I.T.As. Nos. 1441/LB to 1444/LB of 2002; decided on 27th June, 2002. VS I.T.As. Nos. 1441/LB to 1444/LB of 2002; decided on 27th June, 2002., 2002 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 2988 (2002)

(a) Income Tax Ordinance (XXXI of 1979)‑‑‑

‑‑‑‑S.32‑‑‑Method of accounting‑‑‑Rejection of‑‑‑Inclusion of sales tax in sales in the trading account and claiming it as an expense in the profit and loss account‑‑‑Validity‑‑‑Such method of accounting was incorrect for the reason that sales tax being a Federal Government levy and the company being an agent to collect it on behalf of the Government, it could not be included in sales and claimed as expense in the profit and loss account‑‑‑By claiming it so, the assessee had deprived the Department from deducing profits and gains correctly and, therefore, Department was justified under S.32(3) of the Income Tax Ordinance, 1979 to reject assessee's method of accounting.

I.T.As. Nos.3332/LB and 3333/LB of 2001 rel.

(b) Income‑tax‑‑‑

‑‑‑‑Gross profit rate ‑‑‑Modification‑‑‑G.P. rate should be suitably modified when trading account was recast as in that situation the history of G.P. rate would lose its significance.

(c) Income Tax Ordinance (XXXI of 1979)‑‑‑

‑‑‑‑Ss.66‑A & 32(3)‑‑‑C.B.R. Circular No. 14 of 1979 dated 7‑11‑1979‑‑ Powers of Inspecting Additional Commissioner to revise Deputy Commissioner's order‑‑‑Sales tax was included in the sales in the trading account and it was claimed as an expense in the profit and loss account‑‑ Inspecting Additional Commissioner cancelled the order of the Assessing Officer on the ground that assessee had wrongly claimed sales tax in the profit and loss account as a revenue expense and inclusion of sales tax in declared sales while computing the gross profit had resulted in inflating G. P. rate‑‑‑Validity‑‑‑Inspecting Additional Commissioner was justified to take, action under S. 66‑A of the Income Tax Ordinance, 1979 against the assessment orders passed by the Assessing Officer in circumstances‑ Since the assessee had already been made to go through ordeal of long drawn process of litigation and appeals up to the Tribunal, it would be unfair to make the assessee again go through the same process‑‑ Inspecting Additional Commissioner, in the interest of justice and fair play, was directed to modify the assessment order instead of cancelling the same on the guidelines that trading and profit and loss account may be recast by excluding sales tax from the already assessed sales and by rejecting assessee's claim of sales tax in the profit and loss account as expense; that sales of the assessee including sales tax had already been accepted by the Appellate Tribunal during appeals against original assessments for the reason that the sales are verifiable, sales after excluding sales tax were not likely to lose their status of verifiability, hence sales computed after excluding sales tax should be accepted; that the assessee had allegedly declared inflated GP rate at 15.35% , 17.94%, 17.24% & 17.61% respectively for the years 1996‑97, 1997‑98, 1998‑99 & 1999‑200.0 against which GP rate was applied at 18%; after excluding sales tax from sales GP rate would drastically fall to. 1.98 % 7.26 % & 5.48%; considering that assessee's machinery was old and his case was not comparable with other cases in the lane of assessee's business, a suitably modified downward GP rate should be evolved for the years under consideration; that it should be kept in view while applying GP rate that assessee's income already assessed after appeals should not be substantially disturbed except to the extent of benefit derived by the assessee by wrong placement of sales tax in original assessments and adjustment in extra‑shift allowance and that extra‑shift or triple shift depreciation allowance should be computed proportionately in accordance with the number of days the assessee's machinery deployed in extra shift had worked‑‑‑Orders passed by the Inspecting Additional Commissioner under S.66‑A of the Income Tax Ordinance, 1979 for all the years under consideration were set aside by the Appellate Tribunal to be made afresh in accordance with the above directions.

1988 PTD (Trib.) 130; 1985 PTD (Trib.) 336; 1984 PTD 150; PLD 1992 SC 549; 1992 PTD 932; 2002 PTD (Trib.) 99; 1996 PTD (Trib.) 492; Messrs Nylex (Pvt.) Ltd. v: DCIT I.T.A. No.127 of 2000; 2000 PTD (Trib.) 1811; 1996 PTD (Trib.) 492; 1999 PTD (Trib.) 2851 and 1994 PTD 174 ref.

I.T.As. Nos.3332/LB and 3333/LB of 2001 rel.

Javed Iqbal Khan, F.C.A. for Appellant.

Ahmed Kamal, D.R. for Respondent.

Date of hearing: 4th June, 2002.

ORDER

MUHAMMAD SHARIF CHAUDHRY (ACCOUNTANT MEMBER). ‑‑‑These four appeals have been filed at the instance of an assessee for‑the years 1996‑97 to 1999‑2000‑against order passed by Range IAC under section 66A of the Income Tax Ordinance, for the said years. The assessee is a private limited company which derives income from manufacture and sale of paper and board. Appeals have been filed on the following grounds:‑‑‑

(1) x x x x x

(2)The IAC erred in invoking provisions of section 66‑A and in cancelling the assessment order framed under section 62.

(3) Without prejudice to the above, the IAC erred in holding that the 18% GP rate applied on the gross sales inclusive of sales tax and allowing sales tax separately as profit and loss expenditure, is erroneous as the same is prejudicial to the interest of revenue.

(4) Without prejudice to the above, the IAC erred in holding that GP rate of 18% confirmed on gross sales by the learned ITAT is not correct and that gross sales or net sales were never a question before the ITAT and Appellate Authorities.

(5) Without prejudice to the above, the IAC erred in holding that his action under section 66A does not constitute challenging the decisions of the ITAT in appeal for the earlier years where GP rate of 18 %, applied on gross sales has been upheld.

(6) Without prejudice to the above, the IAC erred in holding that proper profits cannot be adduced from the method of accounting regularly being employed by the Assessee.

(7) Without prejudice to the above, the IAC erred in alleging that detail of particulars required for claiming extra‑shift allowance (ESA) for depreciation was not obtained before allowing ESA depreciation which treatment is erroneous as the same is prejudicial to the interest of revenue.

2. On behalf of appellants Mr. Javed Iqbal Khan, FCA appeared and on behalf of respondents Mr. Ahmad Kamal, DR and Mr. Shahid Hussain Asad, IAC appeared. Authorized representatives of both the parties have been heard. Available records have been perused.

3. From the impugned order of the IAC it transpires that action under section 66A has been taken for the following reasons:

"(1) The assessee has .wrongly claimed sales tax in the P&L account as a revenue expense for the assessment years 1996‑97 to 1999‑00. Similarly, the inclusion of sales tax in declared, sales while computing the gross profit .has also resulted in inflated G.P. for all these years. This treatment is neither in accordance with the accounting principles nor with the procedure adopted by other similar cases of paper and board industry.

(2) It has been further observed that claim of tax depreciation under the head triple shift allowance has been allowed by the Assessing Officer without obtaining necessary documentary evidence and evaluating the same on the criteria determined by 3rd Schedule to the Income Tax Ordinance, 1979. Perusal of the record shows that assessing officers have neither requisitioned any details regarding the actual number of days for 'which the machinery was used in double/triple shift nor the assessee has furnished the same. Similarly, no detail regarding claim of extra shift allowance of new machinery installed by the company and the exact date of its coming into operation has been requisitioned."

On the above mentioned defects/discrepancies the learned IAC has proceeded to hold assessment orders passed by DCIT as erroneous and prejudicial to the interest of revenue. The same has, therefore, been cancelled and the DCIT has been directed to proceed de novo. It is against this action of the learned IAC that the assessee has come up in appeals before us:

4. The A.R. of the assessee has strongly pleaded the case of the appellant and has contested each and every objection raised by‑the IAC in the impugned order with the help of documents and multitude of case law. In brief the contentions and the arguments of the A.R. are as follows:

(i) It has been submitted that the assessee is following the method of accounting regularly since the very establishment of the present business by the company. According to the method of accounting adopted by the assessee sales tax is included in sales in the trading account and it is claimed as an expense in the profit and loss account. This method of accounting has never been objected by the department in the past. During the years under consideration this method of accounting has been followed and so the IAC cannot reject it under section 66A. According to the A.R., section 32(1) of the Income Tax Ordinance, 1979 provides that the income, profit and gains of an assessee shall be computed in accordance with the method of accounting regularly employed by the assessee. The Income Tax Ordinance, 1979 has not prescribed any particular method of accounting or format for presentation of the accounts in the case of a particular trade or business. The only criteria is that profit and gains should be deduced from the method of account followed by the assessee regularly. No discretion has been allowed by the Income Tax Department to deviate from the method regularly' followed by the assessee and to reject it and insist on re‑casting of figures to determine the gross profit. In support of this contention following case‑law has been produced:

1988 PTD (Trib.) 130.

1985 PTD (Trib.) 336.

1984 PTD 150 (High Court Karachi).

(ii) During the years under consideration the assessee included sales tax in its gross sales and claimed it as expense in the profit and loss account as per regular practice. This method of accounting sales tax was accepted by the DCIT in his assessment orders. Appeals were filed against the assessment orders before the Commissioner and then before the ITAT. The ITAT finally determined assessee's sales at the declared level and GP rate at 18% on the basis of the method of accounting adopted by the assessee. Since sales including sales tax as well as GP have been determined by the ITAT, the order of the Assessing Officer has merged into the order of the ITAT and, therefore, no action under section 66‑A can be taken by the IAC. According to the AR, section 66A(1A) debars the IAC to take action in a case on points or issues which have been the subject‑matter of appeal. Since sales and GP rate have been determined by the ITAT, IAC cannot take action on these points because it would disturb the findings of a higher appellate forum. In support of this plea the learned AR has relied on the following case‑law:

PLD 1992 SC 549 = 1992 PTD 932.

2002 PTD (Trib.) 99.

1996 PTD (Trib.) 492.

(iii) Regarding extra shift depreciation allowance the AR has referred to C.B.R. Circular No.14 of 1979, dated November 7, 1979 which explains concept of class of assets and says that action of the Assessing Officer regarding this allowance is justified which cannot be rejected by the IAC. In the view of the AR, action of the DCIT on extra shift allowance is in accordance with the C.B.R. Circular and it cannot be held erroneous or, prejudicial to the interest of revenue.

(iv) It has been also submitted by the AR that appellant's circumstances are different from those of the other assessees in this line of business. Industry was set up with a low priced second hand/used imported plant in dilapidated condition in combination with some local machinery. On operation the machinery being old and unbalanced, was very heavy on fuel and, power which resulted in a certain level of margin declared by the company. To overcome this draw back the company is continuously making additions/modification and has achieved partial improvement in this area as can be observed by the results declared over the years. Without prejudice to the above if you make a comparison of the company's result by excluding the factor of fuel and power, on which there can be no dispute of verifiability it will prove that the results are fair in the remaining factors.

(v) It is an established fact that if trading account is re‑casted by the department, then the GP rate applied as per history of the case would become irrelevant. In that case GP rate will have to be suitably modified. In support of this contention following case law has been produced:

I.T.A. No. 127 of 2000, dated July 23, 2001

Messrs Nylex (Pvt.) Ltd. v. DCIT

(vi) The AR has also submitted two or three assessment orders of other cases where sales tax is being included in the gross sales and charged to profit and loss account as expenditure and the department is accepting the situation as such. However, the AR has not been able to produce a precedent of a case pertaining to paper and board industry where sales tax is being included in sales and is being claimed as expense in the profit and loss account and such arrangement has been accepted by the department.

(vii) In addition to the above contentions/pleas the AR has taken some other pleas which are general in nature and not specific to the case under consideration. It has been contended that poor quality of assessment cannot be made a ground for action under section 66A and in support of this following case‑law are produced:

2000 PTD (Trib.) 1811:

On the word erroneous some case‑law has been produced and it has been contended that the assessment order passed by the Assessing Officer in the case of the appellant is not erroneous. It has also been submitted that IAC cannot upset determination of sales and treatment of profit and loss account of the ITAT. In support of this contention following case‑law has been produced:

1996 PTD (Trib.) 492:

It has been further pleaded that error and prejudice should be manifested in the show‑cause notice and not subsequently by a fishing inquiry. In support of this reliance has been placed on 1999 PTD (Trib.) 2851.

5. Representatives of revenue, the learned DR and the learned IAC who passed the order under section 66A have also defended the case vehemently. On the issues and contentions raised by the AR of the assessee they have expressed the following views:

(i) It has been submitted that method of accounting adopted by the assessee can be chariged/rejected if the profits/income cannot be deduced, properly as laid down under section 32(3) of the Income Tax Ordinance. In this case the assessee has wrongly included the figure of sales tax in its sales whereas it is only an agent of the State to collect this tax on behalf of the State and deposit it in the treasury. Therefore, G.P. evolved on the basis of figure of sales, inclusive of sales tax is not proper as the sales tax expenditure in profit and loss account is also incorrect because of the reason that sales tax is not the liability of the assessee Company, as it is just an agent of the State which collects the tax from the consumers and passes it on to the State exchequer. Therefore, in view of subsection (3) of section 32, the method of accounting (even if regularly) employed by the assessee has wrongly been accepted by the Assessing Officers from year to year as proper profit cannot be deduced by this method, therefore, the provisions of section 66A are very much attracted.

(ii) According to the learned IAC, the treatment of sales tax as well as the issue of extra depreciation allowance have never been subject‑matter of appeal before the First Appellate Authority or before the ITAT during the years under consideration and, therefore, action under section 66A(1A) is not debarred.

(iii) Regarding claim of extra shift depreciation it has been submitted by the learned IAC that the Circular issued by the C.B.R. was rendered inoperative as the concept of class of assets was done away with by Finance Act of 1991. So, the plea of the AR on this point is not relevant as the concept of class of assets was dropped much before the assessment years under consideration.

(iv) It has been further submitted that Income Tax Rule 22 provides that some prescribed details/particulars are to be furnished for claiming depreciation allowance. Under this rule among other things to provide information for number of days multiple shift worked is mandatory to claim extra shift allowance. This was not furnished by the assessee and the Assessing Officer allowed him extra shift allowance without examining these details. Hence the assessment order has rightly been held as erroneous and prejudicial to the interest of revenue.

(v) Uniform treatment is being given to paper and board industry and in all the cases sales tax is being excluded from sales and is not being allowed in profit and loss account. Since the assessee has adopted the method of accounting sales tax contrary to the practice of other assesses of this industry and against the treatment, of sales ‑tax by the department in this industry, therefore, action under section 66A is justified.

(vi) It has been pointed out that in a case decided by the ITAT in I.T.As. Nos.3332 and 3333/LB of 2001 on 3‑4‑2002 IAC's action in similar circumstances under section 66A has been upheld. The asses see had claimed sales tax as an expense in profit and less account and had included it in gross sales for the purpose of calculation of gross profit. The assessments for the years 1996‑97 and 1997‑98 in that case were canceled under section 66A and the ITAT rejected the appeals of the assessee and held as follows:

"Actually sales tax is a Federal Government levy. The assessee Company collects it on behalf of the Government and is subsequently deposited into Government's treasury as per the prescribed rules. Sales tax collected on behalf of Government is not expense incurred by the assessee entitling him to claim the said amount in the P&L account. Thus collecting sales tax by the assessee on behalf of the Government and crediting the same into sales and then charging to the P&L account is violative of provisions of section 32 of the Income Tax Ordinance, 1979. It is so because ultimate outcome of crediting and debiting sales tax in the trading and the P&L account respectively is that the assessee‑Company has successfully deprived the department from deducting profits and gains correctly from the method of accounting employed by the Company which is certainly in conflict with the provisions of section 32 of the Income Tax Ordinance, 1979. Though the method of crediting sales tax into sales and then charging such amount to the P&L account as business expense' was the assessee's consistent practice in the past and allegedly the department had never objected to such practice but be that as it may two wrongs do not make one, right. "

(vii) In another case in similar circumstances where assessee had claimed discount on sales as an expense in the profit and loss account the Honourable Lahore High Court upheld the recosting of final accounts by the department. The case referred to is M/s. Nylex (Pvt.) Ltd. v. CIT and judgment dated is 31‑7‑2001.

(viii) On the issue of rejection of method of accounting the revenue has relied on judgment of the Supreme Court of Pakistan reported as 1994 PTD 174.

6. Having consulted the available records, having gone through the relevant orders and case‑law produced by both the parties and having considered the arguments of the authorized representatives of both the parties given at the bar, our observations and conclusions are as under:

(i) On the basis of international accounting standards and on the basis of principles of accountancy and bookkeeping, the experts in the field of accountancy and bookkeeping have prescribed methods of accounting which are generally three: cash system where receipts and expenses are charged on the basis of actual payments; mercantile system where receipts and expenses are accounted for on the basis of accrual, and hybrid or mixed system where some of the receipts or expenses are accounted for on the basis of actual receipt or payment and some are accounted for on the basis of accrual. It is these three types of accounting methods which have perhaps been referred to under the head method of accounting under section 32 of the Income Tax Ordinance, 1979. Therefore, in our opinion the mere placement of Sales Tax in the trading or in the profit and loss account does not come within the scope of method of accounting under section 32 and hence the question whether Income Tax Authorities can reject method of accounting or not in the instant case becomes for the most part irrelevant. Anyhow, with a view to avoid academic debate and controversy on the issue and also keeping in view the fact that both the parties insist that the issue under consideration relates to method of accounting under section 32, we have decided to consider it as the parties' want.

In the circumstances of the case when the assessee has included sales tax in his sales in the trading account and has claimed it' as an expense in the profit and lots account, we hold that this method of accounting is incorrect. The ITAT in its judgment in I.T.As. Nos.3332 and 3333/LB of 2001, dated 3‑4‑2002 has held that sales tax being a Federal Government levy and, the company being an agent to collect it on behalf of the Government, it cannot be included in sales and cannot be claimed as expense in the profit and loss account. By claiming ii so, the appellant company has deprived the Department from deducing profits and gains correctly and, therefore, department is justified under section 32(3) to reject assessee's method on accounting. On the issue of treatment of sales tart no case‑law has been produced by the AR of the assessee; whereas .the department has produced ITAT judgment dated 3‑4‑2002, referred to above, which is very relevant to the issue under consideration.

(ii) Assessee's method of accounting sales tax, as stated above, is not correct. The assessee has not produced any parallel case of paper and board industry in his favour to establish that sales tax is being included in sales and is being claimed as expense in the profit and loss account. Neither any case‑law directly pertaining to, the issue under consideration has been produced by the AR. On the other hand revenue has not only produced case-law, as stated above, but has also produced some cases of paper and board wherein sales tax is being excluded from sales and is not being charged to profit and loss account as expense. In view of this situation department is justified to re‑cost assessee's trading and profit and loss account and exclude the sales tax from sales and reject assessee's claim of sales tax as expense in the profit and loss account.

(iii) Doctrine of Merger, which has vehemently been recitated by AR of the assessee, is not relevant. No doubt, appeals were filed by the assessee and these were ultimately decided by the ITAT but the issues of treatment of sales tax and extra shift depreciation allowance have never been subject‑matter of appeals. Hence bar placed against IAC's action under section 66A(1A) is not applicable. Therefore, action taken by the IAC is not assailable on this point.

(iv) Assessee's point of view regarding triple shift allowance is unforceful. The Circular of C.B.R. quoted by the AR has become inoperative by change of statutory law in the year 1991 whereby the concept of class of assets has become obsolete. Hence action of the IAC even on this issue cannot be discarded. Even if C.B.R. circular on class of assets is considered, even then assessee has to furnish detail of assets and actual number of days the machinery worked in order to claim extra shift allowance.

(v) Other arguments given by the AR of the assessee are hardly relevant to the case under consideration. It has been contended that poor quality of assessment cannot be made basis for revision under section 66A by the IAC. Although theoretically correct; it is not applicable to appellant's case: Action in the appellant's case is being taken on definite basis i.e. wrong placement of sales tax in the final accounts and improper claim of triple shift depreciation allowance, the poor quality of assessment is not being made basis.

Arguments of the AR and all the case‑law on the issue of definition of erroneous are also not relevant because in the instant case it has been successfully established by the IAC that the assessments made by the DCIT are prima facie and patently erroneous and prejudicial to the interest of revenue. It has also been argued that IAC cannot upset the determination of sales and GP made by the ITAT but this argument is of hardly any avail. IAC is simply trying to adjust assessee's claim of sales tax in accordance with principles of accountancy and is trying to curtail triple shift allowance given to the assessee on the basis of number of days the machinery actually worked. If any modification or change is made in sales or GP rate, he is justified to do as the issue of sales tax was never considered by the ITAT in appeals. Moreover, the exclusion of sales tax from sales would bring down the sales and would not enhance them. On the question of GP, we are making separate observations in the subsequent para. The AR has also submitted that error or prejudice should be manifest from the assessment order and it should not be established by the IAC by making fishing inquiries or investigations. It is true. But in the instant case the IAC has 'established, beyond any shadow of doubt, that the assessment orders of the DCIT are patently erroneous and prejudicial to the interest of revenue and this fact has been discussed in the impugned order of section 66A. The learned IAC is not making any fishing inquiries or any investigations to‑establish error and prejudice in the order of the Assessing Officer.

(vi) Assessee's case on the basis of GP rate is strong. It has been held by the Courts, even by the ITAT in its judgment which has been relied upon by 'revenue and quoted supra, that GP rate should be suitably modified when trading account is recasted as in that situation the history of GP rate loses its significance.

7. In view of the foregoing discussion, we do not feel any hesitation to hold that IAC, is justified to take action under section 66A against the assessment orders passed by the DCIT. Since the assessee has already been made to go through ordeal of long drawn process of litigation and appeals up to Tribunal level in these very assessment years, it would be unfair to make the assessee again go through the, same process. Therefore, in the interest of justice and fairplay the IAC is directed to modify the assessment orders in question instead of cancelying the same. The assessment orders of the ITO may be modified keeping in view the following guidelines after hearing the assessee:

(i) Trading and profit and loss account may be recasted by excluding sales tax from the already assessed sales and by rejecting assessee's claim of sales tax in the profit and loss. Account as expense.

(ii) Sales of the a6sessee including sales tax have already been accepted by the ITAT during appeals against original assessments for the reason that the sales are verifiable. Sales after excluding sales tax are not likely to lose their status of verifiability. Hence sales computed after excluding sales tax should be accepted.

(iii) The assessee has allegedly declared inflated GP rate at 15.35 % 17.94 % 17.24% and 17.61 % respectively for the years 1996‑97, 1997‑98, 1998‑99 and 1999‑2000 against which GP rate was applied at 18%. After excluding sales tax from sales GP rate would drastically fall to 1.98% 7.26% , 6.38% anti 5.48%. It has also been discussed above that assessee's machinery is old and his case is not comparable with other case in the line of assessee's business. A suitably modified downward GP rate should be evolved for the years under consideration.

(iv) It should be kept in view while applying GP rate that assessee's income already assessed after appeals should not be substantially disturbed except to the extent of benefit derived by the assessee by wrong placement of sales tax in original assessments anti adjustment in extra shift allowance.

(v) Extra shift or triple shift depreciation allowance should be computed proportionately in accordance with the number of days the assessee's machinery deployed in extra shift had worked.

Hence orders passed by IAC under section 66A for all the years under consideration are set aside to be made afresh in accordance with the above directions.

8. Consequently, appeals filed by the assessee partly succeeded as above.

C. M. A. /M. A. K./449/Tax(Trib.) Appeals partly succeeded.