May 02, 2008	Friday	Rabi-us-Sani 25, 1429

LAHORE, May 1: A division bench of the Lahore High Court has restrained the federal government from collecting income tax on financing after declaring the practice unlawful.

Justice Nasim Sikandar and Justice Kh Farooq Saeed held that the arrangement between a borrower and a creditor -- where the borrower pledged its machinery to a financial institution for securing finance -- does not fall within the ambit of a transaction requiring tax.

The bench decided this while hearing the Income Tax Department’s appeal against the decision of the Income Tax Appellate Tribunal. The tribunal had accepted several industrialists’ appeals against the department’s refusal to stop levying tax on loans against assets.

According to the 26-page judgement, authored by Justice Kh Farooq Saeed, the industrialists imported or purchased machinery locally, and installed it in their premises. For the purpose of running the industry or business, they required finances and contacted modaraba finance companies for loans.

Modaraba finance companies, therefore, were contacted and finance was obtained through sale and lease back arrangement. During all this period, the machinery either imported or purchased by the respondent companies remained in their possession but on paper they were transferred and leased back to the petitioner.

Department’s counsel Khadim Ali Zahid said under section 50 (4) of the Income Tax Ordinance 1979 (repealed), tax was liable to be deducted from the transaction of the finance from a financial institution to a borrower. He added under section 80C all the transactions were part of ‘sale and supply’ for the purpose of tax collection.

Representing the JDW Sugar Mills, Ijaz Awan argued that the tax was being deducted (by withholding agents) fearing action by the revenue authorities. Under this pressure, they collect taxes even on the transactions out of the purview of section 50 (4).

The counsels said the amendment in the ordinance excluded buy-and-the-lease-back arrangement from the deduction of tax. The bench observed: “The language of the section 50 (4) indicated that ‘for all practical purposes it is the definition of supply of goods which would decide the issue’”.

“The department’s action of considering the purchase and lease-back arrangement as a supply in our view is a misconception as it is only a financial arrangement created to secure the transaction on the basis of earlier experiences of huge bad debts of the banks in the country,” the bench wrote. The relationship in case of banks for such and similar transactions was on the basis of providing security in terms of pledging property, the bench said.

This is neither a relationship of buyer and seller nor of demand and supply...The financial leasing industry the world over today considers the acquisition of goods by the lesser and retention of title by him as the owner, only a measure to secure its interest as a financer,” the order said.

The ownership is only a camouflage and there is not real intention on the part of the leasing company to retain it or deal in the same goods. The financial leasing transactions in reality are loan transactions, which were held to be not even chargeable to sales tax in some cases,” the bench decided.

Referring to the verdict of Justice Nasim Sikandar of the LHC in Kawther Grani (Pvt) Ltd versus Deputy Commissioner of Income Tax/Wealth Tax, the bench said the machinery fastened to earth was not covered within the definition of goods. “It has been held in unequivocal terms that once the machinery is installed in a factory, it becomes an immoveable property in terms of land, building and machinery,” the bench said.

Regarding the borrowers’ claim that they had been excluded from tax under an amendment, the bench said: “...The amendment that has excluded the purchase and lease-back arrangement from the purview of section 50 (4) has obviously come as a relief to the concerned person. It is obviously a remedial and curative legislation”.

“On one hand it has redressed the grievance of the companies obtaining loan and on the other hand cured the inconvenience the authorities caused by deducting tax and subsequently treating it as the tax payable on a revenue transaction,” the bench wrote.