Messrs PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION LTD. VS COMMISSIONER OF INCOME TAX
2006 P T D 1400
[Karachi High Court]
Before Sabihuddin Ahmed and Zia Perwaz, JJ
Messrs PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION LTD.
Versus
COMMISSIONER OF INCOME TAX and others
Income Tax Appeals Nos. 306 to 308 of 1999 and 785 of 2000, decided on 18/09/2002.
(a) Income Tax Ordinance (XXXI of 1979)---
---S.32---Accounting, system of---Cash system and mercantile system---Distinction.
According to the cash system, the income of an assessee is calculated on the basis of the amount actually received from debtors/ customers and the amount actually paid by way of disbursement during a particular assessment year. In the mercantile system, profits are calculated on the basis of accrual of debts and rights to receive irrespective of the date when the amounts are actually received or paid.
Dhakeswar Persad Narain Singh v. Commissioner of Income Tax 1936 4 ITR 72 rel.
(b) Income Tax Ordinance (XXXI of 1979)---
---S. 136---Findings of fact by Appellate Tribunal---Validity---Such findings would be immune from interference by High Court.
(c) Income Tax Ordinance (XXXI of 1979)---
----Ss. 32 & 136---Finding of Appellate Tribunal regarding maintenance of two systems of accounting by assessee i.e. cash as well as mercantile system---Validity---Question as to whether on basis of such admitted fact, assessee was legally justified in applying cash system to some of its account, while keeping its normal accounts under mercantile system---such question was a pure question of law, which was not immune from interference under S.136 of Income Tax Ordinance, 1979.
(d) Income Tax Ordinance (XXXI of 1979)---
---Ss. 32 & 66-A---Assessee maintaining two systems of accounting simultaneously---Reopening of assessment by Inspecting Additional Commissioner---Validity---Where assessment. was made on a basis, which was wrong in law and tax liability of assessee could be higher than what was determined by Assessing Officer, then Commissioner could always reopen the assessment---Revenue, in the present case found that assessee was not legally entitled to benefit of two systems of accounting and could be made liable to pay tax on interest credited to suspense account on accrual basis---Power to reopen assessment in such circumstances could not be denied to the Commissioner.
(e) Income Tax Ordinance (XXXI of 1979)---
----S.32---Accounting, system of---Right of assessee to keep accounts according to any system they pleased---Assessee under law could apply hybrid system of accounting treating some transactions according to accrual or mercantile system and others according to cash system---Application of cash system to sticky or irrecoverable loans could not be rejected merely for reason that assessee was applying mercantile system to its normal accounts---Duty of Income Tax Authorities was to determine on the basis of faets and circumstances of each case, whether any amount receivable could be properly treated as irrecoverable for the purpose of qualifying for cash system.
Radhaka Corporation v. Central Board of Revenue 1989 SCMR 358; (1998) 77 Tax 231; Commissioner of Income Tax v. Citibank 208 ITR 1994 930; Commissioner of Income Tax v. Jaya Lakshmi Trading Company 214 ITR (95) 661 and UCO Bank v. Commissioner of Income Tax 1999 PTD 3752 ref.
State Bank of Travencore v. Commissioner of Income Tax (1986) 158 ITR 102 disapproved.
Dr. Farough Naseem for Appellants.
Muhammad Fareed for Respondents (in I.T.As. Nos.306, 308 of 1999 and 785 of 2000).
Muhammad Ilyas Khan for Respondents (in I.T.A. No.306 of 1999).
Nasrullah Awan for Respondents (in I.T.A. No.785 of 2000).
Date of hearing: 16th May, 2002.
JUDGMENT
SABIHUDDIN AHMED, J.---In the above four appeals the questions of law and fact are substantially similar. The appellant is a development finance institution and primarily engaged in financing customers in industrial projects. Their normal accounts are admittedly kept according to the "mercantile system of accounting" and any amount receivable or payable is entered into the books of accounts the date where the right to receive or the obligation to pay accrues irrespective of the actual date of receipt or payment. However, loans which are considered "sticky" or irrecoverable are transferred to a suspense account. Admittedly the appellants retain their right to recover such amounts from their debtors together with interest. Nevertheless, for these accounts the appellants apply the cash system of account and credit the interest received at the time of actual receipt and not mere accrual. Their returns for the earlier years on the aforesaid basis were accepted by the Income Tax Authorities for allowing time.
2. For the assessment years 1993-94, 1994-95 and 1995-96 the Assessing Officer finalized the assessments accepting the appellants treatment of not offering to tax "interest taken to the suspense account" the Inspecting Additional Commissioner, however, reopened the assessment for these years under section 66-A of the Income Tax Ordinance, 1979 (hereinafter mentioned as the 1997 Ordinance) in consequence whereof reassessment orders were passed. Aggrieved by such reopening and re-assessment, the appellants preferred three appeals to the Income Tax Appellate Tribunal, which were dismissed by a consolidated order dated 22-4-1999. Against this order I.T.As. Nos.306, 307 and 308 of 1999 have been preferred. I.T.A. No.785 of 2000 arises from the order of the Assessing Officer who declined to accept the returns filed by the appellants according to the above method and appeals against his orders were rejected by the Commissioner of Income Tax (Appeals) and the Tribunal through order dated 3-6-2000.
3. Dr. Farough Naseem learned counsel for the appellants and Mr. Muhammad Fareed learned counsel for the respondent before addressing us on different aspects of the merits of the controversy invited us to frame the questions for consideration with the assistance of both learned counsel. We have decided to formulate the following:
(i) Whether in the admitted facts of the case, including the past practice, the assessee was required to pay tax on the interest due which was transferred to the suspense account at the time of accrual of such interest or whether the tax on the interest received (if any) was payable at the time of actual receipt.
(ii) Whether the findings of the learned Tribunal to the effect that the assessee was maintaining a mercantile system of accounting was a finding of fact and immune from interference by this Court under section 136 of the Ordinance.
(iii) Whether the Inspecting Additional Commissioner could reopen the appellants' assessment under section 66-A of the Income Tax Ordinance.
(iv) Whether an assessee could simultaneously maintain two different systems of accounts.
4. Before attempting to answer the above questions, it may be appropriate in the first instance refer to, the different systems of accounting maintained by the assessees for the purpose of appreciating the crux of the controversy between the parties. Section 32 of the Income Tax Ordinance, 1979 requires that income profits and gains shall be computed in accordance with the method of accounting regularly applied by the assessee. Dr. Farough Naseem learned counsel for the appellants took great pains in explaining to us the difference between the cash system of accounting and the mercantile system and drew our attention inter alia to an old judgment of the Patna High Court in Dhakeswar Persad Narain Singh v. Commissioner of Income Tax (1936) 4 ITR 72 in the following words:
"Now, there are two methods of accounting for the income, profits and gains of a business which are generally referred to as the cash basis and the mercantile basis. According to the former a record is, as in this case, kept of actual receipts and actual payments, entries being made only when money is actually collected or disbursed and if the profits of the business are accounted for in this way the tax is payable on the difference between the receipts and the disbursement for the period in question. There is, secondly, the mercantile system under which a profit and loss account is maintained. At the end of the financial year the assets and liabilities are valued and entered in the account and the difference between the two is the profit upon which the tax is paid. In most cases the debts would be valued as of their face value, that is to say, at the moment at which it is shown as having accrued. Nevertheless, the accounting is on a valuation basis and the debts and so far as they are entered in the accounts are considered in the light only of an asset."
5. In simple words it is quite clear that according to the cash system the income of an assessee is calculated on the basis of the amount actually received from debtors/customers and the amount actually paid by way of disbursement during a particular assessment year. In the mercantile system on the other hand profits are calculated on the basis of accrual of debts and rights to receive irrespective of the date when the amounts are actually received or paid.
6. There seems to be no dispute as regards the import of the above two methods of accounting. It is also acknowledged that the appellants have been applying mercantile system of accounting for the purpose of their normal loans for the purposes of calculation of income tax, though at the same time the department has been assessing their tax liability with respect to bad debts on the cash system basis in the past. It is in the light of the above state of facts that the questions formulated in para. 2 above are required to be answered.
7. With respect to question No.1 it may be observed that admittedly the appellants have been maintaining the mercantile system of accounting in respect of their normal transactions but the interest accrued on loans that were considered to be sticky or irrecoverable was transferred to a suspense account. Therefore, the interest notionally having become payable but whose chances of actual recovery were slim, was not treated as income in the assessment year during which it had theoretically accrued but such transfer implied that it would be treated as income only in case if it was, by a stroke of luck, recovered and for the year when it was actually received. In other words the cash system of accounting was applied to such income. The answer to this question would depend upon the answer to the fourth question i.e. whether it was legally permissible for the appellants to apply the mercantile system to some transactions and cash system to others.
8. The answer to the second question is simple. Indeed the fact that the appellants were keeping their normal accounts according to mercantile system, but a different treatment was accorded to accrued interest on doubtful and sticky loans was not really in issue between the parties. The hierarchy of authorities under the Ordinance drew their conclusion on admitted facts, which could hardly be described as findings. Indeed findings of fact are immune from interference by this Court but no such finding has been called in question before us and the question raised is whether on the basis of admitted fact appellants were illegally justified in applying the cash system to some of its account, while keeping their normal accounts under the mercantile system. This in our humble view, is a pure question of law and no immunity from interference under section 136 of the Ordinance can be claimed on this score.
9. Dr. Farough Nasim attempted to argue that once an assessment had been finalized the Inspecting Additional Commissioner could not exercise and reopen it in his revisional jurisdiction under section 66-A of the Ordinance unless he was satisfied objectively on the basis of tangible material that the assessment was both erroneous and prejudicial to the-interest of Revenue. We regret we cannot uphold his objection in the ' facts and circumstances of this case inasmuch as we are clearly of the view that once it comes to the notice of the Inspecting Additional Commissioner that the assessment had been made on a basis, which is wrong in law and the tax liability of the assessee could be higher than what was determined by the Assessing Authority, he could always reopen the matter. Indeed in case the respondent felt that the appellants were not D legally entitled to the benefit of two systems of accounting and could be made liable to pay tax on interest credited to the suspense account on accrual basis, the power to reopen assessment could not be denied.
10. The crux of the controversy rests on the answer to the fourth question. Dr. Farough Nasim in the first instance relied upon section 32 of the Ordinance, which stipulates that subject to a general or special order of the Central Board of Revenue, requiring an assessee to maintain accounts in particular form, income has to be computed for tax purposes in accordance with the method of accounting regularly applied by the assessee. Indeed there could no cavil with this proposition and the learned Tribunal itself has acknowledged the right of the appellants to keep their accounts according to any method they pleased. Learned counsel however, further argued that the error in the impugned findings arose from the assumption that an assessee could either keep all his accounts under the mercantile system or under the cash system but there was no third system or that an assessee could not keep part of the accounts under one and part under the other system. This view of the law, learned counsel vehemently argued was not correct.
11. Learned counsel argued that the Ordinance did not specify any particular system of accounting and what was not expressly prohibited was always permissible. He further contended that a "hybrid" system of accounting whereby the mercantile system was applied to certain classes of transactions and the cash system of another class was always recognized by law. While we propose to discuss the precedent cited a little later in this judgment, it might suffice to note the contention of Dr. Nasim that the respondents themselves had always accepted the appellants' returns based on this system till the majority judgment of the Honourable Supreme Court of India in State Bank of Travancore v. Commissioner of Income Tax (1986) 158 ITR 102 was noticed and followed by Tribunal. Such consistent acceptance in his view constituted a departmental practice having force of law in terms ' of the pronouncement of our Supreme Court in Radhaka Corporation v. Central Board of Revenue 1989 SCMR 358.
12. We have carefully gone through the judgment of the Supreme Court of India in State Bank of Travancore case. The majority judgment authored Mukherji, J., proceeds on the hypothesis that under section 145 of the Income Tax Act, 1961 (which is similar to section 32 of our Income Tax Ordinance, 1979) income of an assessee is to be computed on the basis of the system of accounting maintained by him and that mainly there are two systems of keeping accounts followed in the country. It is on this hypothesis that the Honourable Judges proceeded to hold that once the assessee was admittedly keeping accounts on accrual basis under mercantile system and the right to recover interest on sticky loans was shown even in the suspense account, the assessee could not evade his liability to pay tax on such interest. It was further held that once the right to recover had accrued and shown in the books of accounts even a subsequent writing off the loan and bad debt could not allow the assessee to claim deduction.
13. In his dissenting opinion Tulzapurkar, J., however took a different view. In his Lordship's opinion irrespective of the system of accounting it was only real income and. not any hypothetical income which might have theoretically accrued that was liable to tax under the Act. His Lordship observed that mere fact that interest on sticky advances was charged to the concerned debtors by making entries in their respective accounts no inference could be drawn that the assessee had regarded it as accrued income because simultaneously such interest was credited to the suspense account and not to the profit and loss account. In fact by making these entries the assessee must be regarded as having demonstrably shown an intention to treat such interest as its hypothetical and not real income. It was further observed that accrual of income even under the mercantile system had to be decided on commercial principles having regard to the realities of the situation and could not be determined by adopting a purely theoretical or doctrinaire approach. It may be added here that even the majority opinion did not deviate from the concept of real income but went to hold that it should be applied with care and not in a manner which may defeat the intention of the law and took the view that mere improbability (as distinguished from impossibility) of recovery and taking the interest to a suspense account could not be treated as evidence to show that no real income had accrued. We have however, been informed that there is no decision of any superior Court in Pakistan covering the above controversy.
14. The view taken by the majority of the Honourable Judges of the Supreme Court of India in the above case was adopted by a Division Bench of the Income Appellate Tribunal in a large number of appeals preferred by several commercial banks reported in (1998) 77 Tax 231 and it was held that the taxing authorities were justified in levying tax on interest in the suspense account where the principal amount had not become irrecoverable but extremely doubtful of being recovered. No detailed discussion of the respective contentions advanced appears to have taken place and the Honourable Judges expressed their full agreement with the reasoning contained in the majority judgment of the Supreme Court of India. The respondents have also primarily relied upon the same view.
15. Dr. Farough Nasim however, argued that the basic thrust of the majority judgment in State Bank of Travancore case was that there were only two recognized systems of keeping accounts and while an assessee was entitled to choose either of the two methods i.e. the mercantile system or the cash system he could not apply both of them to different transactions for his benefit. He argued that the hypothesis was legally unsustainable and it had been held by the High Courts in India even after the pronouncement of the Supreme Court that there were other systems of accounting as well commonly known as "hybrid systems". Learned counsel relied upon the pronouncement of a Division Bench of the Bombay High Court in Commissioner of Income Tax v. Citibank in 208 ITR 1994, 930. In this case it was held that an assessee may imply one method of accounting for one class of business or one class of customer or transactions and a different method for another class. In this case the assessee followed a policy of classifying loans into ordinary loans and problem loans; problem loans were those which were problematic and while mercantile system of accounting was applied to the former category the latter were kept in a different portfolio and subjected to the cash system. Their Lordships held that no objection could be taken to the above system of keeping accounts. In Commissioner of Income Tax v. Jaya Lakshmi Trading Company 214 ITR (95) 661, the Madras High Court held that mere improbability of recovery and taking the interest merely in suspense account might not be sufficient evidence to show that no real income had accrued or had been treated as such by the assessee. However, it was held that if loans had become stagnant and interest had not been shown as accrued on only theoretical possibility, there would be no justification for finding fault with the returns of the assessee. If the assessee's account on such basis had been accepted in the past there could be no valid reason for not doing so subsequently.
16. Finally Dr. Farough Nasim relied upon the recent pronounce?ment of the Honourable Supreme Court of India in UCO Bank v. Commissioner of Income Tax 1999 PTD 3752 where the Court took a different view from that taken in the State Bank of Travancore case. In this case, the assessee-Bank had excluded the amount of interest accrued on loans advanced in respect of which no recovery had been made during the past three years treating such loans as doubtful or irrecoverable. It. was held that notional income accrued by way of interest on amounts credited to the suspense account would not be treated as real income of the appellant-Bank for the purpose of income tax liability. No doubt the principal basis for such decision was a circular dated 9-10-1984 issued by the Central Board of Direct Taxes to the effect that though interest in respect of doubtful debts credited to suspense account by Banking Companies will be subject to tax but interest charged in an account where there has been no recovery for three consecutive years will not be subject to tax in the fourth year and onward. However, if some recovery is actually made during the forth year or afterwards tax will be paid.
17. Indeed it could have been possible to urge, on behalf of the respondents, that in Pakistan no circular requiring an assessee Bank to keep accounts in any particular method has been issued by the Central Board of Revenue and therefore, the ratio decidendi of the above Supreme Court pronouncement is not applicable Nevertheless, it is pertinent to mention that their Lordships did acknowledge that the assessee's method of accounting, transferring the doubtful debt to interest suspense account and not treating as profit until actually received was in accordance with accounting practice. It may be useful to reproduce the following observations of Mrs. Sujata Manohar, J., delivering the unanimous opinion of the Court:
"We have to consider whether interest on a loan whose recovery is doubtful and which has not been recovered by the assessee-Bank for the last three years but has been kept in a suspense account and has not been brought to the profit and loss account of the assessee, can be included in the income of the assessee for the assessment year 1981-82. It is the case of the assessee that in respect of loans which are advanced by it to various customers, recovery of some loans is very doubtful. It is doubtful whether even the interest on the loans advanced will be recovered from the customer. In such cases, the interest calculated on the loan amount is credited in a suspense account. This amount is not brought to the profit and loss account of the assessee-bank because these are amounts which are not likely to be realized by the bank. Hence, they do not form a part of the real income of the bank. If and when any such amount or a part of it is recovered, it is included in that assessment year in the total income of the assessee for the purpose of payment of income-tax.
The method of accounting which is followed by the assessee-Bank is the mercantile system of accounting. However, the assessee considers income by way of interest pertaining to doubtful loans as not real income in the year in which it accrues, but only when it is realized. A mixed method of accounting is thus followed by the assessee-Bank. This method of accounting adopted by the assessee is in accordance with accounting practice."
18. Learned counsel also referred to various treatises on accounting methods indicating that apart from the cash and accrual or mercantile a "hybrid" method, containing elements of both the accrual and cash methods i.e. using the accrual methods for some activity and cash methods for others was an equally well recognized method of accounting. He argued that in the absence of any statutory stipulation or a condition imposed by section 32 or even a definition of recognized accounting systems there. was no justification for the tax authorities to reject appellants' assessment according to hybrid method. Learned counsel also referred to some recent decisions of the learned Income Tax Appellate Tribunal where the pronouncement of the Supreme Court of Indian in UCO Bank's case has been duly considered and having held that the State Bank of Travancore case is no longer good law the benefit of hybrid system has been lately allowed to certain banking companies. In view of the above, we are clearly of the opinion that the forth question must be answered in the affirmative.
19. For the forgoing reasons having answered the second question in the negative and the third in the affirmative we would answer the fourth question in the affirmative holding that an assessee could in law apply the hybrid system of accounting treating some transactions according to accrual or mercantile system and others according to cash system. It would, therefore, follow that the majority opinion in State Bank of Travencore v. Commissioner of Income Tax (1986) 158 ITR 102 is not good law and application of cash system to sticky or irrecoverable loans could not be rejected merely because the assessee was applying the F mercantile system to its normal accounts. Therefore, with reference to Question No.1 it would be necessary for the Income Tax Authorities to determine on the basis of facts and circumstances of each case, whether any amount receivable could be properly treated as irrecoverable for the purpose of qualifying for the cash system. Question No.1 is therefore, answered accordingly.
S.A.K./P-11/K??????????????????????????????????????????????????????????????????????????????????? Answer accordingly.