ORDER SHEET

IN THE HIGH COURT OF SINDH AT KARACHI

Present: Mr. Justice Aqeel Ahmed Abbasi

Mr. Justice Mahmood A. Khan

I.T.R.A. No.65 of 2017

___________________________________________________________ Date Order with signature of Judge

___________________________________________________________

Hearing of Case:

1. For order on CMA No.112/2017.

2. For hearing of main case.

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10^th February 2020

Dr. Shahnawaz Memon, Advocate for Applicant.

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O R D E R

AQEEL AHMED ABBASI, J : -- Through instant reference application, the applicant had proposed following question, as according to learned counsel, is a question of law arising from the impugned order dated 07.10.2016 passed by the Appellate Tribunal Inland Revenue of Pakistan, Karachi in ITA No.388/KB-2014 for the Tax Year 2012:

Whether under the facts and circumstances of the case the learned Tribunal was justified to uphold the order of the Commissioner (Appeals) deleting the addition made on account of provision of interest-free loans to the employees, which transaction was not carried out at an arm’s length?

2. Learned counsel for the applicant, after having read out the question and the impugned order passed by the Appellate Tribunal Inland Revenue of Pakistan, Karachi as well as order of the two authorities below, has candidly stated that the question proposed through instant reference application is based upon the earlier decision of the Appellate Tribunal, whereas, the same has already been decided by a Divisional Bench of this Court in the case of Commissioner Inland Revenue (Zone-IV) vs. Messrs Saima Packaging (Pvt.) Limited (2017 PTD 2413), therefore, it can be answered in the similar terms.

3. We have heard the learned counsel for the applicant, perused the record and the impugned order passed by the Appellate Tribunal as well as orders of the two authorities below in the instant case with his assistance and have also gone through the order of a Divisional Bench of this Court in the case of Commissioner Inland Revenue (Zone-IV) supra.

4. From the perusal of hereinabove position, it appears that question proposed through instant reference application is covered by the decision of this Court, as referred to hereinabove. It will be advantageous to reproduce the relevant findings of the Commissioner Inland Revenue, Appeals-I, Karachi dated 28.02.2014 as well as of the Appellate Tribunal Inland Revenue of Pakistan, Karachi dated 07.10.2016 on the subject controversy, which has already been decided by this Court in the case of Commissioner Inland Revenue (Zone-IV) supra :

Findings of Commissioner Inland Revenue (Appeals-I):

Ground No.7

The AR of the appellant has objected that officer has made addition of Rs.416,400/- u/s. 108 and 109 of Income Tax Ordinance, 2001 on account of interest free loans and advances to its employees, either by way of re-characterization of transaction u/s. 109 or by considering the transaction under the ambit of transfer pricing. But officer was not sure as to which section is applicable. The action of the officer is contrary to the provision of section 85 which itself excludes the employees from the purview of “associates” except under special circumstances but all and sundries employees did not fall under the definition of “associate”. Further, the officer has also failed to give his finding in respect of “tax avoidance scheme” whereby the employer and employees were conscious that once the employees would get interest free loan from employer then the employer would get benefit of Tax Avoidance Scheme for which correction could be made u/s. 109. There is no close relationship between employer and employee for the benefit of Tax Avoidance Scheme in the hand of employer in the shape of interest free loan to the employees. Both employer and employee have different interest and there is no tax avoidance to establish such scheme between them. Therefore, the action taken by the officer is not approved and appeal is allowed on this score.

Findings of Appellate Tribunal Inland Revenue :

3.4. In response to the argument of the DR, the AR of the respondent stated that the amended order passed by the ACIR clearly shows that section 108/109 were invoked for re-characterization of loans to employees. Further the AR stated that the “employer-employee” relationship does not fall under section 108 and the provisions of section 109 of the Ordinance for no reason whatsoever can be invoked in this case as there is no tax avoidance scheme being undertaken through employer-employee relationship and that such loans have been granted to employees and executives of the respondent company in accordance with the policies of the company. He further emphasized that the loans are already treated as perquisites by virtue of section 13(7) and the emp0loyees pay tax on interest on such loans at the benchmark rate in their individual returns. The AR also placed reliance on the Appellate Tribunal’s judgment in the respondent’s own case in ITA 980/KB/2013 for tax year 2011wherein the Tribunal upheld the decision of CIR(A) regarding deletion of the addition made on account of interest free loans to employees. The relevant extract of the decision of the Tribunal is reproduced below:

“We have heard the arguments of the learned representatives from both sides and have also perused the impugned order of the learned CIR(A), relevant provisions of law and available record of the case. We are of the opinion that the learned CIR has rightly deleted the addition of Rs.560,420/- made by the DCIR on account of interest-free loans to employees u/s. 108 and 109 of the Income Tax Ordinance, 2001. Hence we find no interference in the impugned order of the learned CIR(A) which is, therefore, upheld.”

3.5. We have heard the arguments of the learned representatives from both sides and have also perused the impugned order of the learned CIR(A) and available record of the case. Under section 85(2) of the Income Tax Ordinance, 2001 it has specifically been mentioned that employer and employee are not associates. Therefore, the provisions of section 108 of the Income Tax Ordinance, 2001 are not attracted in this case. Further, the DR has also mentioned that provisions of section 109 are applicable in this case, but he has not given any reason/justification for invoking the same. In our view, the action of ACIR in invoking the provisions of section 108/109 of the Ordinance in the instant case is not supported by the sanction of law. Moreover, the matter has already been decided in favor of the taxpayer by the ATIR in tax year 2011. It has also been observed that officer has confronted the taxpayer with two different sections i.e. 108 and 109 of the Ordinance, 2001 with slash (108/109) in the notice which means he is treating intent and purpose of both sections to be the same. We are fully convinced that notice, intent and purpose of both these sections are not the same. There is also serious legal defect observed by us which we cannot endorse. Keeping in view the aforementioned decision of the ATIR, the decision of CIR(A) is upheld. The ground taken by the appellant/department is not forceful and being devoid of force is rejected.”

5. Under similar facts and circumstances of the case, this Court in the afore-cited judgment has been pleased to hold as under:

“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.”

6. Since the facts of instant case are identical to the facts of the afore-cited judgment of this Court, therefore, instant reference application is dismissed being devoid of merits, whereas, the question proposed through instant reference application is answered in the “affirmative” against the applicant and in favour of the respondent.

J U D G E