MCB BANK LTD. VS COMMISSIONER INLAND REVENUE, 2014 PTD-LAHORE-HIGH-COURT-LAHORE 1874 (2014)

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

----Ss.33, 34, 100-A, Sixth Schedule, Part-II, R.4 & Seventh Schedule, R.1---Approved Pension Fund---Surplus under Pension Fund---Income chargeable to tax---Methods of accounting---Petitioner bank had established a Pension Fund through Trust Deed for benefit of its employees---Plea raised by petitioner-bank was that it enjoyed exemption under R.4 of Part-II of Sixth Schedule to Income Tax Ordinance, 2001, and surplus under Pension Fund could not be considered to be income of petitioner-bank unless repaid to petitioner---Validity---Under cash basis accounting, a taxpayer derived income when it was received and incurred expenditure when it had been paid---While under accrual basis accounting, taxpayer derived income when it was payable by that person---Two principal methods of keeping track of income and expenses of business: cash method and accrual method---Surplus amount was deemed to be income of taxpayer for the purposes of tax only when it was repaid to employer---Word 'repaid' signified actual repayment or pay back and fell under the scheme of cash basis accounting---Tax accounting was governed by R.4 of Part-II of Sixth Schedule to Income Tax Ordinance, 2001, which took preference over rules under Seventh Schedule to Income Tax Ordinance, 2001---Lower forums failed to appreciate such difference between tax accounting and financial accounting and had given undue importance to method of accounting over principles of taxation under Income Tax Ordinance, 2001---As surplus was not repaid to bank, it could not be deemed to be the income of petitioner bank and offered to tax---Reference was allowed in circumstances.

Messrs Central Insurance Co. and others v. The Central Board of Revenue, Islamabad and others 1993 PTD 766; Commissioner (Legal) Inland Revenue v. Messrs EFU General Insurance Ltd. 2011 PTD 2042; Commissioner of Income-Tax v. Habib Insurance Co. Ltd. 1975 PTD 234; Messrs Habib Insurance Co. Ltd. and another v. Commissioner of Income Tax, Central, Karachi 1990 PTD 196; ECC Quarries Ltd v. Watkis (Inspector of Taxes) [1975] 3 All ER 843 and Kedarnath Jute Mfg Co. Ltd. v. Commissioner of Income Tax (Central), Calcutta (1971) 82 ITR 363 ref.

(b) Mutatis mutandis---

----Connotation---'Mutatis mutandis' means necessary changes having been made---Phrase 'apply mutatis mutandis' means applicability of any other provision of law, which also includes and brings with it all necessary changes required to make that provision of law functional under law.

(c) Interpretation of statutes---

----Schedule---Scope---Schedule is part of statute and falls within the meaning of 'the provisions of the law'.

(d) Interpretation of statutes---

----Special law prevails over general law.

A. Qutubuddin Khan v. Chec Millwala Dredging Co. (Pvt.) Ltd., 2014 CLD 824; Hafeez Ahmed and others v. Civil Judge, Lahore PLD 2012 SC 400 and The State v. Zia ur Rehman and others PLD 1973 SC 49 rel.

Mansoor Usman Awan for Petitioner.

Liaquat Ali Ch. for Respondent.

Date of hearing: 23rd June, 2014.

JUDGMENT

SYED MANSOOR ALI SHAH, J.---Question of law

The following question of law has been pressed before us and arises out of order of the Appellate Tribunal Inland Revenue (ATIR), Lahore dated 24-6-2013:--

"Whether under the facts and circumstances of the case, the learned ATIR was justified to uphold the taxation of 'reversal of provision of defined benefit plan (Approved Pension Fund), under Rule 1 of the Seventh Schedule read with section 100-A of the Ordinance of 2001, without pointing out any specific rule of the same Schedule (as envisaged in Rule 9) which has dealt with the taxation of above said Approved Pension Fund, therefore, Rule 4 in Part II of Sixth Schedule was applicable ?"

Facts

2.Brief facts are that the petitioner, a listed banking company, has established a Pension Fund (Defined Benefit Plan) through a Trust Deed for the benefit of its employees. Income Tax Ordinance, 2001 ("Ordinance") under section 32(2) requires that the method of accounting for a company to account for income chargeable to tax under the head "Income from Business" shall be on accrual basis. Rule 32(2) of the Income Tax Rules, 2002 requires that the books of accounts of a company to be maintained in accordance with the International Accounting Standards ("IAS"). Under IAS-19 it is required that a qualified chartered actuary computes 'present value' of the assets and liabilities of the Pension Fund every year which results in either a 'surplus' or a 'deficit'. The 'surplus' conventionally arises where assets exceed the liability. The present value is determined on the basis of estimated future return on assets, retirement age, remaining service of employees, estimated annual increments, etc. The "surplus" is recorded as income in the financial statement/books of the petitioner bank and "deficit" appears as expense. Applying this method of accounting the financial statement of the petitioner company reflected the 'surplus' as income for the Tax Year, 2011. However, the said "surplus" or "reversal of provision for approved pension fund" was not offered for tax by the petitioner in the income tax return on the basis of Clause 4, Part-II of the 6th Schedule to the Ordinance, which requires that unless the said surplus is actually repaid to the petitioner it shall not be deemed to be the income of the petitioner. Rejecting the claim of the petitioner, the Additional Commissioner amended the return vide order dated 28-2-2013 under section 122(5A) of the Ordinance. The said amendment order was upheld by the Commissioner (Appeals) on 10-5-2013 and affirmed by Appellate Tribunal Inland Revenue vide impugned order dated 24-6-2013.

Arguments

3.Learned counsel for the petitioner argued that the petitioner enjoys exemption under Rule 4 of Part-II of the 6th Schedule to the Ordinance and the 'surplus' accruing under the Pension Fund cannot be considered to be the income of the petitioner unless the said amount is repaid to the petitioner i.e., until the amount is actually transferred from the Pension Fund to the bank. It is submitted that the accounting system on accrual basis under the International Accounting System (IAS) cannot override the provisions of the Ordinance. It is submitted that Rule 4 of Part-II of the 6th Schedule provides that in respect of a pension fund, the accounting methodology is on cash basis. The general principles of financial accounting or the Rules under the 7th Schedule cannot override the same. It is further submitted that Rule 4 of Part-II of the 6th Schedule is a special provision and read with Rule 9 of the 7th Schedule overrides Rule 1 of the 7th Schedule to the extent of pension funds.

4.Learned counsel for the respondent-department on the other hand submits that the case of the petitioner is covered under Rule 1 of the 7th Schedule. He submits that 7th Schedule being a special law specifically tailored for the Banking Companies, takes preference over the general provisions under the Ordinance including Clause 4, Part-II of the 6th Schedule. He placed reliance on Messrs Central Insurance Co. and others v. The Central Board of Revenue, Islamabad and others (1993 PTD 766) Commissioner (Legal) Inland Revenue v. Messrs EFU General Insurance Ltd. (2011 PTD 2042) Commissioner of Income-Tax v. Habib Insurance Co. Ltd. (1975 PTD 234) and Messrs Habib Insurance Co. Ltd. and another v. Commissioner of Income Tax, Central, Karachi (1990 PTD 196). Learned counsel further submits that 7th Schedule draws its substantive power under section 100A and placed reliance on Rules 6 and 8 of the 7th Schedule in support of his contention.

5.We have carefully analyzed the opposing arguments of the parties and have closely examined the symbiotic relationship between taxation and accounting under the framework of the Ordinance.

Decision

6.The Ordinance provides that income of a person chargeable to tax is computed in accordance with the method of accounting employed by the taxpayer. In case of a company, section 32(2) provides that income chargeable to tax under the head "Income from Business" shall be computed on an accrual basis, while other persons may account for such income on a cash or accrual basis. Under cash-basis accounting, a taxpayer derives income when it is received and incurs expenditure when it is paid.¹ While under accrual-basis accounting, the taxpayer derives income when it is due to that person and shall incur expenditure when it is payable by that person.² There are "two principal methods of keeping track of a business's income and expenses: cash method and accrual method (sometimes called cash basis and accrual basis). In a nutshell, these methods differ only in the timing of when sales and purchases are credited or debited to your accounts. If you use the cash method, income is counted when cash is actually received, and expenses are counted when actually paid. But under the more common accrual method, transactions are counted when they happen, regardless of when the money is actually received or paid. So with the accrual method, income is counted when the sale occurs, and expenses are counted when you receive goods or services. You don't have to wait until you see the money or until you actually pay money out of your checking account."³ Rule 32(2) of the Income Tax Rules, 2002 provides that the books of accounts in case of a company shall be maintained in accordance with the international accounting standards ("IAS"). The above shows that, computation or calculation of income chargeable to tax can be on cash or accrual basis accounting and the principles of accounting shall be in accordance with the IAS. Accounting, as a function, provides support to the tax law in computing the income that is chargeable to tax. Whether the income so computed is taxable is not an accounting function and is to be determined by the taxing law. In the two accounting methodologies under the Ordinance, the difference is of timing. Law determines the taxability of a particular income and is free to link it with either of the two accounting methodologies. This is because, taxability of income, as opposed to computation of income, is dictated by public policy and reflective of the fiscal policy of the government. Therefore, while income is computed through principles of financial accounting under IAS, not every income so computed is taxable. Taxation relies on accounting but is not controlled by it. In A Journey for Clarity⁴, a renowned tax accountant of our country, has articulated this point in the following manner:--

"Another misconception is that income determined for accounting purposes is necessarily taxable under the taxation laws. As identified earlier, income for both purpsoes is always the same; however, certain amounts through being income in commercial sense are not necessarily taxable. In almost all the taxation laws, income is defined in a particular manner where the sum taxable is not the gross amount. Legislature can decide what it intends to tax."⁵

This nuance has also been discussed in ECC Quarries Ltd v. Watkis (Inspector of Taxes) [1975] 3 All ER 843 and Kedarnath Jute Mfg Co. Ltd., v. Commissioner of Income Tax (Central), Calcutta ([1971] 82 ITR 363).

7.Keeping in view this symbiotic yet independent relationship of accounting and taxation, we examine the Ordinance to answer the question in hand. Section 100A of the Ordinance provides that income of any banking company shall be computed in accordance with the Rules under the 7th Schedule to the Ordinance which provides for "computation of profits and gains of a banking company and tax payable thereon." Rule 1 of the 7th Schedule, inter alia, provides that income of a banking company shall be taken to be the income disclosed in the annual accounts required to be furnished to the State Bank of Pakistan. Under the said Rule, the accounts of the petitioner banking company, prepared under IAS-19 on accrual-basis accounting for Tax Year 2011, reflect the amount of "surplus" or 'reversal of provision for approved pension fund" as the income of the petitioner company."

8.There is more to the equation. While the Ordinance deals with the taxability of a banking company under the 7th Schedule, it specifically provides for taxability of Approved Superannuation Funds (Pension Funds) under Part-II of the 6th Schedule. Rule 4, thereunder, provides that where any contribution to the pension fund by an employer, including interest thereon, is repaid to the employer, the amount so repaid is deemed for the purposes of tax to be the income of the employer. In other words, the surplus amount is deemed to be the income of a taxpayer for the purposes of tax only when it is repaid to the employer. The word repaid signifies actual repayment or pay back and falls under the scheme of cash-basis accounting. Rule 9 of the 7th Schedule provides that provisions of the Ordinance not mentioned in the 7th Schedule shall apply mutatis mutandis to the banking company. Mutatis mutandis literally means "necessary changes having been made" and the phrase "apply mutatis mutandis," means, that the applicability of any other provision of the Ordinance to the 7th Schedule will also include and bring with it all the necessary changes required to make the said provision of the Ordinance functional under the law. Rule 4 of Part-II of 6th Schedule, structured on cash-basis accounting, once applicable to the banking company under the 7th Schedule, will change the existing accrual-basis accounting in respect of the surplus arising in a Pension Fund, to cash-basis accounting. This change is mandated by the Ordinance and Rule 9 of the 7th Schedule.

9.It is important to clarify that Schedule is part of the Ordinance and falls within the meaning of "the provisions of the Ordinance." Schedule is "as much a part of the statute and is as such an enactment, as any other part. The Schedule is the extension of the section which induces it. Material is put into a schedule because it is too lengthy or detailed to be conveniently accommodated in a section."⁶

10.At an interpretational plane, 6th Schedule dealing with Superannuation Funds assumes the status of a special law for the purposes of determining the tax liability in respect of a pension fund as compared to the overall taxability of the banking company under the 7th Schedule. It is settled that special law prevails over general law, hence in this case Rule 4 of Part-II of the 6th Schedule prevails over Rule 1 of the 7th Schedule to the extent of pension fund and shall apply to the 7th Schedule in the manner provided under Rule 9. On the point that special law prevails over general law reliance with advantage is placed on A. Qutubuddin Khan v. Chec Millwala Dredging Co. (Pvt.) Ltd., (2014 CLD 824), Hafeez Ahmed and others v. Civil Judge, Lahore (PLD 2012 SC 400) and The State v. Zia ur Rehman and others (PLD 1973 SC 49).

11.Another important dimension that requires to be highlighted and goes to the core of the case, is the difference between tax accounting and book or financial accounting. Tax Accounting is 'the method of accounting that focuses on tax issues; this includes all activities related to filing tax returns and planning for future tax obligations.'⁷ While book or financial accounting follows the Generally Accepted Accounting Principles (GAAP) like IAS or International Financial Reporting Standards (IFRS), tax accounting follows the taxation policy under the law and prevails over financial accounting. It is for this reason that accounting principles employed for the purposes of computing the income chargeable to tax under section 32 are subject to the provisions of the Ordinance and are captioned as Tax Accounting under Division IV of Part IV of Chapter III of the Ordinance. The meaning of Tax Accounting in other jurisdictions also echoes this concept: "accounting methods that focus on taxes rather than the appearance of public financial statements. Tax accounting is governed by the Internal Revenue Code which dictates the specific rules that companies and individuals must follow when preparing their tax returns. Tax principles often differ from Generally Accepted Accounting Principles."⁸ "For all practical purposes, U.S. corporations must keep two sets of books: one set to comply with Generally Accepted Accounting Practices and the other to comply with the Internal Revenue Code. GAAP rules are intended to promote uniform statements that accurately convey the financial history, health, and prospects of a business, while the tax code is intended to generate revenues for the government but also achieve certain public policy goals. It is only natural that these two methods frequently produce very different results."⁹ In this case, tax accounting will be governed by Rule 4 of Part-II, 6th Schedule which takes preference over the Rules under the 7th Schedule. The lower forums have failed to appreciate this difference between tax accounting and financial accounting and have given undue importance to method of accounting over the principles of taxation under the Ordinance. Admittedly, the surplus has not been repaid to the bank, it cannot, therefore, be deemed to be the income of the petitioner bank and offered to tax.

12.For the above reasons the only legal question raised before us is answered in the above terms. Consequently, this petition is allowed. We see no reason to deliberate on the other ancillary questions raised in this reference, which in the light of the above, have been reduced to mere academic questions.

13.Office shall send a copy of this judgment under the seal of the Court to the learned Appellate Tribunal Inland Revenue as per section 133(5) of the Income Tax Ordinance, 2001.

MH/M-331/LReference allowed.