I.T.A. No. 317/KB of 2001, decided on 27th May, 2005. VS I.T.A. No. 317/KB of 2001, decided on 27th May, 2005., 2006 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 2179 (2005)

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

----S.62---Assessment on production of accounts etc.---Addition was made without issuing notice under S.62 of the Income Tax Ordinance, 1979 which was a mandatory condition---First Appellate Authority set aside and remanded back the matter after holding that mandatory provision of law had been violated and add backs were not sustainable in law---Validity---Since Assessing Officer had not issued notice under S.62 of the Income Tax Ordinance, 1979 which was mandatory and condition precedent for making additions in the total income of an assessee, the correct legal course for the First Appellate Authority was to delete the additions instead of setting it aside---Addition was deleted by the Appellate Tribunal.

2005 PTD (Trib) 534 rel.

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

----S.23(1)(vii)---Deduction---Financial charges---Disallowance of financial charges on the ground that since there was introduction of fresh capital there appears to be no justification for the claim---Validity---Action of disallowance of financial charges for the reasons assigned by the Assessing Officer was not sustainable in law and the same was deleted.

1992 PLD 954 and 1987 PTD 149 rel.

Arhad Siraj for Appellant.

Farrukh Ansari, D.R. for Respondent.

ORDER

S. HASAN IMAM (JUDICIAL MEMBER).---This is an appeal filed by the Appellant/assessee inter alia challenging the order of learned Commissioner of Income Tax (Appeals) Zone I. Karachi for the assessment years 2002-03.

2. The brief facts of the case are that for the year under appeal, following expenses were added in the total income of the appellant:---

Financial Charges???????? Rs. 1,825,176

Travelling and Conveyance?????? Rs.?????? 73,292

Repair and Maintenance?????????? Rs.?????? 39,547

Communication Expenses???????? Rs.?????? 18,500

Entertainment Expenses??????????? Rs.?????? 18,302

Other Expenses??????????? Rs.?????? 6,016

Computer Expenses????? Rs.?????? 28,675

Utilities Expenses????????? Rs. 116,594

3. The Assessing Office made the above additions except Financial Charges, without issuing any notice under section 62 which is a mandatory condition. The Appellant, therefore, assailed the additions before the learned Commissioner of Income Tax (Appeal) No. I. Karachi, who after considering the arguments held that mandatory provisions of law have been violated by the DCIT and the impugned add backs are not sustainable in law. After holding the action not sustainable in law, he however set aside and remanded back the matter to the DCIT for re-adjudication.

4. The appellant is aggrieved against the setting aside of the additions, after it has been held that some were not sustainable in law. Mr. Arshad Siraj, Advocate for the appellant at the very outset argued that in view of numerous judgments of this Tribunal and superior Courts the learned Commissioner of Income Tax Appeals should have annulled the assessment instead of setting aside the additions. He relied upon the decision reported as 2005 PTD (Trib) 534 and other decisions in support of his contention. He stated that there is long list of decisions on that account. However, he frankly conceded that so far as financial charges are concerned, the appellant was confronted through Order sheet Entry dated 27-3-2003 wherein the DCIT confront the appellant with his view that claim of financial expenses of Rs.1,825,176 is unjustified in the facts that with the introduction of fresh capital there appears to be no justification for the claim of financial expenses. However, he submitted that Financial charges are fully allowable expenditures within the terms of section 23(1)(vii) as same have been incurred for capital borrowed for purpose of business and have been utilized in the business. Additionally he argued that case of the DCIT is not that financial charges have not been incurred for business purposes, but that since fresh capital was introduced, according to the DCIT there was no justification. He strongly disputed the reason assigned for addition and submitted that such reasoning is against the judgment of Supreme Court of Pakistan in cases reported as 1992 PLD 954 and (1987) 55 Tax 59 HC Kar. He, therefore, argued that additions are not sustainable in law and on merits as expenses are fully verifiable .and have been incurred wholly and exclusively for the purpose of business.

5. On the other hand the learned D.R supported the orders of lower forums; however he was not able to show us that any notice under section 62 was issued for expenses. In respect of financial charges he vehemently argued that transaction has to be examined whether such expenses have been actively utilized for the purpose of business. He stated that to examine the true nature of transaction of financial expanses, department can tier the veil of transaction and would be justified to make addition.

6. The divergent arguments have been considered and matter has been examined. Since the DCIT has not issued any notice under section 62 which is mandatory and condition precedent for making additions in the total income of an assessee, the correct legal course for the learned Commissioner of Income Tax Appeals was to delete the additions instead of setting them aside. Accordingly, the additions are? hereby deleted.

7. As far as financial charges are concerned, the situation is different. The learned A.R has frankly conceded that appellant was confronted as such it has to be dealt with differently. The reason assigned by the DCIT in respect of disallowance of finance charges is since there is the introduction of fresh capital there appears to be no justification for the claim by the appellant. Whereas, the learned A.R for appellant has submitted that reason assigned by the DCIT is against the ratio of judgments of Hon'ble High Court and Hon'ble Supreme Court in cases reported as (1987) 55 Tax 59 and 1992 PTD 954. The judgments cited at bar have been considered and are on all fours to the reason assigned by the Assessing Officer. It will be beneficial to reproduce the observation of Hon'ble Supreme Court of Pakistan in the case 1992 PTD 954:-

"6. It seems clear that from the years 1959-60 to 1968-69 borrowing of capital by the respondent for the purposes of business and payment of interest thereon was accepted by the Department. In the year 1968-69 it was challenged by the Department but did not succeed. Again for the years 1969-70 and 1970-71 the Department came to the conclusion that the loan which was borrowed in the year 1959 lost its characteristic of loan during these years under review and could not any longer be treated as loan. The factors which had influenced this opinion were that the respondent had surplus deposit amounts and no prudent businessman would keep a loan and pay a higher interest while receiving a- lesser amount of interest for his deposits. 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 seems to be based on mere surmises and conjectures. An assessee is entitled to manage his own affairs to the best of his benefit even by adopting legal modes which may result in reduction of tax and the same if covered by the provisions of law cannot be challenged on the ground of prudence, advisability or business practice. In business deficit financing, borrowing loans of huge amounts while keeping reserve funds or deposits of fixed period and running business on such loans and borrowed capital or not uncommon. An assessee is entitled to the allowance if the borrowing is not a colourable device for taking benefits under the said provision. It should be a real borrowing of capital utilized in the business on which interest has been paid without relying on the past treatment by the Department the fact remains that the amount was taken as a loan and has been employed in the business. If the respondent has generated funds, earned huge profit out of which deposits or reserve funds have been created without utilizing them in the business, it does not change the character of the loan. Here it may be advantageous to refer to C.I.T. v. Sh. Muhammad Ismail & Co. 1986 SCMR 968. In this case the assessee had paid huge interest to banks from which overdraft had been secured. The Managing Director of the assessee-Company had borrowed substantial amount from the company free of interest. The Income-tax Officer rejected assessee's claim for deduction of interest under section 10(2)(iii) holding that loan had been diverted to the Managing Director and thus the entire interest paid by the assessee could not be treated as paid on capital borrowed for purposes of business. The Assessee ultimately succeeded in appeal filed before the Tribunal. In reference the High Court agreed with the Tribunal. In appeal the Supreme Court observed:---

"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 books and the bank account 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. Shaikh. Indeed, a finding of fact has been recorded by the Tribunal that the whole of the capital which was borrowed was used for the purpose 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 shareholders which could operate as a bar to the making of advances by companies to their Directors. In order to overcome this lacuna a provision has been made in the new Income Tax Ordinance, 1979, namely clause (7) of section 12.."

7. The fact that the respondent was receiving lesser interest @ 4-1/2% while paying higher interest @ 9% to its creditors cannot be a ground to presume that the transaction was sham or has lost the character of a loan. In C.I.T. 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. C.I.T. 31 1TR 803, Birla v. C.I.T. 44 I.T.R. 847 and Bansidhar v. C.I.T. 58 IT1Z 462, it was observed that in case of genuine business borrowings the Department cannot disallow any part of the interest on the ground that the interest unreasonably high. In Amna Bai v. C.I.T. 51 1TR 835, it was observed that if the assessee had enough funds the same cannot be made a ground for rejection that the needed no borrowing. Similar "view was expressed in Ramkishan v. C.I.T. 56' ITR 186 and C.I.T v. Bombay Samachar 714 ITR 723. The entire observation of the Tribunal is based on the advisability, and possible conduct of a prudent businessman and nowhere it has been held in clear terms that the borrowed amount was not utilized for business purposes. Mr. Shaikh Haider, the learned counsel for the appellant has contended that as the Tribunal had given a finding of fact and the same not having been challenged it was not open to the High Court to have subjected the facts to scrutiny and come to a different conclusion. The respondent had challenged the order of the Tribunal on the plea that the Income-tax Appellate Tribunal had misdirected itself in law in disallowing interest. It may be observed that the question as framed is wide enough and challenges the finding of the Tribunal as well. It was not based on the finding of the Tribunal but had termed the decision of the Tribunal as a result of misdirection in law which will include the challenge to the finding of fact if based on no evidence. We do not find any force in this contention."

8. As stated above, the ratio of judgment referred supra, squarely applies to the present case. In view of above, respectfully following the ratio of Hon'ble Supreme Court, it is held that the action of disallowance of financial charges for the reasons assigned by the DCIT is not sustainable in law and as such same is deleted.

C.M.A.151/Tax (Trib.)???????????????????????????????????????????????????????????? Appeal dismissed.