I.T.A. No. 1094/KB of 2005, decided on 26th January, 2007. VS I.T.A. No. 1094/KB of 2005, decided on 26th January, 2007., 2007 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 1609 (2007)

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

---Fourth Sched., R.5(c)---Insurance Ordinance (XXXIX of 2000), Ss.1(3), 66, 168 & 170---Insurance Act, 1938 (IV of 1938), Preamble---Insurance Rules, 1958, R.40(c)---Insurance Rules, 2002---Computation of profits and gains of insurance business---Health insurance---Management expenses---Disallowance of excess management expenses--Validity---Insurance Rules, 1958 were protected by S.170 (Savings) of the Insurance Ordinance, 2000 for at least the intervening period from 19-8-2000 to 6-8-2002 and the disallowance made by the Taxation Officer was justified---Order of First Appellate Authority was vacated and restored that of the Taxation Officer regarding disallowance of excess management of expenses.

2005 PTD 474 and I.T.A. No.2172/KB of 2000 not applicable.

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

----Fourth Sched., R.5(c)---Insurance Ordinance (XXXIX of 2000), S.34(2)(d)---Insurance Act, 1938 (IV of 1938), S.27(2)(b)---Securities and Exchange Commission (Insurance) Rules, 2002, R.11---Computation of profits and gains of insurance business---Health insurance---Reserve for un-expired risk---Disallowance being excess of 40% limit---Validity---Section of the Insurance Act, 1938 provided limit of reserve in terms of percentage i.e. 40%---Section 34 of the Insurance Ordinance, 2000 read with R.11 of the Insurance Rules, 2002 providing the liability for expired risk shall not be valued at less than the sum of the unearned premium supported by the insurer's valuation performed as envisaged in R.11 of the Insurance Rules, 2002---Taxation Officer was not justified to restrict the claim of 40% since Insurance Act, 1938 was not applicable for the assessment year 2001-2002 onward---Since the assessee had also not provided the basis to determine quantum of reserve as laid down in S.34(2)(d) of the Insurance Ordinance, 2000 and R.11 of the InsuranceRules, 2002, order of First Appellate Authority was vacated and the disallowance was set aside for de novo order by the Appellate Tribunal.

1998 PTD (Trib.) 1103 ref.

Farrukh Ansari, D.R. for Appellant.

Irshad Ansari, ITP and Amir Anwar A.C.A. for Respondent.

ORDER

This appeal has been filed by the department against the order of the learned CIT(A), dated 6-6-2005 under section 62 on the following grounds:

That the learned CIT(A) has erred in deleting the disallowance of Management Expenses at Rs.39,187,094 made under Rule 5(c) of the Fourth Schedule to the repealed Income Tax Ordinance.

That the learned CIT(A) has erred in deleting the disallowance of reserved for un-expired risk at Rs.5,557,361 made under Rule 5(c) of the Fourth Schedule to the repealed Ordinance, 1979.

2. The learned representative of both the sides have been heard in detail. The first issue raised is against the learned CIT(A) order to delete the disallowance of management expenses made by the Taxation Officer (T.O.) at Rs.39,187,094 under Rule 5(c) of the Fourth schedule to the repealed Income Tax Ordinance, 1979 (hereinafter referred to as the repealed Ordinance). The Responded is a public limited company engaged in the business of health insurance where income year comprises of the period from 9th August, to 21st December, 2000 relevant to the assessment year under consideration i.e. 2001-2002. The Respondent company claimed management expenses amounting to Rs.41,970,962. The Taxation Officer invoked Rule 5(c) of the Fourth Schedule in the repealed Ordinance read with Rule 40(c) of the Insurance Rules, 1958 and restricted the claim to Rs.2,783,868 and disallowed the excess claim amounting to Rs.39,187,094. The Taxation Officer did not accept taxpayer's contentions that:--

The Company account for the period under consideration has been prepared on the basis of Insurance Ordinance, 2000. The company while following the provision of the Ordinance, 2000 did not restrict the management expenses, as there were no restriction mentioned in the Ordinance, 2000.

With the promulgation of Ordinance, 2000 the Insurance Act of1938 (repealed Act) and Insurance Rules stood repealed subsection (3) of section 1 of Part-I of the Ordinance, 2000 provided that Ordinance, 2000 come into force at once.

Section 66 of the Ordinance, 2000 authorizes the commissioner to make rule the prescribing and limiting the maximum level of allowable management expenses.

Section 170 of the Ordinance, 2000 provides "Savings" to certain provisions or the repealed Act which is absolutely silent over the management expenses. Leaving no room for interference and surmises for the treatment of management expenses as per the ordinance, 2000.

It is an established Principle of natural justice supported by a plethora of case laws of Higher and Superior Court, that in case of anomaly in law, Of where a taxing statute is not clear and ambiguous, the decision should be made in favour of the assesses.

The Taxation Officer did not accept taxpayer's contentions on the following grounds:--

(1) The limitation regarding the excess management expenses were prescribed vide rule 40(c) of the Insurance of Rule, 1958.

(2) The said rules were Promulgated in pursuant to section 40 of the Insurance Act, 1938, after a lapse of around 20 years.

(3) The Insurance Act, 1938 stands repealed as per section 168 of the Insurance Ordinance, 2000 which was promulgated on 19-8-2000.

(4) Pursuant to section 66 of Insurance Ordinance, 2000, the rules have been enacted on 7-8-2002 as Insurance Rules, 2002, it is admitted that the said Insurance Rules do not put bar/limitation on the expenses incurred on management.

(5) But the fact remains that the Insurance Rules, 1958 remained in tact till the new Rules were enacted on 7-8-2002 as per section 170 of Insurance Ordinance, 2000, which contains "Savings" to interalia the actions done or proceedings initiated, rules of regulation made in pursuant to the repealed Insurance Act, 1938, provided the same are not in consistent with any provision of the Insurance Ordinance, 2000. For the sake of reference, the said saving section 170 is reproduced:-

"170-Saving (2). Save as otherwise provided in this Ordinance, nothing in this Ordinance shall affect or be deemed to affect anything done, investigation of proceedings commenced, order, rule, regulation, appointment, document or agreement made, free prescribed or charged, resolution passed, direction given, proceedings taken, or instrument executed or issued under or pursuant to the repealed Act or any law amended or repealed by this Ordinance and any such thing, action, investigation, proceedings, order rule, regulation, appointment, documents or agreement, fee, resolution, direction, proceedings or instrument shall, if in force at the commencement date for this section and not inconsistent with any of the provisions of this Ordinance, continue enforce and have affect as if it had been respectively done, taken commenced, made, prescribed, changed, directed, passed, given, executed or issued under this Ordinance or any other laws as amended by this Ordinance."

(6) Rules 5(c) of the 4th Schedule puts embargo on the management expenses as per Insurance Act, 1938 read with rule 40(c) of the Insurance Rules, 1958. The legislature intentionally did not substitute the Income Tax Ordinance, 2001 for Insurance Act, 1938 in view intact position of Insurance Rules, 1958.

(7) It is pertinent to mention here that on the said issue the department is in reference appeal at higher forums and the matter is thereafter sub judice.

(b) Without prejudice to the above discussion there is no dispute with regard to the fact that this assessment has to be framed under the provision of Income Tax Ordinance, 1979. Rule 5(c) of the Fourth Schedule of the said Ordinance has not incorporated the provisions of Insurance Ordinance, 2001. It on the contrary continues to refer to the Insurance Act, 1938. Hence Insurance Rules, 1958 shall be treated as basis for restricting the management expenses, As clearly provided in Rule 8 and of Fourth Schedule to the Income Tax Ordinance, 1979, the provisions of Fourth Schedule apply notwithstanding anything contained in the Income Tax Ordinance, 1979 or any other law for the time being in force.

"Hence as long as the Insurance Act, 1938 (IV of 1938) continues to be the base law for disallowances under Rule 5(c) of the Fourth Schedule to the Income Tax Ordinance, 1979, its replacement by the Insurance Ordinance, 2000 shall have no bearing on assessment of income. There is no ambiguity in the minds of legislature in this regard and reference to Insurance Act, 1938 has been mindfully retained in the Income Tax Ordinance, 1979. The intent of the legislature becomes more clearer when we peruse the new Income Tax Ordinance, 2001 which has similar provisions for assessment of income from Insurance business contained in section 99 (parallel to section 26(a) of the Income Tax Ordinance, 1979) and Rules 5(c) of Ordinance, 2001 instead of Insurance Act, 1938 the new Insurance Ordinance, 2000 has been made the base law for disallowance under the said Rule. It is worth noting that as provided in its section 239(1) the new Income Tax Ordinance, 2001 will repeal the Income Tax Ordinance, 1979. However, the repealed Ordinance, 1979 shall continue to apply to the assessment year ending on 30-6-2002. Therefore, upto assessment year 2002-2003 the income of insurance business shall continue to be assessed under section 26(a) read with Fourth Schedule to the Income Tax Ordinance, 1979 wherein for disallowances under Rule 5(c) shall continue to be based on Insurance Act, 1938 notwithstanding its repealing on 19-8-2000.

In the opinion of this office provisions of Insurance Ordinance, 2000 arc not to over-ride the provisions Income Tax Ordinance, 1979. The position in fact is other way round."

3. The learned CIT(A) relying on the arguments of the taxpayer and the case reported as 2005 PTD 474 and another order of the ITAT, dated 20-3-2002 in I.T.A. No. 2172/KB of 2000 (Assessment year 2000-2001) deleted the impugned disallowance. The ITAT in the reported case has held as follows:--

" Since newly promulgated Insurance Ordinance, 2000 contained no saving vis-a-vis section 26(2) of repealed Insurance Act, 1938, R.5(c) of Fourth Schedule. The Income Tax Ordinance, 1979 was not applicable for assessment year under review---Addition made under R.5(c) of the Fourth Schedule to Income Tax Ordinance, 1979 was not maintainable which was ordered to be deleted."

In the other case, the ITAT decided the issue in following terms:

"We are, however, afraid if the gravity of the situation that Insurance Act, 1938 has been repealed vide Insurance Ordinance, 2000 promulgated on August, 19, 2000 and relevant in the year 2000-2001. The amendments have not been brought in the Income Tax Ordinance, 1979, in follow-up of the Insurance Ordinance of 2000 which has repealed the Insurance Act, vide section 108 of the Ordinance. In the present situation decision made by the Assessing Officer referring the provisions of the repealed Act when new law has been promulgated in place of repealed Act will be of no effect. It is worth mentioning that Insurance Ordinance, 2000 shows no savings in context with section 126-A and clause (c) of Rule 5 of the Fourth Schedule to the Income Tax Ordinance, 1979 as the assessment order has been passed after promulgation of the Insurance Ordinance, 2000."

4. We have given serious consideration to the facts of the case and the two cases cited in the learned CIT(A) order in the light of the new enactments relating to insurance business. The new Insurance Ordinance, 2000 was promulgated on 19-8-2000 repealing the old Insurance Act, 1938 under which Insurance Rules, 1958 were framed. Section 66 of the Insurance Ordinance, 2000 authorizes the Commissioner to make the Rule prescribing and limiting the maximum level of allowable management expenses. However, no such rule was made and the new Insurance Rules, 2002 were enacted on 7-8-2002 which do not provide any rule to prescribe the limit of allowable management expenses. Now, the question is whether or not the old Insurance Rules, 1958 are covered by the saving section 170 of the Insurance Ordinance, 2000 for the intervening period from 19-8-2000 to 6-8-2002. This issue has not been decided by our learned brother in the two cases cited supra and as such are not applicable in the facts and circumstances of this case. A careful reading of section 170 shows that the saving provision does protect the old Insurance Rules of 1958 for the said intervening period. The section 170 with reference to saving of rules issued under the repealed Insurance Act, 1938 is reproduced as follows:--

"170 Section (2).---Save as otherwise provided in this Ordinance, nothing in this Ordinance shall effect or be deemed to effect----------, rule ----------, issued under or pursuant to the repealed Act or any--------, rule, ---------, if in force at the commencement date of this section and not inconsistent with any of the provisions of this Ordinance, continue inforce and have effect as if it had been --------made ------- or issued under this Ordinance --------."

5. From the foregoing, we are of the considered opinion that the Insurance Rules, 1958 are protected by section 170 (Savings) of the Insurance Ordinance, 2000 for at least the intervening period from 19-8-2000 to 6-8-2002 and the disallowance made by the Taxation Officer is justified. Accordingly, we vacate the order of the learned CIT(A) and restore that of the Taxation Officer regarding disallowance of excess management expenses.

6. The next issue relates to the disallowance of reserve for un expired risk amounting to Rs.5,557,361 made by the Taxation Officer under Rule 5(c) of the Fourth Schedule to the repealed Income Tax Ordinance, 1979 that has been deleted by the learned CIT(A). The DCIT has made the disallowance being excess of 40% limit provided in section 27(2)(b) of the Insurance Act, 1938 read with Rule 5(c) of Fourth Schedule to the repealed Income Tax Ordinance, 1979. Whereas, the learned CIT(A) has directed to allow the claim in full with the observation that after the promulgation of Insurance Ordinance, 2000, restriction under Rule 5(c) of the Fourth Schedule is no longer applicable. We are not inclined to agree with the findings of the learned CIT(A) since, in the light of section 8 of the General Clauses Act, 1897, reference to the repealed Insurance Act, 1938 in the 4th Schedule to the repealed Income Tax Ordinance, 1979 would be construed as reference to the new Insurance Ordinance, 2000. The learned DR has drawn our attention to the decided case cited as (1998 PTD (Trib.) 1103 and section 34(2)(d) of the Insurance Ordinance, 2000 to support the impugned disallowance made by the Taxation Officer.

7. The ratio of the case law cited by the learned D.R. is as follows:--

"Income---Insurance business---Reserve for un-expired risk---Restriction---Different companies created reserve for un-expired risk in different proportion of the premium---Department restricted the reserve to 40% of the net premium---Whether treatment justified---Held, yes---"

8. Now, it would be useful to reproduce the provision of section 27(2)(b) of the repealed Insurance Act, 1938 and section 34(2)(d) of the new Insurance Ordinance, 2000 and the relevant rule framed there under to find out whether or not these provisions are similar in content to restrict the quantum of the reserve for un-expired risk. The same are reproduced as follows:--

"Insurance Act, 1938

Section 27-A. Insurers of general insurance business to have assets invested in Pakistan.(1) Every insurer transacting general Insurance business in Pakistan shall have assets invested in Pakistan exceeding his liabilities by at least a sum of five lakhs of rupees or ten per cent of the net premium income whichever is higher:

Provided that an insurer defined in sub-clause (a)(ii) or sub-clause (b) of clause' (9) of section 2 who has no paid-up capital or has a paid-up capital of less than five lakhs of rupees shall be deemed to have complied with the requirements of this subsection of the assets invested by him in Pakistan, not being less than ten per cent of the net premium income exceed his liability:--

(a) up to the 31st day of December, 1970, by a sum of not less than two lakh and fifty thousand rupees;

(b) up to the 31st clay of December, 1971, by a sum of not less than three lakh seventy five thousand rupees; and

(c) up to the 31st day of December, 1972, by five lakh rupees.

(2) For the purpose of subsection (1) the following shall be deemed to be the liability of the insurer namely:--

(a) the net claims outstanding in respect of general Insurance business in Pakistan;

(b) forty per cent of the net premium in respect of Fire, Mirine and Miscellaneous insurance business within Pakistan;

(c) one hundred per cent of the net premium in respect of Marine and Aviation Hull insurance business written in Pakistan;

(d) amount of provision for dividends and unpaid dividends;

(e) amount due to Insurance Companies carrying on insurance business;

(f) amount provided for taxation;

(g) amount due to other creditors but excluding share capital general reserves, investment reserve, reserve for bad and doubtful debts, depreciation funds except on such items as are taken credits for an assets.

Explanation.--Marine and Aviation Hull insurance business shall include any policies issued to an owner of a vessel or aircraft relating to any interest of such an owner in respect of a vessel or aircraft."

"Insurance Ordinance, 2000

Section 34. Valuation of assets and liabilities.---(1) For the purposes of this Part, assets and liabilities shall, subject to sub-section (2), be valued in accordance with such accounting rules as may be prescribed by the Commission.

(2) For the purposes of this Part, as at any date (the "balance date") to which a statement of assets and liabilities (however called or described) is made up:--

(a) no assets of an insurer shall be valued at more than the amount, net of transaction costs 'incurred by the transferor, at which it could be transferred in an orderly market in a transaction between two willing be not anxious parties;

(b) no liabilities of an insurer, not being a policy-holder liability, shall be valued at less than the amount, included transaction costs incurred by the transferor, at which it would be transferred in an orderly market in a transaction between two willing but not anxious parties;

(c) the liability for outstanding claims of a non-life insurer shall not be valued at less than the expected settlement cost, including settlement expenses, of all claims incurred by the insurer but not paid as at the balance date, whether or not those claims have been reported to the insurer as at that date, and including, prudent but reasonable provisions for adverse development in that expected settlement cost after balance date: and

(d) the liability for unexpired risk of a non-life insurer shall not be valued at less than the sum of the unearned premium reserve and the premium deficiency reserve, where:

(i) the unearned premium reserve is the unexpired portion of the premium which relates to business in force at the balance date: and

(ii) the premium deficiency reserve is the amount if any by which the expected settlement costs, including. settlement expenses but after deduction of expected reinsurance recoveries of claims expected to be incurred after the balance date in respect of policies in force at the balance date, exceeds the unearned premium reserve.

(3) The Commission may prescribe guidelines for the estimation of amounts set out in subsection (2)."

"Securities and Exchange Commission

(Insurance) Rules, 2002

Rule 11. Valuation.---For the purposes of subsection (3) of section 34 of the Ordinance where an amount referred to in subsection (1) of that section cannot be reliably determined by reason of the absence of relevant information on which to base a determination, an insurer may perform a valuation based on the present value of the expected future cash flows pertaining to an asset or a liability, as the case may be and in determining the present value at discount rate appropriate to the timing of the future cash flows shall be used."

9. From the foregoing we are of the considered opinion that section 27 of repealed Act, 1938 provides limit of such reserve in terms of percentage i.e. 40%. Whereas, section 34 of the Insurance Ordinance, 2001 read with Rule 11 of the Insurance Rules, 2002 provide the liability for unexpired risk shall not be valued at less than the sum of the unearned premium supported by the insurer's valuation performed as envisaged in Rule 11 ibid. Therefore, the Taxation Officer is not justified to restrict the impugned claim to 40% since repealed Insurance Act, 1938 is not applicable for the assessment year 2001-2002 onward. At the same time, the respondent company has also not provided, either at the assessment stage or the appeals stage, the basis tit) determine quantum of the impugned reserve as laid down in section 34(2)(d) and Rule 11 ibid. Accordingly, the learned CIT(A)'s order on this point is vacated and the impugned disallowance is set aside for do novo order in the light of section 34(2)(b) of the Insurance Ordinance, 2000 read with Rule 11 of the Insurance Rules, 2002.

10. The departmental appeal stands disposed off as indicated above.

C.M.A./32/Tax (Trib.)Order accordingly.