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2018 P T D (Trib.) 1391

[Inland Revenue Appellate Tribunal]

Before Mrs. Ambreen Aslam, Judicial Member and Faheemul Haque Khan, Accountant Member

COMMISSIONER INLAND REVENUE, ZONE-II, KARACHI

Versus

Messrs SECURITY LEASING CORPORATION LIMITED, KARACHI

F.E. Appeals Nos. 43/KB and 44/KB of 2013, decided on 30th March, 2016.

PTR No.20 of 2001; 1999 PTD 14; 2002 PTD 2210; 1995 PTD 401; 2003 PTD 1135; 2002 PTD 2210; 2015 PTD 424 and 2015 PTD 772 ref.

Zulfiqar Ali Memon, D.R. for Appellant (in F.E. Appeals Nos.43/KB of 2013).

Nadeem Ahmed Farooqui for Appellant (in F.E. Appeal No.44/KB of 2013).

Nadeem Ahmed Farooqui for Respondent (in F.E. Appeal No.43/KB of 2013).

Zulfiqar Ali Memon, D.R. for Respondent (in F.E. Appeals Nos. 44/KB of 2013).

Date of hearing 11th February, 2016.

ORDER

MRS. AMBREEN ASLAM (JUDICIAL MEMBER).—These cross-appeals have been filed by the taxpayer and the Department against the Order No.33 of 2013 dated 29-03-2013 passed by the learned Commissioner Inland Revenue (Appeals-III), Karachi on the grounds as set-forth in the memo. of appeals.

2. Brief facts of the case are that the respondent is engaged in the business of leasing. The Deputy Commissioner, Unit-III of the Large Tax Payers Unit issued show-cause notice on 06.02.2012 alleging therein that the appellant was liable to federal excise duty under item 8 of Table-II of the Federal Excise Act, 2005, for the period 2007 to 2011. After conducting proceedings she levied federal excise of Rs.105.87 (M) and penalty of Rs.5.29 ibid Vide the combine ONO bearing No.07/2012. The said ONO was challenged in appeal before the Commissioner Inland Revenue (Appeals-III), LTU, Karachi. While disposing appeal the Commissioner (A) held the period of 2007-2008 to be barred by time under section 14(1) of the Federal Excise Act, 2005 prior to amendment in 2011. However, he maintained the levy of federal excise duty for the remaining periods vide the appellate Order No.33 of 2013 dated 29-03-2013 on the analogy of amendment brought item of Table II of the Act as well as sub-rule (4) of Rule 40A read with Rule 45 of Federal Excise Rules, 2005.

3. Instant appeals have been filed by the department and taxpayer against the impugned appellate order with the following grounds:

GROUNDS OF DEPARTMENT

1. That the order of the learned Commissioner Inland Revenue (Appeals-III) is bad in law and on facts of the case.

2. That the learned CIR (Appeals-III), Karachi was not justified in deleting the demand of FED for the period from July 2007 to June 2009 on the assumption that leasing is fund based/Interest based activity, hence not dutiable, without considering various types of receipts.

3. Whether or not Finance Act, 2011 empowers the assessing officer to issue show cause up to 5 years to taxpayers who made short/non payment of FED?

4. Whether the action of the assessing officer for the time period from July 2007 to May 2008 was in time hence not hit by time limitation.

5. That the appeal craves leave to add, alter or amend the grounds of appeal any time on or before at the time of hearing of the appeal.

GROUNDS OF TAXPAYER

1. That the proceedings initiated by the learned Respondents 1 and 2 are bad in law and void ab-initio.

2. That the learned Respondent No.1 passed the ONO in a whimsical manner and failed to give consideration to the valuable written comments furnished by the Appellant.

3. That the learned Respondents Nos.1 and 2 erred in disregarding Note 1 of the annual financial statements of the Appellant which states that the company is principally engaged in leasing business.

4. That the learned Respondent No.1 had grossly failed to honour the general principle of prosecution as laid down in Section 10 of the Civil Court Procedure Act, 1908 by passing the impugned ONO against the Appellant when the instant matters laying before the Respondent No.1 were subjudice before the Honourable High Court at Sindh. Therefore, the impugned ONO passed by the learned Respondent No.1 is prayed to be struck down and declared to have no legal effect on the principles of res-sub judice.

“10. No Court shall proceed with the trial of any suit in which the matter in issue is also directly and substantially in issue in a previously instituted suit between the same parties or between parties under whom they or any of them claim litigating under the same title where such suit is pending in the same or any other Court in [Pakistan] having jurisdiction to grant the relief claimed or in any Court beyond the limits of [Pakistan] established or continued by [the Central Government] and having like jurisdiction, or before [the Supreme Court]” (Underline ours)

5. That the learned Respondent No.1 failed to comprehend that the Section 3 of the Financial Excise Act, 2005 (FE Act, 2005) is applicable on services provided in Pakistan and not on every stream of income reported in the profit and loss account. The Entry No.8 of the First Schedule to the FE Act, 2005 clearly stipulates its application on the “services” provided by banking companies and non-banking financial institutions. Therefore, the view of the learned Respondent No.2 that every stream of income generated by entitles listed in the First Schedule to the FE Act, 2005 is incorrect and only “service” are subject to FED under the FE Act, 2005.

6. That the learned Respondents Nos.1 and 2 erred in passing ONO by rejecting the Appellant’s contention that leasing activities are interest based activities rendered or provided by banking companies, non-banking financial companies or financial institution (including leasing companies) and therefore are exempt from levy of FED under the FE Act, 2005

7. That in paragraph 5.5 of the impugned ONO, the learned Respondent No.1 have conferred that leasing is a fund based activity; however surprisingly disregarded the element of interest or mark up in the fund based activity of leasing company.

8. That without prejudice to any other ground taken hereafter the learned Respondent No.1 has misconceived the entire issues relating leasing business with the loan and advanced provided by the banking companies and discussed in the entire order the exclusion of interest/mark-up on loans and advances under Sub-Rule (4) of Rule 40A of Special procedure provided by banking companies under PCT Heading 9813.2000 which were the subject matter in the appeal before the learned Respondent No.1.

9. That the learned Respondent No.1 has grossly failed to distinguish between the non fund based activities and fund based activities relating to interest and mark up. The learned Respondent No.1 interpreted that all fund based activities are non interest based activities and fails to identify the difference among the two source of revenue/income which are different in nature.

10. The learned Respondent No.1 erroneously intermingled the two terminologies i.e. fund based activities and interest/markup derived from fund based activities.

In paragraph 5.5.2 of the impugned ONO, the learned Respondent No.1 have totally misunderstood the contentions of the Appellant which were based on the grounds that interest and mark up from fund based activity is not subject to FED in terms of Sub-Rule (4) of Rule 30 of Special Procedure and nowhere the Appellant has confronted the levy of FED on any other fee, commission or income arising out of fund based activities.

11. That in paragraph 5.6 of the impugned ONO, Respondent No.1 wrongly deliberated the reason for the deletion of the word “non fund” from Entry No.8 of the First Schedule to the FE Act, 2005 and Rules thereunder to mean that all the fund based activities of non-banking finance companies involving interest or mark-up may also be subject to FED. The Appellant prays that this is not the intent of the law makers and the reason for exclusion of the word “non fund” from the Special Procedure. The words “non fund” were deleted to levy FED on all fund based activities which do not involve interest of mark-up whereas the income booked in the profit and loss account of the leasing companies is purely interest.

12. That the learned Respondent No.1 erred to adopt a unqiue and unprecedented interpretation to hold that Rule 40A Sub-Rule (4) is only applicable to advances and loans provided by a banking company falling under the Tariff Heading 9813.2000 which exclude the mark up or interest from the levy of FED whereas no such distinction is made in aforesaid Sub-Rule (4) of Rule 40A.

If for argument sake, such interpretation was correct then the word “non-banking finance companies” clearly mentioned in the Sub-Rule (4) of Special Procedure would become redundant. If this would have been the case, there would be separate Rules for non-banking finance companies and financial institution other than banking company. Further, the leasing business carried out by the banks may also be separately required to be subject to FED, which is not the case.

13. That paragraphs 5.7 and 5.8 of the ONO are self-contradictory. The learned Respondent No.1 in paragraph 5.7 of the ONO have explained that in leasing arrangement the asset used by the lessee is owned by the lessor and the lessor enjoys the benefit of the ownership of the asset. Thus the learned Respondent No.1 in the impugned ONO had made all efforts to prove that leasing in not a financing arrangement and no asset is transferred against a loan.

THAT the learned Respondent No.1 by providing the aforesaid explanation has totally neglected the true and correct essence of leasing arrangement which is in nature of loan against an asset. The Appellant submit that in a finance lease arrangement, the lessee is entitled to all the risk and rewards of the ownership and enjoys all the inflow of economic benefits related to the assets. The income derived from the use of the asset is not booked by the lessor but by the lessee in the financial statements. The asset remains in the use of the lessee for most of the economic life of the asset and transferred to the lessee at nominal value after the lease tenure.

14. THAT the Respondent 1 erred in concluding that “Lease Rental” is a kind of proceed which is different from “interest” hence, leasing could not classified as interest based transaction. It will be pertinent to mention that lease rental is not merely comprises of the income earned by the lesser, it is also repayment of money (loan) provided to or paid on behalf of the company for acquiring the asset. Therefore, it consists of two portions; one is principal amount (re-payment of loan) and another is income (interest) portion and the company is eligible to declared only interest portion in its income which is in excess of principal amount (re-payment of loan).

In terms of International Accounting Standards 17 i.e. Leases, the lessee is required to book the asset with corresponding liability as loan in its own financial statements. The lessee is required to pay off the loan according to terms agreed between the lessor and the lessee and the interest expenses arising from the lease in charged in the financial statements of lessee. The lessor booked the lease arrangement as investment in the lease and earns interest/mark up on the investment. The relevant paragraphs of IAS 17 are reproduced below.

Paragraph 20:

“At the commencement of the lease term, lessees shall recognize finance lease as asset and liabilities in their statements of the financial positions (balance sheet) at amount equal to the fair value of the leased property or if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculation of the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practical to determine, if not, ‘the lessee’s incremental borrowing rate shall be used.” (Underline ours)

Paragraph 25:

“Minimum lease payments shall be apportioned between the finance charge (i.e. interest) and the reduction of outstanding liability. The finance charge (interest) shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of liability” (Underline ours).

Paragraph 36:

“Lessor shall recognise asset held under finance lease in their statements of financial position (balance sheet) and present them as receivable at an amount equal to the net investment in the lease.” (Underline ours)

Paragraph 39:

“The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return (i.e. interest rate) on the lessor’s net investment in the finance lease (investment).” (Underline ours)

An illustration of the amounts booked in the financial statement of the lessee is reproduced in the below table:

Years

Opening Lease Liability

Lease Rent

Financial Charges @14%

Reduction in Lease Liability

Closing Lease Liability

1.

1,500,000.00

175,000.00

83,980.00

91,020.00

1,408,980.00

2.

1,408,980.00

175,000.00

78,884.09

96,115.91

1,312,864.09

3.

1,312,864.09

175,000.00

73,502.88

101,497.12 107,179.60

1,211,366.97 1,104,187.37

4.

1,211,366.97

175,000.00

67,820.40

 

 

5.

1,104,187,37

175,000.00

61,819.77

113,180.23

991,007.14

6.

991,007.14

175,000.00

55,483.19

119,516.81

871,490.33

7.

871,490.33

175,000.00

48,791.84

126,108.16

745,282.17

8.

745,282.17

175,000.00

41,725.86

133,274.14

612,008.03

9.

612,008.03

175,000.00

34,264.29

140,735.71

471,272.32

10.

471,272.32

175,000.00

26,384.97

148,615.03

322,657.28

11.

322,657.28

175,000.00

18,064.51

156,935.49

165,721.79

12.

165,721.79

175,000.00

9,278.11

165,721.79

0.00

 

 

2,100,000

600,000

1,500,000

 

 

 

 

Interest expense booked in Profit and Loss

Repayment of loan

 

 

15. THAT the Respondent 1 failed to acknowledge the letter written by the Chairman, Securities and Exchange Commission of Pakistan to Chairman Federal Board of Revenue in the concerned issue. In this letter, the Chairman SECP contended that leasing companies are wrongly denied exemption of FED available under Rule 40A of the Special Procedure [Annexure E] The relevant extracts are reproduced below:

“Being a financial institution, the major source of earning of a leasing company is the interest/mark up income on the lease finance facilities provided to their client. Lease finance is a recognized fund based finance facility in terms of International Accounting Standards and the existing regulatory framework governing the leasing business. Accordingly, the income earned by the leasing companies on the lease portfolio is classifiable as interest mark-up income”

16. THAT Respondent No.1 was not justified to hold interest/mark-up on fund based leasing activity, subject to FED under Sub-rule (4) of the Rule 10A of the FE Act, 2005.

17. THAT the learned Respondents 1 and 2 erred in rejecting the Appellant’s claim that it is involved in the business of lending money to this clients against the consideration of markup/interest.

18. THAT the learned Respondent No.1 did not consider FBR Letter C.No.3(9)STP/99 dated 21 February, 2001 whereby FBR has addressed this issues and stated that leasing business is a kind of loan activity. The Respondent No.1 had rejected the aforesaid Ruling on the basis that the said clarification was issued on the matter pertaining to sales tax. However, at the same time the learned Respondent No.1 did not comment on the clarification of lease transaction in the aforesaid Ruling. The relevant extracts are reproduced below:

“Leasing companies are non banking financial institutions which, inter alia, provide funds for acquisition of foreign or local machinery to registered persons (taxpayers). The invoices or bills of entry of such machinery are usually in the name of such registered persons but on acquiring the machinery, they enter into “sales and lease-back agreement” with the leasing companies. During the tenure of such agreements, the title of the machinery remains with leasing companies, though it simultaneously remains installed in the factory for use by such registered persons. The machinery is de-leased on repayment of loan as per agreed terms and conditions.

The transaction called the “financial lease” have been specifically excluded from the definition of the term “supply” through the Finance Ordinance, 2000. Sales and lease back transaction is a mode of securing the amount of loan by the non banking financial institutions. Since in such a transaction where there is neither any intention to actually sell the machinery or transfer its title or possession, nor such financial institutions need the machinery, and the real intention of the transaction is merely a disguised security” against a lease contract, such transactions essentially fall in the category of financial services which do not attract sales tax.”

19. THAT if without prejudice all the foregoing grounds leasing involves rendering of non fund based services, even then the learned Respondent failed to allow input tax paid by the company on leased assets in terms of Serial No.6 of SRO 550(I)/2006 read with Section 7 of the Federal Excise Act, 2005.

20. THAT the learned Respondent grossly failed to consider the following rulings issued by Federal Board of Revenue whereby leasing was classified as a ‘financing activity’:

C.No.3(9)STP/99 dated 9th February 2001

C.No.3(9)STP/99 dated 21st February 2001

21. THAT the learned Respondent grossly failed to acknowledge the following dictum of superior courts whereby ‘leasing’ has been classified as financing business:

PTR No.20 of 2001 (Lahore High Court)

1999 PTD 14 (Income Tax Appellate Tribunal)

2002 PTD 2210 (Income Tax Appellate Tribunal)

1995 PTD 401 (Income Tax Appellate Tribunal)

2003 PTD 1135 (Income Tax Appellate Tribunal)

2002 PTD 2210 (Income Tax Appellate Tribunal)

22. THAT without prejudice to aforesaid Grounds, the Appellant craves permission to add, amend, alter or substitute any or all of the above grounds before or at the time of hearing.

4. On the date of hearing, Mr. Zulfiqar Ali Memon, D.R. appeared on behalf of the department while Mr. Nadeem Ahmed Farooqui, Advocate attended on behalf of the Taxpayer.

5. During the course of proceedings, the learned DR argued that the learned CIR (Appeals-III), Karachi was not justified in deleting the demand of FED for the period from July 2007 to June-2009 on the assumption that leasing is fund based/Interest based activity, hence not dutiable, without considering various types of receipts. He further argued that Finance Act, 2011 empowers the assessing officer to issue show cause beyond 5 years to taxpayers who made short/non payment of FED. According to him, the action of the assessing officer for the time period from July 2007 to May 2008 was in time hence not hit by time limitation.

6. On the other hand, Mr. Nadeem Ahmed Farooqui, Advocate appearing on behalf of the taxpayer argued upon all grounds in the appeal of the taxpayer and vehemently opposed the contentions made by the D.R.

7. The AR of the appellant assailed the impugned appellate order on the grounds of appeal appended with the memo. of appeal. He invited our attention to the amendment brought in by the Finance Act, 2013 by virtue whereof leasing companies have been added to item 8 of Table II of the Act. He further added that issue is settled as per order of the division Bench bearing No.65/KB/2012 dated 13-7-2013 pronounced in the case of M/s. Pak Gulf Leasing Limited as worded below;

“Keeping in view facts and circumstances of the case and legal position on the subject contention of the learned AR has been found convincing. We have found that the appellant is engaged in fund based leasing activity. The return on lease financing constitutes incomes from mark up /interest and is not income from rendering/providing of services. Such return on lease financing is excluded from the ambit of Federal Excise duty in terms of Rule 40A (4) of the Federal Excise Rules, 2005. Even otherwise as we have already held that the notice issued on 10.6.2013 for the tax period July 2007 to June 2008 was barred by time limitation in terms of section 14(1) of the FED Act, 2005 as existed before amendment through Finance Act, 2011. The impugned order of the learned CIR(A) and the order passed by the DCIR are not sustainable in the eyes of law. The same are vacated and demand created as a result of the order of DCIR and confirmed by the CIR(A) is directed to be deleted.”

8. On the other hand the DR supported the order of the authorities below. He argued that the leasing activities are services liable to excise duty in view of the prevalent law and the appellant was correctly charged to tax. He also stated the amendment in Section 14(1) through Finance Act, 2011 would apply retrospectively and proceedings commenced by the department on 06.02.2012 will the entire period i.e. from July 2007 to June 2011.

9. The learned AR Mr. Nadeem Ahmed Farooqi referred to a letter written by the SECP to the Chairman FBR to the effect that in conformity with international accounting standards and the existing regulatory framework governing the leasing business, lease finance is recognized as a fund based finance facility and accordingly the income earned by the leasing companies on the lease portfolio is classifiable as interest/markup income. Since SECP is the statutory regulatory authority of the leasing companies and is fully aware of the ins and outs of leasing business besides being well versed with applicable laws. Therefore, as a matter of principle, it required due consideration by the FBR especially when the FBR vide its letter No.3(9)STP/99 dated 21st February, 2001 already held that the leasing business is a kind of loan activities. The said letter has been ignored by the adjudicating authorities on the pretext that it relates to sales tax.

10. The case was thoroughly discussed and available record was examined. Moreover, written reply to the grounds of appeals has also been filed by the respondents. We proceed on towards our findings as below;

Limitation

11. As far as the issue of limitation is concern we endorse the findings of learned CIR(A) in respect of the period from July 2007 to June 2008 being outside the scope of chargeability on the basis of statutory concession. The learned DR has referred to as case declared by this Tribunal vide FE Nos.51 to 54/KB/2013 in the case of Messrs Schlumberger Seaco Inc. On the contrary and in the light of decision of Hon’ble Lahore High Court is reported cases 2015 PTD 424, 2015 PTD 772 followed by the judgment of Hon’ble Supreme Court of Pakistan in C.P. No.1306 of 2014, dated 03-9-2014 on the issue of extension of time limitation for any adverse action against the taxpayer, the rule of “prospectiveness” has to be followed. Therefore, the present amendment in Section 14(1) inserted in 2011 would not apply on the taxpayer with retrospective effect. We find the order of CIR(A) quite judicious and accordingly uphold the treatment. The appeal of the department fails on this issue.

Leasing Services (Non-fund or funded)

12. At the very outset, we are of the opinion that fundamental difference between funded and non-funded service is that when a bank or NBFC provide credit facility with funds (real cash) it is called funded, while unfunded are like guarantees and documentary credits where Bank/NBFC does not give cash but take risk and consequently charges commission/service income. In banking terminology, funded facilities are over drafts, loans while non-funded are L.C., tender, bonds etc.

13. In the context of levy of services upto 2009 the law is very clear in respect of concession to both non-funded or funded leases from the levy of FED. However, in the Finance Act, 2009, the word ‘non-funded service’ was omitted from Pakistan Customs Tariff Code (PCTC) 9.813 viz simultaneous insertion in Sub-Rule (4) of Rule 40A of Federal Excise Rules, 2006 by grating concession to interest income or markup income earned by leasing company/banking company by providing exclusion through S.R.O. No.475(I)/2009 dated 13.6.2009. In the instant case, the taxpayer earns interest income and recovers principle amount while receiving the installment of lease. The business of leasing is inherently funded, capital oriented and investment based and its yield is in the form of interest whatever other name given to it. We are of the opinion that leasing company can’t operate without the support of adequate capital. Even otherwise, revenue recognition of income of leasing companies is based on interest earned on the principle amount of loan. On the contrary, in the cases of banking companies who also undertake the business of leasing, interest income of lease would not be considered service income distinguishable from interest income on loans. Therefore, in the presence of S.R.O. 475(I)/2009 dated 13-6-2009, markup or interest earned by a NBFC in apparent form of “lease” can’t be subjected to FED and would be dealt as per substance of the transaction.

14. That amongst the terms of any lease, most important is the effective rate of interest and payback period. The capital structure of taxpayer as ascertainable from the balance sheets vividly make the taxpayer as money-lender in the form of commodities. No other activity carried out by the taxpayer as a matter of prime concern. Moreover, the instant taxpayer does not derive income from any sort of consultancy, financial services or other services as envisaged in PCTC Heading 9.813.3 not otherwise requiring the capital as a primary or secondary ingredient. The taxpayer had been deriving lease income by appropriating his capital. To draw a line of distinction, we are of the view that any service which is not capital oriented would be considered as service for the purpose of FED.

15. In the context of foregoing, we stand with our previous decision in this regard which had already been incorporated earlier. Thus we vacate the orders of two authorities below. Consequently, appeal of the taxpayer is allowed.

HBT/11/Tax(Trib.) Appeal allowe

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