Dr. Ikramul Haq
| Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 6365584, e-mail: irm@brain.net.pk; website: http://www.paktax.com.pk). He is a member of the visiting faculty of Punjab University Law College and the Lahore Institute of Tax Education (LITE). He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari. 1 |
I. INTRODUCTION
Expenses on account of any “penalty” or “fine” for violating a law, rule or regulation have always been held inadmissible for the purpose of computing income of business or profession under the Income Tax Law in India and Pakistan even in the absence of any explicit provision in the statute. This was a unanimous decision of higher courts in the Subcontinent since the introduction of income tax law by the colonial forces in 1860.
In the Income Tax Ordinance, 1979 [hereinafter:” the Ordinance”.], there was no provision to this effect up to 30th June 2000. The Finance Ordinance, 2000 inserted with effect from 1st July 2001 section 24(j) [This is incorporated as section 21(g) in the new Income Tax Ordinance, 2001, promulgated on 13 September 2001, which will be effective from 1st July 2002], which reads as follows:
“Nothing contained in section 23 shall be so construed as to authorize the allowance or deduction of any expenditure on account of payment of a fine or penalty for the violation of any law or rule or regulation for the time being in force.
[underlined for emphasis]
This new provision of law explicitly provides disallowance of any expenditure incurred on account of:
a. payment of fine for violation of any law, rule or regulation for the time being in force.
b. Payment of any penalty for violation of any law or rule or regulation for the time being in force.
This amendment appears to aim at nullifying the effect of a judgement of Income Tax Appellate Tribunal [ITAT], Karachi [(2000) 81 TAX 265 (Trib)] whereby it is held that the judgement of the Honourable Supreme Court of Pakistan in 1999 PTD 3005[i] will not apply in certain circumstances. Another purpose of this amendment may be to disallow huge payments made to National Accountability Bureau [NAB][ii] by a number of companies as compensation on account of alleged “undue gains” derived by them in the past. A number of companies, who got Liquefied Petroleum Gas [LPG] quotas during the time of the Nawaz Sharif regime, paid very heavy amounts as compensation or settlement to avoid court litigation and to save their businesses from cessation.
II. SCOPE OF SECTION 24(j)
The important issue that arises is the determination of the scope of section 24(j) of the Income Tax Ordinance, 1979 [hereinafter: “the Ordinance”]. Does it cover the payments made as compensation or settlement in action to avoid criminal proceedings under section 25 read with section 11 of the National Accountability Bureau Ordinance, 1999 [hereinafter: “ NAB Ordinance”]? It is important to note that many companies who struck a deal with NAB did not admit any corrupt practices, but agreed to pay certain amounts to avoid any court proceedings and save their business repute and goodwill. Can these payments be termed as “fine” or “penalty” for the violation of any law or rule or regulation for the time being in force?
It can be argued that payments to the NAB constitute neither “fine” nor “penalty” for a “proved offence” or an amount for compounding of an offence, but were merely a sum in settlement of an action charging the companies with an offence. It is important to note that the companies denied the guilt, and the NAB did not even try to prove the allegations of corruption or any wrongdoing or undue benefit. The companies made the payment not for compounding of any offence but for the avoidance of a criminal trial, which could have badly affected the reputation of their businesses. Sections 25 and 31 of the NAB Ordinance give powers to the Chairman to accept plea-bargaining or tender pardon to an accomplice for cooperating with the Bureau.
The question is whether payments to NAB in such circumstances are “fine” or “penalty” in terms of section 24(j) of the Ordinance [hereinafter: “the said section”] or not. Do these payments constitute business expenditure incurred wholly and exclusively for carrying on of the business as envisaged in section 23(1)(xviii) of the Ordinance? The ratio of the latest judgement of the Honourable Supreme Court of Pakistan PLD 2001 SC 201 seems to support the view that such payments are not fine or penalty for violation of any law or rule or regulation for the time being in force.
It is held by courts in Pakistan and India that where payments are made to avoid any adverse action against the company which would affect the reputation of business, it is a business expense– Sui Northern Gas Company Ltd v CIT PLD 2001 Supreme Court 201, (2000) 81 tax 265 (Trib), Annamalai Timber Trust Ltd v CIT (1963) 47 ITR 814 (Ker); CIT v Manekal Harilal Spg & Mfg Co Ltd (1983) 141 ITR 129 (Guj); CIT v Chemical & Fiber of India Ltd (1983) 142 ITR 413 (Bom) and CIT v Raj Kumar Mills Ltd (1982) 125 ITR 811 (MP). In all these cases, it is held that compensation paid for carrying on the business would stand on a different footing from fine/penalty or illegal expenses and be entitled to deduction.
III. SYNOPSIS OF RELEVEANT CASE LAW
It is a well-established principle that the expenses incurred by a company to protect the good name of its business, in defending its legal rights against any charges, civil or criminal, relating to transactions carried out in the ordinary course of the company’s business are allowable as business expenditure—Advani & Co Ltd v CIT 18 ITR 557; Singh & Co. Ltd v CIT 60 ITR 732; Rohtas Industries Ltd v CIT 67 ITR 361; Lakshmiji Sugar Mills Co. Ltd v CIT 98 ITR 568 and CIT v Ahmedabad Controlled Iron & Steel Regd Stock-holder Assn Ltd 99 ITR 567.
The Honourable Supreme Court of Pakistan in Commissioner of Income Tax, Cos. II, vs General Tyre and Rubber Company of Pakistan Limited (1993 PTD 383) made a detailed discussion regarding the allowability of such expenses. In this case, the assessee claimed deduction on account of technical assistance fee remitted by it to its parent company on accrual and the amount was increased to some extent due to devaluation of Pakistan currency. The Income-tax Officer disallowed the claim of deduction that had accrued due to failure of the assessee to remit the amount in the earlier assessment year, holding that the same cannot be treated as revenue expenditure. Ultimately, following the view taken in the case of Radio Picture Limited v. Commissioner of Inland Revenue (22 Tax Cases 106) it was held by Supreme Court that the large amount paid by the assessee could still be treated as permissible allowance, despite the extra cost incurred to discharge such liability.
The view taken by Supreme Court in CIT v. M/s. Alpha Insurance Co. Limited (PLD 1981 SC 293) is more or less the same. In this case the assessee had exceeded the ceiling fixed in respect of the insurance companies’ expenses vide Rule 40 of the Insurance Rules. It was held that such expenditure was not in the nature of penalty, fine or forfeiture and therefore, it was allowable under section 10 of the Income-Tax Act of 1922 [parallel to section 23 of the Income Tax ordinance, 1979].
Similar line of reasoning was adopted by the High Court of Sindh in Beecham Pakistan Ltd. v. CIT (1995) 71 Tax 57. The question was, whether the expenditure incurred by the assessee in excess of ceiling provided by Rule 33 of the Drugs (Licensing Registration and Advertising) Rules, 1976, could be allowed as a legitimate deduction. The question was determined in favour of the assessee, notwithstanding the infringement of law committed by it.
Reference may also be made to a Full Bench judgement of the Allahabad High Court in the case of Triveni Engineering Works Ltd. v. CIT, Delhi (1993) 144-ITR 732, wherein, in case of interest paid by the assessee on sugarcane purchase tax arrears, it was held that, the same was revenue expenditure laid out wholly or exclusively for the purpose of business, as distinguished from a penalty paid for infraction of law and, therefore, it could be allowed as admissible expenses.
Similarly in Govind Choudhry and Sons v. CIT (1971) 79-ITR 493, it was held that although penalty paid by the assessee was for supply of inferior quality of paddy, but such payment being integrally connected with the income itself was admissible under section 10(1) of the Income-Tax Act.
The decision of the Supreme Court of India in the case reported as 123 ITR 429 also held that interest paid on arrears of cess payable is allowable expenditure. The High Court held that the interest paid was by way of penalty for infringement of the Cess Act. The Supreme Court reversing the decision of the High Court held that interest paid under the Cess Act, was not a penalty for infringement of law and was an allowable deduction.
In the case of ACIT v. Rustam Jehangir Vakil Mills Limited [1976] 103 ITR 298 (Gujarat High Court), the assessee was a Limited company manufacturing cotton textile. The Textile Commissioner under the provisions of the Cotton Textile (Control Order) directed the assessee to produce certain types of cloth in the quantity set out in the direction. The assessee did not manufacture that type of cloth and, therefore, under clause 21C(1)(b) the assessee was called upon to pay different amounts from time to time. The assessee paid the amount to Textile Commissioner and claimed this amount as allowable expenditure on the ground that it was expended wholly and exclusively for the purpose of business. The I.T.C. did not allow the deduction. The Appellate Assistant Commissioner allowed the claim. The revenue took the matter in further appeal to Tribunal. The Tribunal confirmed the decision of AAC. The revenue filed reference in Gujarat High Court. The Gujarat High Court held that under the law the assessee had opted to make payment in lieu of manufacturing of minimum quantity of cloth and, therefore, the payment was not in the nature of infraction of law and the amount paid was neither penalty nor akin to penalty.
Similar view was taken in the judgment reported as [1979] 120 ITR321. In [1981] 23 ITR 269 (All. H.C.) Nanhoomal Jyoti Prasad v. CIT where it has been held that the demurrage charged by Port Authority is compensation for the delay in clearance of goods in godown from the Port Authorities and is a business expenditure that is admissible. It was held that the commercial expediency dictated and required the assessee to take delivery of the goods from the Port Authorities after paying compensation to them for use of their dock facility beyond the free period allowed under the rules. The demurrage paid by the assessee was not a fine for infraction of any law and, therefore, it was an admissible expenditure. It would be pertinent to refer that the Income Tax Appellate Tribunal of Pakistan has held vide judgment reported as (1960) 2Tax 389 that demurrage is neither a fine nor penalty and is to be allowed as admissible expenditure. The same is the ratio decided by the learned Tribunal in (2000) 81 Tax 265(Trib).
In the case of CIT Karnataka v. Mandya National Paper Mils Ltd. [1984] 150 ITR 27(Karnataka High Court) a reference was made whether the amount paid by an assessee, as penalty for non-payment of sales tax is an allowable deduction or not. The relevant facts were that the assessee committed default in payment of tax under the Karnataka Sales Tax Act, 1957. Consequently it had claimed as allowable deduction and the assessing officer disallowed the claim holding that it was not business expenditure. It was urged before the Tribunal that the penalty collected under section 13(2) of the said Act should not be construed as penalty levied for any infraction of law as it represented only damages paid to the Government for the belated payment of tax due. The contention was accepted and the addition was deleted. It was held by the Karnataka High Court that the amount payable by the assessee was a statutory liability and it was not for the infraction of any law. It was further held that the Act gives no discretion to the authorities to waive or reduce the penalty. Obligation is cast on the defaulting assessee to make payment of the penalty computed in the manner provided by section 13(2). Reliance was placed on the judgement of Supreme Court of India in the case of Mahalakshmi [1980] 123 ITR 429 wherein it was held that the interest paid on arrears of cess under section 3(3) of the U.P. Sugar Cane Cess Act, 1956 was accretion to the cess and not a penalty payable for infringement of any law. Ultimately it was held that the penalty paid under section 13(2) of the Karnataka Sales Tax Act, 1957 was not a penalty in the real sense of the term and it was only a compensation for delay in payment of the tax due. It was thus held as an allowable deduction.
IV. WHAT IS INFRACTION OF LAW?
The Hon’ble Supreme Court of Pakistan in 1999 PTD 3005 and Supreme Court of India in a number of cases held that any expenditure on account of infraction of law is not to be allowed. However, the cases where amounts have been paid to the NAB were in pursuance of an administrative direction and not in pursuance of infraction of any law, rules framed thereunder, notifications issued by Federal Government of Pakistan or by the concerned ministry cannot be termed as penalty or fine for violating any law. The fines or penalties that are imposed by the special courts trying the cases instituted by the NAB after successful prosecution are on a different plank, as these fall within the mischief of the said section to be disallowed as inadmissible expenditure.
There is no infringement, transgression, violation or infraction of law where the amount paid to the NAB under the executive directions of the Chairman NAB. The course adopted by the companies in dealing with the NAB was on account of business expediency. The course adopted was wholly and exclusively for the purpose of business and the option to pay money in settlement was exercised, as the same was permissible under the executive direction of the NAB itself.
The infringement or violation of any law shall take place if there is any commission or omission not warranted in law or a course is adopted that is not permissible under the relevant provisions. However, if the provisions of any law itself envisage different courses of action and option is available to a person to adopt any one of the courses then it would not amount to infraction or violation of law but would come within the precincts and premises of law. Any of the courses open to a person under the law shall be deemed to be compliance of the law and not the infraction or violation thereof.
The ratio of the judgement of Hon’ble Supreme Court of Pakistan in Premier Bank Ltd. [1999 PTD 3005] is that any expenditure on account of infringement of a provision of a statute is not to be disallowed. Only such expenditure is to be disallowed which on account of infringement of a provision of a statute falls within the purview of fine or penalty. This principle has now been inserted in the form of section 24(j) in the Ordinance. For the purposes of ascertaining if any expenditure is not in the nature of fine or penalty, the facts of each case are to the examined. The ratio of the judgement of Hon’ble Supreme Court of Pakistan in Premier Bank case is not applicable to an expenditure incurred by an assessee not in the nature of penalty or fine for infringement of any law of rule, but for purely business consideration provided the same comes within the precincts and premises of law.
V. BROAD PRINCIPLES REGARDING ALLOWABILITY OF EXPENDITURE UNDER SECTION 24(J)
The broad principles decided by the higher courts, some of which are cited above, regarding allowability of expenditure vis-à-vis section 24(j) can be summarized as under:
· An expenditure incurred on account of fine or penalty or in the nature of fine or penalty is not to be allowed as deduction.
· An expenditure which although has been incurred by an assessee on account of infringement of a provision of a statute but not in the nature of fine or penalty can be allowed as admissible deduction provided it is incurred wholly and exclusively for the purpose of business.
· The question whether any expenditure on account of infringement of any provision of law is for the purpose of business and is an admissible expenditure shall depend on the facts and circumstances of each case.
· If any expenditure is claimed on a transaction in flagrant violation of the provisions contained in any law and the transaction, act/omission is liable to the levy of fine or penalty by way of criminal or civil sanction and the competent authority has imposed civil or criminal penalty provided in the law then expenditure incurred on illegal transaction as well as penalty for indulging in such illegal transaction, both shall be inadmissible expenditure.
· If there are various provisions in any law providing for automatic enhanced/ excess payment on commission of a default or delay and there is a provision for imposition of penalty/fine as well within the discretion of authorities have not been invoked and an enhanced/excess amount is charged for any default/delay, such enhanced/excess amount shall be deemed to be part and parcel of the original liability.
· If the excess amount paid by an assessee in the normal course of business and wholly and exclusively for business purposes on account of any delay or default is within the contemplation of the parties and the excess amount paid is automatic which requires mere calculation it would be in the nature of compensation paid for delay or default and it shall not be deemed as penalty or fine, or in the nature of penalty/fine or akin to penalty or fine.
· If any excess amount is paid by an assessee for any delay or default in performance of an act and the excess charge is fixed and not in the discretion of any competent authority in law and no separate proceeding is required for charging the excess/enhanced amount and no separate order is required to be made and there is no requirement of framing any charge or confronting the defaulting party and seeking explanation then the amount so charged would not be deemed to be penalty/fine.
· Mere use of the word penalty or fine shall not make an amount to be in the nature of penalty or fine until and unless in the substance the amount charged is penalty or fine or in the nature of penalty or fine.
· The payment of such amount only shall be treated as penalty/fine, which is charged as a result of infraction, transgression and violation, imposed by an authority competent in law. Where any amount is paid by an assessee on its violation/discretion/option available in law for the consideration of business purposes in pursuance of commercial expediency and not with the intention of flouting the mandatory provision of law, it shall not be considered to be penalty / fine and shall be deemed to be extension of liability permissible in law and/or compensation for delay/default contemplated by the parties and permissible in law—Sui Southern Gas Company Ltd. V CIT PLD 2001 SC 201
VI. CONCLUSIONS
Applying the above principles and specifically the ratio of PLD 2001 SC 201, it is clear that compensation paid to NAB for alleged “undue gains” by the LPG companies are not fine or penalty but were amounts paid in settlement in pursuance of an order made by a competent authority in exercise of power vested in the said authority and after compliance of the necessary procedure prescribed in law. There is no infringement of any statute law as was in the case of Premier Bank Limited decided by the Hon’ble Supreme Court of Pakistan, where the bank was imposed certain fines and penalties for infringement of specific provisions of the Banking Companies Ordinance, 1962. The provisions of section 24(j) of the Ordinance will certainly apply to bargain amounts paid to the NAB by the accused before or during the criminal proceedings, as the payers admit their guilt and pay a bargain amount to avoid conviction. However, the amounts paid as compensation to the NAB are on a different plank as in such cases the LPG companies did not admit guilt for any infringement of law, but agreed to pay compensation for taking undue advantages by not complying with some terms and conditions of LPG Quota allocations. In violating these terms and conditions they were not guilty of violating any specific provision of law but breach of contract, for which compensation was paid to the concerned Ministry.
In view of the legal position emerging from case law discussed above, it transpires that payments made as compensation or “settlement in action” to the NAB by the LPG companies are business expenditure, which are not hit by section 24(j) of the Income Tax Ordinance, 1979.
[i]. The Income Tax Appellate Tribunal (ITAT) in (2000) 81 TAX 265 (Trib) distinguished the Supreme Court judgement 1999 PTD 3005 holding that the principle laid down by the Supreme Court is that the question whether any expenditure is admissible or not on account of infringement of law would depend upon the circumstances of each case. In the case decided by the Supreme Court, the State Bank of Pakistan imposed penalty on a bank for violating section 35 of the Banking Companies Ordinance, 1962. The expenditure was held inadmissible as being incurred by the assessee bank for violating the provisions of a statute. In the case decided by the Tribunal, an excess amount was paid to the State Bank of Pakistan for certain delay, which was not violation of any provision of statute. The ITAT held that excess amount was neither penalty nor fine or violation of any law, therefore, allowable business expenditure.
[ii]. Pakistan promulgated a special law, the National Accountability Bureau Ordinance, 1999, for curbing corruption and malpractices by public as well as private functionaries and institutions. NAB is constituted under this special law. The chairman of NAB is empowered to accept pre-trial bargain plea or accept any monetary offer during the pendency of trial.