LALAZAR SHIPPING (PVT.) LTD. through Chairman/Chief Executive Officer, Karachi VS COMMISSIONER INCOME TAX, 2011 PTD-KARACHI-HIGH-COURT-SINDH 637 (2010)

(a) Income Tax Ordinance (XLIX of 2001)---

----Ss. 22 (8), 37, 133 (1) & Cl. (21) of Part II, Second Sched.---Presumptive tax---Capital gains---Depreciable assets, disposal of---Assessee company was engaged in shipping business and it contended that its income by disposal of assets fell within the `ambit of its income from business' and was covered under Presumptive Tax Regime---Validity---Depreciation was never been allowed to assessee, therefore, there was no Written Down Value (WDV) available for computation of the gain and such gain could not be computed under S. 22 (8) of Income Tax Ordinance, 2001, therefore, plea raised by assessee that such gain would be treated as income from business under S. 22(8) of Income Tax Ordinance, 2001, did not hold ground---Once assessee's income became liable to presumptive tax under Cl. (21) of Part-II of Second Schedule to Income Tax Ordinance, 2001, then entitlement to depreciation deduction under S. 22 of Income Tax Ordinance, 2001, in respect of any property of such person would cease to exist and therefore, such assets did not fall within the ambit of S. 37(5)(b) of Income Tax Ordinance, 2001---Such income would fall within the definition of `capital assets' and had to be assessed as `capital gains' and not `business income' and therefore, would not be considered to be `income from business' of shipping of assessee company and was not covered by presumptive tax collected in accordance with provisions of Cl. (21) of Part-II of Second Schedule of Income Tax Ordinance, 2001---Income Tax Appellate Tribunal was justified to hold that gain on disposal of vessel was chargeable tax under the head "capital gains" and was not covered by Cl. (21) of Part-II of Second Schedule to Income Tax Ordinance, 2001---Reference was decided accordingly.

Genertech Pakistan Ltd. and others v. Income Tax Appellate Tribunal of Pakistan Lahore and others 2004 PTD 2255 ref.

(b) Income Tax Ordinance (XLIX of 2001)---

----Ss. 37 & 133(1)---Capital assets---Cost of stores---Assessee company claimed certain amounts received against cost of stores and spares on board, cost of bunker with vessel and brokerage paid on disposal of vessel but the same had not been allowed by Taxation Officer---Validity---High Court directed Taxation Officer to re-compute gain under provisions of S. 37 of Income Tax Ordinance, 2001 and also to decide about allowability or disallowability of other deductions claimed by assessee---Reference was disposed of accordingly.

Kashif Paracha and Jawaid Khurram for Applicant.

Kafeel Ahmed Abbasi for Respondent.

ORDER

MUHAMMAD ATHER SAEED, J.---This Income Tax Reference Application has been filed against the order of the Income Tax Appellate Tribunal dated 15-10-2009, in I.T.A. No.559/KB of 2009 and seven questions said to be arising out of that impugned order, have been proposed for the opinion of this Court. However, at the very outset the learned counsel for the applicant submitted that he shall only press questions Nos.4, 5 and 7 and will not press the other questions. We are, therefore, reproducing only those three questions which the learned counsel intends to press:

(i) .

(ii)

(iii) .

iv) Whether on the facts and circumstances of the case the learned ITAT was justified to hold that the gain on disposal of vessel is chargeable to tax under the head "capital gains" and is not covered by clause (21) of Part II of the Second Schedule providing reduction of tax rate to income of a resident person engaged in shipping business especially when section 22(8) of the Ordinance provides for taxation of gain arising on disposal of depreciable assets under the head "income from business".

(v) Whether on the facts and circumstances of the case whilst holding that gain on disposal of vessel is chargeable under the head "capital gains" the learned ITAT was justified not to order re-computation of such gain under the provisions of section 37 of the Ordinance.

(vi) .

(vii) Whether on the facts and circumstances of the case the learned ITAT was justified to hold that the reduced rate of tax under clause (21) of Part II of the Second Schedule is applicable only in respect of core/operational income arising from shipping business and not to the entire income arising from shipping business which include reversal of liabilities no longer payable, insurance claims related to operation of the ship and documentation charges recovered from customers for carriage of goods.

2. The controversy between the parties is to the extent as to whether the profit on sale' of vessel is liable to be assessed as income from business or as "capital gains" because according to the learned counsel if it was assessed as income from business it would be covered under the Presumptive Tax Regime provided in clause (21) of Part II of Second Schedule. Similarly, the applicant is also aggrieved by the treatment of the following items under Normal Tax Regime instead of Presumptive Income; liabilities no longer required to be paid written back, insurance claims and including document charges.

3. Brief facts of the case are that, the applicant is a resident company incorporated in the year 2001 and engaged in the business of shipping through its own vessels. For the tax year 2005 the applicant declared operating income consisting of its income from shipping including charter of vessels, transportation' of cargo and other related services and also other income comprising of profit on disposal of assets, liabilities no longer required to be paid written back, insurance claim and other including bank profit and document charges etc. The applicant claimed that its profit on disposal of assets and other income fell within the ambit of its income from business and was therefore, covered under the Presumptive Tax Regime provided under clause (21) of Part-II of Second Schedule to the Income Tax Ordinance 2001. This contention of the applicant was not accepted by the Income Tax Officer who treated the income on disposal of assets as capital gain and the other incomes as income from other sources and held that they did not fall within the income on which presumptive tax was paid under clause (21) of Part-II of Second Schedule of the Income Tax Ordinance, 2001 and therefore amended the order under section 122(1)(5) and levied tax on the above income in accordance with the provisions of the 1st Schedule of the Income Tax Ordinance.

4. Being aggrieved by the above amended order under sec tion 122(5)(l), the applicant filed an appeal before the CIT (Appeals) who vide its Order No.64 dated 31-7-2009, dismissed the appeal and upheld the order of the Income Tax Officer.

5. Being aggrieved by the order of the CIT (Appeals) the applicant filed an appeal before the Tribunal who dismissed the same vide impugned order dated 15-10-2009. Hence, this reference application.

6. We have heard Mr. Kashif Paracha and Mr. Khurram Jawaid, the learned counsel for applicant and Mr. Kafeel Ahmed Abbasi, the learned counsel for respondent.

7. The learned counsel for applicant read out before us the provisions of clause (21) of part-II of Second Schedule of the Income Tax Ordinance, 2001 and submitted that this clause which was incorporated in 2002, provides for the levy of presumptive income tax on the income of a resident person engaged in the business of shipping. He submitted that a ship "Lalazar" was disposed of during the assessment year in question and since the applicant had, claimed depreciation on it, he therefore, computed the gain on the disposal of such ship in accordance with the provisions of subsection (8) of section 22 and as provided in this subsection, that such gain is to be taxed under the head "income from business" in the year in which it has accrued. Therefore, according to the learned counsel this income did not fall within the definition of capital gains as assets which are entitled to depreciation, do not fall within the definition of capital assets as provided in sub-section (5) of section 37 of the Income Tax Ordinance, 2001.

8. Arguing about the treatment of other incomes, which have not been treated as business income by the Income Tax Officer, he submitted that the liabilities which during the year had been shown in the income as liabilities no longer payable were the liabilities incurred by the applicant during the course of business. Insurance claims related to the operation of the ships and the documentation charges were recovered from the customers for carriage of goods and therefore, all of them fell under the head "income from business" of shipping and they had only been shown as other income as they were not part of the operating income and therefore, had to be shown separately in accordance with the principles of accountancy but for the purposes of income tax they all fell in the head "business income" and therefore, fell within the four, corners of the income on which presumptive tax was leviable under clause (21) of Part II of Second Schedule of Income Tax Ordinance, 2001. He submitted that all the lower forums had treated the income on disposal of assets as capital gain and the income from liabilities no longer payable, insurance claims and documentation charges as income from other sources holding that it was not covered in the income chargeable under the presumptive tax regime under clause (21) of Part-II of the Second Schedule to the Income Tax Ordinance, 2001 without considering that all these incomes fell within the ambit of business income and, therefore, were covered under the presumptive tax regime provided under clause (21) of Part-II of the Second Schedule of the Income Tax Ordinance. He, therefore, prayed that the orders of the lower forums may be set aside and the proposed questions may .be answered in his favour.

9. Mr. Kafeel Ahmed Abbasi, learned counsel for the respondent opposed the arguments of the learned counsel for applicant and submitted that the lower forums had taken pains to establish beyond doubt that the gain accrued on the sale of ships had to be taxed under capital gain and not as business income, whereas the income other than. three heads mentioned above had to be taxed as income from other sources as none of the above incomes were part of the shipping business of the company and only the operating income from shipping business is covered under clause (21) of Part-II of Second Schedule to the Income Tax Ordinance, 2001.

10. In order to substantiate his arguments the learned counsel submitted that one of the principles of interpretation is to find out the intent of the legislature in making the above amendment i.e. insertion of clause (21). On this point he referred to the amendment made by the subsequent incorporation of clause (114-A) in Part- I of the Second Schedule of the Income Tax Ordinance, 2001 which seeks to provide exemption to the income chargeable under the head "capital gains" derived by a person from sale of ships and all floating crafts including tugs, dredgers, survey vessels and other, specialized craft upto tax year ending on the thirtieth day of June, 2011. He submitted that by treating the. above gains as capital gains for the purpose of exemption the legislature has revealed its intention of treating the income from sale of the above assets as capital gains and not as income from business.

11. We have examined the case in the 'light of the above arguments of the learned counsel and have carefully perused the records of the case including the impugned order.

12. Before we proceed with the examination it will be appropriate to reproduce the relevant provisions which are the subject matter of controversy in this case. In our view these are clause (21) of Part-II of Second Schedule of the Income Tax Ordinance 2001, sub-clause (8) of section 22, subsection (5) of section 37 and clause (114-A) of Part-I of the Second Schedule of the Income Tax Ordinance 2001:--

"(21) In the case of any resident person engaged in the business of shipping, a presumptive income tax shall be charged in the following manner, namely:--

(a)Ships and all floating crafts including tugs, dredgers survey vessels and other specialized craft purchased or bare-boat chartered and flying Pakistan flag shall pay tonnage tax of an amount equivalent to one US $ per gross registered tonnage per annum; and

(b)Ships, vessels and all floating crafts including tugs, dredgers, survey vessels and other specialized craft not registered in Pakistan and hired under any charter other than bare-boat charter shall pay tonnage tax of an amount equivalent to fifteen US cents per tonne of gross registered tonnage per chartered voyage provided that such tax shall not exceed one US $ per tonne of gross registered tonnage per annum:

Provided that the reduction under this clause shall not be available after the 30th June, 2020.

22(8) Where, in any tax year, a person disposes of depreciable asset, no depreciation deduction shall be allowed under this for that year--

(a)if the consideration received exceeds the written down value of the asset at the time of disposal, the excess shall be chargeable to tax in that year under the head "Income from Business"; or

(b)if the consideration received is less than the written down value of the asset at the time of disposal, the difference , shall be allowed as a deduction in computing the person's income chargeable under the head "Income from Business" for that year.

Subsection (5) of section 37.

In this section, "capital asset" means property of any kind held by a person, whether or not connected with a business, but does not include---

(a)any stock-in-trade, consumable stores or raw materials held for the purpose of business;

(b)any property with respect to which the person is entitled to depreciation deduction under section 22 or amortization deduction under section 24;

(c)any immovable property; or

(d)any movable property (excluding capital assets specified in subsection (5) of section 38 held for personal use by the person or any member of the person's family dependent on the person.

(e)omitted by the Finance Ordinance 2002.

(114-A) Any income chargeable under the head "capital gains" derived by a person from sale of ships and all floating crafts including tugs, dredgers, survey vessels and other specialized craft upto tax year ending on the thirtieth day of June, 2011.

13. A perusal of clause (21) reveals that a presumptive tax has been levied on a resident person engaged in the business of shipping as noted above. The contention of the learned counsel for the applicant is that the gain on disposal of ship falls within the ambit of section 22(8) of the Income Tax Ordinance and it is mentioned in that section that such gain will be charged to tax under the head income from business and therefore, it will be covered by the presumptive tax being levied under clause (21) of the ordinance.

14. We have examined this contention of the learned counsel in the light of the facts of the case. It is an admitted position as mentioned in the assessment order that the present applicant was incorporated in the year 2001 and clause (21) was introduced in the statute book in the year 2002. Therefore, it will be applicable from tax year 2002 onwards and on the basis of the incorporation of the company in 2001 it can be presumed that the first assessment will fall in tax year 2002, therefore, apparently the applicant company is being assessed to presumptive tax since its incorporation and its receipts and expenses had never been taken into consideration for examination and allowability and taxability under the normal law, which means that depreciation in accordance with the provisions of various subsections of section 22 has never been allowed to it. Written Down Value (WDV) has been defined in subsection (5) of section 22 to be the cost of the asset to the person as reduced by total depreciation deductions (including any initial allowance under section 24) allowed to the person in respect of the asset in previous tax year. If we consider subsection (8) in the light of this definition of WDV, we will see that since depreciation had never been allowed to the present applicant, therefore, there will be no WDV available for computation of the gain and such gain cannot be computed under subsection (8) and therefore, the contention of the learned counsel that such gain will be treated as income from business under subsection (8) does not hold ground.

15. We would now examine as to whether an asset which may be liable to depreciation but such depreciation has never been allowed on such asset will fall within the definition of capital asset given in subsection (5) reproduced above. According to this subsection, capital asset will not include any property with respect to which the person is entitled to depreciation deduction under section 22. For the purposes of presumptive tax it has been provided in clause (b) of subsection (2) of section 169 that no deduction shall be allowable under the Ordinance for any expenditure incurred in deriving the presumptive income.

16. We are therefore, of the view that once the applicant's income becomes liable to presumptive tax under clause (21) of Part-II of the Second schedule then the entitlement to depreciation deduction under section 2 in respect of any property of such person shall cease to exist and therefore, such assets will not fall within the ambit of clause (b) of subsection (5) of section 37 and therefore, will fall within the definition of capital assets and any income arising on the disposal of a capital assets has to be assessed as capital gains and not business income and therefore, will not be considered to be income from business of shipping of the applicant company and will not be covered by the presumptive tax collected in accordance with the provisions of clause (21) of part-II of second schedule of the Income Tax Ordinance 2001.

17. Our above interpretation has been fortified by subsequent incorporation of clause (114-A) of Part-I of the Second Schedule by Finance Ordinance, 2006 which has granted exemption to the capital gain arising on the sale/disposal of ships and all floating craft including tugs, dredgers, survey vessels and other specialized craft as apparently in view of the presumptive tax levied under clause (21), the legislature is also of the view that ships, dredgers and survey vessels will fall within the definition of capital assets and gain on their disposal will be considered capital gain.

18. In view of the above discussion we, answer question No.4 in affirmative.

19. In order to examine question No.5 we have perused the provisions of the assessment order and we have seen that the computation has been made by the Income Tax Officer in the following manner:--

Whereas the applicant had computed the gain in the following manner: --

20. A perusal of the chart by which the Income Tax Officer has computed the gain on disposal of assets leads to the conclusion that the Income Tax Officer is in fact contradicting his own stand that the gain on disposal of ships is not business income falling within the ambit of section 22(8) but capital gain. If it is capital gain as mentioned by him and as held by us then it has to be computed in accordance with the formula prescribed in subsection (3) of section 37 and the procedure provided in subsections (4) and (4-A) of section 37 of the Income Tax Ordinance and not on the basis of the computation provided under section 22(8) which has been adopted by the Taxation Officer.

21. We have also seen that whereas the applicant had claimed certain amounts received against cost of stores and spares on board, cost of bunker with the vessel and brokerage paid on disposal of vessel but the same had not been allowed by the Taxation Officer. We therefore, answer question No.5 in negative and direct the Taxation Officer to re-compute the gain under the provisions of section 37 of the Ordinance and also decide about the allowability or disallowabilty of other deductions claimed by the applicant in his chart reproduced above in accordance with law.

22. We have also noted, that the Income Tax Officer while holding that the incomes under the head liabilities no longer payable, insurance charges and other incomes comprising of documentation charges and interest charges do not fall as income from "operational activities of shipping business" as according to him it is evident from tax payer's own disclosure made in the audited profit and loss accounts, and has held that the presumptive tax under clause (21) of Part II of Second Schedule to the Income Tax Ordinance only applies to income generated from the operational activities of shipping business. The Tribunal has not given any finding on this aspect of the case, whereas the CIT (Appeals) has agreed with the Income Tax Officer that it is leviable only on operational income of shipping company.

23. We have again read clause (21) and we have failed to find out the basis on which the lower forums have held that the presumptive income tax shall only cover operational income of shipping company because the clause states that in case of any resident person engaged in the business of shipping and except profit on debt in which the Hon'ble Supreme Court of Pakistan in the case of Genertech Pakistan Ltd. and others v. Income Tax Appellate Tribunal of Pakistan Lahore and others reported in 2004 PTD 2255 has held that interest income falls within the ambit of income from other sources, all other incomes in our view are incidental to the carrying on of the shipping business and are therefore, covered by the levy of presumptive tax and under clause (21) of part II of Second Schedule. We would therefore, answer question No.7 in negative in favour of the applicant and against the respondent. The additions therefore, made by treating various incomes as non-operational income except the profit on debt is therefore, deleted:

24. This Income Tax Reference Application is disposed of in the' above manner.

25. A copy of this judgment under the signature of the Registrar and seal of this Court be sent to the Income Tax Appellate Tribunal for passing an order in consonance with the Judgment of this Court.

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