COMMISSIONER INLAND REVENUE (ZONE-IV) VS SAIMA PACKAGING (PVT.) LTD.

2017 P T D 2413

[Sindh High Court]

Before Aqeel Ahmed Abbasi and Aziz-ur-Rehman, JJ

COMMISSIONER INLAND REVENUE (ZONE-IV)

Versus

Messrs SAIMA PACKAGING (PVT.) LTD.

I.T.R.A. No.34 of 2013, decided on 13/09/2017.

Income Tax Ordinance (XLIX of 2001)---

----Ss. 13(7), 85(2) & (3), 108, 109 & 133---"Arm's length", principle of---Interest free loans to employees---Concurrent findings of two forums---Authorities were aggrieved of findings of two forums below declaring that interest free loans given by tax payer to its employees was covered under principle of "arm's length"---Validity---Until and unless taxation officer had discharged his onus to establish that interest free loan advanced by an employer to its employee was a transaction which was not at "arm's length" and employee was an associate of employer, provisions of Ss. 108 & 109 of Income Tax Ordinance, 2001 could not be invoked---Taxation officer did not discharge such onus while invoking provisions of Ss. 108 & 109 of Income Tax Ordinance, 2001---High Court declined to interfere in concurrent findings of facts recorded by Appellate Tribunal Inland Revenue and Commissioner (Appeals) as same had depicted correct legal position---Reference was dismissed in circumstances.

Dr. Shahnawaz Memon for Applicant.

Dervesh K. Mandhan for Respondent

Date of hearing: 13th September, 2017.

ORDER

AQEEL AHMED ABBASI, J.---Through instant reference application, the applicant has proposed following questions, which according to the learned counsel for the applicant, are questions of law, arising from the impugned Order dated 19.09.2012 passed by the Appellate Tribunal Inland Revenue, Karachi in I.T.A. No.1042/KB of 2011 (Tax Year 2010), for the opinion of this Court:--

1. Whether on the facts and in the circumstances and on law the learned ATIR was justified to confirm the order of the CIR (Appeals) who deleted the addition made on account of interest charged on loans given to employees?

2. Whether on the facts and in the circumstances and on law the learned Tribunal was justified to hold that such addition could not be made in light of section 108 of the Income Tax Ordinance, 2001 and further to consider that employees are not covered under the definition of Associates as provided under subsection (2) of section 85 of the Income Tax Ordinance, 2001.

3. Whether on the facts and in the circumstances and on law the learned Tribunal was justified to delete the addition made on account of interest on loan given to employees without considering the facts that loans to employees were not given as per employment contracts and therefore principle of "arm's length" was not violated?

4. Whether on the facts and in the circumstance and on law the learned Tribunal was justified to uphold the order of the learned CIR (Appeals), deleting the impugned addition, relying solely upon subsection (3) of section 85, without reading it in conjunction with subsection (1) of the same section, in disregard of the rule of interpretation that the statute has to be read as whole?

2.Learned counsel for the applicant, after having read out the impugned order passed by the Appellate Tribunal Inland Revenue, Karachi in the instant case, as well as the orders of the Commissioner (Appeals) and the Taxation Officer, submits that the Appellate Tribunal, Inland Revenue, was not justified in concurring with the decision of the Commissioner (Appeals) in the instant case, whereby, the addition made by the Taxation Officer, on account of interest free loans to employees, has been deleted. It has been contended by the learned counsel, the interest-free loan given by the Company to its employees was not at arm's length, therefore, was not covered under section 13(7) of the Income Tax Ordinance, 2001. It has been further contended by the learned counsel for the applicant that since there was no agreement in writing between the employer and the employees with regard to advancing interest-free loan, therefore, it could not be treated as perquisite. It has been prayed that impugned order passed by the Commissioner (Appeals) as well as by Appellate Tribunal Inland Revenue in the instant case may be set aside and the questions proposed through instant reference application may be answered in Negative in favour of the applicant and against the respondent.

3.Conversely, learned counsel for the respondent has vehemently controverted the submissions made by the learned counsel for the applicant and submits that the questions proposed through instant reference application are not questions of law arising, from the impugned order passed by the Appellate Tribunal Inland Revenue in the instant case as, according to the learned counsel, concurrent findings as recorded by the two appellate forums are based on finding of facts, therefore, the questions proposed through instant reference application cannot be said to be a question of law arising from the impugned order passed by the Appellate Tribunal Inland Revenue in the instant case. Learned counsel for the respondent further submits that without prejudice to hereinabove objections with regard to maintainability of the instant reference application, the Appellate Tribunal Inland Revenue as well as the Commissioner (Appeals), after having examined the material facts, have properly interpreted the provisions of section 13(7), section 85(2) as well as provisions of sections 108/109 of the Income Tax Ordinance, 2001, which provide that unless the Taxation Officer establishes that the employee to whom interest-free loan has been advanced, is an associate of its employer and the transaction was not at arm's length, provisions of sections 108/109 of the Income Tax Ordinance, 2001 cannot be invoked. Per learned counsel, from perusal of the order passed by the Taxation Officer in the instant case, it is clear that no efforts whatsoever were made by the Taxation Officer to discharge his onus while treating the employees of the company as its associates. Learned counsel for the respondent after having read out the provisions of subsection (7) of section 13 and subsection (2) of section 85 of the Income Tax Ordinance, 2001, submitted that interest-free loan was given by the company to its employees as perquisite in terms of section 13(7) of the Income Tax Ordinance, 2001, whereas, the employees do not fall within the definition of associates. On the contrary, they are excluded from such definition in terms of section 85(2) of the Income Tax Ordinance, 2001. It has been further contended by the learned counsel for the respondent that the impugned order passed by the Appellate Tribunal Inland Revenue is based on concurrent finding of facts, which otherwise, depicts correct position of law, therefore, does not require any interference by this Court while exercising its reference jurisdiction in terms of section 133 of the Income Tax Ordinance, 2001. Learned counsel for the respondent while concluding his arguments submits that instant reference application is devoid any merits, which may be dismissed in limine, whereas, the questions proposed through instant reference application may be answered in affirmative against the applicant and in favour of the respondent.

4.We have heard learned counsel for the parties, perused the record as well as the relevant legal provisions with their assistance.

5.Since the facts in the instant reference application are not disputed between the parties, therefore, we would not narrate the facts of the case, and would dilate upon legal issues agitated through instant reference application.

6.Admittedly, the interest-free loan was advanced by the respondent company to its employees in terms of section 13(7) of the Income Tax Ordinance, 2001, whereas, the Taxation Officer has added the amount of interest free loan while treating the employees as associates under section 85 of the Income Tax Ordinance, 2001 and has held that such transaction is not at arm's length.

7.In order to appreciate the subject controversy agitated through instant reference application, it would be advantageous to examine the provisions of sections 13(7) and 85 as well as sections 108 and 109 of the Income Tax Ordinance, 2001, which read as under:--

Section 13 of the Income Tax Ordinance.

"13. Value of perquisites.---(1) For the purposes of computing the income of an employee for a tax year chargeable to tax under the head "Salary", the value of any perquisite provided by an employer to the employee in that year that is included in the employee's salary under section 12 shall be determined in accordance with this section.

(2)This section shall not apply to any amount referred to in clause (c) or (d) of subsection (2) of section 12.

(3)Where, in a tax year, a motor vehicle is provided by an employer to an employee wholly or partly for the private use of the employee, the amount chargeable to tax to the employee under the head "Salary" for that year shall include an amount computed as may be prescribed.

(4) .

(5)Where, in a tax year, the services of a housekeeper, driver, gardener or other domestic assistant is provided by an employer to an employee, the amount chargeable to tax to the employee under the head "Salary" for that year shall include the total salary paid to the domestic assistant such house keeper, driver, gardener or other domestic assistant] in that year for services rendered to the employee, as reduced by any payment made [to the employer] for such services.

(6)Where, in a tax year, utilities are provided by an employer to an employee, the amount chargeable to tax to the employee under the head "Salary" for that year shall include the fair market value of the utilities provided, as reduced by any payment made by the employee for the utilities.

(7)Where a loan is made, on or after the 1st day of July, 2002, by an employer to an employee and either no profit on loan is payable by the employee or the rate of profit on loan is less than the benchmark rate, the amount chargeable to tax to the employee under the head "Salary" for a tax year shall include an amount equal to

(a)the profit on loan computed at the benchmark rate, where no profit on loan is payable by the employee, or

(b)the difference between the amount of profit on loan paid by the employee in that tax year and the amount of profit on loan computed at the benchmark rate, as the case may be provided that this subsection shall not apply to such benefit arising to an employee due to waiver of interest by such employee on his account with the employer.

Provided further that this subsection shall not apply to loans not exceeding One Million rupees.

(8)For the purposes of this Ordinance not including subsection (7), where the employee uses a loan referred to in subsection (7) wholly or partly for the acquisition of 2 [any asset or property] producing income chargeable to tax under any head of income, the employee shall be treated as having paid an amount as profit equal to the benchmark rate on the loan or that part of the loan used to acquire the [asset or property].

(9)Where, in a tax year, an obligation of an employee to pay or repay an amount owing by the employee to the employer is waived by the employer, the amount chargeable to tax to the employee under the head "Salary" for that year shall include the amount so waived.

(10)Where, in a tax year, an obligation of an employee to pay or repay an amount 4 [owing] by the employee to another person is paid by the employer, the amount chargeable to tax to the employee under the head "Salary" for that year shall include the amount so paid.

(11)Where, in a tax year, property is transferred or services are provided by an employer to an employee, the amount chargeable to tax to the employee under the head "Salary" for that year shall include the fair market value of the property or services determined at the time the property is transferred or the services are provided, as reduced by any payment made by the employee for the property or services.

(12)Where, in the tax year, accommodation or housing is provided by an employer to an employee, the amount chargeable to tax to the employee under the head "Salary" for that year shall include an amount computed as may be prescribed.

(13)Where, in a tax year, an employer has provided an employee with a perquisite which is not covered by subsections (3) through (12), the amount chargeable to tax to the employee under the head "Salary" for that year shall include the fair market value of the perquisite, 1 [except where the rules, if any, provide otherwise,] determined at the time it is provided, as reduced by any payment made by the employee for the perquisite.

(14)In this section,

(a)"benchmark rate" means --

(i)for the tax year commencing on the first day of July, 2002, a rate of five percent per annum; and

(ii)for the tax years next following the tax year referred to in sub-clause (i), the rate for each successive year taken at one percent above the rate applicable for the immediately preceding tax year, but not exceeding such rate, if any, as the Federal Government may, by notification, specify in respect of any tax year:

(b)"services" includes the provision of any facility; and

(c)"utilities" includes electricity, gas, water and telephone.

Section 85 of the Income Tax Ordinance, 2001.

85. Associates.---(1) Subject to subsection (2), two persons shall be associates where the relationship between the two is such that one may reasonably be expected to act in accordance with the intentions of the other, or both persons may reasonably be expected to act in accordance with the intentions of a third person.

(2)Two persons shall not be associates solely by reason of the fact that one person is an employee of the other or both persons are employees of a third person.

(3)Without limiting the generality of subsection (1) and subject to subsection (4), the following shall be treated as associates -

(a)an individual and a relative of the individual;

(b)members of an association of persons;

(c)a member of an association of persons and the association, where the member, either alone or together with an associate or associates under another application of this section, controls fifty per cent or more of the rights to income or capital of the association;

(d)a trust and any person who benefits or may benefit under the trust;

(e)a shareholder in a company and the company, where the shareholder, either alone or together with an associate or associates under another application of this section, controls either directly or through one or more interposed persons

(i)fifty per cent or more of the voting power in the company;

(ii)fifty per cent or more of the rights to dividends; or

(iii)fifty per cent or more of the rights to capital; and

(f)two companies, where a person, either alone or together with an associate or associates under another application of this section, controls either directly or through one or more interposed persons

(i)fifty per cent or more of the voting power in both companies;

(ii)fifty per cent or more of the rights to dividends in both companies; or

(iii)fifty per cent or more of the rights to capital in both companies

(4)Two persons shall not be associates under clause (a) or (b) of subsection (3) where the Commissioner is satisfied that neither person may reasonably be expected to act in accordance with the intentions of the other.

(5)In this section, "relative" in relation to an individual, means:--

(a)an ancestor, a descendant of any of the grandparents, or an adopted child, of the individual, or of a spouse of the individual; or

(b)a spouse of the individual or of any person specified in clause (a).

Sections 108 and 109 of the Income Tax Ordinance, 2001:

108. Transactions between associates.---(1) The Commissioner may, in respect of any transaction between persons who are associates, distribute, apportion or allocate income, deductions or tax credits between the persons as is necessary to reflect the income that the persons would have realized in an arm's length transaction.

(2)In making any adjustment under subsection (1), the Commissioner may determine the source of income and the nature of any payment or loss as revenue, capital or otherwise.

(3)Every taxpayer who has entered into a transaction with its associate shall:

a)maintain a master file and a local file containing documents and information as may be prescribed;

b)keep and maintain prescribed country-by-country report, where applicable.

c)Keep and maintain any other information and document in respect of transaction with its associate as may be prescribed; and

d)Keep the files, documents, information and reports specified in clauses (1) to (c) for the period as may be prescribed.

(4)A taxpayer who has entered into a transaction with its associate shall furnish, within thirty days the documents and information to be kept and maintained under subsection (3) if required by the Commissioner in the course of any proceedings under this Ordinance.

(5)The Commissioner may, by an order in writing, grant the taxpayer an extension of time for furnishing the documents and information under subsection (4), if the taxpayer applies in writing to the Commissioner for an extension of time to furnish the said documents or information:

Provided that the Commissioner shall not grant an extension of more than forty-five days, when such information or documents were required to be furnished under subsection (4), unless there are exceptional circumstances justifying a longer extension of time.

109. Re-characterization of income and deductions.--(1) For the purposes of determining liability to tax under this Ordinance, the Commissioner may -

(a)re-characterize a transaction or an element of a transaction that was entered into as part of a tax avoidance scheme;

(b)disregard a transaction that does not have substantial economic effect; or

(c)re-characterize a transaction where the form of the transaction does not reflect the substance.

(2) In this section, "tax avoidance scheme" means any transaction where one of the main purposes of a person in entering into the transaction is the avoidance or reduction of any person's liability to tax under this Ordinance."

8.From careful perusal of hereinabove relevant provisions of law, with particular reference to subject controversy agitated through instant reference application, it has emerged that in order to treat an employee as an associate of the employer, the Taxation Officer is required to establish relationship between the two, as such that one may reasonably be expected to act in accordance with the intention of the other, or both the persons may reasonably be expected to act in accordance with the intention of a third person. Perusal of provisions of subsection (2) of section 85 of the Income Tax Ordinance, 2001 further reflects that the Legislature being cognizant of the fact that every employee cannot be treated as an associate, it has been clarified that two persons should not be treated as associates solely by reason of the fact that one person is an employee of the other or both are employees of a third person. Similarly, subsection (3) of section 85 of the Income Tax Ordinance, 2001 has further specified the individuals who can be treated as associates, which includes relatives of the individual; m embers of an association of persons; a trust and any person who benefits or may benefit under the trust; a shareholder in a company and the company; where the shareholder either alone or together with an associate or associates under any application of this section controls, either directly or through one or more interposed persons, a certain amount of shareholding in the company.

9.The conclusion which can be safely drawn from the perusal of the hereinabove provisions of law, is that until and unless, the Taxation Officer discharges such onus to establish that the interest-free loan advanced by an employer to its employee is a transaction which is not at arm's length and the employee is an associate of the company, the provisions of sections 108/109 of the Income Tax Ordinance, 2001 cannot be invoked. We are of the opinion that the Taxation Officer has not been able to discharge such onus while invoking the provisions of sections 108/109 of the Income Tax Ordinance, 2001 under the peculiar facts and circumstances of the instant case. On the contrary, this aspect of the matter has been elaborately examined by both the appellate forums who have recorded their finding of facts by applying the correct legal provisions of law. It will be advantageous to reproduce the finding of the Commissioner (Appeals), which is as follows:--

"It is noted that the Additional Commissioner Inland Revenue, while resorting to action under section 122(54) of the Income Tax Ordinance, 2001, made addition on account of interest free loan amounting to Rs.411,132/- on loan to employees/ executives by re-characterization in terms of sections 108/109 of the Income Tax Ordinance, 2001. The perusal of the impugned order reveals that the Inland Revenue has applied arm's length transaction principle and has worked out fair market value of such benefit. Arm's length transactions are covered under section 108 of the Income. Tax Ordinance, 2001 where by the Commissioner may apply the said principle in the case of associates and allocated/distribute/apportion the income among the associates we of associate. While taking into consideration the provisions of section 108 of the Income Tax Ordinance, 2001, the officer is obliged under the Rules in Chapter-VI of Income Tax Rules, 2002 to evolve method and ways and means as to how to apply the provisions of section 108 of the Income Tax Ordinance, 2001. Rule No.23 of the Income Tax Rules, 2002 provides that the standard or arm's length which includes following method for determination of arm's length transaction.

a.The comparable uncontrolled price method;

b.The re-sale price method;

c.The cost plus method; or

d.The profit split method.

In case no result comes out by application of these methods, the Commissioner may use of the method which should be consistent with the arm's length transaction. Rule 24 prescribes the comparable un-control price method, Rule 25 deals with resale price method, Rule 26 applied on cost plus method and Rule 27 gives the method for profit split. In the impugned order the Officer Inland Revenue has neither confronted the appellant with the provision of section 108 of the Income Tax Ordinance, 2001 in true spirit nor has referred to Chapter VI of Income Tax Rules, 2002 whereby putting specific pointation on the applied Rule from 24 to 27 which are prescribed for determination of arm's length transaction. Without referring to section 108 read with provision in Chapter IV of Income Tax Rules, 2002, the principle of arm's length transaction as mentioned by Officer Inland Revenue on page No.8 of the impugned order is misplaced. Officer Inland Revenue was under legal obligation to follow the law and procedure of application of arm's length transaction principle. More making reference to this principle without following its law and procedure is uncurable mistake on the part of the Office.

In view of the above discussion the interest applied is not an income, and there is no such benefit derived by the appellant except what was declared in the return of income. Besides above, the Officer Inland Revenue could not establish exact relation between the loaner and the appellant as an associate. The Officer Inland Revenue on one hand has referred the arm's length transaction in his impugned orders and on the other hand he has to follow the law and procedure as prescribed in section 108 of the Income Tax Ordinance, 2001, read with Chapter VI of the Income Tax Rules, 2002.

Consideration all the above legal as well as factual points, the addition made by Officer Inland Revenue by re-characterization under section 108 of Income Tax Ordinance, 2001 is not sustainable in the law and on facts and is hereby deleted."

10.The Appellate Tribunal Inland Revenue concurred with the hereinabove finding of the Commissioner (Appeals) through the impugned order in the following terms:--

"5. We have heard the arguments from both the sides and perused the case record. The contention of the A.R. of the taxpayer has force and the taxpayer being an employer, such addition could not be made in the light of section 108 of the Income Tax Ordinance, 2001 in its income as the employee is not covered under the definition of Associates as provided in subsection (2) of section 85 of the Income Tax Ordinance, 2001. Therefore, we are of the view that the order passed by CIR(A) has no infirmity, irregularity, impropriety or illegality and are inclined to agree with the findings of the learned CIR(A) which is upheld. The order passed by CIR(A) is confirmed."

11.We do not find any error in the concurrent findings of fact recorded by the Appellate Tribunal Inland Revenue and Commissioner (Appeals), reproduced hereinabove, which otherwise depict the correct legal position. Accordingly, instant reference application is devoid of any merits, which is hereby dismissed, whereas, the questions proposed through instant reference application are answered in the affirmative in favour of the respondent and against the applicant.

MH/C-16/Sindh Reference dismissed.