Income Tax Ordinance (XXXI of 1979)‑‑‑

‑‑‑Ss.15 & 2(12)‑‑‑Banking Companies Ordinance (LVII of 1962), Ss.7(1)(a), 13(1)(2), (4) & 29‑‑‑Head of income‑‑‑Capital assets‑‑ Banking companies‑‑‑Income from sale of Government securities‑- Income from capital gain and income from business‑‑‑Determination of‑ Principle‑‑‑If the investment in securities was made to meet the statutory requirements of the State . Bank of Pakistan, the gain or loss on sale of these securities would be computable under the head "capital gain" and if the securities are dealt with as stock‑in‑trade, a function which a Banking Company was allowed to perform under S.7 of the Banking Companies Ordinance, 1962, the gain or loss would be computable under the head "business income"‑‑‑Banking Company may purchase the securities for the purpose of dealing in securities or for the purpose of investment‑‑‑Intention in this regard could be determined by examining the circumstances in which a security was purchased‑‑‑When security was purchased in order to meet with the statutory requirements of S.13 of the Banking Companies Ordinance, 1962 then it was purchased as an investment, whenever such securities were disposed of the resultant gain or loss therefrom will be computable as "capital gain or loss" because these securities not being stock‑in‑trade but being an asset of the company satisfy the definition of capital asset as given in S.2(12) of the Income Tax Ordinance, 1979‑‑‑If, on the other hand, the securities were purchased for the purpose of dealing in them, then, if matured, the income received therefrom was to be computed as interest from Government securities and the loss or gain on sale was Revenue loss or gain because these securities were purchased as stock‑in‑trade‑‑ Appellate Tribunal set aside the assessment on this issue and sent the case back to the Assessing Officer with the direction that it may be examined as to which of the securities were purchased as investment and which of them were purchased as stock‑in‑trade‑‑‑Where the securities were purchased as investment, then, the gain or loss on disposal of these securities may be computed as capital gain/loss and where the securities were purchased as stock‑in‑trade, the loss or gain on disposal of these securities may be treated as Revenue loss or gain.

Grindlay's Bank v. C.I.T. Central 1985 PTD 329 and 1995 PTD Trib.) 807 rel.

City Bank, N.A.'s case I.T.As. Nos. 277 to 284/KB of 1982‑83; Agricultural Development Bank's case I.T.A. No. 1178/KB of 1980‑81; I.T.A. No. 2247/KB of 1984‑85; Citi Bank N.A.'s case 1994 P TD 271; 1995 PTD (Trib.) 435; American Express Bank's case I.T.A. No.1361/KB of 1985‑86 and American Express Bank's case I.T.A. No.753/KB of 1997‑98 ref.

Ali Hasnain, D.R. for Appellant.

E.U. Khawaja for Respondent.

Date of hearing: 10th September, 2002.

ORDER

MUHAMMAD AKHTAR NAZAR MIAN (ACCOUNTANT MEMBER). ‑‑‑Income Tax Appeal I.T.A. No. 293/KB of 1095‑96 for the assessment year 1992‑93 filed by the department as appellant and Messrs American Express Bank Karachi as respondent was decided on 24‑11‑1002. In para. 3 of the order, direction of the learned CIT(A) was maintained that income from sale of Government securities may be treated as capital gain as against income from business as was treated by the Assessing Officer. The learned CIT(A) as well as this Tribunal while deciding the appeal on 24‑11‑2001 banked upon the reported case of Grindlays Bank v. C.I.T. Central cited as 1985 PTD 329 (Sindh High Court Karachi). The department came in reference against the order of the Tribunal and during hearing of the said reference application it was noticed by us that while deciding the appeal, the Tribunal had through oversight omitted to examine the case‑law on the issue of gain on sale of Government securities reported as 1995 PTD (Trib.) 807 which was duly presented and referred 'to by the learned D.R. while arguing the appeal. Since the mistake was apparent from record, a notice under section 156 was served on both the parties showing our intention to rectify our order suo motu by recalling it and deciding the issue after discussing the point of view of the department. On the date of hearing of this notice under section 156 of the Income Tax Ordinance, 1979, both the parties agreed that the mistake made by the Tribunal was apparent from record and required to be rectified. In view of this position the order of the Tribunal was recalled for regular hearing so as to decide on merits the contents of para. 3 of the said order.

2. Mr. E.U. Khawaja the learned A.R. and Mr. Ali Hasnain the learned D.R. have been heard and in support of their contention they are still relying respectively upon the cases reported as 1985 PTD 329 (Sindh High Court Karachi) and 1995 PTD (Trib.) 807 After hearing both the representatives, and for reasons given hereunder, a are of the view that para‑3 of the order in I.T.A. No. 293/KB of 1995‑96 (assessment year 1992‑93), decided on 24‑11‑2001 needs to be amended and it is so directed that para. 3 may be replaced by the following:‑‑‑

"1. Treating income from sale of Government Securities as Capital Gain.

3.1 The Assessing Officer had treated the income from sale of Government securities as business income whereas the CIT(A) directed that income from sale of Government securities may be treated as capital gain. The CIT(A) his based his order on a judgment of the Hon'ble Sindh High Court, Karachi in the case of Grindlays Bank v. CIT Central reported as 1985 PTD 329 (Sindh High Court, Karachi). The department on the other hand is depending heavily on the case reported as 1995 PTD (Trib.) 807, wherein it has been held that such income is business income. The learned A.R. has produced copies of the orders in following cases to show that varying decisions have been given by different appellate authorities on the issue of profit on sale of Government securities by Banks, being revenue income or capital gain:‑‑‑

3.2 We have had an opportunity of going through the case‑law cited at bar. Before referring to the cases cited before us, we would like to reproduce clause (a) of subsection (1) of section 7, subsections (1), (2) and (4) of section 13 and section 29 of the Banking Companies Ordinance, 1962:‑‑‑

7. Forms of business in which Banking Companies may engage.‑‑ (1) In addition to the business of banking, a Banking Company may engage in anyone or more of the following forms of business, namely:‑‑‑

(a) the borrowing, raising or taking up of money; the lending or advancing of money either upon or without security; the drawing making, accepting, discounting buying selling, collecting and dealing in bills of exchange, hundis, promissory notes; coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips, participation term certificates, modaraba certificates and such other instruments as may be approved by the State Bank and other instruments, and securities, whether transferable or negotiable or not the granting and issuing of letters of credit, traveller's cheques and circular notes; the buying selling, and dealing in bullion and species; the buying and selling of foreign exchange including foreign bank notes; the acquiring holding issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities, participation term certificates, term finance certificates, musharika certificates, modaraba certificates and such other instruments as may be approved by the State Bank and investment of all kinds; the purchasing and selling of bonds, scrips or other forms of securities, participation term certificates, term finance certificates, musharika certificates, modaraba certificates and such other instruments as may be approved by the State Bank on behalf of constituents of others, the negotiating of loans and advances; the receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; the providing of safe deposit vaults, the collecting‑and transmitting of money and securities;

13. Requirement as ‑to minimum paid‑up capital and reserves.‑‑‑(1) Subject to subsection (2) no Banking Company shall:‑‑‑

(a) commence business unless it has a minimum paid‑up capital as may be determined by the State Bank; or

(b) carry on business unless the aggregate of its capital and unencumbered general reserves is of such minimum value within such period as may be determined and notified by the State Bank from time to time for Banking Companies in general or for a Banking Company in particular.

(2) No Banking Company incorporated outside Pakistan shall be deemed to have complied with the provisions of subsection (1) unless it deposits and keeps deposited with the State Bank an amount by transfer of funds from outside Pakistan or in the form of asses acquired out of remittable profits made by it from deposits in Pakistan which is not less than what is required to be maintained under subsection (1), in any one or more of the following forms, namely:‑‑‑

(i) interest‑free deposit in cash in Pakistani rupees;

(ii) interest‑free deposit in a freely convertible approved foreign exchange within the meaning of the State Bank of Pakistan Act, 1956 (XXXIII of 1956), specified by the State Bank in respect of such Banking Company; and

(iii) deposit of unencumbered approved securities:

(3) ...................

(4) Any amount deposited and kept deposited with the State Bank under the subsection (2) by any banking company incorporated outside Pakistan shall, in the event of the banking company ceasing for any reason to carry on banking business in Pakistan be an asset of the banking company on which the claims of all the creditors of the banking company in Pakistan shall be the first charge.

29. Maintenance of liquid assets.‑‑‑(1) Every banking company shall maintain in Pakistan in cash, gold or unencumbered approved securities valued at a price not exceeding the current market price, an amount which shall not at the close of business on any day be less than twenty percent. of the total of its time and demand liabilities in Pakistan:

Provided that the requirements of subsection (1) as to the maintenance in Pakistan of cash, gold or unencumbered approved securities may from time to time, by notification in the official Gazette, be varied by the Federal Government.

Explanation. ‑‑‑For the purposes of this section, 'unencumbered approved securities' of a banking company shall include its approved securities lodged with another institution for an advance' or any other credit arrangement to the extent to which such securities have not been drawn against or availed of.

(2) In computing the amount provided for in subsection (1) any deposit required under subsection (2) of section 13 to be made with the State Bank by a banking company incorporated outside Pakistan and any balances maintained in Pakistan by a banking company in current account with the State Bank or its agent or both, or in profit and loss sharing term, deposit account with the State Bank including in the case of a scheduled bank the balance required to be so maintained under subsection (1) of section 36 of the State Bank of Pakistan Act, 1956 (XXXIII of 1956), shall be deemed to be cash maintained.

(3) Every banking company shall, before the close of the month succeeding the month to which the return relates, furnish to the State Bank a monthly return in the prescribed form and manner showing particulars of the company's assets maintained in accordance with this section and its time and demand liabilities in Pakistan at the close of business on each Thursday during the month, or if any Thursday is a public holiday under the Negotiable Instruments Act, 1881 (XXXVI of 1881), at the close of business on the preceding working day.

The bare reading of the sections quoted above, reveals that a banking company may deal in Government securities or may invest in these securities in order to carry on the business of banking or earn interest income and the resultant capital gain on disposal of these securities. Under section 29 the Banking Company has to maintain in Pakistan prescribed percentage of the total of its time and demand liabilities in the form of cash, gold or unencumbered approved securities. A banking company incorporated outside Pakistan can commence or carry on business in Pakistan only if it deposits and keeps deposited with the State Bank an amount not less than what is prescribed under subsection (1) of section 13 of the Banking Companies Ordinance, 1962 in any one or more of the following forms namely:‑‑‑

(i) Interest free deposits in cash in Pakistan rupees;

(ii) Interest free deposit in a freely convertible in foreign exchange specified by the State Bank in respect of the said Banking Company;

(iii) Deposit on unencumbered approved securities.

It needs no emphasis that whatever has to be kept deposited with the State Bank is an investment for the purpose of carrying on the banking business.

3.3. In the case before us, we are concerned with Government securities which are unencumbered approved securities and can be deposited with the State Bank of Pakistan in order to comply with the provisions of subsection (1) of section 13 of the Banking Companies Ordinance, 1962.

3.4. After referring to the provisions of law, we go for the case‑law which has been cited at bar so that we can seek guidance from the principles laid down on this issue by the authorities:‑‑‑

(A) I.T.As. Nos. 277 to 284/KB of 1982‑83 (assessment years 1975‑76 to 1981‑82 dated 31‑3‑1983 decided b Division Bench.

In the assessment year 1975‑76 the assessee‑company earned an amount of Rs.99,907 being discount on treasury bills. It was shown as income from business in the original return of income but in the revised return the bank claimed exemption on this amount being in the nature of capital gains. It was held by the Income Tax Officer that Treasury Bills and NIT were purchased by the assessee for relatively short periods through normal course of banking business. The treasury bills were purchased at a discounted rate from State Bank of Pakistan and the difference between the amounts paid as the cost price of bills and the amount received on their maturity was nothing but interest. In this view of the matter he treated profit on sale of investment as a revenue gain and did not allow the exemption as Capital Gain. The main argument of the Assessing Officer, it appears, was that such investment was easily realizable and it formed part of the trading assets of the bank: Since the stocks‑in‑trade were not capital assets as defined in the Repealed Income. tax Act, 1922 or even in the Income Tax Ordinance 1979 the Assessing Officer treated the securities as stock‑in‑trade and hence tile income from trading therefrom was treated as business income. This treatment was approved by the Income Tax Appellate Tribunal.

(B) Grindlays Bank Ltd 1985 PTD 329.

In this case the Tribunal had given finding of fact that the Government securities were held by the bank by way of investment and not by way of stock‑in‑trade. In these circumstances the Tribunal had held that the loss on sale of these securities which were held by way of investment was a capital loss and not deductible from profits. This finding of the Tribunal was maintained by the Hon'ble High Court. It is thus clear that the finding of the Hon'ble High Court is based on a question of fact as to whether the securities were held as investment or as stock‑in‑trade. Since in the instant case the Tribunal had given finding on fact that securities were actually held as investment, the loss on disposal of these securities was held to be capital loss.

(C) I.T.A. No. 1178/KB of 1980‑81 (assessment year 1978‑79), decided by Full Bench.

In this case of a local bank, investment in treasury bills made by the bank in order to carry on its business operations under the statute was held to be an investment and not stock‑in‑trade. Following the decision of the Grindlays Bank of Pakistan quoted above, it was held by the Full Bench of this Tribunal that the gain on sale of securities held for the purpose of meeting the statutory requirements of the banking law was capital gain and therefore, not liable to be included in the business income.

(D) I.T.A. No. 2247/KB of 1984‑85 (assessment year 1982 83):

In this case the learned Bench of this Tribunal comprising Saiyed Saeed Ashhad, Judicial Member as he then was, (presently Chief Justice of the Sindh High Court) and Mr. Manzoorul Haq as Accountant Member followed the decision of the Full Bench as discussed at (C) above and held that the income, profits or gains realized by the Bank from the sale of Government securities and treasury bills as required to be kept under the statutory provisions of the banking law was not revenue income and should be treated as capital gain/income.

(E) 1994 PTD 271

In this case the question referred to the Hon'ble High Court was "Whether on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the applicant was liable to tax on income on sale realization of securities including treasury bills." This question was answered in the negative in view of the decision in the case of Grindlays Bank v. CIT Central (1985) 51 Tax 102 (H.C. Karachi) = 1985 PTD 329 referred supra. The learned A.R. has stated at bar before us that on this issue the department had not gone in appeal before the Hon'ble Supreme Court against this judgment of the Hon'ble High Court.

(F) 1995 PTD (Trib.) 435

In this case the ITAT while holding that the profit from sale of Government securities meant for meeting the margin requirements was the Revenue gain made following observations:‑‑

"The question is, whether the assessee will be able to carry on his business of banking without meeting margin requirements and abiding by the rules of the State Bank of Pakistan. If he cannot carry on his business of banking in absence of margin requirements then the investment is part of the business of banking. The wisdom of making these investment could be financial prudence of the banking business required of all them by the controlling authority:"

It was further added that;

"As pointed out above, meeting margin requirements is objective reality of baking business. The assessee under these circumstances cannot claim that he can carry on his business without meeting .the requirements. The investment under the circumstances in securities is part of his business of banking. It cannot be separated from the said business. Under these circumstances of action of the I.T.O. and the direction of the CIT(A) on this issue is maintained."

As is clear, the Tribunal was influenced that since without making investment in securities as required under the Banking Ordinance no banking business could be carried on, income from the said securities was business income of the bank, notwithstanding as to how it was derived and obviously under which of the heads of income it was required to be computed. With due respect to the Members of this Bench, we submit that income computed under all heads of income undoubtedly is income of the banking company but not necessarily income under the head business as the treatment regarding inclusion in total income, charging tax, or allowing exemption etc. may vary subject the head of income under which the income is computable. We may also observe here that statutory requirements to be met so as to enable the company to Carry on a particular business are, in essence, of substantive nature.

(G) 1995 PTD (Trib.) 807

In this judgment, it was held that purchase of securities and treasury bills was part of normal banking business and therefore, profit earned from the sale of investment was revenue gain. This case heavily depends upon the observations made by the Kerala High Court in the case of Malabar Cooperative Bank v. CIT (1975) 101 ITR 87. We have had the benefit of going through this case decided by the Kerala High Court. The facts of that case before Kerala High Court were that the Malabar Cooperative Central Bank Ltd., a cooperative society, way carrying on banking business. It earned Rs. 49,086 by way of interest on securities. The assessee claimed that this amount should be exempted under section 80P(2)(a)(i) of the (Indian) Income Tax Act, 1961 of the reason that the Banking Regulation Act, 1949 had been made applicable to the assessee and the provisions of that regulation clearly indicated the holding of securities, the realization of those securities and the earning of interest from those securities all spelt carrying on the business of banking and therefore, the interest that accrued on the securities show be treated as banking business income. It would be pertinent to it into the provisions of law under which the exemption was claimed section 80P(2)(a)(i). The relevant portion as appearing in the case cited as (1975) 101 ITR 87 is reproduced below:‑‑‑

80P(2). The sums referred to in subsection (1) shall be the following namely:

(a) In the case of a Cooperative Society engaged in

(i) carrying on business of banking or providing credit facilities to its members.

So, the question before the Kerala High Court in essence was as to whether the interest on securities to the sum of Rs. 49,086 was an amount which the cooperative society had earned from business activity of banking. Obviously the income under any head of income which was permissible as per Memorandum and Article of this Banking Cooperative Society was to be included in the total income of the Society and ultimately treated as income from the business of banking. In this very judgment a quotation has been made from the judgment of Supreme Court of India in the case of Commissioner of Income Tax v. Chugandaa & Company (1965) 5 ITR 17, 24 (SC):‑‑‑

"The heads described in section 6 and further elaborated for the purpose of computation of income in sections 7 to 10 and 12, 12‑A, 12‑AA and 12‑B are intended merely to indicate the classes of income, the heads do not exhaust or limit sources from which income arises. This is made clearly in the judgment of this Court in the United Commercial Bank Limited's cast (1957) 2 ITR, 688 (Supreme Court) that business income is broken up under different heads only for the purpose of computation of the total income; by that break‑up the income does not cease to be the income of the business the different heads of income being only the classification prescribed by the Indian Income Tax Act for computation of income."

From this citation, it is clear that in the circumstances of the case a banking company may be deriving income computable under various heads of income but the total of all the incomes under various heads will be considered as the income from the banking business of the assessee provided it is legally entitled to derive income computable under various heads of income as referred to above. These importable observations from the orders of the Supreme Court of India missed consideration by the Income Tax Appellate Tribunal while deciding the case 1995 PTD (Trib.) 807 when it came to the conclusion that the profit from sale of Government securities or treasury bills under all circumstances was business income as the said securities were stock‑in-trade of the banking company.

(H) I.T.A. No. 1361/KB of 1985‑86 (assessment year 1982‑83);

This is the case of the appellant for the year 1982‑83 wherein it was held that investment in Government securities was not purely in the nature of investment as it was made to meet liquidity requirements prescribed by the State Bank and for earning interest and also keeping the securities as stock‑in‑trade. The gain was, therefore, adjudged as revenue gain.

(I) I.T.A. No. 753/KB of 1997‑98 (assessment year of 1996‑97).

In this case the Tribunal depending upon the earlier decision reported as (1995) 71 Tax 262 (Trib.) discussed at (G) above, held that the gain or loss on sale of Government securities was revenue in nature.

3.5. We have elaborately discussed the case‑law stated at bar before us and we have given our reasoning on the decision of various authorities. Whereas the decisions of the Hon'ble High Court of Sindh and the Full Bench of this Tribunal are based upon the understanding that if the investment in securities is made to meet the statutory requirements of the State Bank of Pakistan, the gain or loss on sale of these securities would be computable under the head Capital Gain and if the securities are dealt with as stock‑in‑trade, a function which a banking company is allowed to perform under section 7 of the Banking Companies Ordinance, 1962, the gain or loss would be computable under the head business income. As respectfully stated above, in the case discussed at (G) above, the issue before the Kerala High Court was not sale of securities but only income earned as interest on securities which was to be decided to be income from business of banking or not. Heavy dependence by the Tribunal on observations made in that case does not appear to be justified. We have also noticed that the cases, where all Government securities have been held to be stock‑in‑trade appear to have overlooked the statutory provisions contained in subsection (2) of section 13 of the Banking Companies Ordinance, 1962 which provides that a Banking Company incorporated outside Pakistan has to deposit and keep it deposited perforce unencumbered approved securities with the State Bank. These securities obviously are not available to the assessee as stock‑in‑trade.

3.6 After considering the arguments and the case‑law as discussed above we are of the view that a banking company may purchase the securities for the purpose of dealing in securities or for the purpose of investment. The intention in this regard can be determined by examining the circumstances in which a security is purchased. Obviously when it is purchased in order to meet with the statutory requirements of section 13 of the Banking Companies (Ordinance, 1962 then it is purchased as an investment, whenever such; securities are disposed of, the resultant gain or loss therefrom will be computable as Capital Gain or loss because these securities not being stock‑in‑trade but being an asset of the company satisfy the definition of capital asset as given in section 2(12) of the Income Tax Ordinance, 1979. If on the other hand the securities were purchased for the purpose of dealing in them, then, if matured, the income received therefrorm is to be computed as interest from Government securities and tithe loss or gain on sale is revenue loss or gain because these securities were purchased as stock‑in‑trade.

3.7. Since the case has s not been examined in this perspective as detailed in sub‑para. (3.6) above, we hereby set aside the assessment on this issue and send the case back to the Assessing Officer with the direction that it may be examined as to which of the securities were purchased as investment and which of them were purchased as stock‑in -trade. Where the securities were purchased as investment, then for reasons detailed above, the gain or loss on disposal of these securities may be computed as capital gain/loss and where the securities were purchased as stock‑in‑trade, the loss or gain on disposal of these securities may be treated ass revenue loss or gain."

C.M.A./543/Tax (Trib.)Order accordingly.