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Overriding ‘doctrine of mutuality’

Huzaima Bukhari & Dr. Ikramul Haq

Through the Finance Act, 2021 [“the Act”], the Parliament has made an amendment with retrospective application to override the well-established principle that what is not “income” under the income tax law cannot be taxed, and where there is no sale of “goods” or providing and rendering of services between two persons, natural or juridical, there cannot be any indirect taxes (General Sales Tax or Value Added Tax). This amendment will affect all cooperative societies and their members. This retroactive amendment needs to be discussed in totality.   

The amendment made by the Act in section 18(1)(b) by way of Explanation in the Income Tax Ordinance, 2001 [“the Ordinance’] reads as under:

Explanation.– For the removal of doubt, it is clarified that income derived by co-operative societies from the sale of goods, immoveable property or provision of services to its members is and has always been chargeable to tax under the provisions of this Ordinance”.

Section 18(1)(b) reads as under:

“Income from business.– (1) The following incomes of a person for a tax year, other than income exempt from tax under this Ordinance, shall be chargeable to tax under the head “Income from Business”–

  • the profits and gains of any business carried on by a person at any time in the year;
  • any income derived by any trade, professional or similar association from the sale of goods or provision of services to its members”.

The above provision of law contains no ambiguity. What is then the rationale behind the retrospective amendment? The answer is given in Circular 3 of 2022 [Operations (Income Tax)] to override the recent judgement of the Sindh High Court in Sindh Club Karachi v Commissioner of Income Tax South Zone Karachi (2021 PTD 658) that holds as under:

 “…..it is a settled proposition of law that neither anybody could make profit out of oneself nor members could trade with themselves. In our view, the decisions given in the cases of CHELMSFORD and LYALLPUR CENTRAL CO-OPERATIVE BANK are the complete answer to the question referred in the present ITR. We, therefore, answer the question referred to us by the ITAT in affirmative i.e. in favour of the club and against the department. The amounts thus received by the club from its members for providing temporary accommodation is hereby replied to be exempt from the ambit of tax under section 10 of the Act on the basis of principle of “DOCTRINE OF MUTUALITY” being fully applicable in the instant reference”. [Para 14 page 672]

Circular 3 of 2022 [“the said Circular”] rightly says that since tax year 2013, the cooperative societies are companies under the Ordinance and therefore the DOM does not apply. However, taxation in their case cannot be under section 18 as the following proposed amendment in the Finance Bill 2021, was dropped in the Act:   

“in section 37,–


            (i)…….; and

            (ii)        for the full stop at the end, a colon shall be substituted and thereafter the following shall be added, namely:–                                        

“Provided that where the taxable gain on disposal of immoveable property exceeds five million rupees, it shall be chargeable to tax under sub-section (1) of this section and provisions of sub-section (3) shall not apply. However, the taxable gain shall be calculated while taking into consideration the benefit of holding period as provided in sub-section (3A).

Explanation. – For removal of doubt, it is clarified that where a person is habitually engaged in transactions of sale and purchase of immoveable property or such sale and purchase is adventure in the nature of trade and business, the provisions of this sub-section shall not apply and the income from such transactions shall be chargeable under the head Income from Business”

The Sindh High Court in Sindh Club Karachi v Commissioner of Income Tax South Zone Karachi (2021 PTD 658) referred to Commissioner of Income Tax, Lahore v. The Lyallpur Central Co-operative Bank Ltd., Lyallpur [1959] 1-TAX (III-150) (H.C. West Pakistan, Lahore Bench). This is also referred to in the said Circular of the Federal Board of Revenue (FBR).

The Explanation added by the Act cannot make something income which is actually not income. It is a cardinal principle that what is not “income” cannot be taxed under the income tax law so question of exemption does not arise. Exemption applies where something is taxable. In this case FBR wants to tax something that is not income. In FBR, a misconception prevails that National Assembly can declare anything “income” through the Finance Act, passed as Money Bill every year, in terms of Articles 73(2), 77 and 142(a) read with Entry 47 or 52, Part I, Fourth Schedule to the Constitution of Islamic Republic of Pakistan [“the Constitution”]. In support of this contention, FBR (de facto legislature because members of National Assembly and Senators as well as standing committees on revenue never bother to read carefully finance bills, annual or supplementary, whenever presented, do proper homework or take input from experts) places reliance on Elahi Cotton Mills Ltd. and others v. Federation of Pakistan through Secretary Finance, Islamabad [(1997) 76 TAX 5 (S.C. Pak)], which, in fact, holds the contrary.

The legislators have read the above judgement and the professionals (who are always keen to issue commentaries even before seeing the gazette copy of Finance Acts) did not note omission of proposed amendment cited above in the Act! Now, further mess is created by the said Circular.    

In para 31 (xxxiii) of the Elahi Cotton case, the Supreme Court held: “That before charging tax, an assessee must be shown to have received income or the same has arisen and accrued or deemed to be so under the statute. Any amount which cannot be treated as above is not an income and; therefore, cannot be subject to tax”. This is a binding command of Supreme Court under Article 189 of the Constitution and no court or authority, except Supreme Court can change it [Pervaiz v Ejaz Ahmad and others 2017 SCMR 206 and Mirza Shaukat Baig and Other v Shahid Jamil & Others P L D 2005 Supreme Court 530].

Notwithstanding the above debate, the Act has held that sale and purchase in immovable property will be taxed as capital gain under section 37 and not section 18 of the Ordinance. Capital Gain on immovable property by the Federal Government is even otherwise against the Constitution (‘Services’ and immovable property income taxation: constitutional violation, Business Recorder, December 4, 2020). The legal position narrated above renders the said Circular issued invalid and against the law.  In the light of this and above, the Explanation inserted by the Act in section 18 of the Ordinance, if challenged in the High Court, will certainly be declared ultra vires of the Constitution as what is not income cannot be so made income even by the Parliament as held by the Supreme Court of Pakistan in Elahi Cotton case which is binding under Article 189 of the Constitution of Pakistan as well as the  Act  is not providing its taxation under section 18 of the Ordinance after dropping the prosed amendment reproduced above.   


The writers, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE)

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