HARMONE LABORATORIES PAKISTAN LTD., KARACHI VS COMMISSIONER INCOME TAX, CENTRAL ZONE-B, KARACHI, 2011 PTD-KARACHI-HIGH-COURT-SINDH 625 (2010)

Income Tax Ordinance (XXXI of 1979)---

----S.79---Transfer pricing---Putative source---Income or windfall---Proof---Assessee was a subsidiary of a non-resident foreign company and in assessment years in question it received certain amount from its parent company, which were stated to be a voluntary payment by way of gift and voluntary payment by way of subsidy---In both years, amount received from abroad was stated to be remittances. to help assessee improve its financial position, which deteriorated due to accumulated losses-Plea raised by assessee was that such amounts were not income but rather a windfall received from parent company---Income Tax Appellate Tribunal concluded that since parent company had charged a higher price from assessee than that was prevailing internationally, it would continue to do so---Tribunal further stated that there was a continuous siphoning off of funds with attendant result that parent company would have to periodically make remittances to assessee to (partially) replenish the funds being siphoned off---Income Tax Appellate Tribunal also found that on such basis there was periodical monetary return coming in with an expected regularity front a definite source---Validity---Such reasoning and conclusion was fundamentally flawed and unsustainable in law and if such was the Tribunal's rationale, it could only be described as conjectural---Remittances were what the assessee claimed they were: a mere windfall, which could be regarded as periodical monetary return coming in with an expected regularity---Income Tax Appellate Tribunal erred in its conclusion that the remittances constituted assessee's income---Question was decided in favour of assessee and against the authorities---Reference was decided accordingly.

Pakistan International Airlines Corporation v. Commissioner of Income-Tax 1975 PTD 219; PLD 1975 Kar. 924 and 1991 PTD 999 = 1991 'SCMR 2374 ref.

PLD 1975 Kar. 924 distinguished.

Commissioner of Income Tax v. Smith, Kline and French of Pakistan Ltd. and others 1991 PTD 999 = 1991 SCMR 2374 rel.

Iqbal Salman Pasha for Applicant.

Nasrullah Awan for Respondent.

ORDER

MUNIB AKHTAR, J.---This Income Tax Reference relates to two assessment years of the applicant assessee (assessment years 1983-84 and 1986-87), and requires determination of the following questions referred to this Court by the Tribunal, said to be questions of law arising out of the combined impugned order dated 31-1-1996, whereby the Tribunal had disposed of the appeals filed by the applicant for the foregoing assessment years, being respectively I.T.As. Nos. 2195/KB and 4083/KB, both of 1987-88:--

(1) Whether the Income Tax Appellate Tribunal was justified on the facts and in the circumstances of the case, to hold that the gift of Rs. 4,881,000 and the subsidy of Rs. 6,701,760 received by the applicant company in the assessment years 1983-84 and 1986-87 respectively were "income" and not a mere "windfall".

(2) Whether the Income Tax Appellate Tribunal was justified in holding, on the facts and in the circumstances of the case, that the gift of Rs. 4,881,000 and the subsidy of Rs.6,701,760 received by the applicant company in the assessment years 1983-84 and 1986-87 respectively were not of a casual and non recurring nature.

2. The applicant is a subsidiary of a non-resident Dutch company, Messrs Organon International BY. In the income year corresponding to assessment year 1983-84, it received a sum of Rs. 4,881,000 from its parent company, which was stated to be a voluntary payment by way of gift. In the income year corresponding to assessment year 1986-87, it received a sum of Rs. 6,701,760 from its parent company, which was stated to be a voluntary payment by way of subsidy. In both instances, the stated reason for the remittance was to help the applicant improve its financial position, which had deteriorated due to accumulated losses. Thus, the applicant contended' that the aforesaid payments were not income at all, but rather a windfall received from the parent company. In the alternative, it was claimed that the payments were in any case of a casual and non-recurring nature and could not therefore be brought to tax.

3. In framing the assessments for both the years, the income tax officer rejected the stand taken by the applicant, and brought both amounts to tax. His rationale for doing so was the same in both cases. That rationale, as understood by the Tribunal, is set forth in para. 7 of the impugned order as follows:--

"The learned DCIT, has proceeded on the ground that assessee has been regularly importing chemical from the non-resident parent company in such a way as to transfer its profit to the principal; that the import of raw material from the parent company establishes a close business connection, and by payment of much higher prices for such raw material to the parent company, the assessee has so arranged its dealings that the business transacted between them, either produces to the assessee no profits or less than ordinary profits. He therefore, has inferred that the so called 'gift' or 'subsidy' being given from year to year are the amounts being paid in order to replenish, partly, the funds so siphoned off the assessee's legitimate business and has held that the receipts thus have a direct nexus with the assessee's business; hence in the nature of income."

4. The applicant's appeals to the CIT(A) failed, and it therefore appealed further to the Tribunal. The two appeals were heard and disposed of together by means of the impugned order. Before the Tribunal, reference was made by the learned counsel to the two well known decisions on the question before it, the decision of this Court in Pakistan International Airlines Corporation v. Commissioner of Income-Tax 1975 PTD 219; PLD 1975 Kar. 924 (hereinafter the "PIAC case") and the subsequent decision of the Supreme Court reported as Commissioner of Income Tax v. Smith, Kline and French of Pakistan Ltd. and others 1991 PTD 999; 1991 PTD 999 = 1991 SCMR 2374 (hereinafter the "SKF case"). The Tribunal cited at length from the SKF case, and after recording the submissions of the departmental representative, held as under:-

"14. We find, on the foregoing facts and circumstances of the case and the conditions under which, according to the findings of the Supreme Court, a receipt acquires the characteristics of income envisaged under the provisions of the Income Tax Ordinance, when there is a nexus between the gift/subsidy received by the appellant from its parent company and the trading of the appellant.

(15) We also find that unlike the case of H.H. Moharani Shri Vigaykuverba Sahab of Morvi and another v. CIT (1963) 49 ITR 594, the impugned payment by the parent company to the appellant are not entirely without consideration and these are traceable to a source which a practical man may regard as real source of income. In our view there is enough evidence to conclude that the impugned receipts are in the nature of periodical monetary return coming in. with an expected regularity from a definite source. It has been established before us that on its facts and circumstances, the appellant's case is distinguishable from the facts and circumstances of the case decided vide the decision reported as 1991 PTD 999 = 1991 SCMR 2374 and that ratio of the decision reported as PIAC v. CIT PLD 1975 Kar. 924 is applicable to the facts of appellant's case.

(16) We accordingly hold that the impugned receipts in each of the two years are in the nature of income and that these are not of a casual and non-recurring nature; hence liable to tax. Consequently the impugned order of the learned CIT(A) is confirmed and the appeals are dismissed."

Being aggrieved by the aforesaid decision, the applicant moved the appropriate application before the Tribunal, which by means of its order dated 11-1-1997, referred the two questions noted above to this Court.

5. Learned counsel appearing for the applicant submitted that the matter was fully covered by the SKF case and that the learned Tribunal had erred in coming to the contrary conclusion. He submitted that the purported findings of fact recorded by the income tax officer (noted in para. 7 of the impugned order and reproduced above), and applied by the Tribunal, were nothing other than mere conjecture and surmises. He placed on record the applicant's assessment orders for a number of years both before and after the years in appeal to show that no action had been taken (whether by way of addition or otherwise) in respect of the allegation that the parent company was siphoning off funds by charging abnormally high prices for the supply of raw materials. (This is of course, the well known problem of transfer pricing, for which a remedy was provided both in section 79 of the 1979 Ordinance and section 42(4) of the 1922 Act). Thus, the very basis of the findings recorded by the learned Tribunal was entirely illusory. His case was that the remittances in question were either not income at all (being a mere windfall) or at best, receipts of a casual and non-recurring nature. Either way, the amounts could not be brought to tax and he prayed that the questions referred be answered accordingly. Learned counsel for the respondent Department on the other hand defended the impugned order. His case was that the learned Tribunal had correctly concluded that the matter was fully covered by the PIAC case. He submitted that the reference merited dismissal.

6. We have heard learned counsel for the parties, examined the record with their assistance, and considered the case law relied upon by them. The reasoning of the Tribunal, as is clear from the operative part of the impugned order reproduced above, was as follows. It was first noted, as a general principle, that if there was a "nexus" between the gift/subsidy and the "trading" of the assessee, then the receipt had the characteristics of income. This principle was held applicable to the applicant's case for two reasons. Firstly, it was concluded that the remittances were "traceable to a source which a practical man may regard as real source of income". Secondly, it was held that "there is enough evidence to conclude that the impugned receipts are in the nature of periodical monetary return coming in with an expected regularity from a definite source". On this basis, the Tribunal concluded that the fact-situation in the applicant's case was different from that in the SKF case, and more akin to that in the PIAC case. Both remittances were therefore found to be income, and of a non-casual and recurring nature, and hence liable to tax.

7. Insofar as the first reason is concerned, we are unable to agree with the Tribunal. The putative "source", which a "practical man" would regard as a "real" source of income, simply did not exist. As is obvious even from a bare perusal, the exercise purportedly carried out by the income tax officer (per para. 7 of the impugned order reproduced above) involved many steps, each of which had to be supported by proper and independent findings of facts. Such findings simply do not exist. Even the Tribunal itself expressly noted in para. 7 that the income tax officer "inferred" that the gift/subsidy was being given to (partially) "replenish" the funds being siphoned off. Quite obviously, the necessary facts must first be found to exist before any inference can properly be drawn. However, the only basis for the entire exercise was the claim that the parent company was charging a price for the supply of raw materials which was higher than the international price. Even this "finding" of "fact" was not supported by cogent and convincing evidence. In fact, as far as can be made out from the assessment orders, there was no evidence for this at all. Even otherwise, the Tribunal has failed to comprehend that the charging of higher price for raw materials than the international price falls under the theory of "transfer pricing" and could have been taxed by the I.T.O. under section 79 of the Income Tax Ordinance, 1979 in the same year if the I.T.O. could have substantiated his above statement by cogent evidence. Failure to do so reveals that he had no such evidence in his possession and had taken shelter behind this statement to tax the above amounts in the assessment years in relation to which they have been received. The remaining exercise was simply a series of conclusions derived or inferred from this basic "fact". We therefore have no hesitation in agreeing with learned counsel for the applicant that the conclusion arrived at by the Tribunal was based on mere conjecture and surmises, and is not sustainable in law.

8. The second reason is, in one sense, simply an extension of the first. It appears that the Tribunal has, in effect, concluded that since the parent company has charged a higher price from the applicant than that prevailing internationally, it will continue to do so. There will be thus a continuous siphoning off funds, with the attendant result that the parent company would have to periodically make remittances to the applicant to (partially) "replenish" the funds being siphoned off. On this basis, there would be then be, or have to be, a "periodical monetary return coming in with an expected regularity from a definite source". As is quite obvious, such reasoning and conclusion is fundamentally flawed and completely unsustainable in law, and if this was indeed the Tribunal's rationale, it can only be described as completely conjectural.

9. To be fair to the Tribunal, there may be another basis for the second reason, and although this is not expressly spelt out in the operative part of the impugned order, it must also be considered. In paras.12 and 13 of the impugned order, the Tribunal noted the submissions of the departmental representative. One reason why he claimed that the gift/subsidy was a "periodical monetary return coming in with some sort of regularity" was a statement made by the applicant's auditors in their report on the accounts for the income year corresponding to assessment year 1986-87. The auditors, after referring to the losses and outstanding liabilities of the applicant, had noted as follows:

"As in previous years the company has been able to sustain' the adverse liquidity situation with financial support from the parent company, and management has assured us that such support will be forthcoming whenever required and continuity of operations will not be affected."

The departmental representative contended before the Tribunal on the foregoing basis that the remittances had been paid to the applicant to offset its trading losses and were thus revenue receipts which were liable to be taxed.

10. In our view, the fact-situation of the present case is more akin to the SKF case rather than the PIAC case. As in the SKF case, there is a local resident entity in which the principal shareholder is a foreign non-resident entity. The local assessee made losses which were recouped by the non-resident parent company without however there being any contractual or other obligation to do so. That was precisely the situation in the relevant appeal decided by the SKF case (which was a common judgment whereby three sets of appeals were disposed of). The Supreme Court held that the remittances in question:--

"... could be termed as mere windfall, for, the foreign shareholders/companies were- under no obligation to remit these amounts or to make good the losses incurred by the Pakistani companies and for the further reason that they could contribute these amounts as capital if there was no prohibition in increasing the capital." (para 25)

In our view therefore, the Tribunal erred in concluding that the facts of the present case were closer to the PIAC case. However, the Supreme Court also held as follows in the SKF case:--

"It may not be out of place to observe that even a receipt by an assessee of voluntary payment, on certain facts and in certain circumstances, may constitute income provided it arises from business or the exercise of a profession, vocation or occupation, in other words, if there is nexus between the receipt and the business or the exercise of profession or vocation or occupation." (para 26)

11. The only question that remains therefore is whether the auditors' comment in their report, relied upon by the departmental representative, could be regarded as showing or establishing that there was a "nexus" between the receipt and the business of the applicant. After careful consideration, we conclude that it could not. The auditors' comment was based only on the statement of the local entity's management, and does not obviously constitute or establish any binding commitment by the parent company. It must also be kept in mind that the auditors have, in effect, to certify that the company whose accounts they audit is a going concern, and the statement made by the local management may well have been made to assuage their concerns in this regard. What is relevant for present purposes is whether a clear "nexus" has been established between the payments made and the business of the applicant. We have also seen the assessment orders for the other years placed on the record by learned counsel for the applicant (being the assessment years from 1976-77 to 1988-89), and as far as can be made out, no issue of any such remittance was raised in any year except the years in question. It should also be remembered, as noted by the Supreme Court in the SKF case, that the onus lies on the Department to show that a particular receipt constitutes "income" (para 22). In our view, that burden has not been discharged in the present case. The remittances were precisely what the applicant claimed they were: a mere windfall, which could not be regarded as "a periodical monetary return coming in with an expected regularity". We therefore conclude that the Tribunal erred in its conclusion that the remittances constituted the applicant's income.

12. Accordingly, in light of the foregoing, we answer the first question in the negative, in favour of the applicant and against the Department. In view of our answer to this question, it is not necessary to give an answer to the second question. This reference application stands disposed of in the above terms. A copy of this decision may be sent under the seal of the Court and the signature of the Registrar to the Tribunal to pass such orders as are necessary to dispose of the case conformably with the decision.

M.H./H-1/KOrder accordingly.