M/s Sophia.Com. B.V; Vs CIR, Zone-I, CRTO, Karachi.

APPELATE TRIBUNAL INLAND REVENUE,
KARACHI BENCH, KARACHI
 
ITA No.1289/KB/2019
(Tax Year 2016)

M/s Sophia.Com. B.V;

Gevers Deynootweg 61 2586 BJ Den Haag

The Netherlands, C/o A.F. Ferguson & Co, C.A..                …Appellant

Versus

CIR, Zone-I, CRTO, Karachi.                                            …Respondent

 

Appellant by:                   Mr. Muhammad Raza, FCA       

Respondent by:               Mr. Ashfaq Awan, DR

Date of hearing:              18.03.2021         Date of order: 18.03.2021

O R D E R

M. M. AKRAM (Judicial Member): The titled appeal pertaining to tax the year 2016, has been preferred by the taxpayer, calling in question the impugned appellate order No.52/2019 dated 23.09.2019, passed by the learned CIR(A), Karachi.

2.      Briefly stated, the relevant facts for the disposal of the present appeal are that the appellant taxpayer, in this case, is a non-resident company engaged in the business of providing services. The non-resident company does not have a Permanent Establishment (PE) in Pakistan. Return of income for the tax year 2016 was e-filed declaring income from other revenue at Rs.1,445,622,718/- which was claimed as exempt from tax in Pakistan. Later on, the case of the taxpayer was selected for audit by the concerned Commissioner IR under section 177 of the Income Tax Ordinance, 2001 (“the Ordinance”), for the following reasons/grounds: -

1.   You have shown business receipts at Rs.1,445,622,718/- in your return of income for the tax year under consideration and claimed exemption from tax under the provisions of the Double Tax Treaty signed between the Government of Pakistan and the Government of Netherlands. The claim of exemption needs to be examined in audit in the light of the Double Taxation Treaty between two Governments and prevailing tax law in Pakistan. 

2.   Your residential status regarding permanent establishment or branch office in Pakistan needs to be ascertained in the audit. 

3.   You have not furnished any details regarding its Pakistan-based associated companies whether resident or non-resident in the return of income. This aspect needs careful examination during an audit. 

4.   You are doing business for the last two years i.e. 2015 and 2016 but not paying any tax in Pakistan and claiming income as exempt on the ground of having no permanent establishment in Pakistan. The audit needs to verify this aspect in the audit. 

5.   The agreements/contracts signed with Pakistan-based companies/corporations whether resident or non-resident needs thorough scrutiny during an audit for ascertainment of tax implications. 

6.   You have not submitted any copy of audited accounts along with the return of income which renders its return invalid as per provisions of section 120 of the Income Tax Ordinance, 2001. This aspect needs to be probed in the audit. 

7.   You have earned business receipts from Pakistan but have not filed withholding statements required to be filed u/s 149/165 of the Income Tax Ordinance, 2001, in case, if it incurred any expenses on earning such income. This aspect needs to be looked into during the audit. 

Statutory intimation regarding the selection of case for audit and subsequent notice under section 176 of the Ordinance calling for record/information was issued. In response, the taxpayer challenged the very selection of case for audit by the Commissioner and submitted its objection which was considered and found unsatisfactory by the assessing officer. Accordingly, the taxpayer company submitted replies to the notices and furnished record/information sought for by the department. Finally, the deemed assessment for the tax year under consideration was amended by the assessing officer under section 122(1) whereby the taxpayer’s claim of exempt income being ‘business profits’ under Article 7 of the Double Taxation Treaty (DTT) was executed and existed between the Governments of Pakistan and Netherlands was rejected and declared revenue was adjudged to be taxed in Pakistan being “Royalty” as defined in section 2(54) of the Ordinance read with Article 12(2)(a) and Article 12(3)(a) of the Double Taxation Treaty (DTT). Furthermore, an addition under section 111(1)(a) was also made towards income on account of concealment of receipts of Rs.14,612,513/- on the basis of income received from the appellant’s two clients namely M/s Schlumberger Seaco Inc. (SSI) and Dowell Schlumberger (Western) S.A. (DSW). Since the taxpayer’s assessed income exceeded Rs.500 (Million), super-tax under section 4B of the Ordinance has also been charged. As a result, the amendment of assessment under section 122(1) was made and income for the tax year 2016 and tax thereon was computed as under: -

Income from business/other revenue as per return 1,445,622,718

Add: Under declared royalty u/s 111(1)(a)                14,612,512

Total income from business/ other revenue         1,460,235,230 

Rate of tax as per Article 12(2) read with

Article 14(3) @ 15%                                           219,035,284

Add: Super tax under section 4B@3%                     43,807,057

Total tax payable                                                262,842,341 

3.      Being aggrieved, the taxpayer filed the first appeal before the learned CIR(A) which was disposed of vide impugned appellate order whereby the learned CIR(A) confirmed the treatment accorded by the assessing officer and taxed the taxpayer’s claim of exempt income as “Royalty” as defined in section 2(54) of the Ordinance read with Articles 12(2)(a) and 12(3)(a) of the DTT executed between the Governments of Pakistan and Netherlands. Similarly, the addition made under section 111(1)(d)(i) amounting to Rs.14,612,512/- was also upheld. However, the learned CIR(A) annulled the charge of super tax levied under section 4B of the Ordinance. Being dissatisfied with the order of the learned CIR(A), the taxpayer has come up in the second appeal before this Tribunal and assailed the impugned order of the learned CIR(A) on the following grounds: -

1.      That the order as passed by the Commissioner Inland Revenue-Appeals (CIRA) is bad in law and on the facts of the case.  

2.      Without prejudice to the above ground of appeal, the CIR(As) erred in confirming the Deputy Commissioner Inland Revenue (DCIR)’s order despite the fact that the principles of natural justice and fair play were not adhered to when the impugned order was passed without identifying and confronting the appellant in writing a regards the alleged defects in the explanations and documentation, duly submitted by the appellant during the course of proceedings.  

3.      Without prejudice to the above grounds of appeal, the CIR(A) erred in confirming the DCIR’s action of treating the receipts of the taxpayer as “Royalty” under Article 12 and not as “Business Profit” under Article 7 of the Double Tax Treaty between the Netherlands and Pakistan, and in confirming the DCIR’s action of subjecting the appellant’s receipts of Rs.1,445,622,718/- to tax at 15% under Article 12 of the DTT. 

         It is submitted that the CIRA erred in disregarding the principles laid down by the Hon’ble Sindh High Court in its judgment reported as (2008) 97 Tax 74 (H.C. Sindh) in the case of Interquest Information Service B.V. 

4.      Without prejudice to the grounds of appeal No.1 and 2, the CIRA erred in confirming the DCIR’s action making addition of Rs.14,612,612 to the appellant’s income under section 111(1)(d)(i) of the Ordinance. 

4.      This case came up for hearing on 18.03.2021. The learned AR contended before us that there was no justification for the learned CIR (A) to uphold the action of the assessing officer’s action to treat the receipts of the appellant as “Royalty” under Article 12 and not as “business profits” under Article 7 of the Double Taxation Treaty between the Netherlands and Government of Pakistan. It is explained by the learned AR that the taxpayer is engaged in providing technical advice, data, and information either in physical or electronic form through its web portal from the remote terminals worldwide. The taxpayer provides its customer’s authorized employees, the services and facilities for raising queries and viewing and downloading technical advice and information from the SCBV Network. These services are web-based and the Company’s system also entails including a support helpdesk to which requests in form of tickets can be submitted as and when technical advice is required. It is further submitted that no intellectual property right is granted by SCBV under the underlying subscription agreements for exploitation or use of technical information, software or to sell, transfer, export, license, sub-license or transmit to any other person outside the customer’s internal business organization. On contrary, the learned DR has supported the orders of the lower authorities and contended that the learned CIR(A) has passed a speaking order and there is no infirmity in the impugned order. He, therefore, pleaded that the appeal be dismissed.    

5       we have heard both the parties and perused the available record with their assistance. The main controversy involved in the instant case is as to whether the web-based “subscription fee” earned by the appellant from non-resident companies having PEs in Pakistan falls within the “Business Profit” as provided in Article 7 of Double Taxation Treaty (DTT) or taxable in the hand of the appellant in Pakistan as “royalty” defined in Article 12(2)(a) of the DTT read with section 2(54)(b) and 2(54)(d) of the Ordinance? Before dilating upon the issue, it is essentially required to first examine and understand the nature of activities carried on by the appellant. Undisputedly, the appellant is a non-resident company having no PE in Pakistan. Admittedly, the appellant has created an online database in providing technical advice, data, and information either in physical or electronic form through its web portal from the remote terminals worldwide. It is also not disputed that the appellant provides its customers authorized employees, the services and facilities for raising of quarries and viewing and downloading technical advice and information from the SCBV Network. These services are web-based and the Appellant’s systems also entail including a support helpdesk to which requests in form of tickets can be submitted as and when technical advice is required. The customers and users are allowed to access the online database on a 24 hours basis from an agreed internet protocol range either authenticated via user name and password or via Internet Protocol (IP). Thus it is evident that the database is accessible to the users through regular internet access. However, each customer/user has to enter into a subscription agreement with the appellant for accessing the database. While accessing the database the customer/user can access, search, browse and view the subscribed products. As per record, the appellant has provided and rendered services to two non-resident companies namely M/S SSI and M/S DSW after executing the subscription agreements with them. The relevant extracts from the agreement executed with one M/s SSI are reproduced hereunder for ascertaining the exact nature of services/business of the appellant: -

“WHEREAS 

Sophia has established computer systems on one or more servers through which Technical Information and other services (together hereafter: the “In Touch Services”), as further defined below, or made available either in electronic or physical form.        

Subscriber wishes to gain access to computer systems as referred to above and make use of the In Touch Services. 

Article 1-Definition 

“Helpdesk” shall mean a dedicated team of technically-skilled staff, (In Touch Engineers) who can be accessed remotely via the Sophia System as well as via email and telephone link to provide support to Authorized Employees and address technical problems related to the provision of oilfield services. 

“In Touch Services” means those services and technical information to which access is made available by Sophia via the Sophia Systems or by the distribution of CDs, including Helpdesk support, and which are described further in this agreement. 

“Sophia Systems” means the computer systems and web applications established by Sophia on one or more servers through which the In Touch Services are made available. 

Article 2-RIGHTS OF SUBSCRIBER 

During the term of this Agreement and subject to its terms and conditions, Subscribers will be entitled to allow the Authorized Employees to access the Sophia Systems and use the In Touch Services for the sole purpose of enabling Subscriber to perform its obligation to third parties. This right includes the right for Authorized Employees to download an electronic copy of the Technical Information available on the Sophia Systems or to request delivery of a hard copy. Subscriber is permitted to share download content with its clients to the extent required to perform services. Except as permitted in the previous sentence, any modification, display, distribution, performance, or publication in any media requires the prior written consent of Sophia. 

Article 4-RIGHTS OF SOPHIA 

4.1 Sophia is entitled to receive and collect from Subscriber the Access Charges and fee described in Clause 3.2 of this agreement. Sophia has the right to amend the Access Charges, however no more than once every 12 months and no earlier than July 1^st, 2016. Any change of the Access Charges shall be documented by executing amended Attachments by Sophia and Subscriber. 

4.2 Subject to the specifically described rights granted hereunder to Subscriber, Sophia maintains full ownership of all intellectual property rights pertaining to the In Touch Services. 

4.3 It is expressly agreed by Subscriber that Sophia owns all proprietary rights in and title to the Sophia Systems. Ownership of all contributions in whatever form made by Subscriber and/or by any Authorized Employees shall instantly vest in Sophia by virtue of this agreement. 

4.4 Nothing in this Agreement shall be construed or interpreted as granting to Subscriber or any of its employees any license by implication or operation of law under any patent or copyright of Sophia or any third party.” 

On almost similar terms and conditions as stated above, the appellant executed the agreement with the other non-resident company M/s DSW.

Thus, on the reading of the aforesaid important terms of the agreement, it is very much clear that that the appellant is engaged in providing and rendering technical advice, data, and information either in physical or electronic form through its web portal from the remote terminals worldwide. These services are web-based and the company’s systems also entail including a support helpdesk to which requests in form of tickets can be submitted as and when technical advice is required. Further no intellectual property rights are granted by the appellant under the agreements for exploitation or use of technical information, software or to sell, transfer, export, license, sub-license, or transmit to any other person outside the customer’s internal business organization.

6.      Keeping in view the aforesaid factual position, we need to examine whether the subscription fee received by the appellant from the non-resident companies having PEs in Pakistan for allowing access to the online database comes within the ambit of “Royalty”. The expression “Royalty” has been defined in Article 12(3) of the DTT which reads as under: -

The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use; 

(a)  A patent, trademark or trade name, secret formula or process, design or model, or information concerning the industrial, commercial, or scientific experience.

(b)  Industrial, commercial or scientific equipment, cinematograph films, and tapes for television and broadcasting.

(c)  A copyright of a literary artistic or scientific work, but excluding cinematograph films and tapes for television or broadcasting. 

Similarly, the word “Royalty” has been defined in section 2(54) of the Income Tax Ordinance 2001 which read as under:

“2(54) “royalty” means any amount paid or payable, however, described or computed, whether periodical or a lump sum, as consideration for —

(a) the use of, or right to use any patent, invention, design or model, secret formula or process, trademark or other like property or right; 

(b) the use of, or right to use any copyright of a literary, artistic, or scientific work, including films or videotapes for use in connection with television or tapes in connection with radio broadcasting, but shall not include consideration for the sale, distribution, or exhibition of cinematograph films; 

(c) the receipt of, or right to receive, any visual images or sounds, or both, transmitted by satellite, cable, optic fiber, or similar technology in connection with television, radio, or internet broadcasting; 

(d) the supply of any technical, industrial, commercial or scientific knowledge, experience, or skill; 

(e) the use of or right to use any industrial, commercial, or scientific equipment; 

(f) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as mentioned in sub-clauses (a) through (e); and 

(g) the disposal of any property or right referred to in sub-clauses (a) through (e);”

The assessing officer while passing the amended order has observed that the appellant’s receipts come within the ambit of section 2(54)(b) of the Ordinance i.e allowing the access to use its online database the appellant has transferred the right to use the copyright which is in the nature of a literary work, hence, to be treated like royalty. Whereas while deciding the appeal, the learned CIR(A) has observed that the appellant’s receipts are also covered within the definition of clause (d) of section 2(54) ibid. No doubt, the appellant being a resident of the Netherlands is governed by Netherlands-Pakistan Double Taxation Treaty (DTT). Therefore, it is necessary to examine whether the subscription fee received by the appellant fits into the definition of royalty as provided under Article-12 of the DTT. Article 12.1 of the DTT provides that royalty arising in a contracting state and paid to a resident of the other contracting state may be taxed in the other state. As per the plain meaning of the aforesaid provision, the subscription fee paid to the appellant is ordinarily taxable in the Netherlands. However, Article-12.2 also provides for taxation of royalty in Pakistan subject to the condition that the tax leviable shall not exceed 15% of the gross amount of royalty. Article-12.3 of the DTT defines royalty which has been reproduced above.

7.      As per the aforesaid definition of royalty in the tax treaty, any amount received for use of or right to use of any copyright or literary, artistic, or scientific work, etc., can be treated like royalty. In the facts of the present case, there is no dispute that the appellant is engaged in providing technical advice, data, and information either in physical or electronic form through its web portal from the remote terminals worldwide. It is also clear from the terms of the subscription agreement; the appellant has not transferred the use or right to use of any copyright of literary, artistic, or scientific work to its subscribers. What the appellant has done is; it has allowed customers to access its database and utilize the information available therein for their use. Further, it is observed, these services are web-based and the company’s systems also entail including a support helpdesk to which requests in form of tickets can be submitted as and when technical advice is required. There is no material on record which could even remotely demonstrate that while allowing the customer/users to access the database, the appellant had transferred its right to use the copyright of any literary, artistic, or scientific work to the subscribers. Further, from the invoices raised by the appellant, sample copies of which are placed in the paper book, it is noticed that the subscription is period based and further the subscriber may not even use the data stored in the database. That being the case, the payment made cannot be treated as royalty under Article-12(3) of the Netherlands-Pakistan DTT. Recently in the case of Elsevier Information Systems GmbH v. Dy. Commissioner of Income Tax (IT) bearing ITA No.1683/Mum/2015; Order dated April 15, 2019 the Mumbai Bench of the Income Tax Appellate Tribunal (“ITAT”) has held that subscription fees charged by a service order for access to an online database should be considered as business income and not “royalty” or “fees for technical services” (“FTS”). The ITAT also examined the business model of the Taxpayer to understand how the income earned by it should be characterized. The database may be accessed through regular web browsers such as Internet Explorer, Google Chrome, or Firefox on a twenty-four-hour basis from an agreed protocol range either authenticated via user name and password or via Internet Protocol (IP) number. The ITAT held that this is evidence of the fact that no particular software or hardware is required by a user for accessing the database once a customer enters into a subscription agreement with the Taxpayer. From a perusal of a sample subscription agreement, the ITAT found that the Taxpayer only grants a non–exclusive and non–transferrable right to the subscriber to access and use Reaxys.com, and all right, title, and interest in the subscribed products remain with the Taxpayer. Further, the ITAT noted that upon the termination of the subscription agreement, the customer is required to delete all stored copies of items from the database and the Taxpayer also has the right to withdraw content it no longer has the right to provide. From this holistic reading of the subscription agreement, the ITAT held that providing access to the database did not involve the transfer of any right to use any copyright to its customers/subscribers. On the basis of the above, the ITAT held that the subscription fee was in the nature of business income and could not be taxed in India since the Taxpayer did not have any PE in India to which the income could be attributed.

8.      A somewhat similar issue posed before the Hon’ble Sindh High Court in the case titled M/s Interquest Information Services Vs D.C of Income Tax, Circle-11, Companies-1, Karachi, (2007 PTD 2549), wherein the court has dilated upon the issue and held that where the payment is not for the use of exploitation of copyright, patent, know-how, secret process or formula of supply of special knowledge, invention or patent but business use thereof, Article 12 does not apply in the case of the above treaty and that such income was exempt from tax in the hands of the recipient under Article 7 of DTT. The relevant extract of the judgment is reproduced hereunder: -

“21. From a perusal of the agreement we are of the considered opinion that the payment made by M/s Schlumberger Saeco Inc., to the applicant is not for the use or exploitation of copyright patent, know-how, secret process or formula or supply of specialized knowledge, invention, or patent, but for its business use of patented software product and system and since this product can only be utilized for its technical use and cannot be passed off to any other person, therefore, in our opinion, it does not fall within the definition of royalty as defined in para.3 of Article 12 of the double taxation agreement between Pakistan and Netherlands but will fall in other income which may be covered under business profits and, therefore, the order of the Income Tax Appellate Tribunal for all the years cannot be sustained.”    

Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/transferor who divests himself of the rights he possesses pro tanto.

9.      The learned AR argued that the definition of royalty under Article 12 of the DTT is narrower than the definition of royalty under the Income Tax Ordinance, 2001 and submitted that the definition of royalty given in the DTT shall prevail over the Ordinance. Both the authorities have erred in law in applying the definition of royalty given in section 2(54) of the Ordinance. This contention of the learned AR is also well-founded and tenable. Section 107 of the Ordinance provides the statutory gateway through which a double taxation treaty is given effect in the municipal law. Subsection (2) provides that a duly notified double taxation treaty has overriding effect insofar as its terms deal with or provide for any of the matters enumerated in clauses (a) to (e) thereof. Now it is normally said that in case there is a conflict between a provision of a double taxation treaty and a section of the Ordinance, it is the former that will prevail. Reliance may be placed on the case titled A. P. Moller Maersk and others Vs The Commissioner Inland Revenue and others, (2020 PTD 1614).

10.    Looking at the matter from another angle. Undisputedly, the case of the appellant was selected for audit by the concerned Commissioner IR under section 177 of the Ordinance. The available record shows that the assessing officer without first adhere to the provisions of section 177 of the Ordinance straightaway assume the jurisdiction under section 122 of the Ordinance and issued the notice under section 122(9) of the Ordinance to the appellant. The question would arise the interpretation of section 177 of the Ordinance that whether after production of the record and related documents, the conduct of an audit, issuance of an audit report after completion of audit proceedings and seeking an explanation from the taxpayer on all the issues raised in the audit is the sine qua non for the Assessing Officer before assuming the jurisdiction under section 122 of the Ordinance? To answer this question, it would be advantageous to reproduce hereunder the relevant provisions of law: -

177. Audit:- (1) The Commissioner may call for any record or documents including books of accounts maintained under this Ordinance or any other law for the time being in force for conducting an audit of the income tax affairs of the person and where such record or documents have been kept on electronic data, the person shall allow access to the Commissioner or the officer authorized by the Commissioner for use of machine and software on which such data is kept and the Commissioner or the officer may have access to the required information and data and duly attested hard copies of such information or data for the purpose of investigation and proceedings under this Ordinance in respect of such person or any other person:-  

           Provided that: - 

(a)     the Commissioner may, after recording reasons in writing call for record or documents including books of accounts of the taxpayer; and

(b)     the reasons shall be communicated to the taxpayer while calling records or documents including books of accounts of the taxpayer:  

Provided further that the Commissioner shall not call for record or documents of the taxpayer after the expiry of six years from the end of the tax year to which they relate. 

(2) After obtaining the record of a person under sub-section(1) or where the necessary record is not maintained, the Commissioner shall conduct an audit of the income tax affairs (including examination of accounts and records, enquiry into expenditure, assets, and liabilities) of that person or any other person and may call for such other information and documents as he may deem appropriate. 

(3) Omitted.

(4) Omitted.

(5) Omitted. 

(6)     After completion of the audit the Commissioner shall, after obtaining the taxpayer's explanation on all the issues raised in the audit, issue an audit report containing audit observations and findings. 

(6A) After issuing the audit report, the Commissioner may, if considered necessary, amend the assessment under subsection (1) or sub-section (4) of section 122, as the case may be, after providing an opportunity of being heard to the taxpayer under sub-section (9) of section 122. 

(7) …………………………….

(8) …………………………….

(9) ……………………………

(10) Notwithstanding anything contained in sub-section (2)and (6) where a person fails to produce before the Commissioner or a firm of Chartered Accountants or a firm of Cost and Management Accountants appointed by the Board or the Commissioner under sub-section (8) to conduct an audit, any accounts, documents and records, required to be maintained under section174 or any other relevant document, electronically kept a record, electronic machine or any other evidence that may be required by the Commissioner or the firm of Chartered Accountants or the firm of Cost and Management Accountants for the purpose of audit or determination of income and tax due thereon, the Commissioner may proceed to make best judgment assessment under section 121 of this Ordinance and the assessment treated to have been made on the basis of return or revised return filed by the taxpayer shall be of no legal effect. 

(11) ……………………………

(12) ……………………………

(13) …………………………..

(14) …….............................

(15) ………………………….

(16) …………………………. 

(17) …………………………. 

Section 114. Return of income: - (1) Subject to this Ordinance, the following persons are required to furnish a return of income for a tax year, namely: -    

                 ……………..……………

(1A)   …………………………..

(2)     …………………………..                 

         (2A)   ………………………….. 

(3)     ………………………….. 

(4)     ………………………….. 

(5)     ………………………….. 

(6)     …………………………..  

(6A)   If a taxpayer files a revised return voluntarily along with a deposit of the amount of tax short paid or amount of tax sought to be evaded along with the default surcharge, whenever it comes to his notice, before receipt of notice under sections 177 or sub-section (9) of 122, no penalty shall be recovered from him: 

Provided that in case the taxpayer deposits the amount of tax as pointed out by the Commissioner during the audit or before the issuance of notice under sub-section (9) of section 122, he shall deposit the amount of tax sought to be evaded, the default surcharge and twenty-five percent of the penalties leviable under the Ordinance along with the revised return: - 

Provided further that in case the taxpayer revises the return after the issuance of a show-cause notice under sub-section (9) of section 122, he shall deposit the amount of tax sought to be evaded, default surcharge, and fifty percent of the leviable penalties under the Ordinance along with the revised return and thereafter, the show cause notice shall stand abated.

                                                                          

           (7)   ……………………………” (Emphasis supplied) 

It can be seen from the combined reading of the above provisions of law that after selection of the case for audit under section 177, the audit shall be conducted as per procedure given in section 177 of the Ordinance. Under sub-section (5) of section 177, the Commissioner shall conduct an audit of income tax affairs, call for records or documents including books of accounts maintained under the Ordinance for conducting an audit of income tax affairs of the taxpayer. After obtaining the record of a taxpayer under sub-section (5) of section 177, the Commissioner shall conduct an audit of the income tax affairs of the taxpayer. After completion of the audit, the Commissioner under sub-section (6) of section 177 shall after obtaining the taxpayer’s explanation on all the issues raised in the audit, issue an audit report. After issuance of the audit report, the Commissioner may proceed if he considered necessary to amend the assessment order under section 122 of the Ordinance. The language of sub-section (6) of section 177 is express, explicit, and mandatory to the effect that the Commissioner proceeds to amend the deemed assessment only after obtaining the taxpayer’s explanation on all the issues raised in the Audit Report. Hence it is very clear that no proceedings for amendment of deemed assessment can be initiated without obtaining taxpayer’s explanation on the Audit Observations.  This view is fortified by the judgment reported as Nestle Pakistan Limited etc. Vs. The Federal Board of Revenue etc, (2017 PTD 686) which says that: -

“Selection for audit cannot and should not be allowed to be used for raising revenue simpliciter, without conducting any audit and preparation of Audit Report. It is reiterated that audit, necessarily, is administrative in nature, which starts by selection for audit and ends on the issuance of “Audit Report” after seeking an explanation from the taxpayer.  Issuance of “Audit Report” is the sine qua non for to maintain separation between administrative and judicial powers, as envisaged in Article 175 (3) of the Constitution of 1973.” 

It is further held in the said judgment that: -

“Audit, being administrative proceedings, shall complete on the issuance of Audit Report.  If an audit is not completed within the given time frame, the selection shall be deemed to have been dropped.  After issuance of Audit Report; adjudication proceedings shall be carried out by some other taxation officer to satisfy the command of the Constitution under Article 10A.” 

It has very clearly and authoritatively held in the judgment supra that the Audit Officer should issue an audit report before stepping towards amendment of the already completed assessment order. The above judgment was subsequently upheld by the Honorable Division Bench of Lahore High Court in the ICA No.338 of 2017 through an order dated 18-07-2017. The Honorable Division Bench, while discussing the matter of audit report, has annunciated the legal procedure in the following words: -

“However, in doing so it is vital that due process is followed and the basic requirements of the FTS are not ignored. In terms of Section 177 of the Ordinance read with Section 25 of the Act and Section 46 of the 2005 Act, the Commissioner can call for the record or documents for conducting the audit of the income tax affairs of the person provided that he give reasons in writing and the reasons must be communicated to the Taxpayer. Under Section 177(6) of the Ordinance the Commissioner can seek an explanation from the Taxpayer on the issues raised during the audit and only if satisfied that the explanation is unsatisfactory, may proceed to amend the assessment under Section 122 of the Ordinance.” 

The above judgments were subsequently upheld by the Hon’ble Supreme Court in the case titled CIR Vs Allah Din Steel & Re-rolling Mills (2018 PTD 1444) wherein it observed as follows: - 

“16. A perusal of the statutory landscape makes it clear that the provisions of sections 177 and 214C of the Ordinance; section 25 of the Act, 1990, and section 46 of the Act, 2005 provide a mechanism and roadmap which is required to be followed by the Taxation Officer/Auditor. In terms of section 177 of the Ordinance, the Commissioner can call for the record or documents for conducting the audit of the tax affairs of a person, provided he furnishes reasons to do so. Such reasons must be communicated to the Taxpayer. He can also seek explanations from the Taxpayer on issues raised during the audit in terms of section 177 of the Ordinance. It is only if he is convinced that the explanation furnished by the Taxpayers is not satisfactory, he may proceed to amend the assessment under section 122 of the Ordinance, after giving the Taxpayer an opportunity to defend him. We are therefore of the view that the statutory framework together with the overarching umbrella of constitutional guarantees furnish adequate and sufficient safeguards to the Taxpayer where there is a possibility of overstepping by the Tax authorities.”   

It is quite obvious from the judgments referred above that the department is under legal and statutory obligation, prior to further proceed for amendment process contemplates under section 122 of the Ordinance to obtain explanation/clarifications on all the issues raised during an audit from the taxpayer which in the instant case was not done. After the judgment of the Hon’ble Supreme Court cited above, the provision of sub-section (6) was amended and new sub-section (6A) of section 177 inserted through Finance Act, 2019 which expressly mandate that after completion of the audit, the Commissioner shall after obtaining taxpayer’s explanation on all the issues raised in the audit, issue an audit report. After issuance of the audit report, the Commissioner may proceed if he considered necessary to amend the assessment order under section 122 of the Ordinance.

11.    Similarly the first proviso to sub-section (6A) of section 114 of the Ordinance gives safeguard, privilege, and the waiver of penalty to the extent of 75% to the taxpayer if he deposits the amount of tax as pointed out by the Commissioner during the audit proceedings or before the issuance of notice under sub-section (9) of section 122 along with default surcharge and twenty-five percent of the penalties leviable under the Ordinance along with the revised return. If such an opportunity during the audit proceedings or before issuance of notice under section 122(9) of the Ordinance is not given to the taxpayer, it would be seriously deprived of its statutory right enshrined in the said proviso which is not permissible under any canon of interpretation. It is a settled principle of interpretation of the statutes that each and every word appearing in a section is to be given effect to and no word is to be rendered or surplus. So was held by the Apex Court in the cases of (i) In the matter of Reference by the President of Pakistan under Article 162 of the Constitution of Islamic Republic of Pakistan PLD 1957 SC (Pak.) 219, (ii) Muhammadi Steamship Company Ltd Vs CIT, (Central) Karachi (PLD 1966 SC 828), (iii) M/s V. N. Lakhani and Company Vs M. V. Lakatoi Express and 2 others (PLD 1994 SC 894) and (iv) Director General Intelligence and Investigation FBR Vs Sher Andaz and 20 Others (2010 SCMR 1746).

12.    In a peculiar circumstance of the instant case, the only recourse available to the Assessing Officer was to proceed under section 177(6), opportunity for revised return should have been provided to the appellant as required under the first proviso to subsection (6A) of section 114 of the Ordinance which has not been done in the instant case. It is settled law that in order to arrive at the correct conclusion a scheme of law is to be examined in its totality. Reference may be placed on the judgment titled as M/s Bilz (Pvt.) Ltd Vs DCIR, Multan, and another 2002 PTD 1(SC). It is also well-settled law that when the law requires an act to be done in a particular manner, it had to be done in that manner alone. Reliance is placed on the case titled IAC Income Tax Vs Micro Pak (Pvt,) Ltd and others, 2002 PTD 877(SC).

13.    Further we have noticed that the record available before us shows that while assuming the jurisdiction under section 122 of the Ordinance, the mandatory notice under section 122(5) has not been issued to the appellant which is a sine qua none for assuming the jurisdiction under section 122 of the Ordinance. The basic amended order passed by the assessing officer is silent about the issuance of notice under the provisions of sub-section (5) of section 122 ibid. For the purpose of invoking jurisdiction under section 122(1) read with 122(5) of the Ordinance, the following conditions are to be satisfied: -

(a)     There should be definite information acquired from an audit or otherwise or information received as defined in subsection (8) of section 122;

(b)     An income chargeable to tax has escaped the assessment; or

(c)     Total income has been under-assessed, or assessed at too low a rate, or has been the subject to excessive relief or refund; or

(d)     Any amount under a head of income has been misclassified. 

Sub-sections (1), (3), (4), and (5) of section 122 are to be read together and not in isolation or distinctly or separately. Thus, an assessment order or revised assessment order issued or taken/treated as issued can be amended by invoking original jurisdiction under sub-section (5) of section 122, on fulfillment of conditions specified therein, and on no other ground. Reliance may be placed on the judgment of the Hon’ble Sindh High Court titled as Fauji Oil Terminal and Distribution Company Ltd., Karachi Vs Additional Commissioner/Taxation Officer-A, Audit Division, Karachi and 2 others, (2006 PTD 734). As stated before, the impugned amended order is silent about the issuance of notice under the provision of sub-section (5) of section 122 and even does not show under which clause of sub-section (5) the case of the appellant falls. On this score alone, the proceedings are void ab-initio, uncalled for, and cannot be sustained in the eyes of law. Reliance may be placed on the judgment reported as 2007 PTD 2601 wherein it was observed that: -

“16. The upshot of the above discussion, therefore, is obvious. The jurisdiction, in this case, could only be acquired by the Taxation Officer after receiving information from the audit department by the issuance of a notice under section 122(5). Since said notice have not properly been issued for acquiring jurisdiction over this case, one cannot agree with the department that the subsequent proceedings are justified.” 

Similarly in another case reported as 2008 PTD 1549 observed as follows:-

“While perusal of the order passed by the Taxation Officer under section 122(1) of the Income Tax Ordinance, 2001, I have found that he has nowhere mentioned that which assessment order is being amended and the additions have been made on the basis of assessment for the years, 2001-2002 and 2002-2003, without any reference to the assessment order regarding tax year, 2003. I have further noted that the order has been passed by the Taxation Officer under section 122(1) and notice in this regard has been sent to the assessee as mentioned in the amended order under section 122(9) and nowhere in that order, subsections (5) or (5)(a) of section 122 has been mentioned.

In view of these legal infirmities, I am of the view that the learned CIT(A) has upheld the amended order and has not considered the fact that the Taxation Officer has not mentioned in the order that which of the order is going to be amended. The impugned order of the learned CIT(A) is, therefore, vacated and the amended order passed by the Taxation Officer being illegal is annulled.” (Emphasis supplied) 

14.    It is an immutable principle of law that defective assumption/exercise of jurisdiction by the authorities is incurable. Reliance may be placed on Director General Intelligence and Investigation FBR Vs Sher Andaz and 20 Others (2010 SCMR 1746), Director General Intelligence and Investigation and others Vs M/s AL-Faiz Industries (Pvt.) Limited and others PTCL 2008 CL 337(S.C) and Collector, Sahiwal and 2 others Vs Muhammad Akhtar (1971 SCMR 681). In all these judgments it was held by the Hon’ble Supreme Court of Pakistan that: -

i)       Where essential feature of assumption of jurisdiction is contravened or forum exercises power not vested in it, or exceed authority beyond the limit prescribed by law the judgment is rendered Coram non-judice and inoperative (2002 SCMR 122 ).

ii)      If a mandatory condition for the exercise of jurisdiction before the Court, Tribunal, or Authority is not fulfilled, then the entire proceedings which follow become illegal and suffer from want of jurisdiction. Any order passed in continuation of these proceedings in appeal or revisions equally suffer from illegality and are without jurisdiction (2008 SCMR 240).”

15. For what has been discussed above, firstly, we hold that the proceedings initiated by the assessing officer in the instant case are void ab-initio and secondly, the payment received by the appellant is only in the nature of business profit which cannot be brought to tax in Pakistan in the absence of PE. Therefore, the orders passed by the lower authorities are annulled.

16.    In a result, the appeal of the appellant is allowed.

17.    This order consists of (22) pages and each page bears my signature.

  

 

	Sd/- (M.M. AKRAM) Judicial Member
Sd/-  (SAIF ULLAH KHAN) Accountant Member

 

CERTIFICATE U/S 5 OF THE LAW REPORT ACT

                 This case is fit for reporting as it settles the principles highlighted above.

 

(M. M. AKRAM)

                                                                             JUDICIAL MEMBER