I.T.As. Nos.445-IB, 446-IB and 690-IB of 2000-2001 VS I.T.As. Nos.445-IB, 446-IB and 690-IB of 2000-2001, 2004 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 408 (2003)

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

----Ss.62 & 132---Assessment on production of accounts, evidence etc.-- Financial expenses---Disallowance of such expenses after due confrontation under S.62 of the Income Tax Ordinance, 1979---Setting aside of the same by the First Appellate Authority--Validity---No justification existed with the First Appellate Authority to set aside the issue of financial expenses---Expenses were duly confronted through show-cause notices under S.62 of the Income Tax Ordinance, 1979 but the assessee did not respond---Disallowing the expenses claimed was fully justified as the assessee had been unable to justify the same---Rental income derived from the leasing of the assets being chargeable to tax under S.30 of the Income Tax Ordinance, 1979, Assessing Officer rightly disallowed the claim for lack of admissibility under S.31 of the Income Tax Ordinance, 1979---Appellate Tribunal vacated the order of the First Appellate Authority and restored that off Assessing Officer.

(b) Income Tax Ordinance (XXXI of 1979)-----

----S.30---Income from other sources---Lease income---Income from lease 'of fixed assets comprising of land building and machinery for manufacture of poultry feed---Revising of lease agreement for the reason that lessor had failed to provide the lessee with an automatic feed manufacturing plant in working condition---Reduction in rent in spite of increase in fresh investment---Assessment was finalized on the basis of rent fixed by the original lease agreement on the ground that it was not provided anywhere in the original lease agreement that the agreement was subject to any pre-conditions such as the assurance regarding working condition of the new plant---Validity---Since the initial investment was substantially increased after the commencement of lease period, there was no justification for any reduction in lease rent---First Appellate Authority failed to examine the crucial fact that the original lease deed did not contain any stipulation requiring the lessor to install automatic feed production machinery---Very justification for a revision of monthly rent did not remain in field---First Appellate Authority failed to appreciate the reasonableness of the , basis of rent estimation and the amount was held taxable in the hands of assessee---Order of First Appellate Authority was vacated by the Appellate Tribunal and restored that of the Assessing Officer in which rent originally declared was adopted.

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

----Ss.108(b)(i), 55 & Third Sched.---Income Tax Rules, 1982, R.190-- Companies Rules, 1985, Form 35-A---Penalty for failure to furnish return of total income and certain statements---Penalty for non-filing of statement of accounts and balance-sheet with the return filed under S.55 of the Income Tax Ordinance, 1979---Penalty was deleted by the First Appellate Authority with the observation that S.55 of the Income Tax balance-sheet and non-filing of such statements did not render the return invalid---Validity---Section 55 of the Income Tax Ordinance, 1979 requiring the filing of. returns of income, must be read in conjunction with 8:190 of the Income Tax Rules, 1982---Rule clearly provide that if all the documents prescribed under, the Income Tax Rules, 1982 as part of the returns were not enclosed, the. return was liable to be considered as an invalid return under the law--- In case of companies, copies of trading/manufacturing account and P & L Account, balance-sheet, depreciation chart as per Third Schedule of the Income Tax Ordinance, 1979 and audit report in Form 35-A of the Companies Rules, 1985 etc. had been specifically mentioned---Return filed by the assessee without requisite statements of accounts was thus invalid---Default on-the part of assessee stood established---Order of First Appellate Authority in deleting the penalty was not sustainable on facts and law which was vacated by the Appellate Tribunal with the direction that penalty should not exceed the maximum limit laid down in S.108(b)(i) of the Income Tax Ordinance, 1979.

Zulfiqar H. Khan, D.R. for Appellant.

Hafiz M. Idrees for Respondent.

Date of hearing: 21st May, 2003.

ORDER

SYED AQEEL ZAFARUL HASAN (ACCOUNTANT MEMBER).---These appeals by the Department impugn the orders' of the CIT(A), Islamabad dated 28-9-2000 against assessment made for the assessment years 1997-98 and 1998-99 under section 62 of the Income Tax Ordinance, 1979 (hereinafter called the Ordinance) and against penalty order under section 108 of the Ordinance. The issues involved are the determination of the lease, rental the setting aside of the disallowance of financial expenses as well as the deletion of penalty imposed for non-filing of statements of account alongwith the returns of income. All three appeals shall be disposed of by this combined order.

2. The assessee, a private limited company, derived income during the period under consideration from leasing of fixed assets comprising of land, building and machinery for the manufacture of poultry feed. The lease rental originally agreed upon by the assessee-company (Lessor) with Messrs S.B. Poultry, an AOP (Lessee), was fixed at Rs.4,20,000 per month. The annual rent thus worked out to Rs.5,040,000. However, the assessee claimed that the lease agreement was subsequently revised whereby the monthly rent was reduced to Rs.20,000 per month. The reason advanced in this behalf was that the Lessor had failed to provide the Lessee with an automatic feed manufacturing plant - in working condition. The terms of lease were statedly re-negotiated and the Lessee made own investment to replace machinery etc. and bring the production unit in the desired condition. Resultantly, the lease rent was reduced from Rs.4,20,000 per month to Rs.20,000 per month. Meanwhile, the control and management of the lessor company. changed hands and the new management comprising of .members of the Lessee AOP took over command of affairs of the Lessor Company. The lease rent was reduced by the new management, it transpires.

3. The explanation offered by the assessee was found unsatisfactory, inconsistent and unsubstantiated. Accordingly, it was rejected and the rent originally agreed upon between the parties, was assessed as the annual lease rent. Against the treatment so given, the assessee appealed before the Commissioner who, vide his impugned order, accepted the appeal and directed that the lease rental should be taken as per revised agreement produced by the assessee. The Department feels strongly agitated against the direction of the Commissioner and has submitted the following position:--

"(a)As per original lease agreement dated 28-6-1996 available on record, the rent of the building, plant and machinery was fixed at Rs.4,20,000 per month.

(b)As per schedule of assets given-in the lease agreement, the mills comprised land measuring 25 Kanals and 7 Marlas, building constructed on the land and feed manufacturing plant/machinery installed there.

(c)It was not provided anywhere in the original lease agreement that the agreement was subject to any pre-conditions such as the assurance regarding working condition of the new plant.

(d)In fact the reduction in lease income was made only after the purchase of the mill by the new management and incidentally the new Directors of Messrs Prime Feed Industries were also the members of AOP namely Messrs. S.B. Poultry. Therefore, in order to avoid proper taxation of lease income, the rental income was declared. at much lower rate.

(e)It is also a fact that the rent of Rs.4,20,000 was fixed at that time when the Company had fixed assets worth Rs.10,67,136 only as per balance-sheet as on 30-6-1996. Later, during the period ending 30-6-1996 new project worth Rs.25,800,000 had also been completed and after the, completion of new project of Rs.25.8 million, the rent of the feed mills should have been increased in .:the same ratio instead of the huge decrease as shown by the Company."

4. Besides .the issue of lease rental, financial expenses claimed by the assessee at Rs.32,071 for the assessment year 1997-98 and Rs.2,794,501 for the assessment year 1998-99 were disallowed by the Assessing Officer after duly confronting the assessee about the admissibility of the claim. No explanation was offered by the assessee despite proper opportunity. The Commissioner set aside the issue for de novo consideration. The Department feels that the Commissioner was not justified to so set aside the amount disallowed against claim for financial expenses. The interest expenses, it has been pointed out, were claimed on borrowed capital which were not admissible against lease income under section 31 of the Ordinance.

5. As regards the appeal against the deletion of penalty under section 108, facts are that the two returns filed by the assessee were not accompanied by statements of accounts and balance-sheets. A show cause notice under section 116 was issued but remained uncomplied with. Another opportunity was provided whereupon the assessee stated that the Ordinance does not require compulsorily to file balance-sheets and other statements of account. It was further stated that the action taken under section 62 had already been appealed against by the assessee and as such, penalty proceedings at that stage were not justified. The Assessing Officer found the reply unsatisfactory. He held that the default stood established from record and accordingly imposed penalty under section 108 of the Ordinance at Rs.194,649 as per detailed working incorporated in the relevant order.

6. On appeal, the Commissioner observed that the penalty was not justified for two reasons first, because the appellate order passed by him on 28-9-2000 required proceedings under section 116 to be dropped and secondly, the Commissioner held that section 55 of the Ordinance does not require filing of statements of account and copies of balance-sheets. As such, non-filing of those documents did not render the returns invalid under section 55 of the Ordinance.

7. Deletion of penalty so ordered by the Commissioner has been appealed against on the ground that the order of the Commissioner dated 28-9-2000 already stands appealed against by the Department and the failure to furnish statements of account and balance-sheet stood established against the assessee which renders the returns invalid and attracts penal provisions of section 108 of the Ordinance.

8. During hearing of the cases, the DR drew attention to the sequence of events and detailed reasoning recorded in the order passed under section 62 for the two years. He pointed out that lease rental had been estimated as per assessee's own declaration of the amount of rent originally declared and agreed upon between the parties. The claim of subsequent reduction in rent was unprecedented and unwarranted in the circumstances of the case. As indicated in the facts submitted on behalf of the Department in writing the lease agreement originally executed contained no provisions or precondition requiring installation of an automatic plant in working condition. As such, the plea to revise the rent downward was not acceptable. Reference was also made to the fact that the subsequent to the execution of the rent deed whereby the monthly rent of Rs.4,20,000 was agreed upon, the fixed assets. of the assessee had increased with fresh investment of Rs.25,800,000. This should have served to increase the rent rather than decrease it. The fact that reduction in lease rent was made subsequent to a change in management, was also significant. The Directors of the assessee company which had leased out its assets to an AOP, were common with the members of the Lessee AOP. This suggested a collusive arrangement and undermined the veracity of the claimed reduction in the monthly rent.

9. The learned AR on the other hand, submitted that the original lease agreement had been terminated and replaced with a new lease agreement as the landlord had failed to complete the construction of the new plant. The lessee agreed to invest Rs.5,000,000 in the production machinery. This adequately justified a reduced monthly rent of Rs.20,000 for the old machinery and Rs.60,000 per month for the new unit. Upon being questioned by us, the AR explained that the amount of investment of the landlord assessee company, was Rs.26,978,075 while that of the Lessee was Rs.5,000,000.

10. As regards the setting aside of the issue of financial expenses, the learned AR maintained that no prejudice had been caused to the Department and the appeal on this point was not justified.

11. The learned AR reiterated that as regards the penalty under section 108 unaudited balance-sheet and statement of accounts had been furnished. However, this was not cognizable under section 108 and as such, the Commissioner was justified in deleting the penalty.

12. Having heard the parties and after going through the orders under section 62/108 as passed by, the Assessing Officer as well as the appellate order of the Commissioner, we are of the firm opinion that there was no justification for the Commissioner to set aside the issue of financial expenses. The assessee had been duly confronted through show cause notices under section 62 of the Ordinance but the assessee did not respond. This being so, disallowing the expenses claimed was fully A justified as the assessee had been unable to justify the expenses claimed. The rental income derived from the leasing of the assets being chargeable to tax under section 30 of the Ordinance, the Assessing Officer rightly , disallowed the claim for lack of admissibility under section 31 of the Ordinance. We, accordingly, vacate the order of the 7 Commissioner and restore that of the Assessing Officer.

13. As regards the issue of lease rental, we find that the Assessing Officer has recorded detailed reasons for discarding the declared version. The reasons for reducing the monthly rent, are not acceptable. Since the initial investment was substantially increased after the commencement of the lease period, there is no justification for any reduction in lease rent. The ratio of investment by the Lessor at Rs.26,978,075 vis-a-vis Rs.5,000,000 invested, by the Lessee also does not justify the reduction in rent. The Commissioner has failed to examine the crucial fact that the original lease deed did not contain any stipulation requiring the lessor to install automatic feed production machinery.' As such, the very justification for a revision of the monthly rent does not remain in field. We, therefore, find ourselves unable to agree with the treatment, accorded by the Commissioner in summarily holding that the Assessing Officer was not, justified to estimate the lease money for the two years under appeal. In fact, he has also failed to appreciate the reasonableness of the basis of rent estimation and the amount held taxable in the hands of the assessee.

14. We find the following observation of the Assessing Officer pertinent for the determination of the facts of the present case:--

"There is no' denying fact that the value of old machinery, plant and building was shown at Rs.3,45,580 as per balance-sheet as on 30-6-1996. Similarly, work. in progress for building and plant/machinery for new project was declared at Rs.2,69,78,075 in the balance-sheet as on 30-6-1996. However, at the same time it is a fact that the rent of plant/machinery and building was fixed at Rs.4,20,000 per month; as per original agreement dated 28-6-1996. It is also a fact that as. per original agreement no such commitment was given by. the then management of Prime Feed Industries regarding the new plant/machinery in working condition. According to the agreement monthly rent was fixed at Rs.4,20,000 and as per schedule given in the lease agreement the Mills comprised of project land measuring 25 Kanals and 7 Marlas, building constructed on the land and feed manufacturing plant/machinery installed there.

You have taken the plea that the machinery for new unit was totally useless and it never started up and replaced by new machinery. The factual position is quite contrary because up to 30-6-1996 the work in progress was shown at Rs.2,69 78,075. The same work in progress was declared in the balance-sheet as on 30-6-1997 being an addition in fixed assets under the head Building as well as plant/machinery.

You have also claimed depreciation worth Rs.26,51,831 for building as well as plant/machinery during the assessment year 1998-99, therefore your contention that the machinery was useless and replaced by new one is not correct on the face of the record. As per record the plant/machinery has been shown in working condition and. not replaced. by the new one because no .such deletion of the old machinery/plant was shown in fixed assets under the relevant heads, as per depreciation schedule. Similarly, no new addition of plant/machinery was made except capital work in progress which transferred to fixed assets as per schedule of assets. It is relevant to mention here that the rent per month Rs.4,20,000 was fixed for the old machinery/building as well as work in progress. After completion of new project the rent per month should have been increased considering the investment of more than Rs.30.00(m). Instead of any increase in rent this was reduced to Rs.20.000 per month for the assessment year 1997-98 and half year period for. the assessment 1998-99. Similarly, for the remaining half year period for the assessment year 1998-99 the same is declared at Rs.80,000 per month. Keeping in view the facts as discussed above, the declared rent for the assessment years 1997-98 and 1998-99 is ridiculously too low and; therefore, taken at Rs.4,20,000 per month for the both the assessment years."

15. We have carefully considered the facts of the' case as re capitulated above, with particular reference to their sequence, It is significant that these remained un-controverted and must, therefore, be taken to be undisputed correct. That being so, the absence of any explicit condition requiring the Lessor to automate the machinery and to ensure it is working condition, is fatal to the justification offered by the assessee for the downwards revision of the lease rent. It is basically unheard of that a Lessor many months after commencement if the lease period, should agree to reduce the lease rent.

16. Secondly, considering that the lessee had only to invest Rs.50,00,000 to secure a reduction of lease rent to a paltry 1/11th of the original amount, makes it a suspect transaction. If the Lessor had already invested Rs.2,69,78.075 in the fixed assets of the leased mills, it makes no business sense to shy away from an additional Rs.50,00,000 investment and instead accept a massive reduction in lease rent.

17. Thirdly, 'the fact that the lease rent was said to have been re negotiated after a change in management involving a take-over of the Lessor by members of the lessee AOP, is a loud and clear signal of collusive arrangement. It, erodes the credibility of the entire arrangement and casts serious doubts as to its genuineness.

18. Finally, the introduction of bogus creditors to the tune of Rs.48,00,000 which, when confronted and found unsubstantiated, was sought protection of under the Tax Amnesty Scheme (TAS), reflects the machinations that the assessee has demonstrated it was capable of indulging in. It is worth-noticing that in that transaction too, the assessee tried to utilize the business interdependence of the Lessor company and the lessee AOP by claiming that employees of the latter had advanced cash loans to the former. An utterly unacceptable proposition as it was, it also failed the verification it was subjected to, whereupon refuge was taken in the TAS. Be that as it may, it amply reflected the mindset of the new management.

19. For the foregoing reasons, therefore, we find the order of the Commissioner (Appeals) as unsustainable and vacate the same. The estimation of lease rental, which in effect was merely an adoption of the declared rent, is restored as per the order of the Assessing Officer.

20. Regarding the addition of audit fees under section 25(c), we are inclined to agree with the directions of the Commissioner. Considering the quantum of the amount involved, it is more plausible that the figure reflected a current liability and not accumulated over more than three years. The deletion made by the Commissioner is accordingly confirmed.

21. As regards the penalty imposed under section 108, the reasons advanced by the Commissioner to delete, the same are not sound enough. ,His observation that the appellate order dated 28-9-2000 required the proceedings under section 116 to be dropped is inconsistent with the facts of .the case. The appeal against the order under section 108 was filed on 5-1-2000. As such, his directions dated 28-9-2000 were issued long after the penalty order had already been passed and could not as such, be possibly complied with. In the context of the discussion in his order, dated 28-9-2000, we also find that the Commissioner nowhere discussed the failure of the assessee to file statements of accounts and balance-sheet. In fact, his order is entirely confined to the two issues of lease rental and financial expenses. His direction therefore, to drop the proceedings under section 116 had no nexus with the invalidity or otherwise, of the returns for the two years under appeals. As such, the, basis of deleting the penalty is invalid and is overruled.

22. The second reason recorded by the Commissioner to delete penalty pertains to his observation that section 55 of the Ordinance does not require filing of statement of accounts and balance-sheet. He goes on to hold that non-filing of such statements does not render the return invalid as far as provisions of section 55 are concerned. We fail to understand this logic and cannot uphold this opinion of the Commissioner. Section 55 requiring the filing of the returns of income must be read in conjunction with rule 190 of the Income Tax Rules. 1982. The rule clearly provides that. if all the documents prescribed under the Income Tax Rules as part of the returns are not enclosed, the return is liable to be considered as an invalid return under the law. Further, in the case of companies, copies of trading/manufacturing account and P & L account; balance-sheet; depreciation chart as per Third Schedule; and audit report in Form 35-A of the Companies Rules. 1985 etc. have been specifically mentioned. Seen in this context, the return filed by the assessee without requisite statements of accounts were nothing but invalid. The assessee has not challenged the veracity or, the observation of the Assessing Officer to the effect that the requisite statements and balance-sheets had not been filed. In the circumstances the default on the part of the assessee stands established.

23. In view of the foregoing, the order of the Commissioner in deleting the penalty is not sustainable on facts and law. It is accordingly vacated. However, the Assessing Officer is directed to ensure that the penalty does not exceed the maximum limit laid down in clause (i) of section 108(b) of the Ordinance.

24. As a result of foregoing facts, the departmental appeals succeed in the manner and to the extent indicated above.

C.M.A./990/Tax (Trib)Order accordingly.