1. A PPORTIONMENT OF D EDUCTIONS Karachi Tax Bar Association Presented by : Haider Ali Patel 10 September 2011

2. A PPORTIONMENT OF D EDUCTIONs Page 2 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

3. A PPORTIONMENT OF D EDUCTIONs Page 3 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 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13

4. A PPORTIONMENT OF D EDUCTIONs Page 4 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Historical Perspective (cont’d.) 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

5. A PPORTIONMENT OF D EDUCTIONs Page 5 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Historical Perspective (cont’d.) 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

6. A PPORTIONMENT OF D EDUCTIONs Page 6 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

7. A PPORTIONMENT OF D EDUCTIONs Page 7 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

8. A PPORTIONMENT OF D EDUCTIONs Page 8 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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;

9. A PPORTIONMENT OF D EDUCTIONs Page 9 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

10. A PPORTIONMENT OF D EDUCTIONs Page 10 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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)

11. A PPORTIONMENT OF D EDUCTIONs Page 11 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

12. A PPORTIONMENT OF D EDUCTIONs Page 12 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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);

13. A PPORTIONMENT OF D EDUCTIONs Page 13 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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”;

14. A PPORTIONMENT OF D EDUCTIONs Page 14 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

15. A PPORTIONMENT OF D EDUCTIONs Page 15 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

16. A PPORTIONMENT OF D EDUCTIONs Page 16 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

17. A PPORTIONMENT OF D EDUCTIONs Page 17 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 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13

18. A PPORTIONMENT OF D EDUCTIONs Page 18 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

19. A PPORTIONMENT OF D EDUCTIONs Page 19 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

20. A PPORTIONMENT OF D EDUCTIONs Page 20 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 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

21. A PPORTIONMENT OF D EDUCTIONs Page 21 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Issues 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

22. A PPORTIONMENT OF D EDUCTIONs Page 22 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Issues of reasonable basis of allocation – Case Law 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

23. A PPORTIONMENT OF D EDUCTIONs Page 23 APPORTIONMENT OF DEDUCTIONS – Section 67 and Rule 13 Issues of reasonable basis of allocation – Case Law 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

24. T HANK Y OU