Taxing what is not 'income'-II

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

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

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

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

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

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

1. It is an established position of law that compensation relating to capital asset is a capital receipt and that relating to stock-in-trade is revenue receipt as held in Commissioner of Income Tax (East) Karachi v Forbes Campbell & Co. Ltd [1979] 39 TAX 21 (H.C. Kar.). Compensation on delayed refund is capital receipt as it represents damages received for depriving the taxpayer of his capital and not stocks-in-trade.

2. Payment under section 171 of the Ordinance is in the nature of damages as it is not "profits or gains" derived from any activity or investment. It is part and parcel of capital sum due, hence not "income".

3. Additional payment on delayed refund is, in fact, part of the refund due and on payment it merges into refund- the two are not different things but accretion in refund due because of infringement of law by Tax Department. Any relief granted to a taxpayer for compensation of violation of his right is not income.

4. Excess funds (refund due) retained by the Tax Department beyond the prescribed limit are not an investment by taxpayer. Excess money if remained un-paid after due date attracts additional payment that is not "earned income". For that money, Tax Department stands in a fiduciary position to the taxpayer. Violation of fiduciary responsibility entails additional payments that cannot be termed "income" within the widest possible scope of Entry 47 of Part I, Fourth Schedule to the Constitution. If it does not fall in this Entry then Entry 52 imposing tax in lieu of it is also ousted.

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

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

(Concluded)

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

Copyright Business Recorder, 2020