COMMISSIONER OF INCOME TAX VS NATIONAL REFINERY LIMITED, KARACHI, 2010 PTD-KARACHI-HIGH-COURT-SINDH 737 (2009)

Income Tax Ordinance (XXXI of 1979)--

----S.23---Allowable deduction---Scope---Penalty or fine---State owned company deriving income from, refining crude oil---Import of crude oil by assessee-company under loan from a foreign Bank on guarantee of State Bank of Pakistan---Liability of assessee-company to deposit counter part rupee fund with State Bank within specified period---Charging of excess amount by State Bank for late payment of loan amount under Para. 44 of Ch. XIII of Foreign Exchange Manual---Such excess amount charged by State Bank claimed by assessee- company to be an allowable expense, but Assessing Officer added same to its total income---Validity---Expenditure incurred on account of fine or penalty or in nature of fine or penalty would not be allowed as deduction---Expenditure incurred by an assessee on account of infringement of a provision of a statute, but not in nature of fine or penalty, could be allowed as admissible deduction, provided same was incurred wholly and exclusively for purpose of business---Any excess amount fixed as compensation for delay or default, if paid by or charged from an assessee, would not be deemed to be penalty or fine---Payment of excess amount for delayed payment of an original liability would not be deemed as penalty or fine, if same was automatic, without initiation of any separate proceedings and order and exercise of discretion by competent authority---Damages or compensation paid for breach of any contract were expenses incurred exclusively for purpose- of business---Such excess amount paid by assessee-company was not for violation of any law, but was for a breach of contract as compensation for late payment of loan amount---Assessee-company had paid such excess amount wholly and exclusively for business consideration in exercise of option available to company under contract, thus, same was not penalty or fine, but was an admissible expenditure under S.23 of Income Tax Ordinance, 1979---Principles.

I.T.C. No.32 of 1996, I.T.Cs. Nos. 51, 52 and 53 of 1996; I.T.C. 57 and 58 of 1996; I.T.C. No.48 of 1996; (2001) 83 Tax 113; Ata Hussain Khan Limited v. Commissioner of Income Tax, East Pakistan, Dacca (1970) 21 Tax 1; Commissioner. of Income Tax, Central Zone `B' v. Messrs Farrokh Chemical Industries 1992 SCMR 523; Beecham Pak v. Commissioner of Income Tax 1995 PTD 577 and Commissioner (Legal Division) Large Taxpayer Unit, Karachi v. Bawany Metals Ltd. Karachi 2006 PTD 2256 ref.

Hassan Associates (Pvt.) Ltd. v. C.I.T. 2009 PTD 66 and CIT y. Premier Bank Ltd, 1999 SCMR 1213 rel.

Muhammad Farid for Appellant.

Iqbal Salman Pasha for Respondent.

Date of hearing: 27th April, 2009.

JUDGMENT

MUHAMMAD ATHAR SAEED, J.---By this Income Tax Appeal filed against the order dated 11-4-2000, passed by the Income Tax Appellate Tribunal (Headquarters), Karachi in Income Tax Appeal No.126/KB of 1999-2000, the following questions said to have arisen from that order have been proposed for the opinion of this Court.

A. Whether the learned Income Tax Appellate Tribunal was justified in not following the ratio laid down in the judgment delivered by the Honourable Supreme Court of Pakistan in the case of Messrs Premier Bank Ltd., Karachi reported (1999) 79 Tax .589 (Supreme Court of Pakistan) as the payment of Rs.305,000 (M) made to State Bank of Pakistan was a penalty/fine for infraction of law.

B. Whether the learned Income Tax Appellate Tribunal was justified in not maintaining the disallowance of penalty paid by the Refinery to the State Bank of Pakistan amounting to Rs.305,000 (M) for infringing the rules and regulations contained in the circulars and Foreign Exchange Manual issued by the State Bank of Pakistan from time to time.

C. Whether the learned Income Tax Appellate Tribunal had any evidence before it to hold that the penalty of Rs.305,000 (M) paid by the appellant to State Bank of Pakistan was interest and not penalty or fine so as to attract the ratio laid down by the Supreme Court of Pakistan in the case of Messrs Premier Bank Limited Karachi and liable to Tax.

2. Brief facts of the case are that the present respondent is a public limited company mainly owned by the Government deriving income from refining crude oil into various petroleum products. During the assessment year in question crude oil was imported under the loan from Islamic Development Bank Jeddah on the guarantee of the State Bank of Pakistan. As per the State Bank procedure counter part rupee funds are required to be deposited within ten days of disbursement of funds by IDB. However, due to shortage of funds the present respondent could not deposit counter part fund with State Bank of Pakistan within the specified period of ten days for which the State Bank charged further amount at the rate of Rs.4 per day per Rs.10,000 or part thereof for the period of delay under para. 44 of chapter (xiii) of Foreign Exchange Manual. The total payment made under this head amounting to Rs.30,500,000 was claimed by the respondent under the head of financial charges. When the Assessing Officer discovered that such charges were paid allegedly on account of penalties he confronted the appellant on the point that the expenses were not admissible deductions in view of the judgments of the Honourable Supreme Court of Pakistan reported in the case of CIT v. Premier Bank of Pakistan (1999) 79 Tax 589 (S.C. Pak). The applicant filed a detailed explanation which has been reproduced by the Tribunal in the impugned order. The Assessing Officer, however, did not accept this explanation and after holding that the above expenses were not allowable expenses, added the amount of Rs.30,500,000 to the total income of the respondent.

3. Being aggrieved by the order of the Assessing Officer, the present respondent filed an appeal before the CIT, (Appeals), who vide his order No.1292(5) dated 31-5-1999 rejected the appeal on this point and upheld the addition made by the Assessing Officer.

4. Being aggrieved by the order of the CIT (Appeals) the present respondent filed an appeal before the Income Tax Appellate Tribunal who vide their exhaustive order after analyzing the facts of the case in the light of the various judgments of the Superior Courts of Pakistan and India including the judgment of the Honourable Supreme Court in the Premier Bank case quoted supra and after distinguishing the case of the Honourable Supreme Court allowed the appeal and held that the amount of Rs.30,500,000 paid by the present respondent to the State Bank of Pakistan was not fine or penalty paid in respect of any infringement of law or State Bank of Pakistan Regulations but was a payment made on account of delay of the payment of principal amount of loan and was an expenditure laid down wholly and exclusively for the business of the respondent and was therefore an allowable deduction. On the basis of their above opinion the Tribunal deleted the addition of Rs.30,500,000. Hence this reference application.

5. We have heard Mr. Muhammad Farid, Advocate for the applicant and Mr. Iqbal Salman Pasha, Advocate for the respondent.

6. Mr. Muhammad Farid, the learned counsel for the applicant submitted that what the applicant had paid was not normal interest but penal interest and this amount was fully covered by the judgment of the Honourable Supreme Court of Pakistan in the case of Premier Bank case quoted supra and therefore was wrongly allowed by the Tribunal. He read out the various extracts from the judgment of Premier Bank case quoted supra to point out that the Honourable Supreme Court has held that any amount in the nature of penalty, fine or penal interest is not allowable expenditure under the provisions of the Income Tax Ordinance and has to be added back to the income. He also relied on an unreported judgment of this Court dated 26-5-2000 in the case of CIT v. Sui Southern Gas Company Ltd. wherein this Court had held that payment made by Sui Southern Gas Company on account of gas development surcharge and late payment fell within the definition of penal interest and was covered by the judgment of the Honourable Supreme Court in the Premier Bank case quoted supra. He also relied on a number of unreported judgments of this Court of I.T.C. No. 32 of 1996 dated, 2-12-2005, I.T.Cs. Nos. 51, 52 and 53 all of 1996, dated 2-12-2005, I.T.C. 57 and 58 both of 1996 dated 25-9-2008, I.T.C. No.48 of 1996 dated 1-3-2007 in support of his contention that this Court has always held that payment of penal interest fell within the ambit of the Judgment of Honourable Supreme Court in Premier Bank case quoted supra and has, therefore, disallowed such penal interest. Referring to the questions proposed by him the learned counsel submitted that the Tribunal had not followed binding judgment of the Honourable Supreme Court in the case of Premier Bank Ltd. quoted supra and therefore, prayed that the impugned order should be set aside and the order of the Income Tax Officer and the CIT (Appeals) be restored.

7. The learned counsel for the respondent Mr. Iqbal Salman Pasha vehemently opposed the arguments of the learned counsel S for the applicant and supported the order of the Tribunal. The learned counsel argued that the Tribunal had by an exhaustive order examined not only the facts of the, case but had also analyzed the various provisions of the Foreign Exchange Regulations and had held that the above payment did not represent any penalty or fine levied by the State Bank of Pakistan in exercise of its powers under the penal provisions of State Bank Manual and Foreign Exchange Regulations and laid down the principles which have to be followed by analyzing the cases of the Honourable Supreme Court of Pakistan' and other Courts of Pakistan and also the Supreme Court of India and other High Courts of India and after distinguishing the judgment of the Honourable Supreme Court in Premier Bank case quoted supra and on the facts of the case that the payment made by the respondent by whatever name called was not penalty or fine for infringement or violation of any rule or regulation of the State Bank Manual or Foreign Exchange Regulations but was payment on account of late and delayed payment of the principal amount and was not payable on the basis of any order levying penalty or fine by the State Bank of Pakistan but only on the basis of computation in accordance with para.44 of chapter (xiii) of Foreign Exchange Manual. He, therefore, submitted that proposed question No.1 does not raise out of the order of the Tribunal whereas proposed question No.2 is against the factual position of the case as the Tribunal has given a factual finding that no rules or regulations contained in the Circulars or Foreign Exchange Manual issued by the State Bank of Pakistan from time to time had been infringed by the respondent.

8. Coming to third question he submitted that this question also relate to factual finding which had been given by the Tribunal on the basis of analysis of the fact that the payment made by the respondent to the State Bank of Pakistan was interest and not penalty or fine and on the basis of this factual finding they had distinguished the judgment of the Honourable Supreme Court in the case of Premier Bank Ltd. quoted supra. The learned counsel further submitted that unreported judgment of this Court in the case of Sui Southern Gas Company relied on by the learned counsel had been set aside by the Honourable Supreme Court on an appeal filed by the Sui Southern Gas Company and this judgment is reported in (2001) 83 Tax 113 (SC Pakistan). Besides the judgment of the Honourable Supreme Court the learned counsel also relied on the following judgments in support of his arguments:--

(1i) Ata Hussain Khan Limited v. Commissioner of Income Tax, East Pakistan, Dacca (1970) 21 Tax 1 SC Pak.

(2) Commissioner of Income Tax, Central Zone `B' v. Messrs Farrokh Chemical Industries, 1992 SCMR 523.

(3) (3). Beecham Pak v. Commissioner of Income Tax 1995 PTD 577.

(4) Commissioner (Legal Division) Large Taxpayers Unit, Karachi v. Bawany Metals Ltd., Karachi, 2006 PTD 2256.

(5) Hassan Associates (Pvt.) Ltd. v. C.I.T. 2009 PTD 66.

9. Besides the above cases, the learned counsel also relied on certain extracts from the judgment relied on by the learned counsel for the appellant i.e. the case of CIT v. Premier Bank Ltd, 1999 SCMR 1213.

10. Exercising his right to reply the learned counsel for the applicant submitted that although unreported judgment of this Court relied on by him in the case of Sui Southern Gas Company quoted supra has been set-aside by the Honourable Supreme Court by its judgment quoted supra but even in that judgment the Honourable Supreme Court had approved the judgment in the Premier Bank case quoted supra. He further submitted that in ITC 32 relied on by him, Mr. Iqbal Salman Pasha had relied on the judgment in the case of Sui Southern Gas Company quoted supra but this Court had repelled his arguments in the following manner:--

"There is no cavil to this proposition but the fact remains that in the earlier Judgment of the Honourable Supreme Court of Pakistan, which has been explicitly affirmed in the case of Sui Southern Gas (Supra) it has been held that the expenditures incurred by the assessee, which are in nature of fine or penalty are not allowable expenditures."

11. We have examined the case in the light of the arguments of the learned counsel and have carefully perused the records of the case and judgments relied on by the learned counsel. On an examination of the impugned order we have seen that the Tribunal has passed a very elaborate order in which they have not only examined the facts of this case but have also analyzed various provisions of the State Bank Manual including the provisions by which the State Bank has been empowered to levy criminal and civil penalties and fines for infringement and violation of various provisions of the State Bank Manual and Foreign Exchange Regulations. They have also analyzed the effect of para. 44 of Chapter (xiii) of Foreign Exchange Manual wherein the State Bank has been authorized to recover additional interest for payment made after a specified period and have held that the additional payment made under this para does not tantamount to any payment made on account of fine or penalty for infringement or violation of any rule or regulation of the State Bank of Pakistan Manual or Foreign Exchange Regulations or any Circular issued by the State Bank of Pakistan but for delay in payment of the principal amount and had given findings of facts that this delay occurred due to shortage of funds and was, therefore, an expense wholly and exclusively laid down for business. The Tribunal after analyzing the various judgments of the Honourable Supreme Court of Pakistan and the Pakistani High Courts and the Indian Supreme Court and High Court have drawn the following inferences from the various judgments cited before them:

27. (1) An expenditure incurred on account of fine or penalty or in the nature of fine or penalty is not to be allowed as deduction.

(2) An expenditure which although has been incurred by an assessee on account of infringement of a provision of a statute but not in the nature of fine or penalty can be allowed as admissible deduction provided it is incurred wholly and exclusively for the purpose of business.

(3) The question whether any expenditure on account of infringement of any provision of law is for the purpose of business and is an admissible expenditure shall depend on the facts and circumstances of each case.

(4) If any expenditure is claimed on a transaction in flagrant violation of the provisions contained in any law and the transaction, act/omission is liable to the levy of fine or penalty by way of criminal or civil sanction and the competent authority has imposed civil or criminal penalty provided in the law that expenditure incurred .on illegal transaction as well as penalty for indulging in such illegal transaction both shall be inadmissible expenditures.

(5) If there are various provisions in any law providing for automatic enhanced/excess payment on commission of a default or delay and there is a provision for imposition of penalty/fine as well within the discretion of authorities competent under a law and the provisions for imposition of fine or penalty within the discretion of competent authorities have not been invoked and an enhanced/excess amount is charged for any default/delay, such enhanced/excess amount shall be deemed to be part and parcel of the original liability.

(6) If the excess amount paid by an assessee in the normal course of business and wholly and exclusively for business purposes on account of any delay or default is within the contemplation of the parties and the excess amount paid is automatic which requires mere calculation it would be in the nature of compensation paid for delay or default and it shall not be deemed as penalty or fine, or in the nature of penalty/fine or to the penalty or fine.

(7) If any excess amount is paid by an assessee for any delay or default in performance of an act and the excess charge is fixed and not in the discretion of any competent authority in law and no separate proceeding is required for charging the excess/enhanced amount and no separate order is required to be made and there is no requirement of framing any charge or confronting the defaulting party and seeking explanation then the amount so charged would not be deemed to be penalty/fine.

(8) Mere use of word penalty of fine shall not make an amount to be in the nature of penalty or fine until and unless in the substance the amount charged is penalty or fine or in the nature of penalty or fine.

(9) The payment of such amount only shall be treated as penalty/fine which is charged as a result of infraction/ infringement/violation which is imposed by an authority competent in law and an amount paid by an assessee on its violation/discretion/option available in law for the consideration of business purposes in pursuance of commercial expediency and not with the intention of floating the mandatory provision of law will not be deemed to be extension of liability permissible in law and/or compensation for delay/default contemplated by the parties and permissible in law.

(10) The demurrage paid to the Port and Railway authorities which is in excess of the original liability, likewise surcharge for delayed payment of utility bills such as, electricity bill, gas bill, telephone bill, property tax, water tax, municipal taxes, motor vehicle taxes, arms licence fee, late payment fee for examination, late payment fee for renewal of various licences so on and so forth are not in the nature of penalty or fine, as all of these payments are automatic without initiation of any separate proceedings and without any separate order and exercise of any discretion by any competent authority on the consideration of fact and circumstances of each case.

(11) In the case of Mahalakshmi (supra) the Supreme Court of India has dealt with the issue elaborately. Under section 3(3) of the Sugar Cane Cess Act, 1956 the payment of interest at 6% was automatic for which no separate or specific order was required and the obligation to pay interest was to accord automatically and, therefore, payment of such amount was held to be part of the original liability and not penalty or fine. The excess amount was held to be compensatory in nature. Under Subsection (5) of section 3 of the same Act the officer or authority empowered to collect the cess may direct for payment of additional tax and such amount was held to be penalty and it was not automatic or a mere matter of calculation without discretion. In the case of Premier Bank Limited the Honourable Supreme Court of Pakistan has held the payment of penal interest under subsection (4) of section 36 of the State Bank Act, 1956 in the nature of fine. A perusal of subsection (4) of section 36 of the State Bank Act, 1956 shows that the penal interest was to be made by order of the Bank. It was not automatic. The words used in subsection (4) of section 36 are "scheduled Bank may be ordered by the Bank to pay to the Bank". Thus it was within the competence and discretion of the State Bank of Pakistan to order for the payment by scheduled Bank. Once it is provided that a separate and specific order is to be made then it would not make any difference if the rate of penal interest is fixed.

and after applying the above principles to this case they had arrived at the conclusion as under:-

"The appellant has proved upto the hilt that excess payment was made wholly and exclusively for business consideration, the excess payment is neither in the nature of penalty nor fine and, therefore, the principle laid' down by the Honourable Supreme Court of Pakistan in the case of Premier Bank Limited on which both the parties have placed reliance is not applicable. The Honourable Supreme Court has held that in the case of expenditure which, although, has been incurred by the assessee on account of infringement of a provision of a statute but is not in the nature of penalty, the question whether such expenditure is admissible or not would depend upon the circumstances of each case. In the present case the expenditure is for business consideration and, therefore, we are of the considered opinion that the excess payment having been incurred for business consideration, in exercise of option available to the appellant in contemplation of the parties is an admissible expenditure under section 23 of the Income Tax Ordinance, 1979."

12. We find ourselves in full agreement with the principles enunciated by the Tribunal and the conclusion arrived at by them by applying these principles to the facts of this case. At this stage we may also reproduce the following extract from the judgment in the case of Hassan Associates (Pvt.) Ltd. v. CIT quoted supra which has been authored by one of us i.e. Muhammad Athar Saeed, J.--

From a perusal of these judgments and the judgment of the Honourable Supreme Court of Pakistan quoted supra relied on by the learned counsel for respondent it is clear that case of the applicant falls within the ambit of judgments relied on 'by the learned counsel for the applicants as in all these cases including the applicants' case the damages or compensation has been paid for breach of contract which had been executed by the applicants and the taxpayers who are parties to the judgments relied on by the learned counsel for applicants wholly and exclusively for the purpose of their businesses and in all these judgments the learned Courts have held that the damages/compensation paid for breach of contract are expenses incurred exclusively for the purpose of business and are allowable under the provisions of section 23(2)(xviii) and its paramateria sections in other Acts/Ordinances. The judgment of Honourable Apex Court, however, deals with penalty fine or penal interests paid on account of infringement of law. It is nobody's case that infringement of law can be equated with breach of contract. One is an infraction against the public at large, an authority and a society whereas other is an infraction against a private person:

13. From a perusal of the above extract it can be seen that late payment of the principal amount is not an infringement or violation of any law but at the most a breach/infraction of contract and it cannot be equated with an infringement of law and in the Premier Bank case quoted supra the Honourable Court had only held that any payment made for penalty, fine or violation of infringement of any law cannot be allowed c as an expenditure. We are, therefore, of the considered opinion that the conclusion reached by the Tribunal is unexceptionable and they have rightly held that the judgment of the Premier Bank case quoted supra does not apply to the facts of the present case and have therefore, rightly held that the payment made by the respondent to the State Bank of Pakistan was an allowable deduction.

14. We may also add that the argument of the learned counsel for applicant that the amount paid is penal interest and this Court in the unreported judgments has held that penal interest is an unallowable deduction is misconceived because in those cases penal interest was levied on infringement of provisions of State Bank Manual and Foreign Exchange Regulations like bursting of ceiling etc. whereas in this case it has been paid only in respect of delayed payment and therefore, in this case the judgment of Honourable Supreme Court in Sui Southern Gas case quoted supra will apply with full force.

15. The above are the reasons in support of our short order by which we had answered question No.C in affirmative in favour of the respondent and against the appellant. We are also of the view that in view of our answer to question No. C the questions Nos. A and B are not required.

S.A.K./C-29/KOrder accordingly.