For business information, annual reports, laws, ordinances, regulations and articles.

	Web Paksearch.com

(1) The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other state but only so much of them as is attributable to (a) that permanent establishment, (b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of the same or similar kind as those affected through that permanent establishment.

(2) Subject to the provisions of paragraph (3), where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

(3) In the determination of the profits of a permanent establishment there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement o actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise by way of interest on moneys lent to the head office of the enterprise or any of its other offices.

(4) Insofar as it has been customary in a Contracting State to determine the profits to be attributed to a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts, nothing in paragraph (2) shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary; the method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article.

(5) For the purposes of the preceding paragraphs, the profits, to be attributed to the permanent establishment shall be determined by the same method year-by-year unless there is good and sufficient reason to the contrary.

(6) Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.

NOTE: The question of whether profits should be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods and merchandise for the enterprise was not resolved. It should therefore be settled in bilateral negotiations.

44. Scope
the business profit of a foreign enterprise is taxable only if it has a permanent establishment in the other Contracting State. Article 7 is a corollary to Article 5 whereunder the expression ‘permanent establishment’ has been defined, and has, therefore, to be read in the continuation of that Article. The taxability of business income of a foreign enterprise depends upon two questions: one, whether the enterprise has a permanent establishment in the source State; and second, if the answer is in the affirmative, what are the profits on which the permanent establishment should pay tax. For an answer to the first question, reference has to be made to Article 5 and for that to the second, to Article 7.

The concept of permanent establishment determines the tax jurisdiction of the source country; so that possibility of dispute between States regarding taxability of income is averted. The tax claim of the two States both legitimately interested in taxing business income is regulated by Articles 5 and 7.

Business profits, subject to the double taxation agreement, derived by a foreign enterprise could be taxed in the source State only if it has a permanent establishment in that State, and only to the extent as are attributable to the permanent establishment.

45. Business profit from transaction outside permanent establishment is also taxable
Paragraph (1) is the amplification of the corresponding provision of the OECD Model Convention, as it gives tax jurisdiction not only to the profits attributable to the permanent establishment [clause (a)] but also to those arising from the transactions outside the permanent establishment [clauses (b) and (c)]. The permanent establishment is equated with ‘residence’ so that once it is found to be existing, the foreign enterprise becomes chargeable to tax in respect of transactions not associated or connected with it. non-business income, or the business income which is not associated or connected with the permanent establishment, becomes taxable in the source country, if the foreign enterprise is found to be maintaining a permanent establishment in that country irrespective of whether that establishment has been instrumental in the generation of that income. This is popularly known as ‘force of attraction’ rule, which enunciates that income arising from all sources in a country, where a foreign enterprise maintains a permanent establishment is subject to tax in that country. Its application has been limited, however, only to the business income, and not extended to income from investment, such as dividends, interest, royalties and rents, which are covered by other provisions of the convention.

45.1. Business profits are taxable to the extent attributable to permanent establishment - The important question which concerns taxation of business profit in a foreign country is about its calculation. For that matter determination of the gross profits and thereafter determination of the expenses incurred for the purposes of the business are necessary to arrive at the net profits. The entire profit of an enterprise is not subjected to tax; but only so much is subjected as is attributable to--

(a) the permanent establishment;
(b) sales in the host country of goods or merchandise of the same or similar kind as sold through that permanent establishment; or
(c) other business activities carried on in the host country of the same or similar kind as those effected through that permanent establishment.

The condition to be satisfied is that the enterprise must carry on business in the host country through a permanent establishment situated therein before any income of a foreign enterprise is taxed as business profit. Only when does such an establishment exist, profits could be taxed; and not otherwise. Once this condition having been satisfied, it is not always necessary for the taxability of profits that all sales of goods or merchandise be effected, or the entire business activities be routed through the permanent establishment. The ‘attribution’ principle of the OECD Model [see agreement with Belgium] has been amplified by UN Model by the so-called principle ‘force of attraction’ which permits an enterprise to be taxed on business profits in other State arising from transactions outside the permanent establishment. Sale of goods or merchandise of the same or of even similar kind as those sold through the permanent establishment, or the carrying of the business activities which are of the same or similar kind as those effected through the aforesaid establishment, may attract tax in the host country on so much profits as are attributable to such sale or activities. However, in some agreements, the provision about the attribution of profits to business activities carried on in the host country of the same or similar kind as those effected through permanent establishment, does not exist. Thus, in those cases, if business activity is undertaken in the host country which is not effected through permanent establishment, the profits arising therefrom cannot be taxed as business profits. The exercise about the attribution of the profits has to be undertaken when (i) the sale or business is effected through permanent establishment, or (ii) when it is done not through that establishment excepting in cases where such provision does not exist as in the case of agreement with Belgium.

According to the OECD Model, profits attributable to the permanent establishment is taxable in the source country. The OECD view is based on the principle that the revenue authorities of the host country should focus their attention to the separate sources of profits of the enterprise and tax the profit of that source which is worked out through the ‘permanent establishment’. It ignored completely the other well-recognised rule of ‘force of attraction’.

45.2. Attribution rule and Income Tax Ordinance, 1979 - The Income Tax Ordinance contains provisions which corresponds ‘attribution rule’, known as ‘business connection’. If all the operations of a business are carried out in Pakistan, the entire income accruing therefrom shall be deemed to have accrued in Pakistan. If however, all the operations are not carried out in Pakistan, the profits and gains of the business deemed to accrue in Pakistan through or from business connection in Pakistan shall only such profits and gains as are reasonably attributable to that part of the operations carried out in Pakistan. If no business operations are carried out, it follows that the income accruing or arising abroad through or from any business connection in Pakistan cannot be deemed to accrue or arise in Pakistan. The expression ‘business connection’ postulates a real intimate relation between the trading activity carried on outside the taxable territories and the trading activity within the taxable territories, the relation between the two contributing to the earning of income by the non-resident in his trading activity. Whether it is goods that are supplied or services that are rendered, the common thread of the mutual interest must run through the fabric of the trading activities carried on outside or inside of the taxable territories. That is what has been described by the judges as the ‘real and intimate connection’. the commonness of the interest may be by way of management, control or financial control or by way of sharing of profits. It may also come into existence in some other manner. But there must be something more than a mere transaction of sale or purchase between the principal and principal. There should be real and intimate relation between trading activity carried on outside the taxation territories and trading activities within the territories. An isolated transaction does not mean a ‘business connection’.

45.2-1 Doing business/doing business with or within a country - The expression ‘doing business’ means soliciting orders, purchases, service contracts, opening offices (liaison offices or branches) or any other activity commercial in nature or incidental to and in the prosecution of commercial gain or for the purpose and object of business organisation. Thus, the branches of foreign corporations if engaged in any of the activities as aforesaid, could be said to be the projections of those corporations. The mere activity which facilitates receipt of orders from the local distributors without contributing anything towards pricing, distribution or marketing product would not render it the status of ‘doing business’. The activity if merely confined to purchase of goods in Pakistan, or to collection of news and views in Pakistan for transmission outside (in case of a non-resident engaged in the business of running a news agency, or of publishing newspapers, magazines or journals) or to the shooting of cinematograph film in Pakistan cannot yield income which could be taxed in Pakistan.

Doing business with a country connotes exporting goods or merchandise capital, services, technical know-how and expertise, providing patent rights, etc. It has no bearing on investment or flow of investment from one country to another. Many merchants and manufacturers export their goods to all parts of the world, but no one can say they exercise or carry on trade in every country in which their goods find customers. If all that a merchant does in any particular country is to solicit orders, he cannot reasonably be said to exercise or carry on his trade in that country. What is done there is only ancillary to the exercise of his trade in the country where he buys or makes, stores or sells his goods. Solicitation of customer in a country by a foreign merchant would not in all cases amount to an exercise by him in his trade ‘within’ country. If contract is made abroad, and the delivery takes place there, the mode in which the orders are solicited and obtained, whether by an agent or by circulars or advertisements does not make any difference. For a non-resident to be charged to tax, it is necessary that he should exercise trade within Pakistan, as distinct from exercising trade with Pakistan. Mere seeking orders is not by itself conclusive of a non-resident carrying business in Pakistan.

Doing business within a country means indulging actively in some economic activity in that country that produces income through an agent or broker or directly by establishing a branch or any other type of permanent establishment.

46. Determination of profits and arm’s length method
Worldwide income of a person is taxed by the country, when such a person is resident of that country in terms of its income-tax law. This is also provided in the double taxation agreements. But such a provision is not enough to debar a country of which the person is not resident to tax that amount of income which could be attributed to the business activities in the territories of that country. The double taxation agreements normally provide that the business profits earned within the other country can only be taxed where such profits are attributable to a ‘permanent establishment’ located in that country. How this could be done, has been provided in paragraph (2) of Article 7.

The establishment in a country can be treated as if it were completely independent of the head office in another country and were dealing at arm’s length with it, and the profits which such an independent enterprise might be expected to derive on the amount so ascertained.

Where a Contracting State includes in the profits of an enterprise of that State-and taxes accordingly - profits on which an enterprise of the other Contracting State have been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first-mentioned State if the condition made between the two enterprises has been those which could have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of tax charged therein on those profits. In determining such adjustments, due regard shall be had to the other provisions of this convention and the competent authorities of the Contracting States shall if necessary consult each other.

This Article does not seek to avoid double charge to tax which arises where the profits of one associated enterprise are increased to such a level where they exceed what they would have been if they had been correctly computed on an arm’s length basis. the other State is committed to make an adjustment of the profits of the associated company if it considers that such adjustment is justified in principle and also in amount. This matter has been discussed in detail in the Chapter dealing with Article 9.

47. Relevant questions regarding taxability of income in Pakistan
Paragraph (3) of the Article deals with determination of profits of a permanent establishment. A foreign enterprise which carries on business or trading activities in Pakistan, which produces income, is taxable in Pakistan as income from business. The following questions at once arise in the mind of that enterprise:
- What could be taken as business or trading activity?
- When income from such activity is deemed to be present?
- What income and expenditure are taken into consideration, i.e., how the taxable profits are worked out?
- How much is the tax rate?

47.1 Business and trading activity - Income from business of an industrial or commercial nature conducted by a non-resident which has a source in Pakistan, will be subjected to tax in Pakistan and computed and assessed in accordance with the provision of the Pakistani Income Tax Ordinance. However, industrial, commercial or business profits, subject to a tax agreement, would be taxed on the basis of the concept of permanent establishment. Under an agreement a corporation is resident in, and subject to tax on its worldwide income in, only one country. But where the profits are attributable to business activities carried on in another country, that country cannot be prevented from taxing such income which could be so attributed. The concept of ‘permanent establishment’ thus becomes relevant for determining the extent of business activities, to which a portion of the profit could be attributed. The agreement provides that business profits earned within the other country can only be taxed where such profits are attributable to a ‘permanent establishment’ located in that country. If a non-resident does not have a permanent establishment in Pakistan, he will not be subjected to tax in Pakistan in respect of any of the industrial, commercial or business profits.

47.1-1 Concept of business - The expression ‘business’, though extensively used in taxing statutes, is used in the sense of occupation, or profession which occupies the time, attention and labour of a person, normally with the object of making profit. The word ‘business’ is an etymological chameleon; it suits its meaning to the context in which it is found. It is not a term of legal art and its dictionary meanings embrace almost anything which is an occupation, as distinguished from a pleasure anything which is an occupation or a duty which requires attention is business.

To regard an activity to be business, there must be a course of dealings either actually continued or contemplated to be continued with a profit motive; there must be some real and systematic or organised course of activity or conduct with a set purpose of making profit. To infer from a course of transactions that it is intended thereby to carry on business, ordinarily there must exist the characteristics of volume, frequency; continuity and system, indicating an intention to continue the activity of carrying on the transactions for a profit. But on single test or group of tests is decisive of the intention to carry on the business. It must be decided in the circumstances of each case whether an inference could be raised that the assessee is carrying on the business within the meaning of the statute.

The expression ‘profit motive’ does not suggest that the profit must in fact be earned. Nor does the expression cover a mere desire to make some monetary gain out of a transaction or a series of transactions. It predicates a motive which pervades the whole series of transactions, effected by the person in the course of his activity.

Business, as contemplated, is an activity carried on with a profit motive, the activity being manual or mercantile, as distinguished from the liberal arts or learned profession or agriculture. If the transactions are many and on a large scale, it is said commerce. The continuous repetitions of such transactions would constitute business. Business involves a constant flow of transactions upon transactions every day, subject to risks, vicissitude requiring overt acts of management by those who wish to profit by it. Thus a real, substantial and systematic or organised activity or conduct with a set purpose is called business. Therefore, a nexus with the profit of the commercial activity, is an essential ingredient of a business. ‘Business’ in taxing statute has not been used in isolation but has been used in connection with earning of profits or gains from it being carried on. Whether a particular activity amounted to any trade, commerce or manufacture is always a difficult question to answer. The Privy Council in CIT v. Shaw Wallace & Co. observed that though words used to define ‘business’ are wide but underlying each of them is the fundamental idea of the continuous exercise of an activity.

Therefore, carrying on business connotes some substantial, systematic and organised activity with the object of making gain or profit therefrom, with the inevitable control and direction of such activity or business. Consequently, the two faces of the coin of carrying on a business imply a control or direction o the business activity with a direct or indirect nexus with the profits or losses therefrom, of course, subject to any express terms of the contract. In the converse, it necessary follows that if there is neither control not direction of the activity of a business nor a direct nexus with its gain or profit, then a person or an assessee cannot possibly be said to have carried on such a business.

The Indian Supreme Court in CIT v. A. Dharma Reddy held that the word ‘business’ has been defined in section 2(13) of the Indian Income-tax Act of 1961 [Parallel to section 2(11) of the Income Tax Ordinance, 1979; both the provisions are identical] as including any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. These words are of wide import and underlying idea being of continuous exercise of activity.

Business is contemplated to be a real, substantial and systematic or organised course of activity or conduct, capable of producing a profit which could be taxed.

47.1-2 Business includes professional and commercial services - However, the expression ‘business’ does not necessarily mean trade or manufacture only, it is being used as including within its scope professions, vocations and callings for a fairly long time, that is any activity which is carried on continuously and systematically by a person by the application of his labour and skill with a view to earning income. The activities which constitute carrying on of business need not necessarily consist of activities by way of trade, commerce or manufacture or activities in the exercise of a profession or vocation. They may even consist of rendering services to other which services may be of variegated character. These are material and professional services. Material services are not services which depend wholly or largely upon the contribution of the professional knowledge, skill or dexterity for the production of a result. Such services being given individually by individuals are services no doubt but not material services. Even an establishment where many professionals operate cannot be said to convert their professional services into material services. Material services involve an activity carried on through the cooperation between employers and employees to provide the community with the use of something, such as electric power, water, transportation, mail delivery, telephones and the like. In providing these services there may be employment of trained men and even professional men, but the emphasis is not on what these men do but upon their productivity of service organised as an industry and commercially viable. Thus, the services of professional men involving benefit to individuals according to their needs such as doctors, teachers lawyers, solicitors, etc., are easily distinguishable from an activity such as transport service. The latter is of commercial character in which something is brought into existence quite apart from the benefit to particular individuals. It is the production of something which is described as the production of material services.

Section 22 of the Ordinance contemplates a dichotomy between ‘business’ and ‘profession’. The expressions ‘business’, ‘profession’ including ‘vocation’ have been used in contradistinction to each other, and having regard to the scheme of taxation underlying the Ordinance, the conclusion irresistible that the word ‘profession’ is of wider import than the word ‘business’ and the word ‘vocation’ is of wider import than the word ‘profession’ and lastly ‘occupation’ is a word of wider signification than the word ‘vocation’. In other words, what may not amount to business may amount to vocation and what may not amount to vocation may amount to occupation within the meaning of the Ordinance.

* Distinction between business and profession - The blurring of the distinction between these words could be found in the decision of the Indian Supreme Court in Bangalore Water Supply & Sewerage Board v. A. Rajappa The Indian Supreme Court was concerned with the question whether the Bangalore Water Supply Board and certain other entities could be considered ‘industry’ within the meaning of the Industrial Disputes Act, so that the provisions of that Act could apply to them. The Court considered the case of a hospital, a university, a library, a service club, a local body, a research institute, a pinjrapole, a chamber of commerce and a Gandhi Ashram. All these were taken to be industries to which the provisions of the Industrial Disputes Act applied. In the course of the judgment Krishna Iyer, J., who delivered the leading judgment, referred to a decision in Management of Safadar Jung Hospital v. Kuldip Sindh Sethi and the following observations of Hidayatullah, CJ. therein:

"A profession ordinarily is an occupation requiring intellectual skill often coupled with manual skill. Thus a teacher uses purely intellectual skill while a painter uses both. In any event, they are not engaged in an occupation in which employer and employees co-operate in the production or sale of commodities or arrangement of their production or sale or distribution and their services cannot be described as material services."

Krishna Iyer, J. was not prepared to agree with this, and it was stated that where there was a systematic activity organised by co-operation between the employer and the employees for production of goods and services calculated to satisfy human wants and wishes, prima facie, was an industry in that enterprise and that the true focus was functional and the decisive test was the nature of the activity with special emphasis on the employer-employee relationship, and if the organisation was a trade or business, it did not cease to be one because of philanthropy animating the undertaking. The result was that the distinction between a trade and a profession was practically annihilated in view of the definition of ‘industry’ given in section 2(1) of the Industrial Disputes Act.

But such annihilation could be limited to the matter falling under the Indian Industrial Disputes Act. The definition of the expression ‘industry’ in the Industrial Disputes Act is as wide as the Legislature could have possibly made it. The expression ‘industry’ has many meanings. It means ‘skill, ‘ingenuity’, ‘dexterity’, ‘diligence’, ‘systematic’, ‘word or labour’ ‘Bahitual employment in the productive acts’, ‘manufacturing establishments’, etc. The expression ‘industry’ ordinarily means the process of manufacture or production. While construing word which occurs in a statute or a statutory instrument in the absence of any definition in that very document, it must be given the same meaning which it receives in ordinary parlance or understood in the sense in which people conversant with the subject-matter of the statute if statutory instrument understand it. It is hazardous to interpret a word in accordance with its definition in another statute and more so when such statute or statutory instrument is not dealing with any cognate subject. When the word to be construed is used in a taxing statute or a notification issued thereunder it should be understood in its commercial sense.

* Whether an activity is a business or profession or admixture of both - The Income Tax Ordinance is of no assistance in determination of question whether a particulars activity or course is profession, vocation or occupation, as the definitions of ‘business’ and ‘profession’ are not exhaustive. The question must be answered by giving these words their plain and ordinary meaning. The expression ‘business’ has been used in the Ordinance in a commercial and limited sense, but there is no warrant in the Ordinance to give the expressions ‘profession’, ‘vocation’ or ‘occupation’ a limited meaning.

The expression ‘profession’ includes vocation [section 2 (35) of the Ordinance]. The expression ‘vocation’ means a calling, an occupation; it is different from a business or a profession in the sense that it denotes an activity or pursuit in which a person regularly devotes his time and skill. ‘Vocation’ is a much wider term than profession, though not as pervasive as occupation. Vocation is a sphere of activity for which one has special fitness. It is not necessary that such activity should be one indulged in for earning a livelihood before it could be called vocation. A motive for making a profit is an essential requisite for a vocation. It is also a settled position in law that in order to become a vocation an activity need not be organised.

Once a receipt can be linked to a profession or vocation, it is liable to tax as profits and gains of a profession or vocation even though the payer might have made the payment voluntarily by way of gift or gratuitously.

A mere windfall or a gift from an outside organisation may not be liable to be treated as part of the receipts of a business/profession.

An assessee who is a professional and an expert contemporaneously can carry on a trade which is annexed to the exercise of his profession. An activity, though garbed as profession, may really be a commercial or in any event, the vocation of the assessee or may be admixture of both.

* Can professional activity be tinged with commercial character - Even a professional activity can be tinged with a commercial character if indicia of commerce are manifest in it. If a doctor who has acquired X-ray plant undertakes the job of doing X-rays for other doctors along with that for his own patients as an aid for diagnosis his activity is in no way different from a non-qualified person carrying on a radiological clinic. The mere fact that a professional man had, as an adjunct to his professional activities, such a clinic did not disable him from running it as a commercial venture and earning income therefrom. A medical practitioner can have a medical shop in which medicines are sold not only to his patients, but also to other who come and ask for them. In such a case, it cannot be gainsaid that he was carrying on a trade as such. Medical practitioner running a nursing home is another illustration of a professional man carrying on a business activity.

The learned professions of medicine, law and theology enfold into their conclave only members who practise such professions as a vocation and not as a trade. But in these days of advanced science and ebullient development commensurating with the need of the community, society and country, a professional activity may be interpreted in a commercial way. An expert professionalist, if he has the inclination, capacity and zeal to expand his activities may do so. As a result thereof he might tread into the arena of business activity. Such a composite activity is conceivable and indeed is plausible in modern days. No doubt, no decisive test can be laid down but the multitude of incidents holding the same might reflect on the true nature of the vocation. If, therefore, an expert equips himself with plant and machinery with which he, with the aid of his professional skill and in collaboration with the qualified assistants, is able to turn out an activity which is not strictly a professional activity but savours of a commercial activity as well, is to be understood still that he is mechanically exercising his profession. Any kind of commercial activity telescoped to professional activity ought to be understood as a business, as is properly understood. In such circumstances it may be that the business aspect of the activity springs from the professional activity of the person concerned and is irretrievably connected with it. Nevertheless, if it is said that if there is an organic and composite activity and if there is a merger of professional skill with trading or business, the poser to be answered is whether the combined endeavour results in emoluments which, though not strictly termable as profits, are really gains in the shape of profits. If the answer is in the affirmative, it is a business as it is the outcome of combined efforts.

Though under the Income Tax Ordinance, 1979, the dividing line between business or profession is tenuous, and income from each is assessable under the same head, the double taxation agreements, UN and the OECD Model Conventions provide separate Articles for computation of profits from business and from professional services, the content of these Articles being, however, the same. The phraseology used is different, though they convey similar meaning. What is ‘permanent establishment’ to business is the ‘fixed base’ to professional services and other activities of independent nature. The income covered by the special Article (Article 14 in this case) be taxed either separately, or as industrial and commercial profits in conformity with the tax laws of the Contracting States. Income from professional services and other activities of independent nature if cannot be taxed under Article 14 because of the absence of conditions as laid down in that Article, can be so done in the source country by virtue of Article 7 if its nature qualifies as commercial and industrial profits (for detailed discussion see Chapter dealing with Article 14).

* Any activity though strictly not business but carried by a company is a business activity - The consideration which applies in the case of individuals in the matter of determining whether activities constitute business, may not apply in the case of incorporated companies, which may be formed for purposes other than carrying on business. Though virtually any commercial activity or adventure amounts to a business for the purpose of the Income Tax Ordinance, 1979, it is not every occupation which results in monetary gain that constitutes business. The management of the landed estates may be profitable but it does not necessarily fall within the definition of ‘business’. The double taxation agreement uses the expression ‘business profits’ unlike the Income Tax Ordinance ‘profits and gains of business or profession’. Profits in common parlance means excess of income over expenditure. ‘Gains’ is also a word of very wide import. A man working for gain is not necessarily engaged in trade or business.

Business includes any trade, commerce or manufacture or any adventure in the nature of trade, commerce or manufacture [section 2(11) of the Income Tax Ordinance, 1979]. Business is, therefore, an activity of a commercial nature.³² There are many things which in common colloquial English language would not be called a business, even when carried on by a single person which would be so called when carried on by a number of persons. That is a distinction not to be forgotten, even if we were trying the question by the ordinary use of the English language. For instance, a man who is the owner of offices, that is, of a house divided into several floors and used for commercial purposes, would not be said to carry on a business because he let the offices as such, but suppose a company was formed for the purpose of buying a building, or leasing a house, to be divided into offices, and to be let out, should not we say, if that was the object of the company, that the company was carrying on business for the purpose of letting offices or was an office-letting company, trying it by the use of the ordinary colloquial language? The same observation may be made as regards a single individual buying or selling land, with this addition, that he may make it a business, and then it is a question of continuity. A man occasionally buys and sells land, as many land owners do, and nobody would say he is a land jobber or dealer in land, but if a man made it his particular business to buy and sell land to obtain profit, he would be designated as land-jobber or dealer in land. When you come to an association or a company formed for a purpose you say at once that it is a business because there you have that from which you would infer continuity. Thus, an activity which might not constitute business if carried out by an individual would amount to a business in the case of a company.

47.2 Income from business or trading activity - The income or profits attributable to permanent establishment is taxable. A question arises whether where an amount is not income and so not taxable under the Income Tax Ordinance or is exempt either wholly or partly, that amount should be subjected to tax in terms of the double tax agreement on the ground that it represents profit attributable to permanent establishment.

Income or profits are not usually defined in the double taxation agreements. Generally, a clause under the Article defining general terms is found, which states that any term not defined in the agreement shall, unless the context otherwise requires, has the meaning which it has for the purposes of the laws in force in the State relating to taxes. Income has been defined in the Ordinance by an inclusive definition, though the expression ‘profits’ has not been defined. However, section 22 states that the income as specified thereunder is chargeable to income-tax under the head ‘income’ from business or profession’ namely, inter alia, the profits and gains of any business or profession which is carried on by an assessee, value of any benefit or perquisite whether convertible into money or not, arising from business or the exercise of a profession.

If a receipt is not income at all, in terms of the Ordinance, or if it is of such a nature as it is not covered under the provision of section 22 of the Ordinance such amount cannot be taxed in Pakistan as a business income of the permanent establishment. Thus, if the nature of income is such as is not to be taken into the scope of chargeability thus in terms of the legal pronouncements or by virtue of the provisions of the Ordinance on account of its being exempt or not otherwise taxable, such amount has to be excluded. There is a distinction between ‘income’ and ‘taxable income.’ The Ordinance does not purport to subject all sources of income to tax, for the liability is expressly made subject to the provision of the Ordinance and among the provisions are a series of exceptions and exemptions.

47.2-1 Concept of real income - It is here the doctrine of real income creeps in. The question of how far the concept of real income enters in the question of taxability in each case and to what extent the concept of real income intermingle with the accrual of income. When and how does an income accrue and what are the consequences that follow from accrual of income are well settled. The accrual must be real taking into account the activity of the situation. Whether an accrual has taken place or not must, in appropriate cases, be judged on the principles of real income theory. After accrual, non-charging of tax on the same because of certain conduct based on the ipse dixit of a particular assessee cannot be accepted. In determining the question whether it is the hypothetical income or whether the real income has materialised or not, various factors will have to be taken into account. An acceptable formula of co-relating the notion of real income in conjunction with the method of accounting for purposes of computation of income for the purposes of taxation is difficult to evolve. It is difficult and improper to extend the concept of real income to all cases depending upon the ipse dixit of the assessee. What has really accrued to the assessee has to be found out and what has accrued must be considered from the point of the real income taking the probability and the improbability of realisation in a realistic manner and dovetailing of these factors together but once the accrual takes place on the conduct of the parties subsequent to the year of closing an income which has accrued cannot be made ‘income’.

The doctrine of real income comes in for application in two types of cases:

- Where there is surrender of income before it has accrued.
- Where there is diversion of income through overriding title

* Surrender of income before it has accrued - Income given up or foregone by an assessee on the basis of bilateral agreements or under the provisions of statutes but before its accrual, is not chargeable notwithstanding the fact that entries in respect of it has been made in his books of account which are maintained on a mercantile basis. ‘Hypothetical income’ is the income of the assessee which he could have had under the original agreement which was subsequently varied in the course of the current year reducing the quantum before its accrual and once it has accrued, it ceases to be hypothetical income. The real profits of a businessman could not obviously include the amount surrendered by him by way of rebate under statutory compulsion. It is as if he has received only the original amount minus the amount to be surrendered. The amount surrendered is not part of the profits at all. Income surrendered because of contract is not likewise included.

* Diversion of income - Receipts which are impressed with an obligation to be applied in a particular manner, may not form part of the trading receipts of an assessee. If the obligation is in the nature of a charge on the source (i.e., the profit-earning apparatus of the assessee), the income is stated to be diverted at source and when the assessee receives the amount he does so on behalf of somebody else. What has got to be considered is what is the income of the assessee and when that question arises what has got to be considered is the real income and not any artificial income. For purposes of ascertaining that real income, every part of that income which may seem to be the income, if in fact it is not his income, if that part has been diverted and never constituted his real income, has got to be excluded. Real income is what remains after deducting the amount which may be said to have been diverted and, which never constituted the real income of the assessee and such amounts will have to be excluded from the consideration before the real income of the assessee is reached.

When we say that the effect of the overriding title diverts income at source, it does not mean to suggest that the sale proceeds or the gross receipts also belong to the title holder, and the recipient of the proceeds or the gross receipts also belong to the title holder, and the recipient of the proceeds or receipt is his agent. The dealings in the transaction, resulting in the sale, are done by the concerned person with the other parties not as an agent of the person who would ultimately be the beneficiary of income and who has a right to claim it before the amount of income becomes the income of that person.

47.2-2 Tests to determine whether income is diverted at source - The real test in this respect has been laid down by the Indian Supreme Court in CIT v. Sitaldas Tirathdas⁴⁰in the following words:

"...the true test, is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one’s own income, which has been received and is since applied. The first is a case in which income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable." (P. 374)

In order that a payment should be treated as a diversion at source it is necessary that it should have been made under some legal obligation. Such obligation must attach to the source of income. In other words, for such a payment, there should be an overriding charge; a charge which is created under any law for the time being in force or by virtue of any court’s decree, or by agreement or by a voluntary settlement or the obligation must be such, though not made a specific charge on the property, can be enforced in court of law.

47.2-3 Diversion versus application of income - The obligation as a result of which income is diverted at source is substantially different from the obligation in which income is applied after its accrual or receipt. The obligation in the former kind ordinarily arises out of an overriding charge existing either upon the asset or its income or is traceable to an assignment or creation of a superior title over it or springing from a division of assets between joint owners or co-owners and requires that the income which accrues or is received from such asset should be applied to discharge the said obligation. The obligation of the latter kind is usually undertaken or incurred by the taxpayer, be it by virtue of a decree, settlement, agreement, testamentary direction or the like and requires that a portion of one’s own income after its accrual or receipt should be paid to another to get relieved of the said publication. In the former case, there should be diversion of income is such a way that it never becomes the income of the taxpayer. An obligation which diverts the income at source may be treated by charging the property or by making the source of income the capital asset of another (as in the case of sub-partnership) or by an obligation to pay the price of acquiring a business or capital asset from its income. But, however, the fact that an assessee is constrained to apply income in a particular manner either under a statute or under certain contract, would not affect its liability to tax. Profits do not change their character because these are intended to be applied for charity, and those would continue belonging to the assessee.

In the case before the Bombay High Court in CIT v. Naritnan B. Bharucha & Sons⁴⁶, there was a clause in the partnership deed according to which after the death of one of the partners, the partnership business was to be continued by the other two partners, who were the sons, in equal shares, but subject to paying their mother 25 per cent of the net profits of the partnership. It was held that the document of partnership created an overriding title in the mother of the two surviving partners to the extent of 25 per cent of the profits of the partnership firm, and that the said amount was liable to be diverted before the profits reached the partnership of the assessee-firm.

Ordinary, a person who is not a party to the contract cannot enforce a payment, but provision to make payment of the amount to the widow of the deceased partner was held in CIT v. Crawford Bayley & Co., as an absolute obligation in the nature of trust. Such payment was to be made even if there were no profits or whatever made by the firm and as such there could be no question of application of the income of the assessee-firm after the same had accrued. Such payments had to be made by reason of an overriding title.

If an assessee sets apart a sum of money every year for meeting its unknown liability in business, it cannot be said that the sum so set apart has been diverted at source by an overriding title. Similarly, if a sum is set apart under a compulsion of law for meeting unknown business needs of the company, a diversion of income at source by an overriding title does not take place. The Indian Supreme Court in the case of CIT v. Jatan Trading Co. (P.) Ltd, considered the concept of real income in the context of the assessee’s obligation to part with 75 per cent of net profits to a firm Jalan Trading Co., as a consideration for assigning the selling agency in favour of the assessee.

The contention of the assessee was that when 75 per cent of the net profits had been paid to the firm, the real income in its hands was reduced to 25 per cent of the net profits and that amount alone be subjected to tax. This contention was not accepted by the Indian Supreme Court on the ground that if the amount had been spent on obtaining a capital asset, the assessee would not be entitled to claim it as a deduction, and that income-tax is to be levied on the real income and so the amount paid for obtaining capital asset would not be deductible.

The following propositions emerge:

* It is the income which has really accrued or arisen to the assessee that is taxable. Whether the income has really accrued or arisen to an assessee must be judged in the light of reality o the situation.

*The concept for real income would arise where there is surrender of income which in theory may have accrued but in reality of the situation, no income has resulted because the income did not actually accrue.

* The concept of real income should not so read as to defeat the provisions of the Ordinance.

* If there is any diversion of income at source under any statute or by overriding title, then there is no income to the assessee.

* Mere improbability of recovery cannot be treated as evidence of the fact that income has not accrued or resulted.

* The concept of real income is certainly applicable in judging whether there has been income or not. But in every case it must be applied with care and within well recognised limits.

47.2-4 Whether gain on account of fluctuation in exchange rate amounts to income - A question may arise whether on account of fluctuations in exchange rate in respect of foreign assets of a company or of any other assessee could be subject-matter of profits and gains of a business. The verdict of the House of Lords in Pattison v. Marine Midland Ltd., has pronounced a historical principle. A United Kingdom resident bank carried on business in international commercial banking. For the purpose of making dollar loans and advances in the course of its banking business, it borrowed 15 million US dollars in the form of subordinated loan stock, redeemable in 10 years. As a result of exchange rate fluctuations, the sterling value of the loans to its customers increased, but so also did the liability in sterling term of the loan stock. After 5 years the loan stock was repaid out of the existing dollar funds and at no time was any of the 1.5 million dollars converted into sterling. The assessee has been evaluating the monetary assets and liability denominated in a foreign currency is sterling at the exchange rate at balance sheet date and showing no profit or loss to the extent that currency liabilities were matched by currency assets. The revenue was seeking to assess to tax a profit on the transaction which produced no economic gain and no which no profit was shown in the accounts. The Court of Appeal and the House of Lords held that no profit or loss arose for tax purposes, other than those which arose from an unmatched position as included by the assessee itself in the profit and loss account and accounted for tax purposes. This practice reflected the bank’s success or failure in acquiring and holding an excess of foreign currency over its foreign currency liability which it was due to convert.

This judgment indicates that where currency borrowings are matched by currency assets in circumstances that no exchange adjustments are made to the profits and loss account, the capital or current nature of the borrowing will no longer be relevant in determining whether such adjustments are to be made for computing trading profits or losses. Exchange differences arising on long-term borrowings are not to be distinguished and adjusted for the purposes of computation of profits and gains of an assessee. This decision, however, has not resolved the controversy. As for Pakistani tax laws are concerned, the matter does not admit of any controversy. If by virtue of exchange operations profits are made during the course of business and in connection with the business transactions, the amount received because of variation in currency rates is revenue receipt. But if the profit by exchange operations comes in not by way of business of the assessee, the profit is taken on capital account. The test is, whether the profit arises out of any trading activity. It is not sufficient to be taxable if it is in any way connected with the trade o that assessee. Trading activity should be originating source. Receipt of amount more than what would have been received otherwise would not transform the extra amount on account of the fluctuation into a trading profit, unless such receipt has a reasonable nexus with the trading activity or holding or dealing in foreign exchange o the particular currency is the trading activity of the assessee. Even where the stock-in-trade remains unused or unsold, the mere book appreciation in the value thereof cannot be brought to tax. But where an assessee himself declares the surplus resulting from the currency fluctuations as his income, the matter may be different.

47.2-5 Exploitation of commercial asset, whether business income - It is a well settled principle that if an assessee derives any income by exploitation of its commercial assets whether itself or through other agencies such income should normally be considered to be the business income of the assessee. If a commercial asset is not capable of being used as such, then its being let out to others does not result in an income which is the income of the business, but it cannot be said that an asset which is acquired and used for the purpose of the business ceases to be a commercial asset of that business as soon as it is temporarily put out of use or let out to another person for use in his business or trade. The yield of income by a commercial asset is the profit of the business irrespective of the manner in which that asset is exploitated by the owner of the business. He is entitled to exploit it to his best advantage and he may do so either by using it himself personally or by letting it out to somebody else.

47.2-6 Letting/leasing of commercial assets, whether business income - If the asset remains a commercial asset in the hands of the assessee after the letting out arrangement has been made the income continues to be classed as business income. But if it ceases to be a commercial asset, then the income has to be treated as ‘income from other sources’ [section 30 of Income Tax Ordinance, 1979]. When an asset ceases to be a commercial asset is a question which has been the subject matter of debate before various High Courts and the Supreme Courts of Pakistan and India. Before the Indian Supreme court not less than four times the question arose whether a business concern in any particular period has not carried on any business yet no general principles are laid down. In CEPT v. Shri Lakshmi Silk Mills Ltd. the Indian Supreme Court categorically stated that ‘no general principle can be laid down’. The question however, was considered from the standpoint when a concern ‘ceased to be a commercial asset’. The question again was considered in Narain Swadeshi Wug Mills v. CEPT and broadly the question was considered from the standpoint o view when a concern ceased to be a commercial asset and the referred question was returned. In New Savan Sugar & Gur Refining Co. Ltd. v. CIT, the Indian Supreme Court again reiterated that no general principle can be laid down. The fourth occasion arose in Karanpura Development Co. Ltd. v. CIT.⁵⁹ In this case, the concept of ‘commercial asset’ was not preferred, but the facts were considered from the standpoint of ‘trading receipts in business’. What activity of a concern is considered as cessation of trading operation, it was observed, ‘the dividing line is difficult to find, but in case of a company with its professed objects and manner of its activities and the nature of its dealings with its property, it is possible to say on which side the operations fall and to what head the income is to be assigned’. The Andhra Pradesh High Court in CIT v. Aryan Industries (P.) Ltd. observed that the totality of circumstances are to be considered to hold whether an asset ceased to be a commercial asset. Thus it would be seen that there is no consensus though there is an attempt to lay down a general principle. There is discussion in some cases of High Courts in Pakistan and India whether it is from the standpoint of ‘lull’ in activity of the business or what is the nature of the trading receipt or whether as a fact the commercial asset ceased to do business, etc.

In whiteman Wheatcraft on Income-tax and surtax, 1971 Edition, the authors propounded two theories-one relevant to ‘the nature of any change in the trading activities’, secondly ‘any change in ownership of the trade terminating the existing trade and commencing a new trade’.

The question whether income arising from the exploitation of an asset is a business income, could be answered on consideration of the following aspects:

- Whether an asset has not ceased to be a commercial asset?
- Whether the assessee has not intended to stop the business?
- What is the nature of trading receipts?

What is a commercial asset and when it ceased to be so and becomes a capital? The test appears to depend on the nature of the asset. If an asset has been exploited commercially before the lease is given, then the question can easily be decided by determining the intention of the parties. But when the asset has never been previously commercially exploited, it may be urged that the asset has not become a commercial asset, and cannot become a commercial asset by merely letting it out. this raises a fundamental question as to what is a commercial asset.

It would appear that a commercial asset is a term utilised in reported cases to define a capital asset which is used in a business. If you have an asset, you can exploit it in various ways. You can use it in business yourself by actually running it. It may be a car, it may be a mill, it may be a shop or it may be any other asset which can be commercially exploited. At the same time you can use the same asset to yield rent by giving it on hire under a hire-purchase agreement to some other person. If such an asset which is or can be commercially exploited is given on hire or rent to some other person, then the question will arise: Is the asset being commercially exploited by the owner? For answering this question one has to examine the facts existing before the asset was leased out and then one has to see the subsequent facts. From these facts, one can infer what was in the mind of the assessee or the person concerned.

It is not necessary that in order that the income of the assessee should be business income it should be produced by the assessee utilising the business asset itself. So long as these assets are used as business assets, it is irrelevant whether the business assets are exploited and used by the assessee itself or someone else. Sometimes the assessee may stop doing business. These assets then cease to have the character of the business or commercial assets and take on an entirely different character. They become capital assets, and qua those assets the assessee has become their owner. As an owner the assessee may also exploit those assets and receive income. But the income which it receives is no longer business income because no business is being carried on and the assets are not business assets. In such a case the income would be an income derived by the owner from his capital assets, and the relevant section for the Income Tax Ordinance, 1979 would be section 30 and not section 22.

Whether a business is carried on or not and whether assets of an assessee are business assets or not are questions of fact, and they should be decided by the authorities on the evidence led before them.

Whether the assessee intended to go out of the business altogether is another aspect to be seen. In Shri Lakshmi Silk Mills Ltd. (supra), it was held that the leasing of the dyeing plant for a short period was a business venture. In Ram Mahadeo Prasad v. CIT newly set up oil mills were let out temporarily and the Court held that the assets were commercial assets. In CIT v. Vikram Cotton Mills Ltd. it was held that the company had no intention to permanently discontinue its business, that the income derived from the lease of plant and machinery was income from business and that the income so derived could be set off against losses of the company from the business of the manufacture of textile brought forward from the preceding year. In Addl. CIT v. Rajindra Flour & Allied Industries (P.) Ltd. the Delhi High Court held that the leasing of the mill was essentially a temporary measure to tide over a period of difficulties and the letting must be taken as one possible way available to the assessee for exploiting its commercial assets and had to be treated as part and parcel of its carrying on of the business and, therefore, the income from the lease was to be computed under the head ‘Profits and gains of business or profession’. The Delhi High Court in another case of CIT v. Northern India Theatres (P.) Ltd. held that the leased of cinema house coupled with interest free loan was an arrangement made by the assessee-company for both financing the setting up of the cinema and the exploitation of the same is a commercial manner, and hence the assessee’s income from letting out the cinema was assessable as business income.

In Aryan Industries (P.) Ltd.’s case (supra), it was held that while the length of the lease period is undoubtedly a relevant circumstance in finding out the intention of the assessee, it is not conclusive that on the facts and in the circumstances of the case, the assessee could not be said to have stopped exploiting the asset as a commercial asset and had expressed its intention of discounting the business altogether.

In Narain Stvadeshi Wug. Mills’ case (supra) it was held that profit from leasing of the plant and machinery was not a business income. In New Savan Sugar & Gur Refining Co. Ltd.’s case (supra), it was held that the intention of the assessee was not to treat the factory and machinery as a commercial asset during the subsistence of lease, and was to go out of the business altogether so far as the factory and machinery was concerned, and the intention was to use the income arising from the royalty in its capacity as the owner of the factory. In Seth Banarsi Das Gupta v. CIT, it was held that lease of partnership asset which was let out after the business had been closed did not yield income under the head "Profits and gains of business or profession’.

In Sultan Bros. (P.) Ltd v. CIT, the assessee had set up a hotel and let that out on a monthly rent. On consideration of the lease, the Court held that the intention of the lessee was to enjoy the rent from the building, that the assessee was not running the business through the agency of another, but was merely enjoying rent from the building and furniture.

The Andhra Pradesh High Court in Guntur Merchants Cotton Press Co. Ltd. v. CIT held that the assessee-company did not exhibit any intention to revive its business and hence letting out of the godowns and the factories with machinery did not amount to carrying on of business by the assessee.

In CIT v. Super Fine Cables (P.) Ltd., the Delhi High Court answered the question whether the income arising out of the letting out of the factory building was assessable under the head ‘Income from other sources’ in the affirmative and in favour of the revenue, that income has to be assessed as income from other sources.

	Web Paksearch.com

Home | About Us | Contact | Information Resources