I.T.As. Nos. 2983/LB and 3901/LB of 2001, decided VS I.T.As. Nos. 2983/LB and 3901/LB of 2001, decided, 2002 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 1997 (2002)

Income Tax Ordinance (XXXI of 1979)‑‑‑

‑‑‑S. 23(1)(vii)‑‑‑Deductions‑‑‑Interest on short term borrowings used for purpose of business‑‑‑Loan/advance was given to the sister concern by the assessee from his own sources‑‑‑Disallowance of interest paid on short term borrowing proportionately to the amount paid to the sister concern as loan/advance‑‑‑Validity‑‑‑Bank loan obtained by an organization for the purpose of a particular business if utilized in the same spirit, interest paid on the said amount becomes an allowable expense ‑‑‑Assessee had advanced loan to the sister concern but it had got nothing to do with that of the Bank advances‑‑‑Entire amount of loan had been utilized for the assessee's own business and the eventuality which could disentitle him did not exist‑‑‑Requirement of law was that the loan should have been obtained for the purpose of business and it should have been invested for that purpose‑‑‑Interest paid in such circumstances thus become had allowable deduction‑‑‑Observations that capital had not generated profit, or assessee himself had enough capital or he was not in need of loan from Bank or he had given loan to some other company from his own sources without interest or at a lesser interest, all were alien to the requirements of law‑‑‑Assessing Officer's entire exercise revealed that assessee was not prudent businessman‑‑‑In converse position, where borrowed capital had not been utilized and the business had been conducted with own resource the claim of‑interest would be disallowed‑‑‑Facts of present case did not warrant any proportionate disallowance ‑‑‑Assessee had utilized the entire amount of short term Bank loan for the purpose of business and the money he lent to the sister concern had no nexus with the capital he borrowed from the Bank‑‑ Disallowance of interest claimed under the head "Financial Expenses" was without any reason and the same was deleted by the Tribunal.

1995 PTD (Trib.) 677; 1986 SCMR 968 and Margalla Textile Mills Ltd.'s case I.T:A. No. 134 of 1998 ref.

Packages Limited v. CIT (1993) SCC 107; 1986 SCMR 968; 1995 PTD (Trib.) 677; CIT v. Pakistan Industrial Engineering Agencies Ltd. (1962) Tax 136 (SC Pak). 1991 PTD 53; 1957 PTD 147; 1987 PTD 149; 1984 PTD 341; PLD 1957 (W.P.) Pak. 130; CIT v. Pudukothai 84 ITR 788; East India Industries v. CIT 31 ITR 803, Birla v. Commissioner of Income‑tax 58 ITR 462; Amna Bai v. Commissioner of Income‑tax 51 ITR 135 and Rawkishan v. Commissioner of Income‑tax 56 ITR 723 rel.

Muhammad Iqbal Khawaja and Faisal Iqbal, F.C.A. for Appellant.

Muhammad Asif, D.R. for Respondent.

Date of hearing: 12th January, 2002.

ORDER

KHAWAJA FAROOQ SAEED (JUDICIAL MEMBER).‑‑‑This appeal has been filed by the assessee. Brief facts of the case are that the appellant is a public limited company that derives income from spinning of cotton‑yarn. The appeals are directed against the additions made in Profit and Loss Account in assessment years 1997‑98 and 1998‑99. Up till 26‑2‑1996, the appellant was allowed exemption under clause (118D) of the Second Schedule read with section 14 of Income Tax Ordinance, 1979 arid in this way the appeal for assessment year,1996‑97 relates to period 26‑2‑1996 to 30‑9‑1996. The position of Profit and Loss Account expenses claimed and disallowed is as under as agitated in the appeals:‑‑‑

Assessment year 1998‑99:

The breakdown of financial expenses as discussed in the order for both the years is as under:‑‑

The disallowance was, made out of short‑term borrowing on the basis of following formula in the years under appeal:‑‑

Total interest on short‑term borrowing x Amount advanced to sister concern.

Total amount of short‑term borrowing.

Assessment Year 1997‑98:

3,34,25,342 x 3,10,55,505=1,41,15,967

7,25,09,309

Assessment year 1998‑99:

2,92,23 095 x 3,16,28,409=1,49,95,998

7,49,23,245

Before Commissioner of Income Tax (Appeals), the appellant's case on this point was, rejected and no relief was allowed.

The appellant submitted that the additions out of financial expenses on the basis of a formula are not maintainable on the following factual as well as legal grounds:‑‑‑

That no bank borrowing was even advanced to the sister concern and it has wrongly been observed by the Deputy Commissioner of Income Tax and later on approved by the Commissioner of Income‑tax (Appeals). To support his submission he submitted that the short‑term borrowing of Rs.7,25,09,309 for assessment year 1997‑98 was invested in stores and spares of Rs.1,04,54,420 stock in trade of Rs.2,82,61,590 and trade‑debtors relating to export sales of Rs. 5,26,85,629.

Likewise appellant submitted that in assessment year 1998‑99 short term borrowing of Rs:7,49,23,245 was invested in store and spares at Rs.1,26,45,862 stock in trade Rs.337,62,206 and trade‑debtors relating to the export sales Rs.4,31,14,736.

The appellant further explained the nature of the short‑term borrowings and said that they are restricted loans and always change with the changing positions of current assets i.e. stock‑in‑trade, store and spares and trade debtors relating to exports. They cannot be utilized against any other activity.

This way the A.R. wanted to‑impress that loan to sister concern was from their own sources. The breakdown of own sources available with the company was explained from the Balance Sheet in the following manner:‑‑

Assessment Year 1997‑98

Assessment Years 1998‑99

It was stated that the above working clarifies that the appellant was fully capable of advancing the abovementioned amounts to the sister concern through his own sources and bank borrowing was utilized for other purposes. He further submitted that even Deputy Commissioner of Income Tax never pointed out any bank borrowings on any specified date his entire addition is based on stereotype formula, which is not a proper base. Law does not put embargo on advancing loan to a sister concern. Further, the higher Courts have disagreed with such disallowances in the identical circumstances: He referred to following case‑law to support his arguments:‑‑‑

1995 PTD (Trib.) 677 Income Tax Appellate Tribunal; (1986) 53 Tax page 122 Supreme Court of Pakistan and (I. T. A. No. 134 of 1998 Lahore High Court, Lahore. In case of Margala Textile Mills Ltd.

In all the cases, it was unanimously held that no disallowance under head financial expenses could be made when the loan or advance made was out of personal finances/own resources.

Regarding other add backs the position is as follows:‑‑‑

Head of account. Assessment year 1997‑98 CIT(A) Assessment year 1998‑99 CIT(A) Claimed Disallowed action Claimed disallowed action

The A. R. said that all these addbacks are ad hoc in nature. No specific example is quoted under any head of account. Only stock phrases were used for disallowance. Alternatively, the A.R. submitted that addbacks are excessive and should be reduced according to the nature and volume of the business.

The learned D.R. on his turn .said that if the assessee had availability of finances there was no fund in obtaining loans from banks. Moreover, it is quite surprising that he is paying interest on the loans while he is not charging it from the sister concerns. This he said is against normal business prudence. No business house can afford to make such a transaction, which results in disadvantage to his business and to benefit to some other concern. Furthermore, he remarked that the Assessing Officer has only proportionately disallowed which is not of any disadvantage to the company as the sale is allowable to other company. He also said that the assessee has not brought these facts to the notice of the Assessing Officer otherwise he would have further dilated upon the issue. Regarding A.R.'s contention .that this‑addition has been made without giving a formal notice under section 62(1) he said that it was a normal assessment and was made after proper confrontation on various issues vis‑a‑vis books of accounts. He said that a notice under section 62, dated 23‑4‑1999 was issued which dealt with all related matters in this case. The addbacks he said have been made after separately discussing each and every claim and the disallowance besides being as per history has also been made by determining its verifiability. He brought out attention to the assessment order wherein the Assessing Officer while making the addbacks in the financial expenses has observed as follows:‑‑‑

"Total financial expenses of Rs.59,138,073 are claimed by the Company, out of which mark‑up on short term finance amounting to Rs. 31,628,409 it is noticed that out of total short term borrowing of Rs.74,923,245 and Rs.29,523,095 have been passed to associated undertaking and no interest is charged from the associated concern. Since to that extent loan has not been utilized for the purpose of business of the assessee hence interest claimed is also disallowed in the same proportion."

Regarding calculations given by the learned A.R. he said that the same is not correct. Even otherwise if the same in the opinion of the assessee is a miscalculation, he could have got it ratified through an application under section 156. He, therefore, strongly supported the order of the subordinate officers.

We have gone through the relevant record and have also heard both in detail. It is true that the Assessing Officer had done some effort but the order of the First Appellate Authority on this subject is very sketchy. It is a non‑speaking order and on the point of addbacks the order is as follows:‑‑

"Keeping in view the facts of the case, the additions made under the following heads have been found to be justified and reasonable, hence confirmed.

Perusal of assessment order indicates that the DCIT has made additions out of the expenses claimed under the certain heads, but the figures of expenses claimed by the appellant have not been recorded.

From the above it, is quite apparent that the First Appellate; Authority has not given any heed to the arguments of the either side. He has confirmed the addbacks in a very slipshod manner. In this regard the, findings from the judgments referred have been ignored. The Supreme Court of Pakistan in the case of Packages Limited v. CIT reported (1993) SCC 107 while deciding". Whether in the facts and circumstances of the case the Appellate Tribunal was justified in not allowing the sum of Rs.1,47,668 being interest on loan taken for import of certain machinery, under section 10(2) (iii) of repealed Income‑tax Act, 1922". Held as follows:‑‑

"Lastly we are not persuaded to agree with the contention of Mr. Shaikh Haider that case of Khairpur Textile Mills (supra) is distinguishable for the reason that it was a case of running business because in the instant case also facts clearly show that assessee was having running business when he obtained loan for the purchase of additional machinery in support of the contention reliance by the learned counsel on the case of Commissioner of Income‑tax v. Pakistan Industrial Engineering Agencies Ltd. (1992) 66 Tax 176 (S.C. Pak) + 1992 PTD 954 is inapt for the reason that case is distinguishable and proposition enunciated therein is different to the effect whether assessee is entitled to allowance under section 10(2)(iii) of the Income‑tax Act of 1922, when Tribunal refused such allowance on the ground that assessee had surplus deposit amounts and further observation was made that no prudent businessman would keep a loan and pay higher interest while receiving a lesser amount of interest of his deposits. It was held by this Court that by making such observation and without giving any finding that the amount was not borrowed and employed or utilized for business purposes the conclusion drawn by the Tribunal was based on mere surmises and conjectures.

For the facts and reasons mentioned above, impugned judgment of the High Court is set aside and so far as reference by the Tribunal to the High Court is concerned, the finding on the question so referred as given by the High Court is reversed and is answered in the negative. Appeal is allowed and there will no order as to costs."

In 1986 SCMR 968 the SC has given a similar finding. It has been held therein that the test for allowance of expense is that the loan should be held for the purposes of earning profit and thus if expenditures are incurred on the job for which it is obtained the fact that assessee gave loan to someone else from his own source becomes immaterial.

The moot point, therefore, is that the bank loan obtained by an organization for the purpose of a particular business if utilized in the same spirit interest paid on the said amount becomes an allowance expense. In this case it has been stated that the amount advanced to sister concern had no relationship with the amount received by the, assessee. He has also pointed out from accounts that the amount of short‑term loan is lesser than the capital involved in business. The figure of stores and spares note‑12, stock in trade, note‑13. Trade Debtors, Note‑14, amounting to Rs.1,26,45,862 Rs.3,37,62,206 and Rs.4,31,14,736 for 1998‑99 and Rs.1,04,54,420, Rs.2.2,61,590 and Rs.5,26,85,629 respectively for 1997‑98. The total of which for 1998‑99 comes to Rs.8,95,22,804 and for 1997‑98 Rs.9,14,01,639 respectively. This amount is more than the short term running finance of Rs.7,49,23,245 as on 30th September, 1997 and Rs.7,25,09,309 as on 30th September, 1998. This means that the capital involved in business even for these three items is more than the total amount of short‑term finance. The obvious conclusion from these figures is that the assessee money involved in his own business is much to higher than the short term running finance for both the years. Keeping this fact in view if we go through the findings of the judgment now referred as 1986 SCMR 968 the ratio is as follows:‑‑‑

"It seems that according to the above provision an assessee is free to carry on a business with his own capital or from money borrowed from any bank or other financial institution and it is only in case where the assessee chooses to run his business with borrowed capital that he would be entitled to deduction in respect of amount paid for and on account of interest. Thus, the only eventuality which might disentitle an assessee to claim deduction of the whole or any part of interest is where the amount is not shown to have been used as capital in the business carried on by the assessee. In this case, the entire account including the cash book and the bank accounts were before the Income‑tax Officer who completed the assessment under subsection (3) of section 23 but he failed to show that any part of the borrowed money was not used in business and was diverted to the personal use of Mian Aziz A. Sheikh. Indeed, a finding of fact has been recorded by the Tribunal that the whole of the capital which was borrowed was used for the purposes of the Company. It appears that no provision exists in the Income‑tax Act, 1922 to prevent a company, from advancing money to a Director or shareholder which could operate as a bar to the making of advances by companies to their Directors."

Above para. seems to be applicable on all fours on the facts and circumstances of this case. In this case the assessee has advanced loan to sister concern but it has got nothing to do with the bank advances. The entire amount of loan has been utilized for the assessee own business and the eventuality which could disentitle him does not exist in this case. In this regard further mentioning 1995 PTD (Trib.) 677 is also of relevance. The ITAT after putting reliance upon the CIT v. Pakistan Industrial Engineering Agencies Ltd. (1962) Tax 136 (SC Pak), 1991 PTD 53, 1986 SCMR 968 and 1957 PTD 147 wherein above mentioning criteria has been followed held:

"Considering the criteria laid down by the Honourable Supreme Court in the above case that assessee would be entitled to claim allowance under this provision if it satisfied that‑‑‑

(1) assessee had borrowed capital;

(2) such borrowed capital was for the purpose of business and the interest has been paid on such borrowed capital.

It is also pertinent to mention here that in the earlier years no such disallowance was made by the ITO. Considering these facts we are of the view that the disallowance made by the ITO under this head was not justified and it is deleted accordingly.

The provision that entitles or disentitles an assessee eve otherwise is also clear in its application. Though above judgments have clarified these situations in a very comprehensive style, yet the mentioning of relevant section shall be of help. It says:‑‑‑

S.23., Deductions. ‑‑‑(1) In computing the income under the head Income from business or profession', the following advances and deductions shall be made, namely:‑‑

(vii) any interest paid in respect of capital borrowed for the purpose of the business or profession

The requirement of law, therefore, is that the loan should have been obtained for the purpose of business. The test (as already laid by various judgments is that the capital borrowed should be invested for the purpose i.e. business for which it has been obtained. Interest paid in such circumstances thus becomes allowable deduction. In this regard the observations that the capital has not generated profit, or assessee himself had enough capital or he was not in need of loan from bank or he had given loan to some other company from his own sources without interest or at a lesser interest, all are alien to the requirements, provided in the above provision. The Assessing Officer's entire effort revolves against his advisability and possible conduct of a prudent businessman. He has failed to take notice that law does not put any such embargo. Out observation finds further strength from the fact that in converse position i.e. where borrowed capital has not been utilized and the business has been conducted with own resource the claim of interest is disallowed.

If the loan amount has been put in F.D. Rs. and the surplus funds have been utilized for purposes of business than clearly the assessee is not entitled to the deductions under section 10(2)(iii) because he has used his own funds and not the borrowed funds for the purpose of business. On this view of the matter also the assessee claim must fail on account of lack of identity of funds for which the exemption is claimed. This extract is from 1987 PTD 149 after reliance on 1984 PTD 341 and (PLD 1957 (W.P.) Pak. 130).

Further, in CIT v. Pudukothai 84 ITR 788, it was held that mere charging of interest at a lower rate on the money earned by the assessee is not sufficient to disentitle an assessee from claiming allowance under section 10(2) (iii). In East India Industries v. CIT 31 ITR 803, Birla v. Commissioner of Income‑tax 58 ITR 462, it was observed that in case of genuine business borrowing the department cannot disallow any part of the interest on the ground that the interest is unreasonably high. In Amna Bai v. Commissioner of Income Tax 51 ITR 135. it was observed that if the assessee has enough funds the same could not be made a ground for rejection that he needed no borrowing. Similar view was expressed in Rawkishan v. Commissioner of Income‑tax 56 ITR 723.

Above discussion, therefore, leaves no doubt that the facts of the present case did not warrant any proportionate disallowance. The assessee had utilized the entire amount of short‑term bank loan for the purpose of business and the money he lent to sister concern has no nexus with the capital he borrowed from the bank. The question of disallowance, of interest claimed under the head Financial Expenses for both the years, therefore, is without any reason the same is hereby deleted.

Coming to the other addbacks, we have gone through each one of them separately and have compared the same with the previous year. So far as the issue of unvarifiability is concerned it has not been argued very seriously except that it is all on ad hoc basis and against the history.

On the other hand the learned D.R. has supported the order of the CIT and said that the relief wherever available has already been allowed. Our feeling is that except for the head of Traveling and Conveyance for the assessment year 1998‑99 wherein the assessee claimed Rs.6,85,152 as against last year at Rs.8,41,847. The addback of Rs.3,00,000 as against Rs.2,00,000 respectively is quite excessive. We, therefore, deem it more appropriate to reduce the same to Rs.1,75,000. On all other heads for both the years the action of the C.I.T. is confirmed

C.M.A./M.A.K./293/Tax (Trib.)Order accordingly.