resident is so close and the freedom or purchase from the International market existed purchases from the principal at exorbitant prices as a rule and not as an exception, would necessarily lead to the inference that the business between the two has been so arranged as to make it more disadvantageous for the resident and correspondingly advantageous to the non-resident by either reducing the profit or at no profit basis and will attract the application of S. 79, Income Tax Ordinance, 1979---Difference of price, therefore, will be deemed to be income of the resident assessee and shall be included in the total income of the resident.
(i) Income Tax Ordinance (XXXI of 1979)---
----S. 79---Transaction with non-resident principal---Real spirit and purpose of S.79---Any agreement purporting to restrict the freedom of purchase as a result of collusive arrangements between the resident and non-resident associated concern shall not be deemed to be real restriction on freedom of purchase and on the contrary it shall lead to the inference that the arrangement is collusive---Provisions of S.79, Income Tax Ordinance, 1979 shall fully apply to such a situation.
The real spirit and purport of section 79 is to discourage the collusive arrangement and curb the exploitation whereby the course of business between the resident company and the non-resident associated concerns are so arranged that a part of the profit which should accrue to the resident company is diverted to the non-resident associated concern which is to the disadvantage of the revenue in Pakistan and is advantageous to the non-resident associated concerns. Thus, any agreement purporting to restrict the freedom of purchase as a result of collusive arrangement between the resident and non-resident associated concern shall not be deemed to be real restriction on freedom of purchase and on the contrary it shall lead to the inference that the arrangement is collusive. The provisions contained in section 79 shall fully apply to such situation.
(j) Income Tax Ordinance (XXXI of 1979)---
---S. 79---Addition---Transaction with non-resident principal--- Assessee, a manufacturer of pharmaceutical products---Purchase of raw material by assessee from a non-resident principal for its pharmaceutical products-- Monopoly of principal cannot be recognised after expiry of patent and once raw material is manufactured by the other concerns as its efficacy is similar and is registered by the Government of Pakistan, assessee cannot seek protection under the cover of agreement with the principal company the effect of which is to reduce the margin of profit of the assessee---Applicability of S. 79, Income Tax Ordinance will be justified in circumstances.
Naseem Haider and Ebrahim Sidad for Appellant.
Muhammad Yousaf Butt, D.R. for Respondent.
Date of hearing: 14th September, 1994.
ORDER
A.S.K. SHEERANI (ACCOUNTANT MEMBER).--These appeals have been filed by the appellant against the orders of the learned CIT(A) for the years 1990-91 and 1991-92. Since the grounds of appeal in both the years are almost common therefore the appeals are disposed of by a combined order.
Briefly stated the facts of the case are that the appellant company derived income from manufacture and sale of pharmaceutical products. The learned ITO made additions under section 79 of the Income Tax Ordinance in both the years. Certain disallowances were also made. The appellant agitated the additions made by the learned ITO under section 79 and the learned CIT(A) upheld the action of the learned ITO. These appeals have been filed against this confirmation of addition by the learned CIT(A).
The appellant company has declared following results in the years 1990-91 and 1991-92.
| | 1990-91 | 1991-92 |
| Sales (Net) | Rs.85,521,251 | Rs.92,967,459 |
| Cost of sales | Rs.66,826,209 | Rs.76,934,368 |
| G.P.Rate | 21.86% | Rs.17.24% |
The learned ITO observed that both the G.P. rate as well as turnover have increased. Regarding sales and purchases, it was observed that both were verifiable and accounts books have been maintained on the same pattern as in the past and there has been no change in the accounting policy.
While examining the details of imports from non-resident associated concern the learned ITO noticed that, inter alia, imported raw material CLOTRINAZOLE from its non-resident associated concern at much excessive price as compared to the same raw material imported by a local company. He therefore invoked provisions of section 79 and a notice under section 62 was issued and served on the appellant. The learned ITO noticed that the rates of imported material declared by the assessee were much higher than the rates shown by the other company with imported raw material from some other source. In the notice issued by the learned ITO under section 62 rates of import of raw material shown by the appellant and other importers were specifically mentioned. The appellant was given an opportunity and it was mentioned in the notice: "you are given an opportunity to show cause the reason as to why abovementioned difference between the rates of purchases made by you from associated non-resident company" import made by the other parallel companies may not be added to your income under section 79 of theIncome Tax Ordinance. It may also be mentioned here that the raw materials imported by the other parallel companies as mentioned above fulfils the requirements as laid down in the Drugs Act, 1976".
A very comprehensive reply was submitted by the appellant which has been incorporated in the assessment order. The learned ITO made an effort to rebut each and every contention of the explanation submitted by the appellant and after examining the various aspects of the matter the ITO repelled all the pleas of the assessee and held that the assessee-company had in fact tried to divert its profits by way of paying high purchase price from the raw material to its foreign principal. He further held that such a collusive transaction attracts the mischief of section 79 of the Income Tax Ordinance, 1979. Consequently the learned ITO made an addition of Rs.22,20,598 in the year 1990-91 and Rs.2,26,73,849 in the year 1991-92 to the total income of the assessee-company by invoking the provision of section 79.
On appeal before the learned CIT(A) it was urged by the appellant that the learned ITO wrongly applied section 79 and urged that the addition on account of section 79 should be deleted. The learned CIT(A) confirmed the addition made by the ITO in the year 1990-91 with the following observation :-
"The learned counsel has been heard and the matter has been considered. The appellant has not denied payment of higher price for the raw material, but has tried to defend it with ifs and buts, which are, however, not unusual and equally apply to the other sellers of the raw material as well. Therefore, ratio of the decision, reported as 1991 PTD 393 (Kar. H.C.), CIT v. Glaxo Laboratories (Pak.) Ltd., would apply. Their Lordships had held that its applicability would depend on a clear finding that purchases from the non-resident supplier of the raw material had been made at higher price (which is the case in the appellant's case) and the real profit had been depleted, reduced or made extinct by manipulation and arranged transaction. In view of the fact that the finding of higher purchase price recorded by the learned assessing officer could not be rebutted, therefore, ratio of the supra quoted judgment fully applies to the case of the appellant. The treatment of the learned assessing officer in invoking the provisions of section 79 being in accordance with law is, therefore, confirmed:"
Regarding the addition for the year 1991-92 the learned CIT observed:--
"Since the facts and circumstances of the case are the same as in the preceding year, in respectful agreement with my learned predecessor and for similar reasons the addition under section 79 is hereby confirmed."
These appeals have been filed against the orders of the learned CIT(A). The learned counsel for the appellant Mr. Ebrahim Sidat, argued that the application of provision of section 79 in respect of the raw material purchased from its parent company on the ground of higher price payment as against Ruling International Price was not justified. He submitted that there did not exist any collusive arrangement between the appellant and its principal for charging higher prices. The learned counsel also referred to an agreement according to which the raw material was to be purchased from the parent company. While referring to the cost of raw material available in the local market or international market from other countries vis-a-vis the material got from the 'parent company he referred to the quality of the raw material and claimed that the quality of raw material was better than the one available from other countries. He further submitted that while fixing the rates of the medicines the Health Ministry looks into various aspects and the prices are fixed in relation to the cost of raw material. The point of comparative efficacy of the medicines manufactured by the appellant was also explained and discussed at length by the learned counsel.
The learned D.R. in his turn argued that the arguments advanced by the learned counsel of the appellant had already been considered in the assessment order and the same have been considered by the. learned CIT(A) also. He supported the assessment orders and the appellate orders of both the officers below. While referring to the cost of raw material imported by the appellant company and referred to by the learned ITO in the assessment order he submitted that the appellant was confronted on this point. The NTN was supplied to the appellant and explanation was obtained which has been incorporated in the assessment order.
We have considered the arguments of both the counsel and we have referred to a case reported as 1988 PTD 447/456 whereby the principle for invoking provision of section 79 has been laid down. The Tribunal in the above-referred case has laid down the principles:
"To tax the income from transactions with non-resident, the following conditions, as laid down in section 79, have to be fulfilled :--
(i) That there should be Business relationship between a resident and non-resident;
(ii) there must be close connection between them (of Principal and Agent);
(iii) the course of business is so arranged that it:--
(a) produced to the resident no profit, or
(b) less than ordinary profits, which might be expected to arise in that business.
Business relationship and close connection is established beyond any doubt. The ITO, while determining the amount of profit which may reasonably be deemed to accrue to the resident, gave an opportunity to the assessee to explain various points.
Notices under section 62 were issued to the appellant by the learned ITO and sufficient opportunity was allowed to explain the position. The contents of notice issued under section 62 and the explanation submitted by the appellant have been incorporated in the assessment orders. The points of business relationship between the appellant and non-resident has been discussed by the learned ITO. Close connection between the principal and the appellant has been tried to establish and ordinary profit which could have been earned by the company in view of the rates of raw material has also been discussed.
The learned I.T.O. has observed:
"Parawise rebuttal on A.R. M/s. Sidat Hyder Aslam & Co. C. As. Letter No. T/2509/92 dated 31-3-1992, filed on 14-4-1992 in this office."
In the paragraphs of the assessment order that followed the learned ITO has referred to the paragraphs of the explanation of the appellant. Parawise rebuttal have been made in the assessment order, and then analysed the explanation and having rebutted explanation submitted by the appellant, the learned ITO observed:---
"Thus, section 79 is fully attracted and hereby applied. Addition is made at Rs.22,20,598 (1990-91) and Rs.2,26,73,849 (1991-92):"
In our opinion the assessing officer has very rightly discussed at length in his assessment order that by purchasing raw material at a higher cost from parent company the appellant has shown less profit than ordinary profit which would have been earned had the raw material been purchased at lower price. The raw material was available at much lower price in open market and the appellant was not compelled to buy the raw material from a particular source. The learned ITO has rightly added the amount under section 79 which has been worked out on the basis of the rate available with him in case of a parallel case of an importer whose NTN has been incorporated in the assessment order. The learned CIT(A) rightly confirmed the addition made by the learned ITO in both the years under appeal and we do not find any infirmity in the order of the learned CIT(A) and we decline to interfere.
Other grounds of appeal have not been pressed by the learned counsel regarding repair and maintenance travelling and conveyance, printing and stationery.
Regarding ground No.7 for the year 1991-92 the learned counsel for the appellant submitted that learned CIT(A) has not given any decision on the action of the learned IAC who disallowed Rs.84,145 on account of rebate claimed written off. The learned D.R. also agreed with the learned counsel. Since the point of rebate has not been considered by the learned CIT(A). The learned CIT(A) is hereby directed to consider this ground of appeal and give his decision in accordance with law.
Both the appeals are disposed of in the manner indicated above.
(Sd.)
A.S.K. Sheerani,
Accountant Member.
MUHAMMAD MUJIBULLAH SIDDIQUI (CHAIRMAN).---- I agree with the findings and conclusions drawn by my learned brother, the Accountant Member on all the points. However, I would like to add few words of my own on the point of applicability of section 79 of the Income Tax Ordinance, 1979 just as a matter of elaboration on certain points. The relevant facts for the purpose of assessment year 1990-91 are contained in the notice issued by the assessing officer dated 23-2-1992 which is reproduced below for the sake of convenience:
"During the year under consideration the quantity of the abovesaid raw materials imported by you from the non-resident associated company with price thereof and the prices of imports by other companies from other sources duly certified by the Assistant Drug Controller stating that the imported drugs covered in the invoice has been made in conformity with the Drugs Act, 1976, show comparative rates as under:--
| | Name of raw material | Price per K.G. C&F Karachi |
| (a)(i) Import from patent/ non-resident Associated Company | Clotrimazole | Rs.40,765.64 |
| (ii)Import by other Companyfrom other sources NTN(Photo copy of QKMP attached) | Clotrimazole 13-01-3308253 Regn.No.8385 | Rs.1,737.93 |
(b) The perusal of the above comparative rates show that owing to close connection with the non-resident associated parent company, you have opted to purchase the raw material on much higher price front your parent company/associated undertaking the quantity of imports of which made by you from the parent company with price thereof and the prices of raw materials imported by other companies from other sources with rates as given above will result the total difference in the cost as under:
| Name of raw material | Clotrimazole | Price per Unit C&F Karachi | Quantity | Value in rupees |
| (i) Import from parent non-resident associated Co. | Clotrimazole | 40,765.64 | 56,898 | 2,319,483.14 |
| (ii) Import by other company at the average rate of conversion of Pak rupee i.e. | Clotrimazole | 1,737.93 | 56,898 | 98,884.91 |
| (iii) Difference in the cost attracting provision of section 79 of I.T. Ordinance, 1979 | | | | 2,220,598.23 |
In view, of the above facts, you are given an opportunity to show cause the reasons as to why abovementioned difference between rates of purchases made by you from your associated non-resident Company and the import made by other parallel companies may not be added to your income under section 79 of Income Tax Ordinance, 1979. It may also be mentioned here that the raw materials imported by the other parallel companies as mentioned above, fulfills the requirements as laid down in the Drugs Act, 1976, and were cleared by the Assistant Drugs Controller after ensuring that the same are in conformity with the Drugs Act, 1976. The certificate of analysis enclosed alongwith your invoice and the invoice of parallel companies confirms that the same are in conformity with the specifications of Drugs Act, 1976 viz. B.P. U.S.P. etc. as mentioned in Drugs Act, 1976.
The principles for invoking of section 79 as laid down by Honourable I.TA.T. in the case of M/s. Beecham (Pak.) Ltd. (Assessment year 1979-80) reported as 1988 PTD 447/456 are as under:--
"To tax the income from transactions with non-resident, the following conditions, as laid down in section 79, have to be fulfilled:---
(i) that there should be business relationship between a resident and non resident;
(ii) there must be close connection between them (of Principal and Agent);
(iii) the course of business is so arranged that it--
(a) produced to the resident no profit, or
(b) less than ordinary profits, which might be expected to arise in that business.
The ITO will then determine the amount of profit, which may reasonably be deemed to accrue to the resident:
Likewise the relevant facts for the purpose of assessment year 1991-92 are contained in the notice issued by the assessing officer dated 21-10-1992 and 3-12-1992 which are reproduced below:--
"During the year under consideration the quantity of the abovesaid raw materials imported by you from the non-resident associated company with price thereof and the prices of imports by other companies from other sources duly certified by the Assistant Drugs Controller stating that the imported drugs covered in the invoice has been made in conformity with the Drugs Act,1976, show comparative rates as under:
| | Name of raw material | Price per Kg. C&F. Karachi |
| (a) (i) Import from patent/ non- resident Co. | 1.Clotrimazole 2.Nifedipine 3.Cholorequine Phosphate 4.Mebhydrelin | 49,500 83,250 855 6,900 |
| (ii) Import by other company from other sources | 1.Clotrimazole N.T.No.13-O1-3308253 Reg.No.8385 2. Nifedipine N.T.No.13-01-3308253 3. Chloroquine Phosphate N.T. No.13-01-3308161 Regd.No.2731 4. Mebhydroline N.T. No.13-01-3308224 Regd. No.12045 | 2,500 2,034 548.10 5,607.14 |
Copies of parallel invoices were also attached with these notices under section 62.
(b) The perusal of the above comparative rates show that owing to close connection with the non-resident associated parent company, you have opted to purchase the raw material on much higher price from your parent company/associated undertaking the quantity of imports of which made by you from the parent company with price thereof and the prices of raw materials imported by other companies from other sources with rates as given above will result the total difference in the cost as under:
Name ofPrice perQuantityValue in Pak.
rawUnit C&FimportedRupees.
material
| (i) import from parent non-resident associated | Clotrimazole | 49,500 | 118 Kg. | 5,841,000 |
| Nifedipine | 83,250 | 122 Kg. | 10,156,500 |
| Chloroquine | | |
| Phosphate | 855 | 8800 Kg | 7,524,000 |
| Mebhydrolin | 6,900 | 3450 Kg. | 23,805,000 |
| | | | 47,326,500 |
| (ii) Imported by other Co. at the average rate of conversion of Pak. Rs.i.e. | Clotrimazole | 2,005 | 118 Kg. | 236,590 |
| Nifedipine | 2,034 | 122 Kg | 248,148 |
| Chloroquine | |
| Phosphate | 548.10 | 8800 Kg. | 4,823,280 |
| Mebhydrolin | 607.14 | 3450 Kg. | 19,344,633 |
| | | | | 24,652,651 |
| (iii) Difference in the cost attracting provision of section 79 of I.T. Ordinance, 1979. | | 47,326,500 | 24,652,651 | 22,675,849 |
In view of the above facts, you are given an opportunity to show cause the reasons as to why abovementioned difference between rates of purchases made by you from your associated non-resident company and the import made by other parallel companies may not be added to your income under section 79 of Income Tax Ordinance, 1979. It may also be mentioned here that the raw materials imported by the other parallel companies as mentioned above fulfil the requirements as laid down in the Drugs Act, 1976. and were cleared by the Assistant Drugs Controller after ensuring that the same are in conformity with the Drugs Act, 1976. The certificate of analysis enclosed alongwith your invoice and the invoice of parallel companies confirms that the same are in conformity that the specifications of Drugs Act, 1976 viz: B.P. U.S.P. etc. as mentioned in Drugs Act, 1976."
The appellant company took various pleas before the assessing officer, first appellate authority and before this Tribunal. Initially one of the contentions was that the purchases cannot generate profit and reliance was placed on some judgments of this Tribunal but subsequently the plea has been given up obviously for the reason that the point on issue stands decided otherwise in the subsequent decisions by this Tribunal, the Hon'ble Sindh High Court and the Hon'ble Supreme Court of Pakistan. In the following judgments it has been held that the purchases can generate profit
(i) 1988 PTD (Trib) 447 (I.T.O. v. Beecham Pakistan Limited).
(ii)1989 PTD 612 (Sindh H.C.) (C.I.T. v. Pfizer Laboratories Limited.)
(iii)1991 PTD 393 (Sindh H. C.) (C.I.T. v. Glaxo Laboratories Limited).
(iv)Civil Appeal No. 237-K of 1991, Glaxo Laboratories v. C.I.T. Karachi (SC of Pakistan) order dated April 21, 1992 (unreported).
The controversy has been laid to rest by the Hon'ble Supreme Court of Pakistan and, therefore, now there is no room for any arguments on the point whether purchases can earn profit or not. Since the applicability of section 79 of the Income Tax Ordinance, 1979 (as it stood before amendment by Finance Act, 1992) is under consideration, therefore, it would be convenient to reproduce the original section which reads as follows:
"79. Income from transactions with non-resident ---Where business is carried on between a resident and a ton-resident and it appears to the Income Tax Officer that, owing to the close connection between them, the course of business is so arranged that the business transacted between them produces to the resident either no profits or less than the ordinary, profits which might be expected to arise. in that business, the Income Tax Officer shall determine the amount of profits which may reasonably be deemed to have accrued to the resident and include such amount in the total income of the resident.-
A perusal of the above section shows that the first condition for the applicability of section 79 is that there should be business carried on between a resident and non-resident. It is admitted at Bar that the condition admittedly exists as the appellant company is a resident company dealing in business with non-resident company. The second condition is that owing to the close connection between the resident and non-resident the course of business is so arranged that the business transaction between them produces to the resident either no profit or less than the ordinary profit which might be expected to arise in that business. There is no dispute about the second condition as well that there is a close connection between the resident company, the appellant and non-resident company which is associated concern of the appellant and, there is close connection between them. The point of controversy between the department and the assessee/appellant is that according to the department because of the close connection between the appellant, resident company and its associated concern, non-resident company, the course of business has been so arranged that because of higher purchase rates paid to the non-resident associated concern for purchase of raw material as compared to the ruling international market the profit has been depleted while the contention of assessee is that no such arrangement exists. The contention of department is contained in the notices issued to the appellant company and reproduced in earlier part of my order which require no further elaboration. So far the contentions raised on behalf of the appellant are concerned, the first argument of Mr. Ebrahim Sidat, learned counsel for the appellant before us was that if the gross profit rate is satisfactory, sales and purchases are verifiable, the trading account is without defect then section 79 is not applicable. Mr. Ebrahim Sidat contended that in the assessment year 1990-91 gross profit rate was declared at 21.86% which is much higher as compared to 13.32% declared in the assessment year 1989-90, 8.39% declared in 1988-89 and 19.71% declared in 1987-88. He has further submitted that in the assessment year 1991-92 the gross profit rate declared at 17.24% is also satisfactory and, , therefore, when satisfactory profit has been earned the question of applicability of section 79 does not arise. The contention is not tenable and has been repelled after detailed consideration by the Tribunal in the case of Beecham (Pakistan) Limited reported as 1988 PTD (Trib.) 447. The relevant finding is reproduced below:
"However, section 79 of the Ordinance does not stipulate that if the t profit of the year is higher in comparison with the earlier year the said section cannot be roped in with the object of taxing deemed profit based on a legal fiction. Therefore, I have no hesitation in stating that learned C.I.T (Appeals) committed a patent error when he referred to a comparative increase in the declaration of profit for the charge year 1979-80 in comparison to the charge year 1978-79 with a view to concluding that section 79 was not applicable in this case. What he really missed was the point that but for purchases of Ampicillin Trihydrate made from its sister concern at Singapore, the profit of the assessee would have been higher by a sum of Rs.27,94,332 for the charge year 1979-80 ... .... ... ... ...Learned counsel of the assessee has raised a plea that the I.T.O. did not record a finding in regard to the fact that either no profit was made by the assessee on purchases made from its sister concern in Singapore or the profit made was less than the ordinary profit which might be expected to arise in that business. This contention has not found favour with me as the assessee by making purchases of its raw material from its sister concern in Singapore at the rata of $ 165 Kg. in comparison to the import value of the same raw material by other pharmaceutical companies in West Europe at rates ranging from $ 90 to $ 96.7 per Kg. had certainly managed to transfer its profit to the non-resident. The mere fact that gross profit is disclosed at 31.38% during the previous year relevant to the charge year was higher in comparison to the charge year 1978-79, did not make any difference because had the assessee made purchases from pharmaceutical companies of West Europe its profits would have been more by a sum of Rs:27,94,332. Therefore, the assessee on account of close connection with its sister concern in Singapore managed to declare less than the ordinary profit which could be realised in that business:"
The contention raised by Mr. Ibrahim Sidat that in the case of declaration of satisfactory gross profit rate section 79 is not applicable already stands repelled by this Tribunal in the earlier judgment as narrated above. I would like to further observe that the acceptance or rejection of accounts has nothing to do with the applicability of section 79 of the Income Tax Ordinance, 1979. The consideration for acceptance or rejection of accounts depend on the facts of each case in the light of provisions contained in section 32 of the Income Tax Ordinance, 1979. Section 79 is a deeming provision and thus by fiction of law a profit which is expected to arise in the business is to be determined by the Income Tax Officer which has been diverted because of close connection between the resident and non-resident by arranging the course of business in such a manner which depletes the profit. Thus, the income determined under section 79 is the deemed income which is always a fiction of law which has nothing to do with the rejection or acceptance of the accounts. The contention that since the assessing officer is not able to find any defects in the books, of accounts and the gross profit rate declared is reasonable, therefore, section 79 is not applicable, is not tenable in law and stands repelled. Mr. Ibrahim Sidat has next contended that because of restrictions placed in the Users Agreement Form TM-28 the appellant is bound to purchase active ingredients/raw material directly or indirectly by Bayer and/or, from case to case, locally obtained with Bayer's approval, from a supplier recommended by Bayer, in accordance with the recipes, technical information and direction furnished or approved by Bayer. He has submitted that because of such condition in the Users agreement the freedom of purchase is not available to the appellant. On the other hand, the learned D.R. has vehemently argued that the contention is misplaced. He has contended that admittedly the patent has expired much earlier and now the associated concern has no monopoly on the manufacture of raw material. With the expiry of patent the raw material can be manufactured by any concern and, therefore, other manufactures are producing the raw material of equal efficacy, which is evident from the facts that the Ministry of Health has registered the other raw material also and has accorded permission to import the same in Pakistan. He has submitted that with the expiry of patent there is no law local or international under which there is any restriction on the manufacture and sale of, the raw material and, therefore, but for the conditions in the Users agreement there is no restriction on the manufacture, sale and purchase of the raw materials in question in the international market. The learned D.R. has contended that the restrictions agreed upon between the resident company/appellant and the non-resident associated concern, on the contrary proves that the course of business has been arranged between them in such a manner that muchless profit is earned by the resident company than expected if the purchases are made on the basis of arms length agreement and in accordance with the international ruling price. The learned D.R. has submitted that due to arrangement between the appellant company and the non-resident associated concern the course of business has been so arranged that the profit has been reduced substantially. He has drawn our attention to the working given by assessing officer on page 5 of the assessment order for the assessment year 1990-91 which is reproduced below:
"Such depletion of profit will be clear from the following wording as well:
| Gross profit declared | Rs.18,695.050 |
| Add: Difference in import price | Rs.02.220,598 |
| Total Profit: | Rs.30,915,648 |
| Thus G.P. rate works out at | 24.45% |
| Declared G.P. rate | 21.86% |
G.P. rate so worked out i.e. 24.45% and still much more profit rate can be expected to accrue in this line of business."
The learned D.R. has further submitted that the appellants have themselves given working of the profit, if raw material is purchased at the ruling international market price which is contained in Para. 12 of the assessment order for the A/Y 1991-92 and is reproduced below:
"Apart from purely legal consideration, viewed at as mixed question of law and facts, let us examine what section 79 seeks to attract. Firstly it presupposes a situation in which the application of the provision would be justified only in a case where the course of business is so arranged that the business transacted between the resident and non-resident should produce to the resident either no profit or less than ordinary profits. Taking the situation of no profit first, the application of the section is outright out of question because Bayer's operation for the instant year have resulted in substantial profits. Taking the second situation that there are lower profits than expected or which may deem to have accrued we submit that there has to be incontrovertible evidence to support or indicate the norms or expectation against which the profit are held to be lower. It is submitted that this factor alone can trigger the operation of section 79 in case of your assessee. For a better understanding of the situation we give a brief as under:
Gross profit rate declared by the company in the year under consideration
17.24%
Gross profit rate in the past accepted by the department where no addition undersection 79 was made.
| 1989-90 | 13.32% |
| 1988-89 | 8.39% |
| 1987-88 | 19.71% |
The above proves satisfactory profitable position. For the sake of arguments if we calculate the gross profit rate for the assessment year under consideration after taking your intended addition which is undoubtedly part and parcel of trading account the position would be as under:
| Sales | 92,967,459 |
| Gross profit declared | 16,033,091 |
| Addition on account of alleged difference in purchase price of aforesaid material | 17,069,439 |
| Additions on account of alleged difference in purchase price of Cletrimazole | 5.604,410 |
| Gross profit rate after intended additions | 38,706,940 |
| Gross profit rate | 41.63% |
Therefore, we urge your indulgence to consider this aspect of the case that section 79 simply cannot be invoked in the Bayer's case based on what you have attempted to produce because neither there is a situation whereby Bayer could be charged with as not having made any profit or having made less than the ordinary profits. We, therefore, contend that beside the ground on which the learned Tribunal upheld the application of the then section 42(2) and now section 79 as being without lawful justification, on this- count as well, the application of section 79 is totally devoid of all legal merits. Had it been the case that the assessee who are purported to have imported aforesaid material from supplier other than Bayer's made profit either in respect of products or on overall basis, better than what results of Bayer have been, the matter would have been perhaps different. This is however not your case and your notice does not give any indication to the effect that other manufacturers of the aforesaid products in Pakistan have made more profit than Bayer's, and therefore, correspondingly Bayer's profits are less than the ordinary profit which might be expected to arise in that business:
The learned D.R. contended that in the case of Beecham (Pakistan) Limited it has already been held that the declaration of reasonable gross profit rate is not a ground for non-application of section 79. As already shown in the case of Beecham (Pakistan) Limited gross profit rate was declared at 31.38% for the charge year 1979-80 and still it was held that because of payment of I higher purchase rates to the sister concern the provision contained in section 79 of the Income Tax Ordinance. 1979 were applicable and the difference of purchase price paid to the sister concern and ruling international market price was to be deemed as income liable to be added to the total income of the resident company.
We have carefully considered the contentions raised on behalf of the parties and we are persuaded to agree with the contention of learned D.R. that the following observation of the Hon'ble Supreme Court of Pakistan in the case of Glaxo Laboratories is fully applicable to the facts of the present case:
"Where the business connection between the resident and the non resident is so close as it has been shown to existence in the present case and the freedom of purchase from the international market did exist, purchases from the principal at exorbitant prices over a long period as a rule and not as an exception will necessarily lead to the inference that the business between the two has been so arranged as to make it more disadvantageous for the resident and correspondingly advantageous to the non-resident by either reducing the profit or at no profit basis:"
It is admitted position that with the expiry of patent as in the present case no embargo or any impediment exists in law internationally on manufacture and sale of any raw material for the manufacture of drugs. In the absence of any clog on the freedom of purchase if a non-resident company and a resident company having- close connection as is admitted to exist in the present case enter into an agreement whereby with free consent and free will a resident company binds itself to purchase the raw material from its sister concern which is non-resident at much higher price than the ruling international market price, it would be deemed to arrange the course of business in such a manner that the resident assessee earns- lesser profit than expected to arise in that business and it will attract the application of section 79 of the Income Tax Ordinance, 1979. The difference will be deemed to be income of the resident assessee and shall be included in the total income of the resident. The Users agreement in Form TM-28 in which it has been contemplated that the resident company, the appellant shall purchase raw material from the associated concern or from the supplier recommended by the associated concern has been executed on 28th day of October, 1987. We have observed while hearing appeals of the other pharmaceutical companies also that such agreements have been executed after the enactment of section 79 of the Income Tax Ordinance, 1979 thereby creating an impression that the freedom of purchase is not available to the resident companies. In fact the spirit and purport of section 79 is to discourage the collusive arrangements and curb the exploitation whereby the course of business between the resident company and the non-resident associated concerns are so arranged that a part of the profit which should accrue to the resident company is diverted to the non-resident associated concern which is to the disadvantage of the revenue in Pakistan and is advantageous to the non-resident associated concerns. Thus, any agreement purporting to restrict the freedom of purchase as a result of collusive arrangements between the resident and non-resident associated concern shall not be deemed to be real restriction on freedom of purchase and on the contrary it shall lead to the inference that the arrangement is collusive. The provisions contained in section 79 shall fully apply to such situations.
Mr. Ibrahim Sidat has next contended that Ministry of Health fixes price of a drug on the basis of import prices and if the raw material is imported on lower price the sale price of the drug would be fixed at much lower rate by the Ministry of Health. We asked Mr. Ibrahim Sidat whether the purchase price of a raw material was the only consideration for fixation of sale price to which he very frankly replied in negative. We asked him to give the proportion of purchase price of raw material in the costing of drugs in question but he expressed his inability in providing such data. However, he conceded that there are other factors which are considered towards the costing of a drug and Ministry of Health takes all the factors into consideration while fixing the sale price of the drugs. We have considered the contention raised by Mr. Ibrahim Sidat. We are not impressed with the contention because raw material imported by the appellant resident company from its associated concern a non resident is registered with the Ministry of Health and the other raw material available as much cheaper price is similarly registered with the Ministry of Health, therefore, there cannot be any difference in the efficacy of the raw material both of which have been registered by the Ministry of Health and have been allowed to be imported in Pakistan.
Mr. Ibrahim Sidat next argued that the associated company is charging same prices from other affiliated companies in the world and, therefore, there is no collusive arrangement between the appellant company and its non resident associated company. He has conceded that the principal company has not sold the raw material to any non-subsidiary. However, it does not make any difference if the principal company which is not holding the patent rights and has no monopoly in law is charging much higher prices for the raw material as compared to the ruling price internationally in the market. As already discussed earlier the monopoly cannot be recognised after expiry of patent and once a raw material is manufactured by several concerns and their efficacy is similar as is evident from the fact that the Ministry of Health has registered the raw material manufactured by the other concerns also then the resident company cannot seek protection under the cover of agreement with the principal company the effect of which is to reduce the margin of profit of the resident company.
It has further been contended that the imports of the appellant company are examined by Coteena inspection SA. Geneva, Switzerland and, therefore, the question of over-invoicing does not apply. The contention is without substance because examination by Coteena inspection SA. Geneva is for the purpose of custom duty only which has nothing to do with the provision contained in section 79 of the Income Tax Ordinance. The Customs Act and the Income Tax -Ordinance are entirely different statutes and deal with different types of revenue which have nothing in common. The considerations for the purposes of customs duty are entirely different from the considerations for the purpose of income-tax and, therefore, any report for the purpose of levy of customs duty is absolutely irrelevant and immaterial for the purpose of application of. the provisions contained in Income Tax Ordinance.
For the foregoing reasons and respectfully following the view taken by another Bench of this Tribunal in the case of Bayer (Pakistan) Ltd. reported as 1988 PTD (Trib.) 447 and the judgment of High Court in the case of Pfizer Laboratories Limited and Glaxo Laboratories Pakistan Ltd. as well as the judgment of Hon'ble Supreme Court of Pakistan in the case of Glaxo Laboratories Pakistan Ltd. (supra) I am of the view that the assessing officer has rightly applied section 79 to the facts of the present case and the additions in the two assessment years under appeal are here by confirmed.
The appeals stand dismissed accordingly.
M.BA./66/T.T. Appeals dismissed.