Taxing what is not “income”

Huzaima Bukhari & Dr. Ikramul Haq

It is a cardinal principle that what is not “income” cannot be taxed under the income tax law (presently in operation is Income Tax Ordinance, 200I]. In Pakistan, 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, Federal Board of Revenue (de facto legislature as finance bills, annual or supplementary, whenever presented, members of National Assembly and Senators as well as standing committees on revenue never bother to read these carefully, 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. This point has never noted by legislators.   

A Money Bill only originates in the National Assembly and a copy of the same is transmitted to the Senate which may within 14 days make recommendations thereon to the National Assembly. After the Bill has been passed by the Assembly with or without incorporating the recommendations of the Senate, it is presented to the President, who shall give assent in 10 days.

Even majority of experts in the fields of taxation and constitution justify it on the basis of the wrong notion that through legal fiction, the National Assembly can deem anything as “income”.

The gist of judgement of Supreme Court of Pakistan in Elahi Cotton case (supra) is:

• Legal fictions are limited for a definite purpose that cannot be extended beyond the purpose for which they are created.
• Taxing power is unlimited as long as it does not amount to confiscation.
• A direct tax is one which is demanded from the very person, who it is intended or desired should pay it, whereas indirect taxes are those, whichare demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another, like custom duties, excise taxes and sales tax, which are borne by the consumers.
• There is a clear distinction between the subject-matter of a tax and the standard by which the amount of ‘tax is measured keeping in view the practical difficulties, which are encountered by the Revenue to locate the persons and to collect the tax due in certain trades. If the Legislature in its wisdom thinks that it would facilitate the collection of tax due from specified traders on a presumptive basis, the same is not violative of the fundamental right relating to equality.
• Legislature has the prerogative to decide the questions of quantum of tax, the conditions subject to which it is levied, the manner in which it is sought to be recovered. If, however, a taxing statute is plainly discriminatory or provides no procedural machinery for assessment and levy of the tax or that is confiscatory, the Court may strike down the impugned statute as unconstitutional.
• There is a marked distinction between a tax on gross revenue and a tax on income, which for taxation purposes, means gains and profits. There may be considerable gross revenues, but no income taxable.
• Sections 80C (imports, contracts and supplies) and 80CC (exports) of the repealed Income Tax Ordinance, 1979 fall within the category of presumptive tax as under the same the persons covered by them pay a pre-determined amount of “presumptive tax in full and final discharge of their liability” in respect of the transactions on which the above tax is levied. Section 80D (turnover tax) is founded on the theory of minimum tax. These sections of the repealed Income Tax Ordinance, 1979 are pari materia in pith and substance to section 148, 153, 154 and 113 of the prevalent Income Tax Ordinance, 2001, though year after year, since their inception these are made more burdensome by enhancing rates and creating numerous  distortions and dichotomies.
• If one is to read Entry 47, Part I of the Fourth Schedule to the Constitution of Pakistan (1973) in isolation without referring to Entry 52, it can be argued that Entry 47 does not admit the imposition of presumptive tax as the expression “taxes on income” employed therein should be understood as to mean the working out of the same on the basis of computation as provided in the various provisions of the Ordinance.    
• Presumptive tax is in fact akin to capacity tax i.e., capacity to earn. In this view of the matter, one will have to read Entry 47 in conjunction with Entry 52 which provides tax and duties on production capacity of any plant, machinery, undertaking, establishment or installation in lieu of the taxes or duties specified in Entries 44, 47, 48 and 49 or in lieu of any one or more of them. “If we were to construe Entry 52 of the Legislative List keeping in view the expression “in lieu of”, it becomes evident that the Legislature has the option whereby instead of invoking Entry 47 for imposing taxes on income, it can impose the same under Entry 52 on the basis of capacity to earn in lieu of Entry 47, but it cannot adopt both the methods in respect of one particular tax. Since under sections 80C and 80CC the imposition of presumptive tax is in substitution of the normal method of levy and recovery of the income-tax, the same is in consonance with Entry 52’.
• “While computing the annual turnover of an assessee, the amounts of sales tax and excise duty charged in terms of paras. 3 & 4 of C.B.R. Circular No. 3 of 1996, dated 18-3-1996 would be excluded”.
• It is true that the power to tax cannot be used to destroy businesses/occupations, which are sine qua non for the prosperity of the people and the country. The object of the levy and recovery of taxes is to run the State and to make efforts for creation of an egalitarian society. If the rates of taxes are too high and disproportionate to the actual earnings or earning capacities that they destroy the taxpayers, the very object of their levy and recovery is defeated.
• While interpreting an entry in a Legislative List it should be given widest possible meaning, “does not mean that Parliament can choose to tax as income which, in no rational sense, can be regarded as a citizen’s income”.

[Above is not verbatim reproduction of parts of the judgement, except where quotation marks are provided]

In para 31 (xii) of the Elahi Cotton case, the Supreme Court held: “That what is not “income” under the Income Tax Act cannot be made “income” by a Finance Act. An exemption granted by the Income Tax Act can be withdrawn by the Finance Act or the efficacy of that exemption may be reduced by the imposition of a new charge, of course, subject to Constitutional limitations”. This is the binding command of Supreme Court under Article 189 of the Constitution and no court or authority, except Supreme Court can revisit it.

In Shahid Pervaiz v Ejaz Ahmad and others 2017 SCMR 206, 14-member bench of Supreme Court held: “….where the Supreme Court deliberately and with the intention of settling the law, pronounces upon a question of law, such pronouncement is the law declared by the Supreme Court within the meaning of Article 189 and is binding on all the Courts of Pakistan. It cannot be treated as mere obiter dictum. Even obiter dictum of the Supreme Court, due to high place which the Court holds in the hierarchy in the country enjoy a highly respected position as if it contains a definite expression of the Court’s view on a legal principle, or the meaning of law”.

Any adverse, derogatory and/or contemptuous remarks about the judgement of the apex court by any subordinate court or an authority can lead to serious consequences as explained in Mirza Shaukat Baig and Other v Shahid Jamil & Others PLD 2005 Supreme Court 530.

The Elahi Cotton case (it is the most misunderstood and misapplied judgement) makes absolutely clear that any item to be taxed should rationally be capable of being considered as the “income” of a citizen”. In this perspective, flagrant violation was committed by the Parliament in Finance Act, 2012 by inserting clause (cc) in sub-section (1) of section 39 of the Income Tax Ordinance, 2001 [“the Ordinance’] making “additional payment on delayed refund under any tax law” as “income” of the taxpayer, chargeable to tax under the head “income from other sources” [section 39 of the Ordinance]. Interestingly, section 21(g) of the Ordinance says that “any fine or penalty paid or payable by the person for the violation of any law, rule or regulation” shall be disallowed as expense. If Tax Department makes violation of section 170 and does not pay due refund within the time fixed by the law, then “additional payment on delayed refund” under section 171 of the Ordinance cannot be treated as “income” on the same analogy for which taxpayer’s expenditure is disallowed. The additional payment for delayed refund under section 171 of the Ordinance is in the nature of healing of wounds of the taxpayer and/or penalty imposed for not following the law. Payment for unlawfully holding money due to the taxpayer on the part of Tax Department cannot be termed as “income” under any principle, legal or moral, especially when violating law penalty and fine is not allowed as expenditure under section 21(g) of the Ordinance.

The insertion through Finance Act, 2012 for taxing additional amount under section 171 of the Ordinance is patently against the judgement of Supreme Court in Elahi Cotton case holding that “the widest amplitude of even Constitutional Entry relating to taxation of ‘income’ does not extend to tax something that is not a citizen’s income”.

The opening sentence of section 171(1) of the Ordinance says: “Where a refund due to a taxpayer is not paid within three months of the date on which it becomes due, the Commissioner shall pay to the taxpayer a further amount by way of compensation at the rate of KIBOR plus 0.5 per cent per annum of the amount of the refund computed for the period commencing at the end of the three month period and ending on the date on which it was paid”.  

In the light of principle laid down by the Supreme Court, compensation for infraction of law even after inserting in the Ordinance as ‘income’, envisaged in section 2(29) read with section 4 and 39(1)(aa), can be challenged inter alia on the following grounds in the High Court under Article 199 of the Constitution:

1. It is an established position of law that compensation relating to capital asset is a capital receipt and that relating to stock-in-trade is revenue receipt as held in Commissioner of Income Tax (East) Karachi v Forbes Campbell & Co. Ltd [1979] 39 TAX 21 (H.C. Kar.). Compensation on delayed refund is capital receipt as it represents damages received for depriving the taxpayer of his capital and not stocks-in-trade.  
2. Payment under section 171 of the Ordinance is in the nature of damages as it is not “profits or gains” derived from any activity or investment. It is part and parcel of capital sum due, hence not “income”.
3. Additional payment on delayed refund is, in fact, part of the refund due and on payment it merges into refund— the two are not different things but accretion in refund due because of infringement of law by Tax Department. Any relief granted to a taxpayer for compensation of violation of his right is not income.
4. Excess funds (refund due) retained by the Tax Department beyond the prescribed limit are not an investment by taxpayer. Excess money if remained un-paid after due date attracts additional payment that is not “earned income”. For that money, Tax Department stands in a fiduciary position to the taxpayer. Violation of fiduciary responsibility entails additional payments that cannot be termed as “income” within the widest possible scope of Entry 47 of Part I, Fourth Schedule to the Constitution. If it does not fall in this Entry then Entry 52 imposing tax in lieu of it is also ousted.

Since additional payment on delayed refund arises out of injury caused to capital asset [refund due is not revenue receipt], it is not “income”. Thus its insertion as “income” from other sources through Finance Act, 2012 was in blatant violation of Constitution and judgement of Supreme Court in Elahi Cotton case. It is in substance a “fine” for loss suffered on account of deprivation of property that unlawfully remained in the possession of the Tax Department beyond the limitation fixed by law in section 170 of the Ordinance.

It is the command of the Constitution under Article 189 that law enunciated by the Supreme Court becomes binding and enforceable for all forums including the Parliament. All the institutions are bound to follow the supreme law of the land and orders of the Supreme Court. The Legislature violated them both by inserting a receipt for taxation that is not “income” at all. Since it is against the Constitution and ratio decidendi of the Elahi Cotton case, it must be withdrawn by the Parliament, failing which the only option with affected taxpayers is to invoke constitutional jurisdiction of High Court under Article 199 of the Constitution to get it declared ultra vires of the Constitution on the basis of binding judgement of Supreme Court discussed above.

______________________________________________________________________

The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).