I.T.As. Nos. 443/LB and 605/LB of 2000, decided on 3rd January. 2002. VS I.T.As. Nos. 443/LB and 605/LB of 2000, decided on 3rd January. 2002.
2002 P T D (Trib.) 1000
[Income-tax Appellate Tribunal Pakistan]
Before Inam Ellahi Sheikh, Chairman and
Muhammad Tauqir Afzal Malik, Judicial Member
I.T.As. Nos. 443/LB and 605/LB of 2000, decided on /01/.
rd
January. 2002. (a) Income-tax---
----Method of accounting---Change of---Rejection of changed method of accounting---Validity---Assessing Officer could not reject the change in the accounting policy simply because he had found the same to be against the interest of the Revenue.
1992 S C M R 763 ref.
(b) Income-tax---
----Addition---Interest/mark-up in respect of subsidiary company-- Assessee had not charged any interest thus, there was no real income ;accruing to the assessee---Deeming provision, under which such interest could be calculated, `shad already been withdrawn from the relevant Statute---Income could not be deemed to have been earned without specific provisions of the law----Addition was deleted by the Tribunal.
(c) Income-tax---
Financial charges---Notional charge of interest---Interest on capital work in progress---Disallowance of---Validity---Addition had been made in respect of notional charge of interest---Fact that assessee had invested his own funds in the capital work in. progress had not been examined at the assessment stage---Matter was remanded to Assessing Authority by the Tribunal with the direction that assessee should be provided proper Opportunity to substantiate the claim that no borrowed funds were involved.
1993 P T D 758 = 1993 S C M R 1224 distinguished.
(d) Income-tax---
--Addition---Suppressed production---Providing no opportunity to explain----Validity ---Declared production is subsequent years had been accepted----Issue regarding suppressed production required further examination at the assessment stage and the same was set aside by the Tribunal on the ground that no addition could be made without confronting the assessee with the same.
(e) Income-tax---
-----Charity and donation---Disallowance---Issue was set aside by the Tribunal since assessee was not confronted with the same.
Syed Aftab Hameed, F.C.A. for Appellant (in I.T.A. No. 443/LB of 2000).
Muhammad Asif, D.R. for Respondent (in I.T.A. No. 443/LB of 2000).
Muhammad Asif, D.R. for Appellant (in I.T.A. No. 605/LB of 2000).
Syed Aftab Hameed, F.C.A. for Respondent (in I.T.A. No. 605/LB of 2000).
Date of hearing: 21st December, 2001.
ORDER
INAM ELLAHI SHEIKH (CHAIRMAN).---These two cross appeals arise out of an order, dated 17-11-1999 recorded by the learned Commissioner of Income-tax (Appeals), Zone-II, Lahore in the case of a public limited company deriving income from manufacturing of Safety Razor Blades and Soap. The common grievance of both the parties is that the learned Commissioner of Income-tax (Appeals) should not have set aside the issue of retirement benefit. In addition the assessee is aggrieved against the disallowance of interest relating to capital work in progress and charging of interest on balance due from subsidiary company. The department on the other hand is also aggrieved. Against the deletion of addition made on account of allegedly suppressed production and addition in respect of charity and donation.
2. The relevant facts in brief are that the assessee filed a return to show the income at Rs. 58.035 million. The assessee declared the follow ing trading result as compared with the immediately preceding year:---
| | 1998-99 (Fig in thousand) | 1997-98 (Fig in thousand) |
| Sales Net | 774,267 | 695,208 |
| Cost of Sales | 589,829 | 580,655 |
| Gross Profit | 184,438 | 1,141,553 |
| G.P. rate of the Dep. | 23.82% | 16.48% |
| G. P. rate before Dep. | 26.15 % | 18.78 % |
3. The Assessing Officer probed the production declared by the assessee. The assessee was asked to furnish the parameters of carbon/ stainless steel blades and length of steel strip per Kg. which was furnished as under:--
Length of Steel Strip Per Kg. of Steel
Carbon Steel (1300 + 20 * 1.682) = 2200 inches
Stainless Steel (1300 + 20 * 1.682) = 2200 inches
4. The assessee was asked to provide the Assessing Officer with one Kg. Steel Strip to verify the Parameter of production given by the assessee. Such Strip was .provided and when weighed it was found to be 950 grams and not one Kg. whereas the length of the strip was found 2212 inches. Thus the Assessing Officer concluded that one Kg. of the strip would produce 2328 inches and he confronted the assessee with this discrepancy and also proposed to calculate the production on the basis of such physical measurement. The reply of A.R. of the assessee, dated 31-5-1995 has been reproduced in the impugned assessment order in the following manner:
1. The assessee never claimed the stainless steel strip to be exactly of 1 Kg. The truth of the matter is that the assessee imports stainless steel from different renowned suppliers of the world in the form of coils, which are received in its store as sealed and packed in drums. The weight of the coil in different lots ranges from approximately 18 to 34 Kgs. per coil. When you specifically demanded 1 Kg, stainless-steel strip from the assessee, they took one -of the stainless-steel coil and separated approximately 1 Kg. strip from it by measuring it on an ordinary scale of 500 Kgs. You would appreciate that measuring exactly 1 Kg. steel strip from a coil of approximately 18 to 34 Kgs. is practically impossible. The strip of approximately 1 Kg. was wrapped by the assessee on a plastic coil and was produced before you. Please note that the heavy ordinary manual scales usually have a tolerance level of 100 grams.
2. The assessee never claimed an approximately 1 Kg. stainless steel strip to be exactly of 2200 inches. You would appreciate from the information submitted by the assessee that it has provided the following equations to measure the average length of approximately 1 Kg. stainless steel strip:
Number of blades produced * length of blade = Average length of approx. 1 Kg. steel strip with tolerance.
(1300 + 20 1.682) = 2200 inches
Variable * Constant = Variable
5. This reply for the assessee did not convince the Assessing Officer and he found a difference of 75 blades per Kg. in the production and, over the consumption of 45665 Kgs., the additional production was computed at 34,474,875 blades. The Assessing Officer computed sale value of such additional blades at Rs. 37,838,893 which was added to the income of the assessee.
6. An addition of Rs. 29,495,000 was made to the income of the assessee in respect of provision for staff retirement scheme in the following manner:---
Provision for Staff Retirement Scheme
Note No. 2.2(C)
During the year under consideration the assessee made provision of Rs. 2.9,495,000 for cumulative liability for staff retirement benefits, and the same was charged to Revenue. It was stated that the provision was due to change in company's accounting policy this year. Since the change in accounting policy is against the interest of revenue and the same is aimed at depriving the department of its due revenue by minimizing the taxable profit, the assessee was asked to explain as to why this provision should not be disallowed, the explanation offered by the assessee through his A.R's. letter, dated 21-5-1999 has been considered and found to be not convincing. The assessee has referred to decision of the Supreme Court reported as 1992 S C M R 763. The facts of the case quoted by the assessee are different. The provision of cumulative liability for staff retirement benefits due to change in accounting policy is, therefore, disallowed and the amount of Rs. 29,495,000 is added to assessee's income.
7. An addition of Rs. 3,132,250 was to the income of the assessee in respect of the amount due from the subsidiary company in the following manner:---
Interest/Mark-up (Note No. 8)
As per balance sheet, an amount of Rs. 18,425,000 was due from subsidiary company as on 30-6-1998. No interest or mark-up has been offered as income. On the other hand, scrutiny of final account shows that interest/mark-up amounting to Rs. 3,754 thousand has been charged to financial expenses on loan from director and others @ 17 %. When confronted in this regard the assessee contended that amount due from subsidiary company represents the balance receivable on account of trading transaction. The assessee further contended that they have discontinued charging interest from subsidiary company. The explanation offered by the assessee is not acceptable in view of the facts of the case and interest @ 17% charged on Rs. 18,425,000 which come to Rs. 3,132,250.
8. A further addition of Rs. 2,136,680 was made to the income of the assessee by computing the interest at 14% on the amount of capital work in progress shown in the accounts. Various other additions and add backs were made of which an addition of Rs. 167,000 in respect of charity and donation is in dispute before us.
9. The learned Commissioner of Income-tax (Appeals) vide the impugned order deleted the addition on account discrepancy in production and set aside the disallowance of staff retirement benefit whereas the interest/mark-up in respect of subsidiary company as well as capital work in progress was confirmed. The disallowance and donation was deleted.
10. The parties have been heard and the relevant orders perused. The appeals are decided in the following manner.
Provision for Retirement Benefit:-
11. The learned A.R. of the assessee has strongly argued that the assessee has made provision against a definite and ascertained liability -against the potential expenditure of staff retirement benefit payable under an agreement with the Union. It was further submitted that the assessee had to make this provision in order to comply with the International Accounting Standard IAS-19 according to which every entity is required to provide for the potential liability in respect of retirement benefits payable to its employees as per its scheme. It was further submitted that the assessee had not been making any provision in the past and such retirement benefits had been charged off to accounts on payment basis. However, in view of the induction of IAS-19, it had become mandatory for the Company to make this provision, it was argued. Our attention has been drawn to Note 2.2(c) of the accounts for the year under consideration which reads is follows:
"(c) Staff retirement scheme.---The Company has a retirement scheme for all its permanent employees who attain the age of 60 and have at least 10 years of service with the company. The Company has changed its policy with respect of accounting for the staff retirement scheme from the current year. Up to the previous year, the company was charging amounts under this scheme to the profit and loss account as and when paid, however, from the current year, the company will make provision annually to cover its obligations under the scheme. In the current year, the company has made provision for the cumulative liability to date under this scheme, i.e. Rs. 29,495 million."
12. A copy of the agreement with the C.B.A. was also produced and also working of the provision of staff retirement benefits. A comparison of these, however, shows the provision was not strictly in accordance with the agreement. In the agreement, the retirement benefit, i.e., gratuity is payable on the basis of basic wages whereas the provision has been made by including cost of living allowance and dearness allowance as well as increment. The learned A.R. of the assessee has also objected to the observation of the Assessing Officer in which he has indicated that this change of accounting policy was against the interest of the revenue. The plea of the learned A.R. of the assessee is that this is no basis for making disallowance. The learned A.R. of the assessee has also drawn our attention to a decision of apex Court reported as 1992 S C M R 763 which was also produced before the Assessing Officer. The Assessing Officer has, however, rejected this decision holding that the same is op different facts, without pointing out the differences. A perusal of such order of the apex Court shows that the facts may be different, yet the principle is same. In that case the Assessing Officer had allowed gratuity on actual payment basis whereas the unpaid amount had been disallowed and the High Court had allowed such provision which order was upheld by the apex Court. In the present case the question is of a provision which has been rendered necessary by the introduction of IAS-19. It was further submitted that all the International Accounting Standards are binding on the public companies according to the Companies Ordinance. The learned D.R., on the other hand, has submitted that the agreement with C.H.A. was not produced before the Assessing Officer. The learned D.R. also submitted the provisions are not generally allowable in the presence of the provision of section 24(c) of the 1979 Ordinance. Since this issue was not considered by the DCIT, we refrain from giving our finding on the same. Hence the Assessing Officer could not reject the change in the accounting policy simply because he has found the same to be against the interest of the revenue.
13. Considering these facts, we direct the Assessing Officer to accept the change in accounting policy. However, he may examine the provision in the light of the agreement mentioned above and also other provision of the law before deciding this issue. The Assessing Officer should re-examine the claim in the light of the above decision.
Interest/mark-up in respect of the subsidiary company
14. Messrs Zulfiqar Industries Limited is a subsidiary company of this assessee and owed a sum of Rs. 18,425,000 to the assessee as on 30-6-1998 on which no interest has been charged. The Assessing Officer has found that the assessee has charged interest on loans from Directors and other at 17% whereas no interest has been charged on the balance due from the subsidiary company. The assessee has explained that the balance presented the trading transactions. The learned A.R. of the assessee has submitted that the balance is in the account which is in the nature of a current account in which various payments, made on behalf of the subsidiary company, are charged. It was further submitted that the assessee did not find it expedient to charge interest in view of the losses suffered by the subsidiary company. It was conceded by the learned A.R. that the company had been charging interest on this account up to the preceding year. The learned A.R. of the assessee has also submitted that there was no provision in the law requiring the assessee to charge interest on this balance nor there was any provision in the income-tax law which empowered the Assessing Officer to charge such interest. The learned D.R. on the other hand supported the order of the Assessing Officer with the submission that the assessee could not be allowed to divert the profit to the subsidiary company and also that the charge had been made by the Assessing Officer in view of the history of the case. However, the learned D.R. could not point out any specific provisions of the law under which such interest could be added to the income of the assessee. There is no dispute over the fact that the assessee has not charged any interest on such balance during the year under the consideration. Thus there is no real income accruing to the assessee. A deeming provision, under which such interest could be calculated, has already been withdrawn from the statute. Income could not be deemed to have been earned without specific provisions of the law. In these circumstances the order of the departmental officials on this issue are vacated and the addition is deleted. The assessee's appeal is accepted on this issue
Interest on capital work in progress
15. The learned A.R. of the assessee has conceded that the treatment accorded by the Assessing Officer was as per past practice, which had been accepted by the assessee. It was also conceded that in the assessment year. 1992-93 the assessee had filed an appeal on this issue before the First Appellate Authority which had been dismissed, albeit, summarily. However, the plea of the learned A.R. is that there was no estoppel in the law on this issue. The learned A.R. of the assessee also submitted that the apex Court has recently allowed such financial charges in similar consideration in the case of Packages Limited, reported as 1993 PTD 758 = 1993 SCMR 1224. The learned A.R. of the assessee has also submitted that the capital work in progress was not meant for the expansion of the capacity but for the improvement of the existing production facility. Thus, according to the learned A.R. of the assessee had a good case for deletion of such financial charges.
16. The learned D.R. on the other hand supported the orders of the departmental officials in view of the history of the case which according to the learned D.R. constituted a consent of the assessee to the treatment given. The learned D.R. also submitted that the case of Packages Limited was distinguishable as in that case the machinery had been imported by that assessee and use for production purposes and not as capital work in progress.
17. A. perusal of the order of the Hon'ble Supreme Court of Pakistan in the case of Packages Limited (supra) shows that one of the questions considered by the Hon'ble Supreme Court of Pakistan was whether there was any question of pre-production stage arose and it was held that it was not so. In the present case the classification of the expenditure prima facie is of pre-production storage. However, in that case a loan had been obtained for the installation of the machinery, which is not the case before us. The Assessing Officer has simply allocated a part of the financial charges incurred by the assessee on the loans taken from the Directors etc. In the case of Packages interest had actually been incurred by the assessee whereas in the present case an addition has been made in respect of notional charge of interest. The assessee has a history of addition on this account. Another plea of the learned A.R. before us is that the assessee has invested his own funds in the capital work in progress. Thus, there is a claim of the learned A.R. of the assessee that no addition could be made in respect of financial charges. This aspect of; the case has not been examined at the assessment stage. In these circumstances we deem it appropriate to set aside this issue and remand the matter back to the assessing for examination. The assessee should be provided proper opportunity to substantiate the claim that no borrowed funds were involved.
Alleged suppressed production
18. The facts under which the addition was made have already been summarized in Paragraphs 3, 4 and 5 of this order. The learned Commissioner of Income-tax (Appeals) deleted this addition with the following observations:
"The facts of the case, basis of estimated production, submissions made by the appellant at the assessment stage and detailed arguments/documents furnished, the process explained with process-flow diagram have been considered. From the facts of the assessment order and of company briefly discussed above one thing, which clearly emerges, is that the Assessing Officer did not examine the records of the Company. He even did not go into the details of the production process and supporting record before rejecting the same. He proceeded on an idea to ascertain the production but did not examine the hire process in detail.
As a result he believed hypothetical working more than the facts of the production duly supported by the records maintained by the Company. Besides this the action of the Assessing Officer is defective firstly as he did not confront the appellant on the basis of rejection of explanation submitted by them in response to notice under section 62 and secondly he lost sight of the wastage average scrap during the production process. The Assessing' Officer has also not rejected the accounts of the Company as such. After examining the facts of the increase in turnover and almost a quantum jump in the gross profit rate the Assessing Officer could not ignore the facts of the accounts supported by the books, records and past history."
19. The learned D.R. has strongly objected to the observations of the learned Commissioner of Income-tax (Appeals) with the submission that the assessee was duly confronted with the discrepancy in the production as noted by the Assessing Officer. It was further submitted that the assessee had itself provided the steel strip claiming the same to be of one Kg. and of the specific measurement it was not the matter of fact. Thus, according to the learned D.R. the Assessing Officer was fully justified in making the addition on account of the suppressed production. The learned A.R. of the assessee on the other hand submitted that the Assessing Officer did not confront the assessee with the quantum of addition he wished to make. It was also submitted by the learned A.R. that the Assessing Officer did not take necessary factors into the accounts such as scrap and wastage. Another plea of the learned A.R. of the assessee is that the trading results have always been accepted and even in the subsequent two years such results have been accepted and no addition on account of discrepancy in the production has ever been made in the past or in the subsequent years. The learned AR of the assessee further submitted that the assessee was always trying to improve the production results and cut down on the wastage and for that purpose the assessee has recently installed UPS Unit and new machineries which have given improved results and production as well as profit.
20. The submissions of both the parties have been considered: The discrepancies in the recorded production results and those found by the Assessing Officer in actual measurement have not been denied. However, the assessee submitted that the Assessing Officer failed to consider the wastage and other element such as power break-down which result in excess wastage. It is also significant to note the declared production in the subsequent two years has been accepted. In these circumstances we feel that this issue requires further examination at the c assessment stage. Hence we set aside the orders of the departmental officials on this issue and we remand the matter back to the Assessing Officer to provide the assessee another opportunity to explain the discrepancy in the production. No addition may be made without confronting the same to the assessee. The departmental appeal succeeds to that extent.
Charity and donation
21. The learned D.R. argued that such expenditure is not admissible as straight deduction under the law and thus there was no need to issue a notice. The learned A.R. of the assessee on the other hand, emphasised that the issuance of notice was a mandatory requirement. Considering these also considering the fact that certain issues have already been set aside by us, we set aside this issue as Well and direct the Assessing Officer to confront the assessee on this issue-
22. As a result of the above discussions both the appeals are allowed partly to the extent indicated above.
C.M.A./M.A.K./214/Tax(Trib) Appeals partly allowed.