I. T. A. No. 1658/LB of 2003, decided on 11th December, 200 Versus I. T. A. No. 1658/LB of 2003, decided on 11th December, 2003.
ORDER
SYED NADEEM SAQLAIN (JUDICIAL MEMBER).--- The Revenue has come up in appeal for the Assessment Year, 2000-2001 assailing the impugned order, dated 6-1-2003 passed by the learned CIT(A), Multan.
2. Briefly, stated facts of the case are that the assessee is a public limited company running a Scheduled Commercial Bank. Assessment in the instant case for the assessment year under consideration was framed at Rs.5,62,274,992 under section 62 of the repealed Income Tax Ordinance, 1979. The assessee being dissatisfied with the order passed by the Assessing Officer preferred appeal before the learned CIT(A) who vide his order, dated 6-1-2003 had given his decision allowing various reliefs to the, assessee. The department is in further appeal impugning the findings recorded by the learned CIT(A) urging the following grounds:--
(1) The learned CIT(A) was not justified to delete addition of Rs.137,501,402 made on account of "interest on securities" on accrual basis in the light of C.B.R.'s letter C No 17(I)/1994, dated 28-5-1994 as the said interest was earned on accrual basis.
(2) The learned CIT(A) was not justified to delete the additions of Rs.4,423,374 made by disallowing non-performing advance which was disallowed in view of the provisions of section 23(1)(x) of the Income Tax Ordinance, 1979.
(3) The learned CIT(A) was not justified to delete the addition of Rs.22,516,853 made on account of interest on suspense a/c.
(4) The learned CIT(A) was not justified to delete the addition made on F.I.Bs. in view of the specific provisions of section 18 of the income Tax Ordinance, 1979.
(5) The learned CIT(A) was not justified to delete the addition of Rs.1,897,684 made under the head cost of funds utilized in earning the exempt income as per rated cost of funds deployed in earning of exempt income was rightly added.
(6) The learned CIT(A) was not justified to reduce the disallowance from 20% to 10% of the claim of expenses on account of free furnished accommodation.
(7) The learned CIT(A) was not justified to delete penalties amounting to Rs.874,326 imposed by State Bank of Pakistan as the said expense was Admissible as per the provisions of section 24 of the Ordinance.
3. Learned representatives for both the parties are present and have been heard. After hearing the rival arguments we proceed to adjudicate the respective issues in the following manner:--
Interest securities.
4. The learned AR submitted that in the light of Tribunal's order reported as 87 Tax 148 (Trib.) and I.T.As. Nos.3623 and 3624/LB of 2002, dated 6-5-2003, the issue already stands settled whereby it was adjudicated that interest on Government Securities should be taxed on receipt basis instead of accrual basis. Therefore, no interference is required and the order of learned CIT(A) is being upheld on the issue.
Non-performing Advances.
5. With regard to the instant issue the learned A.R. referred to the judgments of the Tribunal passed in I.T.As. Nos. 3623 and 3624/LB of 2002 in the case of the assessee whereby it was held in tide light of the ITAT order recorded in I.T.A. No.591/LB of 2001 and the judgment of Sindh High Court, Karachi reported as (1991) 643 Tax 7 that the provision for bad debts is an allowable expenditure.
6. We have no option but to follow the ratio settled by these judgments. Resultantly, no interference is warranted in the impugned order on the issue.
Interest on Suspense Account
7. On the said issue the learned A.R. once again drew the attention of the Bench to the Tribunal's order passed I.T.As. Nos. 3623 and 3624/LB of 2002 wherein the present issue has already been decided in D favour of the assessee. This being the case, we are constrained to maintain the impugned order. Departmental assertion stands rejected.
Addition made on Federal Investment Bonds
8. Representatives for both contesting parties argued the case with reference to the above-mentioned issue extensively.
9. However, during the arguments, both the representatives were asked to submit a "write up" elaborating their point of vie The learned A.R. submitted the following arguments:--
"PREMIUM ON FEDERAL INVESTMENT BONDS (FIB)
That the learned Assistant Commissioner of Income Tax Circle 01, Multan Zone, Multan is not justified in disallowing the premium paid for the purchase of F.I.Bs amounting to Rs.4,836,395.
Premium on FIB is the payment of an amount over and above the face-value of FIBs. The reason for the premium on bonds is the lowering interest rates on the instruments of comparable tenor and terms. Due to lower interest rates on other comparable instruments, high coupons bonds are traded at premium i.e. above face-value.
Bank records the premium on FIB's paid as other asset and charges off the same over the remaining tenor of bonds in order to determine the true market yield on investment/FIB etc. Basically premium on bonds is paid to receive higher coupons in future periods; therefore allocation of premium over future period is imperative. The adoption of his process is based on `Matching Revenues with Costs principal as specified in `Framework for preparation and presentation of Financial Statements'. "
Paragraph 95 of Framework of International Accounting Standards reads as under;--
"Expenses are recognized in the income statement on the basis of a direct association between of specific items of income. This process, commonly referred to as the matching of costs with revenues, invoices the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events."
Paragraph 96 of Framework reads as follows:--
"When economic benefits are expected to arise over several accounting periods and the association with income can only be broadly or indirectly determined, expenses are recognized in the income statement on basis on systematic and rational allocation procedures."
From the foregoing, it is evident that the process of allocating premium of FIB is in consonance with International. Accounting Standards.
From the above discussion, it is evident that premium paid on security is nothing but the component of interest which is directly related with the earning of interest income at more than the prevailing market rate of interest on instruments of similar tenor and nature. Therefore, while recognizing the interest income on accrual basis, in our accounts, proportionate premium is charged off to the revenue accounts in order to arrive at the realistic income earned on security for the period thus 'the premium is not an expense being claimed against the interest income but is actually the interest paid in advance to the seller so as to receive the same later on in the form of higher amounts of coupons attached with. the bonds.
The Assessing Officer disallowed an amount of Rs. 4,836,395 being premium paid on purchase of FIB on the following ground that:
"The premium paid cost of security on which it is paid forms purchase price of these securities. Being part of capital cost, in tax law, it cannot be amortized over the life of the securities. Therefore, an amount of Rs.4,836,395 is not allowed being capital in nature. However, as this forms part of cost of acquisitions the security, it shall be taken into consideration while computing income from such securities at the time of their disposal."
Whereas the superior Courts in Indo-Pakistan Sub-continent have consistently been holding that interest arising on securities (section 17) and the profits made on sale of securities (chargeable either under section 22 or 27) are distinct and have to -be so regarded for the purpose of bringing any receipt chargeable to tax interest income received on maturity of Government securities is chargeable to tax is the owner's hands who exercises the right of encashment of such securities. Gain or loss on sale of securities on the other hand may give rise to either capital gain (chargeable to tax under section 27) or revenue profits (chargeable to tax under section 22) depending upon the nature of investment i.e. fixed capital or floating/circulating capital. This dictum was pronounced by Honourable apex Court in a case reported as CIT, Central Karachi v. Habib Bank Executors and Trustees Co., Karachi (1986) 53 Tax 59 (SC Pak.)
The nature of premium paid on FIBs stating that it represented payment of interest cost in advance against which interest income was received at accelerated rate over the life of security. In every transaction of sale and purchase of a security between the transferor (seller) and the transferee (buyer), interest on securities could have been computed de die in diem, but in fact it did not really accrue to the buyer from day-to-day, as he was not entitled to receive any interest before the maturity date.
Moreover section 17 makes it clear that the person chargeable to tax under section 17 is the holder of the security on the date of its maturity who exercises the right of encashment. The law does not provide for taking separately the vendor and the purchaser liable to tax for interest related to broken period or to keep track of interest adjustments between transferors and transferees. Where an interest-bearing security is sold and part of the sale price represents accrued but hitherto unpaid interest, that accrued interest is not chargeable to tax under section 17 but as capital gain or business income as the case may be, at the time of sale of that security. It is thus well-established that if a security changes hands between a number of buyers and sellers, tax under section 17 is eligible when the security matures and the person who received the entire amount of interest becomes liable to deduction of tax under section 50(2) The intermediaries only get business profits/loss or capital gains/loss on sale of securities and not "interest on securities" within the meaning and scope of section 17 of the Ordinance."
In the light of above, it can be concluded that:--
(1) Any amount exceeding the face-value of stocks, shares or securities (being the stock-in-trade) paid by a bank at the time of their purchases is a revenue expenditure and is to be allowed. Support is drawn from a reported case 15 Tax 145 (H.C. Kar.) wherever an ordinary person, but being in money lending business, was allowed the excess price he paid for purchase of shares as business expenditure
(2) The premium paid by the appellant-Bank on the purchase of FIBS from open market represented the qualification of interest accrued to the seller till the date of transaction when sale was effected. It cannot be termed as part of capital cost of the Bank for which investment in FIBs was on revenue account.
The allowability of premium paid is also justified if your appellant case is seen from the angle of well-accepted and well established principle that banking business is a composite activity and rule of apportionment does not apply for the purpose of taxation of composite income. This legal aspect has been laid down in a number of judgments by the. Courts some of which are as under:--
(1) (1987) 50 Tax 196 (H.C. Kar.); (2) 1993 PTD (Trib.) 472; (3) (1980) 42 Tax 24 (Trib.) and (4) (1976) 33 Tax 23 (Trib.)
The Central Board of Revenue (C.B.R.) in its latest Circular No.7 of 2003, dated 12th July, 2003, has reaffirmed that " ....Income earned by a financial institution from any source is liable to normal tax rates... as business income". It means that even if the argument of the Assessing Officer is accepted that premium paid on FIBS relates to capital cost of securities, it cannot be disallowed in the case of bank as per C.B.R.'s instructions that every income of a bank is "business income."
10. The learned D.R. vehemently contested the arguments tendered by the learned A.R. but failed to dislodge the impugned findings recorded by the learned CIT(A). The arguments addressed by the learned D.R. were not at all convincing and failed to persuade the Bench to seek reversal of the order passed by the learned First Appellate Authority.
11. It is observed that premium paid on purchase of FIB is a cost incurred by the assessee for the purpose of business of the Bank and has to be allowed during the period in which it is incurred. This is in form of a prepaid expense which is speared over the period to which it; relates.
12. After hearing the learned counsel for both the parties and in the light of discussion as well as case-law cited at the Bar, we are of the considered view that department has got no case hence we are not inclined to interfere in the impugned order passed by the learned CIT(A) which is hereby maintained.
13. Resultantly, the appeal of the Department on this issue fails.
Addition on account of cost of Funds availed- for earning income.
14. Learned counsel for both the parties were also heard on the, issue in detail. The learned DR vehemently argued the case and reiterated almost the same arguments, which were used by the Assessing Officer and were incorporated by him in the assessment order.
15. The learned A.R. submitted that the interest cost is not directly allocable against investment as the Bank has sufficient funds in the form of capital and reserves to generate investment assets amounting to Rs.1,322,197,000. Moreover the capital gains earned by the Bank are exempt unconditionally, under clause 116 of Part 1 of Second Schedule to the repealed Income Tax Ordinance, 1979. The learned A.R. contended that the learned CIT(A) rightly deleted the addition made by the Assessing Officer with regard to disallowing certain expenses on proportionate basis stating that if income is exempt the same are not allowable.
16. It was further pleaded that the banking is a composite business and it has been held by various judicial forums that where income is earned from one and divisible source, expenses cannot be proportioned between income from taxable source and from exempt source, the learned A.R. referred to a judgment of the Tribunal passed in I.T.A. No. 106/LB of 2000 wherein the Tribunal while relying by earlier judgment of the Tribunal delivered in I.T.A. No. 1047/LB of 1998 has held that expenses cannot be proportionate between taxable income and exempt income as the banking business is a composite business. The learned A.R. drew the attention of the Bench to ratio settled by the tribunal while adjudicating the issue in the case of Fidelity Investment Bank. The same is being reproduced as under:--
"(4) In the Assessment Year, 1995-96 the appellant claimed interest expenses amounting to Rs.7,859,578. The Assessing Officer observed that the expenses relates to exempt income. He, therefore, disallowed the same. It was conducted before the learned First Appellant Authority and now before us that the Assessing Officer was not justified in co-relating the interest expenses under the head with exempt income as these expenses were clearly admissible under clause (vii) or alternatively clause (xvii) of section 23(1) of the Ordinance. The learned counsel submitted that the learned ITAT in an order, dated 18-11-1997 passed in I.T.A. 2060/LB of 1993 in the case of Bank of Punjab has held that the department cannot allocate interest or other expense to income claimed to be exempt by the assessee. In arriving at this conclusion the learned ITAT has relied on its earlier decisions reported as (1993) 67 Tax 125 (Trib.), 1992 PTD (Trib.) 1141, 1984 PTD 341, 1984 PTD 390 and 1998 PTD 626. The Honourable Karachi High Court in a reported case 1984 PTD 341 at 384 PTD 390 held that "no part of the administrative and other expenses and interest should be allocated against dividend income which was exempt from tax and other income which was not so exempt" in view of the decision of the superior Courts be learned CIT(A) was fully justified to delete the addition made on account of disallowance of interest expenses."
17. To further substantiate his point of law, the learned A.R. also placed reliance on judgments of the Tribunal as well as Honourable Karachi High Court reported as 1984 PTD 390; 1993 PTD (Trib.) 472; 1980 PTD (Trib.) 68 and 1975 PTD (Trib.) 63.
18. We have given our anxious consideration to the submissions) addressed at the Bar, we do not find any merit in the arguments tendered by the learned D.R. while praying for the vacation of the impugned' order. The learned First Appellate Authority deleted the addition under this head through a well-reasoned order on the basis of law laid down by the Tribunal as well as Karachi High Court.
19. We are constrained to observe that findings recorded by the learned CIT(A) are unexceptionable, hence need not be disturbed.
Reduction in disallowance from 20% to 10% on account of free furnished accommodation:
20. The learned A. R. argued that the accommodation was also used as guest houses for the purpose of the business of the assessee. Nevertheless, the argument reveals that these are also used for the purpose of accommodation of Banks Executives, thus relief provided by the learned CIT(A) appears to be excessive. In this view of the fact; the order passed by the learned CIT(A) on the issue is vacated and the 20% disallowance as made by the Assessing Officer is restored.
Deletion of addition on account of penalties imposed by the State Bank of Pakistan.
21. The learned D.R. supported the assessment order while pleading at, the bar. The learned A. R. countered the argument by submitting that the law regarding disallowance of penalties i.e. vide clause (i) of section 24 of the Income Tax Ordinance, 1979 has been introduced vide Finance Ordinance, 2000, which is applicable from the Assessment Year, 2001-2002, whereas the assessment in question is Assessment Year, 2000-2001. The learned D.R. could not rebut the contention raised by the learned A.R. Admittedly, the law on the issue was introduced vide Finance Ordinance, 2000 applicable for the Assessment Year, 2001-2002 and cannot the applied retrospectively. Hence order passed by the learned CIT(A) on the issue does not warrant our interference, the same is upheld.
The appeal is disposed of as indicated above.
H.B.T./303/Tax(Trib.) Order accordingly.