Recent Developments in Direct Taxation

Venue : IMC Hall, Churchgate, Mumbai

Speaker : Pinakin D. Desai, Chartered Accountant

The learned speaker explained the decision of Ishikawa
Jima Harima Heavy Industries Ltd. v. CIT, (288 ITR 408) (SC) which had laid
down the theory of Territorial Nexus for taxing the income of a non-resident in
India. The learned speaker was of the view that the retrospective amendment by
the Finance Act was made with a view to overrule the said decision as well as
the ratio of :

Subsequent to the amendment, the Mumbai Tribunal in the case
of Ashapura Minichem Ltd. (2010) (5 Taxman 57) made a distinction between
rendering of service in India and provision of service in India, viz.,
provision of service in India does not require that the service must be
performed or rendered in India. The speaker observed that in the context of
territorial nexus the rendition and provision of service should have been
regarded synonymous conditions. However, since this aspect was not addressed by
the Tribunal, the controversy in regard to whether or not the test of Ishikawa
is satisfied in case of a NR performing service from outside India remains open.

In the opinion of the speaker the following situations would
not be affected by amendment :

2. The next development discussed was the taxability of
shares received by non-corporates. S. 56 was amended w.e.f. 1st June 2010 to
hold that in case of a partnership firm or a closely-held company, if there is
receipt of shares of a closely-held company, without consideration or for a
consideration less than the fair market value (FMV), then such shares would be
liable to tax in the hands of the recipient if the difference between the FMV
and the consideration exceeds Rs.50,000.

As per the explanatory memorandum, the purpose of this
provision was to capture the clandestine transactions in the transfer of
property through the medium of shares. The speaker felt that this intent may not
be appreciated by lower judicial forums and that could result in problems in
respect of genuine transactions.

According to the learned speaker the amendment would not
apply to the following assets :

Areas of concern would be receipt of bonus shares, rights
shares, receipt of shares on amalgamation, conversion, split, etc.

3. The third amendment was the insertion of S. 47(xiiib). The
speaker was of the view that the following conditions specified may pose a
challenge for a smooth conversion of a company to an LLP :

Another issue would be as regards the operation of S. 79. In
the opinion of the speaker, the term shareholding has been defined very
restrictively by courts and hence, conversion to LLP could constitute change in
shareholding and as a result the benefit of carry forward of losses may be lost.

The fourth issue was regarding losses in respect of transaction in derivatives. The learned speaker felt that the CBDT issued Instruction to Assessing Officers to disallow losses in respect of such transactions decision of the Apex Court in Woodward Governor India P. Ltd. (312 ITR 254]  Actual losses allowable only if the transactions qualify as ‘eligible derivative transactions’ under clause (d) of proviso to S. 43(5)  : There have been judicial decisions that if a derivative transaction, not covered by S. 43(5)(d), is a hedging transaction, then the onus is on the assessee to prove the same. However, once it has been proved, then the transaction has to be treated as a business transaction and not as a speculation transaction. Hence, this part of the instruction is also questionable.

  4.  The speaker then discussed various proposal mooted by the Direct tax code (DTC) the concept of place of effective management (POEM) proposed by the DTC. According to judicial forums POEM would be where the Board of Directors or Executive Directors make their decisions. In such a case a wholly-owned foreign subsidiary of an Indian company would have a POEM in India and therefore become resident.

The provision regarding Controlled Foreign Company (CFC) proposes to tax passive undistributed income of a CFC of a resident. In respect of the passive income earned by a Foreign Company (FCo) controlled directly or indirectly by an Indian resident, the DTC proposes that income not distributed shall be deemed to be dividend received from FCo.

As a result, there could be double taxation. The income of the CFC would be taxed once in the hands of the FCo on the basis of residential status and again, in the hands of the ICo on the basis of the CFC provisions.

General Anti-avoidance Rules (GAAR), gave immense powers to the Assessing Officer to disregard an arrangement that had been entered into by a taxpayer for the purpose of obtaining a tax benefit. According to the speaker, GAAR would apply to a transaction if while obtaining a tax benefit, the transaction fulfils any one of the following four conditions  :

The learned speaker then discussed the concerns regarding the implementation of GAAR provisions.

  5.  Finally, the following recent rulings were discussed by the learned speaker  :

Credit entry in debtor’s account not necessary to constitute ‘write-off’ for the purposes of bad debt write-off deduction u/s.36(1)(vii).

AO does not have power to ‘review’ his own order. S. 147 permits reassessment where there is ‘reason to believe’. Reassessment on change of opinion is review of order.

S. 5(2) creates charge for NR Company, inter alia, in respect of income received in India. If first receipt in kind is in India, subsequent sale and realisation outside India does not impact taxation.

Law as applicable on 1st day of relevant assessment year applies to carry forward and set-off of Unabsorbed Depreciation (UD). S. 32(2) was amended substantively from A.Y. 2002-03 and position applicable to A.Y. 1996-97 was restored. Such amendment is not applicable to UD of the period from A.Y. 1997-98 to A.Y. 2001-02.