Law: Income Tax Ordinance, 2001

Section: 21(c), 21(l), 22(8), 32(2), 34(3), 35, 107(1)-(2), 124A, 152(1)

Case Law Summary

Case: Second appeal (Tax Year 2014, special tax year Jan to Dec 2013), Schlumberger Seaco Inc. Pakistan Branch (SSI) v. Commissioner Inland Revenue, Appellate Tribunal Inland Revenue, Karachi
Bench: Syed Faiq R. R. (Order)
Provisions: Sections 21(c), 21(l), 22(8), 32(2), 34(3), 35, 107(1)-(2), 124A, 152(1) and (5), 174(2), 177, Income Tax Ordinance, 2001; Articles 5, 7 and 12 and Final Protocol (Ad Article 7), Pakistan-Netherlands DTA
Order impugned: CIR(A) order dated 24.11.2017 upholding the amendment order dated 04.10.2017 (demand Rs.652,041,647)

Facts

SSI is the Pakistan branch (a permanent establishment) of a Panama company providing exploration and production services to oil companies. After audit and a Section 122(9) notice (24.08.2016), the department raised a large demand. The CIR(A) remanded the school fee and tax credit issues and upheld four disallowances. Grounds (e) and (f) were not pressed, leaving four issues. A separate application on the absence of a Section 177(6) audit report was decided by a separate order (27.04.2026).

Issues

1. Leave encashment provision (Rs.10,704,463).
2. Loss on inventory sold to an associate (Rs.99,162,338).
3. Communication and stationery expense under Section 21(l) (Rs.3,340,201).
4. Service charges paid to two Netherlands companies, IRIS Express B.V. and Sophia Com B.V., disallowed under Section 21(c) for want of a Section 152(5) exemption certificate (Rs.82,011,336).

Legal Core Points

1. A leave encashment provision is an ascertained, not contingent, liability. It arises from services already rendered and the HR policy. Only the mode of settlement (availment or encashment) is uncertain, which goes to timing and not existence. It was computed arithmetically from verifiable records without actuarial assumptions. Following Oriental Dyes (1992 SCMR 763, gratuity provision), Civil Aviation Authority (2008 PTD 647, bonus) and 2013 PTD 1429, it is deductible under Section 34(3) on the accrual basis. Deleted.

2. Section 22(8) does not apply to inventory. Section 22 governs depreciable assets, while inventory is governed by Section 35. The stores and spares were consistently treated as inventory in the audited accounts (Note 2.9). The loss was the difference between cost of Rs.281,408,296 and proceeds of Rs.182,245,958, disclosed in Note 14.

3. Asymmetry and no tender requirement. The inventory sale was part of one composite Asset Sale Agreement (USD 25.9 million) on which the department accepted a much larger gain. No provision of the Ordinance requires a tender or auction for recognising a business loss, and corporate-governance principles for listed companies did not apply to this branch. The department made no arm's length or market value finding. Deleted.

4. Section 21(l) operates transaction by transaction. It does not allow aggregation of individually compliant payments. The department identified no single transaction above the Rs.10,000 threshold, and the audited books were unqualified and not rejected. A disallowance must rest on specific breaching transactions. Deleted.

5. Section 152(5) is machinery and cannot create a charge. Under Section 107(2), a treaty overrides the Ordinance. Following EFU General Insurance (2010 PTD 1159, paras 16-17), withholding provisions do not apply where income is not taxable under the treaty. So a Section 21(c) disallowance, which presupposes a valid withholding obligation, fails.

6. Article 7(1) is decisive. Business profits of a Netherlands enterprise are taxable "only" in the Netherlands absent a Pakistan PE. No PE was alleged for either payee. Article 7(3) and the Final Protocol (intra-enterprise charges) were held inapplicable since the payees are independent providers.

7. The payments are not royalties under Article 12. The subscription-based advisory and data services conferred no right to use or exploit IP. Following Inter Quest Informatics (2023 SCMR 1803; review 2024 SC 398), royalty requires a transfer of rights enabling the payer to commercially exploit the IP, and billing model or duration is irrelevant. The Ordinance definitions in Sections 2(23) and 2(54) are irrelevant to the treaty inquiry.

8. Consistency and unsupported submissions. The Tribunal's own orders for Sophia Com B.V. (Tax Years 2016 and 2018) on identical services and the same treaty were treated as supporting consistency, with a reference to Section 124A. The department's uncited reference to "recent Supreme Court guidance" was given no weight. Tax residency certificates of both payees were on record.

Order

The appeal was allowed. All four disallowances (Rs.10,704,463; Rs.99,162,338; Rs.3,340,201; Rs.82,011,336) were deleted. Grounds (e) and (f), not pressed, remain subject to the CIR(A)'s order of 24.11.2017.