M/s Wise Communication Systems (Pvt) Limited; Vs Deputy Commissioner Inland Revenue, Zone-IV, Range-II, LTO, Islamabad.

 

APPELLATE TRIBUNAL INLAND REVENUE, DIVISION BENCH-I,

ISLAMABAD 

ITA No.1889/IB/2024

(Tax Period, 2021)

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M/s Wise Communication Systems (Pvt) Limited; House No.96 10 Road, New Mulpur Satellite Town, Rawalpindi. NTN: 1887287		Appellant
	Vs
Deputy Commissioner Inland Revenue, Zone-IV, Range-II, LTO, Islamabad.		Respondent

 

Appellant By:                                         Mr. Amraiz Khan, Advocate

Respondent BY:                                     Mr. Khurshid Alam, DR

 

Date of Hearing:                                    29.01.2025

Date of Order:                                       29.01.2025

ORDER

M. M. AKRAM (Judicial Member): The present appeal has been filed by the appellant challenging the impugned order dated August 29, 2024, issued by the Deputy Commissioner Inland Revenue (DCIR), Zone-IV, Range-II, LTO, Islamabad, under Section 161/205 of the Income Tax Ordinance, 2001 (“the Ordinance”) for the tax year 2021. The appeal is based on the grounds outlined in the memos of appeal.

2.    The brief background of the case is that the appellant, a private limited company, derives income from interconnect and allied telecommunication services. During an internal audit and examination of the tax return for the tax year 2021, it was observed that the appellant had allegedly paid Rs. 102,419,112 as royalty but failed to deduct the applicable tax at the time of payment, as reflected in the withholding statement filed under Section 165 of the Ordinance. Consequently, the appellant was served with a notice under Section 161(1A) on January 2, 2023, requiring compliance by January 10, 2023.

3.    On the due date, the appellant neither submitted a written reply nor requested an adjournment. However, on July 27, 2023, the appellant provided an explanation stating that no payments had been made under the head of royalty and that an error had occurred while transcribing the return. The appellant clarified that the expenses in question were incurred under different account heads but were mistakenly recorded under "Royalty" instead of "Other Direct Expenses" when filing the return. In support of this claim, the appellant submitted a breakdown of expenses, which was also reflected in the audited financial statements annexed with the return.

4.    The assessing officer, however, rejected the explanation and issued the impugned order under Sections 161 and 205 of the Ordinance, charging tax under Section 153B amounting to Rs. 15,362,867 and default surcharge under Section 205 at a rate of 12%, totaling Rs. 5,833,680, thereby creating a total tax demand of Rs. 21,196,547. Dissatisfied with this decision, the appellant has now challenged the impugned order before this Tribunal, raising multiple grounds of contestation.

5.    The case was heard on January 29, 2025. The learned Authorized Representative (AR) for the appellant reiterated the contentions raised in the grounds of appeal, while the learned Departmental Representative (DR) supported the impugned order.

6.   After carefully considering the arguments presented by both parties and thoroughly examining the record, we find merit in the submissions made on behalf of the appellant. In light of the grounds of appeal and the arguments advanced by the learned AR, we have also observed that, regrettably, assessing officers often lack awareness of the procedures prescribed under the Ordinance and the corresponding rules regarding the initiation of proceedings against taxpayers who have either failed to deduct the requisite tax or have made short deductions. Failure to adhere to the prescribed procedure, as mandated under the Ordinance and as established by the superior courts, has resulted in losses to the national exchequer. In this context, we deem it appropriate to reiterate the correct procedural framework to prevent further revenue loss and to minimize unnecessary litigation between the revenue authorities and taxpayers. Moreover, the practice of creating frivolous tax demands to meet budgetary targets not only misallocates resources and revenue but also places an undue burden on the judicial hierarchy, extending up to the Hon’ble Supreme Court. To ensure due diligence, compliance, reconciliation, adherence to legal process, revenue security, and avoidance of unnecessary litigation, the following sequential steps must be followed when initiating proceedings against a taxpayer who has failed to deduct or has short-deducted tax under the law:

Step 1:     Identification of Non-Compliance

In accordance with the Income Tax Ordinance, 2001, and the legal principles established by the superior courts, the following essential prerequisites must be fulfilled before an Assessing Officer can assume jurisdiction under Rule 44 of the Income Tax Rules, 2002, and Section 161 of the Ordinance:

1.   The taxpayer must be classified as a withholding agent and fall within the definition of a prescribed person under the Ordinance.

2.   The transaction in question must be subject to tax deduction/withholding under the relevant provisions of the Ordinance.

3.   The tax liability must pertain to a specific person who is entitled to claim credit for the tax recoverable under Section 161.

These principles have been reinforced through judicial precedents, including CIR vs. Islam Steel Mills, (2015 PTD 2335) and M/s Nishat (Chunian) vs. Federal Board of Revenue, (2015 PTD 1385).

Step 2:      Verification of Taxpayer’s Compliance

Before initiating Rule 44 reconciliation proceedings, the assessing officer must verify whether the taxpayer has met the following statutory obligations:

1.   Filing of the Income Tax Return for the relevant tax year.

2.   Submission of Withholding Tax Statements under Section 165 of the Ordinance.

If both requirements are satisfied, the assessing officer may proceed with issuing a notice under Rule 44 for reconciliation.

Step 3:      Addressing Procedural Deficiencies

If any of the aforementioned documents are missing, the assessing officer must first rectify the deficiency by issuing appropriate legal notices.

A. Non-Filing of Income Tax Return

i.      The assessing officer must issue a notice under Section 114 of the Ordinance, directing the taxpayer to file the return.

2. In case of non-compliance, further legal action may be initiated under Section 182 (penalties) and Section 121 (best judgment assessment).

B. Non-Submission of Withholding Tax Statements

i.      The assessing officer must issue a notice under Sections 165(2) and 165(3), requiring the taxpayer to submit the missing withholding tax statements.

2. Failure to comply may lead to the imposition of penalties under Section 182 of the Ordinance.

C.  Alternative Remedies Under the Ordinance for Section 161 Non-Compliance

If a taxpayer fails to comply with withholding tax obligations under Section 161, even after a penalty has been imposed under Section 182, the assessing officer should take the following steps:-

i. Passing an Ex-Parte Order Under Section 161

• If a withholding agent fails to deduct tax or short-deduct tax, the assessing officer may proceed with an ex-parte order under Section 161, determining the tax recoverable.
• The order should specify the amount of tax not deducted, short deducted, or not deposited and the taxpayer against whom the liability is established.
• The taxpayer is given an opportunity to reconcile their records during the proceedings, but if they remain non-compliant, the order is passed based on available evidence.

ii.  Imposition of Default Surcharge Under Section 205

• If the taxpayer does not deposit the determined amount, a default surcharge under Section 205 is imposed on the outstanding liability, which continues to accrue until full payment is made.

iii.    Recovery Proceedings Under Sections 137 & 140

• Once an order under Section 161 is passed and the taxpayer does not comply, the assessing officer can initiate recovery proceedings under Section 137 (tax demand becomes due within 30 days).
• If the taxpayer still fails to pay, further action under Section 140 (attachment of bank accounts, sale of assets, etc.) can be taken.

iv.    Penalties and Prosecution Under Sections 182 & 191

• Failure to deposit withholding tax may attract penalties under Section 182.
• Continued willful default may lead to criminal prosecution under Section 191, which includes fines and imprisonment.

Step 4:       Initiation of Rule 44 Reconciliation Proceedings

Once compliance with income tax return filing and withholding tax statement submission is ensured, the assessing officer may proceed by Issuing a notice under Rule 44, requiring reconciliation of the tax deducted as per the withholding statements with the return of income. This step ensures procedural fairness, legal compliance, and due diligence, minimizing unnecessary litigation while securing government revenue.

Step 5:     Verification and Reconciliation

Before initiating proceedings under Section 161, the tax department must conduct a reconciliation exercise by:

i.      Cross-checking withholding tax records with the taxpayer’s financial statements and other relevant documentation.

2. Reviewing previous tax filings to confirm whether the alleged tax liability has already been paid under a different category.
3. Identifying any clerical errors or misclassification of expenses.

Where necessary, the taxpayer may approach for clarification before formal proceedings are initiated.

Step 6:     Conclusion of reconciliation proceedings under Rule 44

Legal Basis: Principles of Due Process & Fair Adjudication

1. Objective

i.      The purpose of the confrontation notice is to provide the taxpayer with a final opportunity to explain discrepancies before formal proceedings commenced under section 161 of the Ordinance.

2. This ensures that taxpayers are not arbitrarily declared as “taxpayers in default” without a comprehensive review.

2. Contents of the Confrontation Notice

The notice must:

i.      Identify and highlight specific discrepancies between the withholding statements and the income tax return.

2. Clearly state the grounds of dissatisfaction with the taxpayer’s reconciliation.
3. Provide supporting evidence or analysis from the tax department.
4. Allow the taxpayer a reasonable timeframe (at least 15 days) to submit further clarifications or documentary evidence.
5. Notify the taxpayer that in case of non-compliance or an unsatisfactory response, proceedings under Section 161(1) of the Ordinance will be initiated.

The above-noted contents of the notice are supported by the judgment of the Hon’ble Supreme Court of Pakistan titled CIR, Zone-1, LTU, Lahore Vs MCB Limited, (2021 SCMR 1325) and the judgments of the Lahore High Court, Lahore titled Pepsi Cola International (Pvt.) Ltd Vs Federation of Pakistan etc, (PTCL 2023 CL 71), The CIR Vs Marwat Enterprises (Pvt) Ltd, (2023 PTD 732), M/s Noon Sugar Mills Ltd Vs FOP, (2015 PTD 1653), WP No. 25020 of 2014 RE: Sahir Associates (Pvt) Ltd Vs FOP,  Akhtar Saeed Medical & Dental College Vs FOP, etc (2015 PTD 267), M/s Nishat Chunian Vs Federal Board of Revenue, (2014 PTD 2078) and

3. Taxpayer’s Right to Respond

i.      The taxpayer may submit additional records, explanations, or revised reconciliations.

2. If the explanation is considered satisfactory, the case may be closed without further action.

4. Final Review by the Assessing Officer

• If the taxpayer’s response is unsatisfactory, the assessing officer may proceed with issuing a formal show-cause notice under Sections 161(1) and/or 161(1A).

This step ensures procedural fairness and reduces unnecessary litigation, aligning with judicial precedents and tax law principles.

Step 7:     Issuance of Show Cause Notice Under Sections 161(1) and 161(1A)

If non-compliance is established, the assessing officer issues a show cause notice under:

i.      Section 161(1) (for failure to deduct or short deduction of tax).

2. Section 161(1A) (for failure to deposit deducted tax).

The notice must specify:

i.      The nature and amount of tax that was not deducted or short deducted.

2. The legal provisions under which liability arises.
3. The response deadline for the taxpayer (at least 15 days).
4. Instructions to submit supporting documentary evidence again.

Step 8:     Taxpayer’s Response and Reconciliation Submission

The taxpayer must submit a written explanation with supporting documents, including:

i.      Withholding tax records and reconciliations.

2. Payment vouchers, invoices, and financial statements.
3. Proof of tax already deducted and deposited (if applicable).
4. Justification for any misclassification or clerical errors.

If the response is satisfactory, the assessing officer may withdraw the proceedings.

Step 9:    Consideration of Taxpayer’s Explanation and Decision Making

The assessing officer reviews the taxpayer’s response and supporting documents.

i.      If the explanation is accepted, a formal order of no liability is issued.

2. If the response is unsatisfactory, the taxpayer is declared “taxpayer in default” under Section 161.

Step 10: Issuance of Order Under Section 161 and Imposition of Default Surcharge Under Section 205

i.      If non-compliance is confirmed, the assessing officer issues an order under Section 161, determining the tax liability.

2. A default surcharge under Section 205 is imposed, calculated from the due date of the tax until its actual payment.
3. The final order must state:

a)    The determined tax liability.

b)    The applicable default surcharge.

c)    The due date for payment.

d)    The taxpayer’s right to appeal.

Step 11:   Right to Appeal and Review Process

Legal Reference: Sections 127 & 131 of the Ordinance

• If dissatisfied, the taxpayer may file an appeal before:

a)    The Commissioner (Appeals).

b)    The Appellate Tribunal Inland Revenue (ATIR) under Section 126A.

The appellate authorities assess the case based on procedural compliance, legal validity, and evidentiary support.

Step 12:   Recovery Proceedings (If Necessary)

Legal Reference: Section 137 of the Ordinance

If the taxpayer fails to pay the determined liability, tax authorities may initiate recovery proceedings, including:

a)   Attachment of bank accounts.

b)   Freezing of assets.

c)    Other enforcement actions under tax recovery laws.

By adhering to this structured process, tax authorities can ensure fair, transparent, and legally compliant proceedings, thereby reducing disputes and securing the national exchequer’s rightful revenue.

7.      Section 224 of the Ordinance stipulates that any proceedings conducted under the Ordinance before the Commissioner are deemed to be judicial proceedings. In light of this, it is imperative for the Assessing Officer (AO) to maintain a comprehensive and accurate record of all proceedings on the order sheet. This includes documenting every reconciliation proceeding scheduled with the taxpayer, as well as any correspondence, requests for information, or clarifications made during the reconciliation process.

Maintaining a detailed order sheet serves several critical purposes:

1.   Ensures Fairness and Transparency: By recording all interactions and actions taken, the process reflects a fair and transparent approach, safeguarding the rights of both the department and the taxpayer.

2.   Adherence to Due Process: A well-documented order sheet demonstrates compliance with legal and procedural requirements, reinforcing the integrity of the proceedings.

3.   Facilitates Dispute Resolution: In the event of litigation or appeals, the order sheet serves as a clear and reliable record of the actions undertaken, providing clarity on the issues raised, the taxpayer's responses, and the AO's determinations.

Therefore, it is crucial for the AO to diligently record all relevant proceedings and activities on the order sheet to uphold the principles of fairness, accountability, and legal compliance throughout the legal process.

8.      Based on the structured process outlined above for declaring a taxpayer in default under Section 161 of the Income Tax Ordinance, 2001, the following deficiencies can be identified in the current case proceedings against the appellant:

Deficiencies in the Process:

1.   Non-Adherence to Step 1: Identification of Non-Compliance

i.      Before assuming jurisdiction under Rule 44 and Section 161, the assessing officer was required to verify whether the payment in question (Rs. 102,419,112) actually constituted "Royalty" and whether tax withholding was legally mandated.

ii.     The taxpayer's later clarification suggests that the classification of expenses was erroneous. This should have been verified before issuing a notice under Section 161(1A).

iii.    No prior inquiry was conducted to confirm the nature of the expense, as required by judicial precedents (CIR vs. Islam Steel Mills and M/s Nishat Chunian).

2.   Failure to Conduct Proper Reconciliation Before Issuing Notice Under Section 161(1A) (Step 5)

i.      Before initiating proceedings under Section 161, a reconciliation exercise should have been carried out to cross-check the withholding records, tax return, and financial statements.

ii.     The tax authorities did not proactively verify whether the disputed amount was incorrectly classified before serving the notice.

iii.    Judicial precedent (MCB Limited, 2021 SCMR 1325) supports that taxpayers must be given a proper opportunity to reconcile discrepancies.

3.   Failure to Issue a Confrontation Notice (Pre-Show Cause Notice) (Step 6)

i.      No confrontation notice was issued before serving the show-cause notice under Section 161(1A).

ii.     The confrontation notice should have specifically pointed out the discrepancies and allowed the taxpayer to explain before initiating formal proceedings.

iii.    The lack of this notice violates procedural fairness and due process, as emphasized in cases like Pepsi Cola International (PTCL 2023 CL 71) and Marwat Enterprises (2023 PTD 732).

4.   Issuance of Notice Under Section 161(1A) Without Ensuring Compliance with Preliminary Steps.

i.      The notice under Section 161(1A) was issued without first confirming whether:

a)   The taxpayer had filed the relevant withholding statements correctly.

b)   The expense classification was accurate.

ii.     The taxpayer's explanation (submitted in July 2023) indicates that no royalty payments were made, and a transcription error occurred. This should have been examined before initiating formal default proceedings.

5.   Failure to Grant a Reasonable Opportunity to Respond (Step 7 & Step 8)

i.      The taxpayer was served with a notice on January 2, 2023, with a deadline of January 10, 2023, for compliance. This provided an unreasonably short time (only 8 days) to respond to a complex tax dispute.

ii.     No reminders or follow-ups were made between January and July 2023 before taking adverse action. The authorities should have formally reminded the taxpayer before proceeding.

6.   Lack of Proper Evaluation of Taxpayer’s Explanation (Step 9)

i.      When the taxpayer finally submitted an explanation on July 27, 2023, along with audited financial statements, the tax authorities should have objectively assessed whether the claim was valid.

ii.     There is no indication that the department conducted an independent verification of the explanation. If the classification error was genuine, the case should have been closed without further proceedings.

Conclusion & Recommendations:

i.      The proceedings under Section 161(1A) were initiated prematurely, without fulfilling the due diligence and reconciliation steps outlined in the tax law and judicial precedents.

2. A confrontation notice should have been issued before the formal notice to allow the taxpayer to clarify the classification error.
3. The taxpayer’s explanation (submitted in July 2023) should be objectively examined, with due regard to the financial statements.
4. If the taxpayer’s claim is found valid, the proceedings should be withdrawn to prevent unnecessary litigation.

By addressing these deficiencies, tax authorities can ensure compliance with procedural fairness and avoid unnecessary disputes.

9.      In light of the foregoing discussion, the proceedings initiated directly under Section 161 and subsequently concluded by the impugned order issued by the assessing officer are annulled. The case is remanded with instructions to strictly adhere to the prescribed procedure before issuing a well-reasoned order. Furthermore, as highlighted by the appellant’s authorized representative, the assessing officer, after issuing the impugned order, subsequently issued a notice dated 18.12.2024 under Rule 44 of the Income Tax Rules, 2002, and those proceedings are still ongoing. Therefore, it is directed that these proceedings be consolidated upon receipt of this order, and a fresh order be issued accordingly.

10.    Let this order be sent to the learned Member (Operation) and Member (Legal) Federal Board of Revenue for the purposes of issuing instructions to all assessing officers to ensure compliance with the aforementioned legal provisions, procedures, directions, and their mandatory nature. They should also be apprised of the serious consequences that will follow for any officers who fail to strictly adhere to these provisions and procedures.

        

	Sd/- (M. M. AKRAM) JUDICIAL MEMBER
Sd/- (IMRAN LATIF MINHAS) ACCOUNTANT MEMBER