SHC strikes down section 5 of the Income Tax Ord 2001

KARACHI: An appellate bench of High Court (SHC) struck down section 5(A) of the Income Tax Ordinance 2001 for being ultra vires of the Constitution.

The bench in its judgment declared that insertion of section 5A in the Income Tax Ordinance 2001, including amendments thereto from time to time, does not fall within the parameters delineated per Article 73 of the Constitution of Pakistan, 1973, hence, the provision impugned is found to be ultra vires of the Constitution, and is hereby struck down.  As a consequence, any show cause / demand notices 24 or constituents25 thereof, seeking enforcement of section 5A of the Income Tax Ordinance 2001, are hereby set aside, the bench said.

The petitions were filed by, Sapphire Textile Mills Limited, Reliance Cotton Spinning Mills Ltd and 47 other companies. Hyder Ali Khan advocate lead the case for petitioners.

The petitioners have assailed the vires of section 5A (“5A”) of the Income Tax Ordinance 2001 (“Ordinance”) and seek for the same to be ultra vires of the constitution.

According to counsel for Petitioners section 5A was initially inserted in the Ordinance, vide the Finance Act 2015 (“FA 2015”) and amended, relevant to the present lis, vide the Finance Act 2017 (“FA 2017”), ostensibly in order to induce certain (not all) public companies to distribute dividends among their shareholders2 . The said section reads as follows  “Tax on undistributed profits. (1) For tax years 2017 to 2019, a tax shall be imposed at the rate of five percent of its accounting profit before tax on every public company, other than a scheduled bank or a modaraba, that derives profit for a tax year but does not distribute at least twenty percent of its after tax profits within six months of the end of the tax year through cash: (Underline added for emphasis.) Provided that for tax year 2017, bonus shares or cash dividends may be distributed before the due date mentioned in sub-section (2) of section 118, for filing of a return. (2) The provisions of sub-section (1) shall not apply to (a) a company qualifying for exemption under clause (132) of Part I of the Second Schedule; and (b) a company in which not less than fifty percent shares are held by the Government.” 3. In its original form3 , as inserted per FA 2015, the tax was levied upon the reserves of a company; whereas, post FA 2017 the levy befell upon accounting profit before tax of a company.

The Petitioners counsel submitted that it was the duty of the Court to uphold the constitutionality of a statutory provision, within context, and for a tax to qualify under the Federal Legislative List it had to be covered between entries 43 to 53 therein , since the source and extent of the statutory taxing power had to be derived from a corresponding legislative entry6 . It was sought to be demonstrated that a plain reading of 5A suggests that it amounts to double taxation, as income received or taxed in the same hand ceases to be income. Per learned counsel, double taxation could only be 2 Per Circular 2 of 2015, numbered C.No.4(18)R&S/2015 and dated 24.07.2015, issued by the Federal Board of Revenue. 3 Tax on undistributed reserves. (1) Subject to this Ordinance, a tax shall be imposed at the rate of ten percent, on every public company other than a scheduled bank or a modaraba, that derives profits for a tax year but does not distribute cash dividends within six months of the end of the said tax year or distributes dividends to such an extent that its reserves, after such distribution, are in excess of hundred percent of its paid up capital, so much of its reserves as exceed hundred per cent of its paid up capital shall be treated as income of the said company. The important amendments made in the Income Tax Ordinance, 2001 through Finance Act 2015, are explained as under… 2. Tax on undistributed reserves [Section 5A] Through Finance Act, 2015 a new section 5A has been introduced whereby in order to persuade the public companies to distribute dividend among their shareholders and to encourage investment in stock market, tax at the rate of ten percent has been imposed on every public company except scheduled bank or a modaraba that derives profits in a tax year but does not distribute cash dividend within six months of the end of the tax year or where the said company distributes dividend in such a way that after distribution of the dividend, the company’s reserves are in excess of hundred percent of its paid up capital…” (Underline added for emphasis.).

The Federal Board of Revenue issued another circular, being Circular 04 of 2017, to explain the amendments in the Ordinance brought in vide the FA 2017. The circular expressly states that the basis of the levy, envisaged vide 5A, is solely dependent upon the extent to which a company distributes its profits. It may be beneficial to reproduce the pertinent constituent of the aforementioned circular herein below: “GOVERNMENT OF PAKISTAN REVENUE DIVISION FEDERAL BOARD OF REVENUE C.No. 4(49)IT-Budget/2017 Islamabad, the 6th September, 2017 Circular No.4 of 2017 (Income Tax) SUBJECT: FINANCE ACT, 2017 – EXPLANATION OF IMPORTANT AMENDMENTS MADE IN THE INCOME TAX ORDINANCE, 2001. Finance Act 2017 has brought certain amendments in the Income Tax Ordinance 2001. Some important amendments are explained hereunder: 8. Tax on undistributed profits [Section 5A] A tax on undistributed reserves was introduced vide the Finance Act 2015 … … The basis of levy of such tax, is therefore solely dependent upon the extent to which a public company distributes / disburses its after tax profits…” (Underline added for emphasis.) 8. Finally, this purpose, for inserting 5A in the Ordinance, is also borne from the budget speech of the Finance Minister, Budget 2017-2018, delineating the raison d’etre of 5A, wherefrom it was manifest that the provision was always intended to ensure that shareholders get their return on investment by encouraging companies to distribute dividends. Reliance upon the relevant budget documents is a judicially recognized means of assessment of statutory provisions, as demonstrated by the honorable Supreme Court in Durrani Ceramics and followed by this Division Bench in MSC Switzerand Geneva

It is manifest that the Act itself neither contains any mandatory requirement for declaring dividends nor any prejudicial consequences for the same. While the Parliament may have the right to vary the law in such regard, the exercise of any such right does not appear to be merited vide recourse through a money bill. Ambit of a money bill 15. The august Supreme Court has consistently maintained that bypass of the regular legislative process, by unmerited recourse to money bills, could not be appreciated. Mian Saqib Nisar J (as he then was) illumined upon the ambit of Article 73 of the Constitution in the WWF case17 and observed as follows: “not everything that pertains to finance would necessarily be related to tax. Therefore, merely inserting amendments, albeit relating to finance but which have no nexus to tax, in a Finance Act does not mean that such Act is a Money Bill as defined in Article 73(2) of the Constitution. The tendency to tag all matters pertaining to finance with tax matters (in the true sense of the word) in Finance Acts must be discouraged, for it allows the legislature to pass laws as Money Bills by bypassing the 15 240. Certain restrictions on declaration of dividend. (1) The company in general meeting may declare dividends; but no dividend shall exceed the amount recommended by the board. (2) No dividend shall be declared or paid by a company for any financial year out of the profits of the company made from the sale or disposal of any immovable property or assets of a capital nature comprised in the undertaking or any of the undertaking of the company, unless the business of the company consists, whether wholly or partly, of selling and purchasing any such property or assets, except after such profits are set off or adjusted against losses arising from the sale of any such immovable property or assets of a capital nature: Provided that no dividend shall be declared or paid out of unrealized gain on investment property credited to profit and loss account the bench noted in the judgment.

The bench after detailed hearing held that, It has been established that section 5A of the Ordinance amounts to legislation, not contemplated in the Constitution to be undertaken vide a money bill. In such a scenario no rationale has been articulated before us to justify the regulation of companies’ behavior, pertaining to dividends, to be effected vide a money bill, within the mandate of Article 73 of the Constitution, while abjuring the regular legislative process. Therefore, it is our deliberated view that section 5A of the Income Tax Ordinance 2001 cannot be sustained on the constitutional anvil; hence, could not be construed to have legal effect. 22. In view of the reasoning and rationale herein deliberated, these petitions are allowed in terms delineated herein below: i. It is hereby declared that insertion of section 5A in the Income Tax Ordinance 2001, including amendments thereto from time to time, does not fall within the parameters delineated per Article 73 of the Constitution of Pakistan, 1973, hence, the provision impugned is found to be ultra vires of the Constitution, and is hereby struck down. ii. As a consequence, any show cause / demand notices 24 or constituents25 thereof, seeking enforcement of section 5A of the Income Tax Ordinance 2001, are hereby set aside.

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