COMMISSIONER OF INCOME-TAX, COMPANIES-1 KARACHI VS PREMIER BANK LIMITED, KARACHI
1999 P T D 3005
[Supreme Court of Pakistan]
Present: Nasir Aslam Zahid, Mamoon Kazi and Wajihuddin Ahmed, JJ
COMMISSIONER OF INCOME-TAX, COMPANIES-1 KARACHI
Versus
PREMIER BANK LIMITED, KARACHI and another
Civil Appeals Nos.576 and 577 of 1994, decided on 14/01/1999.
(On appeal from the judgment of the High Court of Sindh dated 21-5-1998 passed in I.T.R. No. 62 of 1982).
(a) Income-tax Act (XI of 1922)---
----S.10(2)(xvi)---Constitution of Pakistan (1973), Art. 185(3)---Allowable deduction---Leave to appeal was granted by Supreme Court to examine the question as to whether the liabilities incurred by the assessee on account of payment of penal interest could be claimed as deductions in terms of S.10(2) (xvi), Income-tax Act, 1922.
(b) Income-tax Act (XI of 1922)---
----S. 10(2)(viii)---Allowable deductions---Expenditure incurred as penalty or fine paid on account of infraction of law cannot be permitted as expenditure laid wholly or exclusively for the purpose of the business of assessee-- Principles---Penalty.
Revenue expenses incurred by the assessee wholly and exclusively for the purpose of his business can legitimately be claimed by him as an allowable deduction under section 10(2) (xvi), Income-tax Act, 1922 but expenditure incurred as penalty or fine paid on account of infraction of law cannot be permitted as expenditure laid out wholly or exclusively for the purpose of the business of the assessee. However, in case of expenditure which, although has been incurred by the assessee on account of infringement of a provision of a statute, but is not in the nature of penalty, the question whether such expenditure is admissible' under section 10(2)(xvi), or not, would depend upon the circumstances of each case.
Messrs General Tyre and Rubber Co. v. Commissioner of Income tax 1986 PTD 52; Commissioner of Income-tax, Lahore Zone, Lahore v. Punjab Oil Expeller Co., Lahore 1979 PTD 437; The Commissioner of Income-tax, Companies, II v. Messrs General Tyre and Rubber Company of Pakistan Ltd. 1993 PTD 383; Radio Picture Limited v. Commissioner of Inland Revenue 22 Tax Cas. 106; Commissioner of Income-tax v. Messrs Alfa Insurance Co, Ltd,. PLD 1981 SC 293; Beecham Pakistan Ltd. v. Commissioner of Income-tax 1995 PTD 577; Commissioner of Income-tax, Bombay City v. Jagannath Kissonlal (1961) 41 ITR 360; Triveni Engineering Works Ltd v. Commissioner of Income-tax, Delhi (1983) 144 ITR 732 and Govind Choudhry & Sons v. Commissioner of Income-tax (1971) 79 ITR 493 ref.
(c) Income-tax Act (XI of 1922)---
----Ss.10 (2)(xvi) & 10(1)---State Bank of Pakistan Act (XXXIII of 1956), S.36---Allowable deductions ---Assessees were Banking Companies-- Expenditure on account of penal interest was necessitated because of the failure of the assessees to maintain the required level of their credit balance---Such expenditure, therefore, was not incurred in the normal course of business of the assessees but was in the nature of penalty and, thus, not allowable deductions under S.10(2)(xvi) or S.10(1) of the Income-tax Act, 1922.
Section 36(4) of State Bank of Pakistan Act, 1956 indicates that for violation of the provisions of section 36(1) two different kinds of liabilities may be incurred by a scheduled bank. Where liability is assumed on the basis of profit and loss sharing "penalty" would be imposed in case of each violation, but in case liability is assumed on the basis other than profit and loss sharing, "penal interest" would be charged. But in both the cases, the object to be achieved appears to be the same as the provisions are meant to operate as a deterrent to prevent any fall in the level of credit balance required to be maintained by the scheduled banks. However, whether liabilities incurred in the form of penalty or in the form of penal interest, the main question, would be, whether such payments were closely related to the business of the assessee. In the present case, the expenditure on account of penal interest was necessitated because of the failure of the assessees to maintain the required level of their credit balance. Such expenditure, therefore, was not incurred in the normal course of business of the assessees but it was in the nature of penalty.
Contention was that the expenditure incurred by the assessees on account of penal interest stood on a different footing as it could not be equated with "penalty". No doubt, "penalty" carries with it an element of punishment which distinguishes it from "interest" even if the same is qualified by the word "penal". However, the answer lies in the violated provisions of the statute itself.
Even if deductions are claimed under section 10(1) of the Income tax Act, 1922 the question to be determined would still remain the same. The payments made by the assessees were in the nature of fine, therefore, in any case, they cannot be held to have been laid out wholly or exclusively for the purpose of its business. Therefore, it cannot be excluded as allowable expenditure for the purpose of determining profits or gains of the business carried on by the said assessee. Consequently, such expenditure, appears, to have been rightly excluded by the Income-Tax Officer from the deductions claimed by the assessees.
Messrs General Tyre and Rubber Co. v. Commissioner of Income Tax 1986 PTD 52; Commissioner of Income-tax, Lahore Zone, Lahore v. Punjab Oil -Expeller co., Lahore 1979 PTD 437; The Commissioner of Income-tax, Companies, II v. Messrs General Tyre and Rubber Company of Pakistan Ltd. 1993 PTD 383; Radio Picture Limited v. Commissioner of Inland Revenue 22 Tax Cas. 106; Commissioner of Income Tax v. Messrs Alfa Insurance Co, Ltd,. PLD 1981 SC 293; Beecham Pakistan Ltd. v. Commissioner of Income-tax 1995 PTD 577; Commissioner of Income-tax, Bombay City v. Jagannath Kissonlal (1961) 41 ITR 360; Triveni Engineering Works Ltd v. Commissioner of Income-tax, Delhi (1983) 144 ITR 732 and Govind Choudhry & Sons v. Commissioner of Income-tax (1971) 79 ITR 493 ref
Nasrullah Khan, Advocate Supreme Court and S.M. Abbas, Advocate-on-Record for Appellant.
Iqbal Naeem Pasha, Advocate Supreme Court and K.A. Wahab, Advocate-on-Record for Respondents.
Date of hearing: 25th November, 1998.
JUDGMENT
MAMOON KAZI, J.---In these appeals, by leave of this Court, the appellants have called into question the judgment of the High Court of Sindh, dated 21-3-1994, in Income Tax References No.62 of 1982 and No.26 of 1985 respectively.
2. The facts of the case are that, M/s. Premier Bank Limited and Citi Bank N.A., Karachi, the respondents herein, having failed to maintain the credit balance levels as required by section 25 of the Banking Companies Ordinance, 1962 and section 36(1) of the State Bank of Pakistan Act, 1956, incurred liabilities to pay penal interest under section 36(4) of the said Act. They subsequently claimed deductions for the aforesaid payments during the relevant assessment years, but were disallowed by the Income Tax Officer as such expenditure had been incurred by the respondents on account of violation of the said provisions of law. The respondents' appeals before the Appellate Assistant Commissioner succeeded, but on the second appeal filed by the appellants before the Income Tax Tribunal, the order of the Appellate Assistant Commissioner was reversed. Consequently, reference was made to the High Court on the question whether such expenditure incurred on account of infraction of statutory provisions can be claimed as admissible allowance under section 10(2) (xvi) of the repealed Income-tax Act, 1922).
3. It was held by the High Court that, the transactions made by the respondents, being connected with their normal business of banking, entitled them to earn more profits against payment of increased interest and hence such payments can be claimed as deductions.
4. Leave was granted by this Court on the question, whether the liabilities incurred by the respondents on account of payment of penal interest can be claimed as deductions in terms of section 10(2) (xvi) of the repealed Income-tax Act, 1922.
5. The relevant provisions of the said Act read as under:--
"10.--(1) Subject to the provisions of this Act, the tax shell be payable by an assessee under the head profits and gains of business, profession or vocation in respect of the profits or gains of any business, profession or vocation carried on by him.
(2) Subject to the provisions of this Act such profits or gains shall be computed after making the following allowances, namely: --
(xvi) any expenditure not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purpose of such business of the assessee. "
6. Mr. Nasrullah Awan on behalf of the department has argued that, only such expenditure, which is incurred in connection with the business of the assessee, can be claimed by him as an admissible deduction. However, as the said amount, which was paid as penalty on account of infraction of law, was not necessitated by the business of the respondents, therefore, it could not be claimed as an allowable expenditure. Reliance has been placed by Mr. Awan on a Division Bench judgment of the High Court of Sindh in Messrs General Tyre and Rubber Co. v. Commissioner of Income-tax 1986 PTD 52 where a somewhat similar question had arisen before the High Court. In the judgment which was delivered by one of us for the Division Bench, it was held that the words "wholly and exclusively for the purpose of such business, profession or vocation" occurring in section 10(2) (xvi) clearly excluded expenditure which is not laid out wholly or exclusively for such purpose. Although, penalty paid by the assessee was not of a personal nature but had been imposed on goods which had been imported for the purpose of the business of the assessee, nevertheless such expenditure was disallowed as being outside the purview of section 10(2) (xvi). Similar appears to be the view taken by the Lahore High Court in Commissioner of Income-tax, Lahore Zone, Lahore v. Punjab Oil Expeller Co., Lahore 1979 PTD 437. In this case the assessee's firm had tendered demonetized currency notes before a committee constituted under M.L.R. No.81 out of which some amounts were forfeited. The assessee claimed deductions against the forfeited amount but his claim was disallowed. It was held by the Lahore High Court that, such expenditure had been incurred by the assessee on account of violation of law and therefore, it was not incurred wholly and exclusively for the purpose of business, profession or vocation of the assessee.
7. Mr. Iqbal Naeem Pasha, learned counsel for the respondents .has, however, argued that, the ratio of the aforesaid cases is not applicable in the present case as the penal interest paid by the respondents was not a penalty. The learned counsel has further argued that such payment was integrally connected with the business of the respondents and, therefore, such expenditure can be allowed as a lawful deduction. Reliance has first of all been placed by the learned counsel on a judgment of this Court in the case of The Commissioner of Income-tax, Companies II v. Messrs General Tyre and Rubber Company of Pakistan Ltd. 1993 PTD 383. In this case, the assessee claimed deduction on account of technical assistance fee remitted by it to its parent company incorporated in Ohio, U.S.A. The amount could not be remitted to the parent company on accrual and the amount was increased to some extent due to devaluation of Pakistan currency. The Income Tax Officer disallowed the claim of deduction which had accrued due to failure of the assessee to remit the amount in the earlier assessment year, holding that, the same cannot be treated as a revenue expenditure. Leave was granted by this Court on the question, whether the assessee could legitimately claim such deduction under section 10(2) xvi). Ultimately, following the view taken in the case of Radio Picture Limited v. Commissioner of Inland Revenue 1970 PTD 562 it was held by this Court that the larger amount paid by the assessee could still be treated as permissible allowance despite the extra cost incurred to discharge such liability. Even the view taken earlier by this Court in Commissioner of Income-tax v. Messrs Alfa Insurance Co. Ltd. PLD 1981 SC 293 was more or less the same. The facts of this case indicate that the assessee had exceeded the ceiling fixed in respect of the insurance companies' expenses vide Rule 40 of the Insurance Rules. It was held that such expenditure was not in the nature of penalty, fine or forfeiture and, therefore, it was allowable under section 10 of the Income Tax Act. Similar line of reasoning was adopted by the High Court of Sindh in Beecham Pakistan Ltd. v. Commissioner of Income-tax 1995 PTD 577 with once again one of us delivering the judgment for the Division Bench of the High Court. The question was, whether the expenditure incurred by the assessee in excess of the ceiling provided by Rule 33 of the Drugs (Licensing, Registration and Advertising) Rules, 1976, could be allowed as a legitmate deduction. The question was determined in favour of the assessee, notwithstanding the infringement of law committed by it.
8 Mr. Iqbal Naim Pasha while extensively quoting from the Indian jurisdiction, has referred to a judgment of the Supreme Court of India in the case of Commissioner of Income-tax, Bombay City v. Jagannath Kissonlal (1961) 41 ITR 360 where the assessee had to pay to the concerned bank the whole of the principal amount with interest for loan taken by him jointly with another. He claimed deduction in respect of loss suffered by him on account of joint and several liability. The Supreme Court while agreeing with the High Court held that, the assessee was entitled to deduct the loss suffered by him in the transaction. Reference may also be made to a Full Bench judgment of the Allah" High Court in the case of Triveni Engineering Works Ltd. v. Commissioner, of Income-tax, Delhi (1983) 144 ITR 732, wherein, in case of interest paid by the assessee on sugarcane purchase tax arrears, it was held that, the same was revenue expenditure laid out wholly or exclusively for the purpose of business, as distinguished from a penalty paid for infraction of law and, therefore, it could be allowed as admissible expense similarly in Govind Choudhury & Sons v. Commissioner of Income-tax (1971) 79 ITR 493, it was held that although penalty paid by the assessee for supply of inferior quality of paddy cannot become admissible as a business expenditure under section 10(2)(xvi) of the Indian Income Tax Act, but such payment being integrally connected with the assessee's business would be deductible from the income itself under section 10(1) of the Income Tax Act.
9. Therefore, the view which appears to have generally prevailed with the Courts is that, revenue expenses incurred by the assessee wholly and exclusively for the purpose of his business-can legitimately be claimed by him as an allowable deduction under section 10(2)(xvi), but expenditure incurred as penalty or fine paid on account of infraction of law cannot be permitted as expenditure laid out wholly or exclusively for the purpose of the business of the assessee. However, in case of expenditure which, although, has been incurred by the assessee on account of infringement of a provision of a statute, but is not in the nature of penalty, the question whether such expenditure is admissible under section 10(2)(xvi), or not, would depend upon the circumstances of each case. Mr. Pasha has argued that the expenditure incurred by the respondents on account of penal interest stands on a different footing as it cannot be equated with "penalty". We are not unmindful of the fact that even the learned Judges in the High Court were 'themselves conscious of such distinction. No doubt, "penalty" carries with it an element of punishment which distinguishes it from "interest" even if the same is qualified by the word "penal". However, as observed by the learned Judges in the High Court, the answer lies in the provisions of the statute itself. The relevant provisions of section 36 of the State Bank of Pakistan Act, 1956, provide:
"36. Cash reserve of scheduled banks to be kept with the Bank.--(1) Subject to subsection (2) every scheduled bank shall maintain with the bank a balance the amount of which shall not at the close of business on any day be less than five per cent of the demand liabilities and two per cent of the time liabilities of such bank in Pakistan.
(2) ................................................. .
(3) ..............................................................
(4) If at the close of business on any day before the day fixed for the next return under the preceding subsection, the balance held at the Bank by any scheduled bank is below the minimum fixed by subsection (1) or varied under subsection (2), such scheduled bank may be ordered by the bank to pay to the Bank:--
(a) in the case of its liabilities assumed on basis other than profit and loss sharing, in respect of such day penal interest at a rate three per cent. above the bank rate on the amount by which the balance with the Bank falls short of the fixed minimum, and if on the day on which the next return is due such balance is still below the fixed minimum as disclosed by this return, the rate of penal interest may be increased to a rate five per cent. above the bank rate in respect of that day and each subsequent day on which the balance held at the Bank at the close of business on the day is below the fixed minimum; and
(b) in the case of its liabilities assumed on the basis of profit and loss sharing, in respect of such day a penalty at a rate that may be prescribed by the Bank from time to time on the amount by which the balance with the Bank falls short of the fixed minimum, and if on the day on which the next return is due such balance is still below the fixed minimum as disclose by this return, the penalty may be increased by twenty-five per cent. in respect of that day and each subsequence day on which the balance held at the Bank at the close of business on the day is below the fixed minimum."
10. Section 36(4) indicates that for violation ofthe provisions of section 36(1) two different kinds of liability may be incurred by a scheduled bank. Where liability is assumed on the basis of profit and loss sharing "penalty" would be imposed in case of each violation, but in case liability is assumed on the basis other than profit and loss sharing, "penal interest" would be charged. But in both the cases, the object to be achieved appears to be the same as the provisions are meant to operate as a deterrent to prevent any fall in the level of credit balance required to be maintained by the schedule banks. However, whether liability is incurred in the form of penalty or in the form of penal interest, the main question, would be, whether such payments were closely related to the business of the respondents. In the present case, the expenditure on account of penal interest was necessitated because of the failure of the respondents to maintain the required level of their credit balance. Such expenditure therefore, was not incurred in the normal course of business of the respondents but it was in the nature of penalty.
11. Mr. Iqbal Naeem Pasha has, however, argued for respondent Citi Bank that, the said respondent had not claimed any deduction under section 10(2)(xvi) but such deductions were claimed by it under section 10(1) from the income itself. According to the learned counsel, even income tainted with illegality is assessable because it is the profits, and not the gross receipts, that are taxable. It is pertinent to point out that the question, whether deductions were allowable to the said respondent under section 10(1) or section 10(2) of the Income-tax Act, 1922, does not appear to have been earlier raised on its behalf either before the High Court or before this Court when leave was granted to the respondents in this case. In fact, leave was granted only onthe question, whether the said expenditure was deductible under section 10(2)(xvi). However, in any case, the question raised by the learned counsel in no manner can advance the case of the said respondent because even if deductions are claimed under section 10(1) the question to be determined would still remain the same. As has been pointed out earlier, the payments made by the respondent were in the nature of fine, therefore, in any case, they cannot be held to have been laid out wholly or exclusively for the purpose of its, business. Therefore, it cannot be excluded as allowable expenditure for the purpose of determining profits or gains of the business carried on by the said respondent. Consequently, such expenditure appears to` have been rightly excluded by the Income Tax Officer from the deductions claimed by the respondent.
12. In the result, the appeals are allowed and the judgment of the High Court is set aside. The parties are, however, left to bear their own costs.
M.B.A./C-36/SCAppeals allowed.