a pportionment of d eductions karachi tax bar association presented by : haider ali patel 10...

APPORTIONMENT OF DEDUCTIONS

Karachi Tax Bar Association

Presented by : Haider Ali Patel

10 September 2011

APPORTIONMENT OF DEDUCTIONs

APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13

Historical Perspective

Apportionment of expenses has been in vogue even before

the promulgation of Income Tax Ordinance, 2001

FBR Circular No. 12 of 1991 laid down the basis of

apportionment of expenses among sources of income

taxable under presumptive and normal tax regime

Circular 12 also directed apportionment of expenses in case

of income from other sources


Historical Perspective (cont’d.)

Apportionment of expenses largely done in cases where

revenue was subjected to Presumptive as well as normal

taxation

The department however carried out apportionment of

expenses in cases that declared exempt income mainly

capital gains and tried to disallow expenses to the extent

allocable to exempt income





Varied decisions were pronounced by various benches of

the Tribunal however, in the case reported as (2005) 92

TAX 128, a larger bench of the Tribunal held that

expenditure relating to a particular class of income should

be allowed and expenditure relatable to exempt income

may only be disallowed after proper examination of the

nature of expense and its relativity to such income




In Atlas Investment Bank V/s. CIT reported as 2005 PTD

2586, the Hon’ble Sindh High Court observed that the

concept of apportionment is very old and is in practice

from the very inception of Income Tax Law in the sub-

continent. Previously, it was being acted upon on the

basis of judicial pronouncements and on the interpretation

of provisions contained in the law and now that principle

has been given legislative recognition



The Law

Where an expenditure relates to –

(a) the derivation of more than one head of income; or

(b) derivation of FTR income; or

(c) derivation of income chargeable to tax under a head of income and to some other purpose

The expenditure may be apportioned on any reasonable basis taking account the relative nature and size of the activities to which the amount relates


APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Rule for specific identifiable expenses [Rule 13(2)]

Any expenditure that is incurred for a particular class or

classes of income shall be allocated to that class or

classes, as the case may be

Any expenditure can be-

Any particular administrative expense

Financial cost

Any other expense incurred directly related to a

particular income



Rule for non specific common expenses [13(3)(a)] (cont’d.)

Any common expenditure [other than expense allocated as per

sub rule 13(2)] allocation formula is A x B/C where –

A. is the amount of the expenditure incurred

B. is the total amount of gross receipts (without deduction

of expenditures) for the tax year for the class of income

C. is the total amount of gross receipts (without deduction of expenses) and net gains for the tax year of all classes of income;



Rule for allocation in case of other income -

Rule 13(3)(b)

Where, allocation is required between normal business

income and any net gain, brokerage, commission and

other income, such income shall be compared with gross

profit from business for adopting figures for components

“B” and “C” of the formula instead of gross receipts



Consideration of nature and source of each activity -

Rule 13(4)

Where expenditures are to be allocated among different

classes of income under sub-rule (3), consideration shall

be given to the nature and source of each class of

income, on reasonable basis to earn each class of

income (particularly, in allocating selling expenses)



Certification by External Auditors – Rule 13(5)

Where books of accounts are maintained, a certificate by a CA or

CMA stating the basis of allocation shall be accepted unless

significant variations are found

Where books are not required to be audited, the reasonable

basis may be adopted which would be accepted by the

Commissioner, unless variation is found

Significant variations would be beyond the limits of 10 + in

collection as in sub-rule (3) under any head of account



Class of income

(a) Pakistan-source income and foreign-source income

chargeable under the head “Salary”

(b) Pakistan-source income and foreign-source income

chargeable under the head “Income from Property”;

(c) Pakistan-source income and foreign source income

chargeable under the head “Income from Business”

(other than income subject to section 19);



Class of income (cont’d.)

(d) Pakistan-source income and foreign-source income

from a speculation business chargeable under the

head “Income from Business”;

(e) Pakistan-source income and foreign-source income

chargeable under the head “Capital Gains”;

(f) Pakistan-source income and foreign-source income

chargeable under the head “Income from Other

Sources”;



Class of income (cont’d.)

(g) income exempt from tax;

(h) Income chargeable to tax under section 5, 6 or 7;

and

(i) amounts to which section 169 applies



Common expenditure

Expenditure that is not clearly allocable to any particular

class or classes of income, such as general administrative

and other such allocable expenditures



Issues of reasonable basis of allocation

Rule 13(2) needs to be adopted first and where it is not

possible to allocate specific expenses then only general

allocation rule should be applied

Every revenue stream may not necessarily have related

expenditure for e.g.

Dividend income

Capital gains


Issues of reasonable basis of allocation (cont’d.)

Revenue based allocation cannot always be a reasonable

basis of allocation

There can be different basis of allocation for e.g. source of

funds utilized needs to be examined in allocating financial

expenses to interest income or capital gains




Issues of reasonable basis of allocation (cont’d.)

Where taxpayer has regular streams of revenue/ income

from different sources for e.g. trading and manufacturing

activity

A good practice would be to prepare segmented Profit &

Loss account, whereby all expenses would be allocated

to the related activities based on certain criteria and

reasoning



Issues of reasonable basis of allocation – Case Law

Bolan Bank V/s. Additional Commissioner

ITRA No.101 of 2008

The Bank itself apportioned/ allocated certain expenses to

dividend income. The Taxation Officer summarily rejected the

apportionment and made apportionment out of administrative

and financial expenses on revenue basis of allocation. The

Hon’ble High Court rejected the apportionment and remanded

the case directing the Taxation Officer to give reasons as to

why the allocation made by the Bank is not acceptable



Issues of reasonable basis of allocation – Case Law

The Commissioner (IR) V/s. Habib Bank AG Zurich

ITRA No.104 of 2010

The Hon’ble High Court held that after filing of a statement by

the taxpayer giving basis of apportionment made by it, the only

way that it could be rejected would be by giving cogent

reasons that the expenses that are claimed to be related are

proved as not relatable


APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13Issues of reasonable basis of allocation – Case Law

The Commissioner of Income-tax V/s. K. Raheja Corporation P.

Limited

2011 PTR 886 (HC Bombay)

The assessee had investments in shares & mutual funds of

Rs.20 crores on which it earned tax-free dividend of Rs.13.35

lakhs. The assessee also had borrowed funds on which it

claimed deduction of interest of Rs.8.70 crores. The AO

disallowed interest of Rs.2.79 crores on the ground that it was

relatable to earning tax free dividend. The Tribunal deleted the



disallowance on the ground that the investments had been

made out of the assessee’s own funds and not out of the

borrowed funds. The department filed an appeal before the

High Court. HELD dismissing the appeal that the department

could not make out a case that the Tribunal’s findings were

incorrect



The Commissioner of Income tax V/s. Dawood Lawrencepur

Limited

2011 PTD (Trib.) 845

The assessee submitted a certificate issued by Chartered

Accountant as per sub-Rule (5) of Rule 13. The certificate was

disregarded and expenses were apportioned to income from

capital gains and dividend income on the basis of turnover.

Amended assessment was set-aside by the learned Tribunal

for denovo proceedings

THANK YOU

a pportionment of d eductions karachi tax bar association presented by : haider ali patel 10...

Documents

case of income

particular income slide

exempt income

head of income

classes of income

basis of apportionment

particular class of

concept of apportionment