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Month: April

Business expenditure — Capital or revenue expenditure — Capital work-in-progress written off — Salary and professional fees expenditure incurred in respect of projects abandoned to conserve cash flow — Revenue expenditure

1 Principal CIT vs. Rediff.Com India Ltd.

[2022] 441 ITR 195 (Bom)
Date of order: 29th September, 2021
S. 37 of ITA, 1961

Business expenditure — Capital or revenue expenditure — Capital work-in-progress written off — Salary and professional fees expenditure incurred in respect of projects abandoned to conserve cash flow — Revenue expenditure

The assessee abandoned some of its incomplete website projects, which were not expected to pay back. The assessee wrote off expenses on account of capital work-in-progress pertaining to such abandoned projects and claimed deduction thereof as revenue expenditure u/s 37 of the Income-tax Act, 1961. The Assessing Officer held that the expenditure was incurred for creating new projects and represented capital assets of its business that were to yield enduring benefit and that by claiming such expenditure under the head ‘capital work-in-progress’, the assessee itself had admitted that those expenses were capital in nature and disallowed the assessee’s claim of writing off ‘capital work-in-progress’.

The Tribunal held that the expenses incurred were in connection with the existing business and were of routine nature, such as salary and professional fees, and that the expenses were revenue in nature and allowed the assessee’s claim.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“The Tribunal’s view that if an expenditure was incurred for doing the business in a more convenient and profitable manner and had not resulted in bringing any new asset into existence, such expenditure was allowable business expenditure u/s. 37 was correct. The expenditure incurred was on salary and professional fees which was revenue in nature and did not bring into existence any new asset. There was no perversity or application of incorrect principles in its order. No question of law arose.”

THE CANTEEN BILL

Here is a story of a raid by Excise authorities. I am told this is a true incident that occurred in Pune.

Mr. Joshi was a hardcore technocrat but an accomplished businessman, very disciplined and upright, and uncompromising on his principles. His business of manufacturing certain engineering goods was very prosperous. Mr. Joshi believed in clean and transparent financial records. Therefore, his company’s Chartered Accountant never had any difficulty completing his audit, submitting all documents and other forms under any law, tax payments, and other compliances. The CA’s fees also used to be paid regularly and in time, within seven days from receiving his invoice.

All the workers and staff members of Mr. Joshi’s company were well trained, satisfied with the working conditions, happy with the remuneration and naturally, loyal to the company. In short, it was a dream situation for all concerned – a role model. The assessments of income and all other revenue laws were very smooth.

The Revenue authorities were rather unhappy with this type of an assessee. They had no ‘incentive’ in this case. Mr. Joshi did not mind fighting up to the highest forum for justice. If there was anything unfair in any law, he had the courage to raise his voice against it and approach the Government for necessary amendments. The Revenue authorities used to think twice before raising any objection on his records or his stand.

In short, Mr. Joshi’s position in his business and his performance on all fronts was too nice to be true! But fortunately, it was a reality. Naturally, some people were jealous due to rivalry. They used to file mischievous complaints against him.

One day, there was a raid on his factory on the pretext of some ‘information’. The Authorities came with the police force. Mr. Joshi coolly received them and asked them to go to any place and check anything, but warned them that they should not harass any employee or disturb the production process. He told them that they could meet him after they finished. The employees also were calm and undisturbed.

The authorities resorted to all types of tricks and intimidating tactics. They checked everything very thoroughly and interrogated the staff. Mr. Joshi was in his cabin throughout the day, entertaining his visitors. At the end of the day, the authorities were tired. They could not find any flaw. They virtually surrendered and wound up the raid. They came to meet Mr. Joshi who smilingly inquired whether they found anything and said that if anything were even slightly wrong, he would close his business! He maintained his cool despite some over smartness of the authorities. He apologised that he could not spare time for them since he had important visitors from abroad.

The authorities finally said, “we would get nothing out of the raid, especially when we saw that during lunchtime, your tiffin came from your residence, and you and your two sons had your lunch without even offering anything to us!” They admitted that it was an unprecedented experience for them!

“OK, Mr. Joshi, we have finished our job. Congratulations on your excellent, disciplined and transparent record keeping. We take your leave”.

“Oh! How can you leave like that? You had lunch and snacks in our canteen; and this is the bill of our canteen – Rs. 24,370. I will appreciate it if you clear it before leaving, as the canteen-man is accountable for this!’ said Mr. Joshi.

Is any of us having such a client?

EXTENDING THE SCOPE OF REASSESSMENT

ISSUES FOR CONSIDERATION
Section 147, applicable up to 31st March, 2021, empowers an Assessing Officer (AO) to assess or reassesses the income in respect of any issue which has escaped assessment and which has come to his notice subsequent to the recording of reasons and the issue of a notice u/s 148, in the course of reassessment proceedings. The relevant part of the said section reads as under:

‘If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or re-compute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned.’

Section 147, effective from 1st April, 2021, has dispensed with the condition of ‘reason to believe’. Instead, a new provision in the form of section 148A has been introduced to provide for compliance of a set of four conditions by an AO before issuing any notice u/s 148. The Explanation thereto empowers the AO to reassess an income in respect of an issue for which the four conditions of s. 148A has not been complied with.

This Explanation is materially the same as Explanation 3 of s. 147 applicable w.e.f. 1st April, 2021, with a change that reference to ‘reasons recorded’ is substituted by ‘compliance of s.148A of the Act’.

Explanation 3 to s. 147 was added w.r.e.f. 1st April, 1989 by Finance (No. 2) Act, 2009 for providing that the reassessment would be valid even where the reasons recorded did not include an issue that has escaped assessment. The said Explanation reads as under:

‘For the purpose of assessment or reassessment under this section, the Assessing Officer may assess or reassess the income in respect of any issue, which has escaped assessment, and such issue comes to his notice subsequently in the course of the proceedings under this section, notwithstanding that the reasons for such issue have not been included in the reasons recorded under sub-section (2) of section 148.’

On the insertion of Explanation 3 to s. 147 by the Finance (No.2) Act, 2009, the then-existing conflict between various decisions of the Courts regarding the expansion of the subject matter of reassessment beyond the reasons recorded, had been rested in cases where some addition or disallowance or variation was made in respect of the subject matter for which the reasons were recorded. Apparently, the provisions, old or new, permit an AO to expand or extend the proceedings to a subject not covered either by notice u/s 148A or the reasons recorded for reopening an assessment.

An interesting issue, however arisen in cases where no addition or disallowance or variation is made in the order of reassessment in respect of the subject matter of the notice u/s 148A or the reasons recorded but all the same the addition or disallowance or variation is made in respect of a subject matter not covered by such notice or the reasons. At the same time, even after insertion of Explanation 3, the issue that remained open was about the power of the AO to travel beyond the reasons recorded, where no addition or disallowance or variation was made in respect of the subject matter recorded in the reasons for reopening.

Conflicting decisions of the courts are available on the subject. The Bombay and the Delhi High Courts have held that where no addition or disallowance or variation was made in respect of the subject matter of the reasons recorded, then, in such a case, the AO could not have extended the scope of reassessment beyond the reasons recorded. The Punjab & Haryana and Karnataka High Courts have, as against the above, held that it was possible for the AO to travel beyond the subject matter of the reasons recorded while reassessing the income.

It is felt that the conflict would apply to the old as well as the new provisions, requiring us to take notice of the conflict.

JET AIRWAYS (I) LTD.’S CASE
The issue arose in the case of CIT vs. Jet Airways (I) Ltd., 195 Taxman 117 (Bom.). In the said case, pertaining to A.Ys. 1994-1995 and 1995-1996, the revenue had raised the following substantial question of law in appeal u/s. 260A for consideration of the Bombay High Court.

“Where upon the issuance of a notice under section 148 of the Income-tax Act, 1961 read with section 147, the Assessing Officer does not assess or, as the case may be reassess the income which he has reason to believe had escaped assessment and which formed the basis of a notice under section 148, is it open to the Assessing Officer to assess or reassess independently any other income, which does not form the subject-matter of the notice?”

The revenue in appeal urged that even if, during the course of assessment or, as the case might be a reassessment, the AO did not assess or reassess the income which he had reason to believe had escaped assessment and which formed the subject matter of a notice u/s 148(2), it was nonetheless open to him to assess any other income which, during the course of the proceedings was brought to his notice as having escaped assessment. It contended that the use of the words ‘and also’ clearly permitted an AO to make addition on an issue, even where no addition was made in respect of the issues for which the reasons were recorded and on the basis of which the assessment was reopened. It submitted that the language of the section was clear to reach such a conclusion. The words were non-conjunctive, and the two parts could operate independently of each other.

The assessee in response contended that the words “and also” in s. 147 postulated that the AO might assess or reassess the income for which he had reason to believe had escaped assessment together with any other income chargeable to tax which had escaped assessment and which came to his notice during the course of the proceedings; unless the AO assessed the income with reference to which he had formed a reason to believe, it was not open to him to assess or reassess any other income chargeable to tax which had escaped assessment and which came to his notice subsequently in the course of the proceedings.

It was clear to the Court, applying the first principle of interpretation for interpreting the section as it stood, and on the basis of precedents on the subject, without adding or deducting from the words used by Parliament, that upon the formation of a reason to believe u/s 147 and following the issuance of a notice u/s 148, the AO had the power to assess or reassess the income, that he had reason to believe had escaped assessment and also any other income chargeable to tax; that the words “and also” could not be ignored; the interpretation which the Court placed on the provision should not result in diluting the effect of those words or rendering any part of the language used by Parliament otiose; Parliament having used the words “assess or reassess such income and also any other income chargeable to tax which has escaped assessment”, the words “and also” could not be read as being in the alternative. On the contrary, the correct interpretation would be to regard those words as being conjunctive and cumulative; that Parliament had not used the word “or” and that it did not rest content by merely using the word “and” it followed it with the word “also” clearly suggesting that the words had been used together and in conjunction.

The Court, after hearing the rival contentions, upheld the decision of the Tribunal in favour of assessee for the reasons recorded in Para 16 and 17 of its order as under:

‘This interpretation will no longer hold the field after the insertion of Explanation 3 by the Finance Act (No. 2) of 2009. However, Explanation 3 does not and cannot override the necessity of fulfilling the conditions set out in the substantive part of section 147. An Explanation to a statutory provision is intended to explain its contents and cannot be construed to override it or render the substance and core nugatory. Section 147 has this effect that the Assessing Officer has to assess or reassess the income (“such income”) which escaped assessment and which was the basis of the formation of belief and if he does so, he can also assess or reassess any other income which has escaped assessment and which, comes to his notice during the course of the proceedings. However, if after issuing a notice under section 148, he accepted the contention of the assessee and holds that the income which he has initially formed a reason to believe had escaped assessment, has as a matter of fact not escaped assessment, it is not open to him independently to assess some other income. If he intends to do so, a fresh notice under section 148 would be necessary, the legality of which would be tested in the event of a challenge by the assessee.

We have………. The words “and also” are used in a cumulative and conjunctive sense. To read these words as being in the alternative would be to rewrite the language used by Parliament. Our view has been supported by the background which led to the insertion of Explanation 3 to section 147. Parliament must be regarded as being aware of the interpretation that was placed on the words “and also” by the Rajasthan High Court in Shri Ram Singh’s case (supra). Parliament has not taken away the basis of that decision. While it is open to Parliament, having regard to the plenitude of its legislative powers to do so, the provisions of section 147(1) as they stood after the amendment of 1-4-1989 continue to hold the field.’

The AO, the Court noted, upon the formation of a reason to believe u/s 147 and the issuance of a notice u/s 148(2), must assess or reassess: (i) ‘such income’; and also (ii) any other income chargeable to tax which had escaped assessment and which came to his notice subsequently in the course of the proceedings under the section. The words ‘such income’ refers to the income chargeable to tax which had escaped assessment, and in respect of which the AO had formed a reason to believe that it had escaped assessment. The language used by the Parliament was indicative of the position that the assessment or reassessment must be in respect of the income in respect of which he had formed a reason to believe that it had escaped assessment and also in respect of any other income which came to his notice subsequently during the course of the proceedings as having escaped assessment. If the income, the escapement of which was the basis of the formation of the reason to believe, was not assessed or reassessed, it would not be open to the AO to independently assess only that income which came to his notice subsequently in the course of the proceedings under the section as having escaped assessment.

The Court observed that the Parliament when it enacted the provisions of s. 147 w.e.f. 1st April, 1989, clearly stipulated that the AO had to assess or reassess the income that he had reason to believe had escaped assessment and any other income chargeable to tax that came to his notice during the proceedings. In the absence of the assessment or reassessment of the former, he could not independently assess the latter.

The Court in deciding the issue, in favour of the contentions of the assessee that it was not possible to make an addition in respect of an issue that was not recorded in the reasons for reopening, in cases where no addition was made in respect of the subject matter of reasons recorded, referred to the decisions in the cases of Vipan Khanna vs. CIT, 255 ITR 220 (Punj. & Har.); Travancore Cements Ltd. vs. Asstt. CIT 305 ITR 170 (Ker.); CIT vs. Sun Engg. Works (P.) Ltd., 198 ITR 297 (SC); V. Jaganmohan Rao vs. CIT, 75 ITR 373 (SC); CIT vs. Shri Ram Singh, 306 ITR 343 (Raj.); and CIT vs. Atlas Cycle Industries, 180 ITR 319 (Punj. & Har.).

N. GOVINDARAJU’S CASE
The issue again arose before the Karnataka High Court in the case of N. Govindaraju vs. ITO, 60 taxmann.com 333 (Karn.). In the said case for A.Y. 2004-05, the assessee, in its appeal against the order of Tribunal, approached the Court with the following substantial questions of law:

• Whether the Tribunal was correct in upholding reassessment proceedings, when the reason recorded for re-opening of assessment under S. 147 of Act itself does not survive.

• Whether the Tribunal was correct in upholding levy of tax on a different issue, which was not a subject matter for re-opening the assessment and moreover the reason recorded for the re-opening of the assessment itself does not survive.

• Whether the Tribunal was justified in law in passing an order without application of mind as to the determination of the fair market value as on 1.4.1981 by not taking into consideration the material on record and the valuation report filed by the appellant and consequently passed a perverse order on the facts and circumstance of the case.

• Whether the Tribunal was justified in law in not allowing a sum of Rs. 3,75,000/- being expenditure incurred wholly and exclusively in connection with the transfer more so when the payments are through banking channels, and consequently passed a perverse order on the facts and circumstance of the case.

On behalf of the assessee, in the appeal, it was contended before the Court that an order u/s 147 of the Act had to be in consonance with the reasons given for which notice u/s 148 had been issued, and once it was found that no tax could be levied for the reasons given in the notice for reopening the assessment, independent assessment or reassessment on other issues would not be permissible, even if subsequently, in the course of such proceedings, some other income chargeable to tax had been found to have escaped assessment. It was further submitted that the reason for which notice was given had to survive. It was only thereafter that ‘any other income’ which was found to have escaped assessment could be assessed or reassessed in such proceeding. Hence, the reopening of assessment should first be valid (which could be only when reason for reopening survived) and once the reopening was valid, then the entire case could be reassessed on all grounds or issues. That was to say, if reopening was valid and reassessment could be made for such reason, then only the AO could proceed further; if the AO could proceed further even without the reason for reopening surviving, it could lead to fishing and roving enquiry and would give unfettered powers to him.

On behalf of the revenue, it was contended that under the old s. 147 (as it stood prior to 1989), grounds or items for which no reasons had been recorded could not be opened, and because of conflicting decisions of the High Courts, the provisions of the said section had been clarified to include or cover any other income chargeable to tax which might have escaped assessment, and for which reasons might not have been recorded before giving the notice. That the said s. 147 was in two parts, which had to be read independently, and the phrase “such income” in the first part was with regard to which reasons had been recorded, and the phrase “any other income” in the second part was with regard to where no reasons were recorded in the notice and had come to notice of the AO during the course of the proceedings. Accordingly, both being independent, once the satisfaction in the notice was found sufficient, the addition could be made on all grounds, i.e., for which reason had been recorded and also for which no reason had been recorded, and all that was necessary was that during the course of the proceedings u/s 147, income chargeable to tax must be found to have escaped assessment relying on Explanation 3 to s. 147 which was inserted by Finance Act, 2009 w.e.f. 1st April, 1989.

The Karnataka High Court on hearing rival contentions observed and held as under:

• From a plain reading of s. 147 of the Act, it was clear that its latter part provides that ‘any other income’ chargeable to tax which has escaped assessment and which had come to the notice of the AO subsequently in the course of the proceedings, could also be taxed.

• The two parts of the section have been joined by the words ‘and also’ and the Court has to consider whether ‘and also’ would be conjunctive, or the second part has to be treated as independent of the first part. If the words were held to be conjunctive, then certainly the assessment or reassessment of ‘any other income’ which was chargeable to tax and had escaped assessment, could not be made where the original issue did not survive.

• The purpose of the provisions of Chapter XV was to bring to tax the entire taxable income of the assessee, and in doing so, where the AO had reason to believe that some income chargeable to tax had escaped assessment, he might assess or reassess such income. Since the purpose was to tax all such income which had escaped assessment, besides ‘such income’ for which he had reason to believe to have escaped assessment, it would be open to him to also independently assess or reassess any other income which did not form the subject matter of notice.

• While interpreting the provisions of s. 147, different High Courts have held differently, i.e., some have held that the second part of s. 147 was to be read in conjunction with the first part, and some have held that the second part was to be read independently. To clarify the same, in 1989, the legislature brought in suitable amendments in sections 147 and 148 of the Act, which was with the object to enhance the power of the AO, and not to help the assessee.

• Explanation 3 was inserted in s. 147 by Finance (No. 2) Act, 2009 w.e.f 1st April, 1989. By the said Explanation, which was merely clarificatory in nature, it had been clearly provided that the AO might assess or reassess the income in respect of any issue, which had escaped assessment, and where such issue came to his notice subsequently in the course of the proceedings, notwithstanding that the reasons for such issue had not been included in the reasons recorded under sub-section (2) of s. 148. Insertion of this Explanation could not be but for the benefit of the Revenue, and not the assessee.

• It was clear that in the phrase ‘and also’ which joined the first and second parts of the section, ‘and’ was conjunctive which was to join the first part with the second part, but ‘also’ was for the second part and was disjunctive; it segregated the first part from the second. Thus, on a comprehensive reading of the entire section, the phrase ‘and also’ could not be said to be conjunctive.

• It was thus clear that once the satisfaction of reasons for the notice was found sufficient, i.e., if the notice u/s 148(2) was found to be valid, then addition could be made on all grounds or issues (with regard to ‘any other income’ also) which might come to the notice of the AO subsequently during the course of proceedings u/s 147, even though the reason for notice for ‘such income’ which might have escaped assessment, did not survive.

• If there was ambiguity in the main provision of the enactment, it could be clarified by inserting an Explanation to the section of the Act which had been done in the case. Section 147 of the Act was interpreted differently by different High Courts, i.e., whether the second part of the section was independent of the first part, or not. To clarify the same, Explanation 3 was inserted by which it had been clarified that the AO could assess the income in respect of any issue which had escaped assessment and also ‘any other income’ (of the second part of s. 147) which came to his notice subsequently during the course of the proceedings under the section.

• After the insertion of Explanation 3 to s. 147, it was clear that the use of the phrase “and also” between the first and the second parts of the section was not conjunctive and assessment of ‘any other income’ (of the second part) could be made independent of the first part (relating to ‘such income’ for which reasons were given in notice u/s 148), notwithstanding that the reasons for such issue (‘any other income’) had not been given in the reasons recorded u/s 148(2).

• The view of the Court was in agreement with the view taken by the Punjab & Haryana High Court in the cases of Majinder Singh Kang 344 ITR 348 and Mehak Finvest 52 taxmann.com 51.

• Considering the provision of s. 147 as well as its Explanation 3, and also keeping in view that s. 147 was for the benefit of the Revenue and not the assessee and was aimed at garnering the escaped income of the assessee (namely Sun Engineering) and also keeping in view that it was the constitutional obligation of every assessee to disclose his total income on which it was to pay tax, the two parts of s. 147 (one relating to ‘such income’ and the other to ‘any other income’) were to be read independently. The phrase ‘such income’ used in the first part of s. 147 was with regard to which reasons have been recorded u/s 148(2) of the Act, and the phrase ‘any other income’ used in the second part of the section was with regard to income where no reasons have been recorded before issuing notice and which has come to the notice of the AO subsequently during the course of the proceedings, which could be assessed independent of the first part, even when no addition could be made with regard to ‘such income’, but the notice on the basis of which proceedings had commenced was found to be valid.

• It was true that where the foundation did not survive, then the structure could not remain. Meaning thereby, if notice had no sufficient reason or was invalid, no proceedings could be initiated. But the same could be checked at the initial stage by challenging the notice. If the notice was challenged and found to be valid, or where the notice was not at all challenged, then, in either case, it could not be said that the notice was invalid. As such, if the notice was valid, then the foundation remains and, the proceedings on the basis of such notice could go on. We might only reiterate here that once the proceedings had been initiated on a valid notice, it became the duty of the AO to levy tax on the entire income (including ‘any other income’) which might have escaped assessment and came to his notice during the course of the proceedings initiated u/s 147 of the Act.

The Karnataka High Court found it unable to persuade itself, with due respect, to follow the decisions in the cases of Ranbaxy Laboratories Ltd. vs. CIT, 336 ITR 136 (Bom.), CIT vs. Adhunik Niryat Ispat Ltd., 63 DTR 212 (Del.) and CIT vs. Mohmed Juned Dadani, 355 ITR 172 (Guj.), and proceeded to hold that it was permissible for an AO to make addition in respect of an issue noticed during the course of assessment even where no addition was made in respect of the issues for which the assessment was reopened by recording the reasons at the time of issue of notice u/s 148 of the Act.

OBSERVATIONS
One of the controversies about expanding the scope of reopened assessment, about the permission to travel beyond the subject matter of reasons recorded for reopening or otherwise, has been sought to be set to rest by insertion of Explanation 3 w.r.e.f 1st April, 1989. The other controversy, relating to AO’s power to make addition or disallowance or variation in cases where no addition or disallowance or variation is made on the subjects recorded in the reasons, continues to be relevant and live. This unresolved issue involves an appreciation of different schools of interpretation of the language used in the section and also of the legislative intent behind it. Very forceful, intense and valid contentions are made by both the schools of interpretation, which are backed by the decisions of the different High Courts. Even an amendment, that too with retrospective effect, has not been able to resolve the conflict. The best solution is to await the final word of wisdom from the Supreme Court.

The issue, in our considered opinion, would continue to be relevant even under the new scheme of reopening and reassessment made effective from 1st April, 2021. The new scheme retains an Explanation that empowers an AO to travel beyond the subject matter of ‘information’ received by an AO, and also the need for compliance of the four conditions of s. 148A of the Act. The Explanation to s. 147 might permit an AO to cover an issue even where ‘no information’ is received by him as per s. 148 of the Act.

The ‘reason to believe’ that any income chargeable to tax has escaped assessment, was one aspect of the matter. If such reason existed, the AO could undoubtedly assess or reassess such income, for which there was such ‘reason to believe’ that income chargeable to tax has escaped assessment. This is the first part of the section, and up to this extent, there is no dispute. The issues as noted however were in respect of two aspects; one was whether the AO was permitted to rope in an issue for which reasons were not recorded. There were conflicting decisions of the Courts on this aspect which conflict was set at rest by the insertion of Explanation 3. The other issue was and is about the power of the AO to make an addition in respect of an additional issue, not recorded in the reasons, even where no addition is made in respect of the main issue recorded in the reasons. It is this second issue that has remained open and unresolved, even after insertion of Explanation in s. 147 and on which conflicting decisions of the Courts are noted.

It is the latter part of the s. 147 and not the Explanation 3 that is to be interpreted, which is as to whether the second part relating to ‘any other income’ is to be read in conjunction with the first part (relating to ‘such income’) or not. If it is to be read in conjunction, then without there being any addition made with regard to ‘such income’ (for which reason had been given in the notice for reopening the assessment), the second part cannot be invoked. But if it is not to be read in conjunction, the second part can be invoked independently, even without reason for the first part surviving, permitting an AO to make addition even where no addition is made in respect of the main issue for which reasons are recorded.

The effect of Explanation 3, inserted by the Finance (No. 2) Act, 2009 as is understood by one school of interpretation is that even though the notice issued u/s 148 containing the reasons for reopening the assessment does not contain a reference to a particular issue with reference to which income has escaped assessment, yet the AO may assess or reassess the income in respect of any issue which has escaped assessment, when such issue comes to his notice subsequently in the course of the proceedings. The reasons for the insertion of Explanation 3 are to be found in the memorandum explaining the provisions of the Finance (No. 2) Bill, 2009.

The memorandum states that some of the Courts have held that the AO has to restrict the reassessment proceedings only to issues in respect of which reasons have been recorded for reopening the assessment, and that it is not open to him to touch upon any other issue for which no reasons have been recorded. This interpretation was regarded by the Parliament as being contrary to the legislative intent. Hence, Explanation 3 came to be inserted to provide that the AO may assess or reassess income in respect of any issue which comes to his notice subsequently in the course of proceedings u/s 147, though the reasons for such issue have not been included in the reasons recorded in the notice u/s 148(2).

The effect of s. 147, as it now stands, after the amendment of 2009, can, therefore, be summarised as follows : (i) the Assessing Officer must have reason to believe that any income chargeable to tax has escaped assessment for any assessment year; (ii) upon the formation of that belief and before he proceeds to make an assessment, reassessment or recomputation, the AO has to serve a notice on the assessee under sub-section (1) of s. 148; (iii) the AO may assess or reassess such income, which he has reason to believe, has escaped assessment and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under the section; and (iv) though the notice u/s 148(2) does not include a particular issue with respect to which income has escaped assessment, yet he may nonetheless, assess or reassess the income in respect of any issue which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under the section.

Insertion of ‘Explanation’ in a section of an Act is for a different purpose than the insertion of a ‘Proviso’. ‘Explanation’ gives a reason or justification and explains the contents of the main section, whereas ‘Proviso’ puts a condition on the contents of the main section or qualifies the same. ‘Proviso’ is generally intended to restrain the enacting clause, whereas ‘Explanation’ explains or clarifies the main section. Meaning thereby, ‘Proviso’ limits the scope of the enactment as it puts a condition, whereas ‘Explanation’ clarifies the enactment as it explains and is useful for settling a matter of controversy.

Having noted that the issue on hand needs to be resolved by a decision of the Supreme Court at the earliest, in our opinion, the decisions of the High Courts in favour of the assessee represent a better view and the decisions of the High Courts holding a contrary view are based on considerations, the following of which require rethinking, for the reasons noted in italics:

• One of the grounds on which the Courts rested their decisions was that the assessee was given an opportunity to challenge the notice along with the reasons for reopening, both of which were held to be valid and the reopening proceedings were therefore validly initiated and with such initiation there would be no question of assessment of either ‘such income’ of the first part of s. 147 or ‘any other income’ of its second part. The courts, with respect, did not appreciate the fact that on the lapse of the reasons recorded, once no addition was made on such reasons, the notice and the proceedings were rendered invalid. The courts also ignored that the assessee had no opportunity to contest the validity of the notice on the reason subsequently added by the AO, and importantly, the proceedings might lead to fishing and roving inquiry.

• The Courts further held that as long as the proceedings had been initiated on the basis of a valid notice, it became the duty of the AO to levy tax on the entire income, which may have escaped assessment during the assessment year. With great respect, if this were to be true, there was no need for having amended the law to expressly provide the AO with the power to expand the scope of reassessment to add an issue or issues beyond the issues covered by the recorded reasons. The scope of the reassessment is limited to the issues recorded in reasons, and a special power was needed to rope in an additional issue without which the AO is not empowered to travel beyond the recorded reasons.

• The Courts admitted that where the words ‘and also’ was to be treated as conjunctive, then certainly, if the reason to believe was there for a particular ground or issue with regard to escaped income which had to be assessed or reassessed, and such ground was not found or did not survive, then the assessment or reassessment of ‘any other income’ which was chargeable to tax and has escaped assessment, could not be made. However, after having done so, for some not very comprehensive reasons, they proceeded to hold that the words were not to be read in conjunction and therefore, the second part could be invoked independently even without reason for the first part surviving.

• The Courts held that the purpose of the scheme was to tax all such income which had escaped assessment, besides ‘such income’ for which he had reason to believe to have escaped assessment and, based on such findings, the Courts held that it would be open to the AO to also independently assess or reassess any other income which did not form the subject matter of notice. With respect, this understanding of the courts might hold true in the case of regular assessment, but are surely not so in cases of reassessment, where the power of the AO to reassess an income for which he had valid reasons and which reasons were duly recorded. In the absence of such compliance, it was not possible to hold that his power was all-encompassing.

• The Courts further held that the insertion of the Explanation could not be but for the benefit of the revenue and not the assessee. This understanding based on the judgement of the Supreme Court in Sun Engineering’s case, might be true in the context of the scope of the reopening but cannot be applied to understand the implication of the written law and the Explanation thereto. In any case, taking a legal view on the language of the provision cannot be termed to be beneficial to the assesssee; rather the courts are bound to take a view that is correct in law, irrespective of the party on which the benefit is conferred; such benefit, even where conferred, is intended by the express language used by the parliament. In any case, the decision of the Supreme Court is capable of a different interpretation, as has been recently found by the Karnataka High Court in a decision in the case of The Karnataka State Co-Operative Apex Bank Limited vs. DCIT 130 taxmann.com 114. (Refer Controversy Feature of BCAJ, March, 2022)

• The Courts further held that the word ‘and’ used in the phrase ‘and also’ was conjunctive, which was used to join the first part with the second part, but the word ‘also’ was only for the second part and would be disjunctive; it segregated the first part from the second and thus, upon reading the full section, the phrase ‘and also’ could not be said to be conjunctive. With utmost respect, we find such a circuitous interpretation not tenable and strange and not found to have any precedent.

• The Courts held that the insertion of Explanation 3 to s. 147 did not in any manner override the main section and had been added with no other purpose than to explain or clarify the main section so as to also bring in ‘any other income’ (of the second part of s. 147) within the ambit of tax, which might have escaped assessment, and came to the notice of the AO subsequently during the course of the proceedings. Circular 5 of 2010 issued by the CBDT also made this position clear. There was no conflict between the main s. 147 and its Explanation 3. This Explanation had been inserted only to clarify the main section and not curtail its scope. Insertion of Explanation 3 was thus clarificatory and was for the benefit of the revenue and not the assessee. We do not think that there is any dispute about the purpose of Explanation and its clarificatory nature. What is disagreeable is the use of the Explanation to prove a point that is not borne out of the Explanation or the Memorandum explaining the object behind its insertion. The language and the memorandum explain that the objective of the Explanation was to clarify that an issue, the subject matter of which was not recorded in the reasons, could be taken up by the AO in reassessment if noticed by him. Nowhere it is clarified that an additional issue could be taken up even where the main issue did not survive. Secondly, the reliance on the circular to prove a complex legal point was avoidable. Thirdly, to hold that the clarification was for the benefit of the revenue is unacceptable.

• Lastly, the Court held that If there was ambiguity in the main provision of the enactment, it could be clarified by insertion of an Explanation to the main section of the Act. The same had been done in the instant case. Section 147 was interpreted differently by different High Courts, i.e., whether the second part of the section was independent of the first part or not. To clarify the same, Explanation 3 was inserted by which it had been clarified that the AO could assess the income in respect of any issue which had escaped assessment and also ‘any other income’ (of the second part of s. 147) which came to his notice subsequently during the course of the proceedings under the section. Again there is no dispute in this understanding of the purpose of insertion of Explanation and its meaning. The difficulty is where one reads it in a manner to hold that the Explanation also permitted to make addition in respect of an additional issue even where the main issues do not survive, and thereby rendering the proceedings otiose. With respect, the language of the Explanation and its objective, as explained, nowhere bears this understanding of the courts. As explained earlier, there were two controversies, and the Explanation clarified the legislative stand only in respect of one of them, namely, to cover an additional issue even where the reason for such issue was not recorded. The other controversy being considered here had and has remained unaddressed.

FORM AND SUBSTANCE OF EXTERNAL AND SELF-REGULATION

If there is ONE regressive belief that is
perpetuated by every government of India and has generally taken the
country backward, it is: if something goes wrong, the answer lies in
government control; because if government controls something, it will
deliver optimum results.

Such an approach to situations results in:

a.  stranglehold of babudom1;

b.  distancing citizens’ from liberty;

c. annihilation of self-governing and self-financing institutions into monolithic government bodies;

d.  developing a false narrative that government delivers and delivers for larger good;

e.  cost overruns, inefficiencies, unaccountable ways generally known by the name ‘public service’ amongst others.

Lacking Government oversight:
Look at the last two big scams – where CAs were blamed, but no
significant government employee responsible for oversight faced any
consequences! Did you see any action on SEBI for the co-location scam?
Did you see action on Reserve Bank of India after the collapse of
systemically important NBFC IL&FS right under its nose called
‘supervision’? One can infer that when regulators fail and/or go unpunished, insiders above them were pulling the strings!

Connect the Dots: Two issues have been debated this week – changes in 3 Institutes and the formation of IIA.

Let’s
look at the past sequence of events – NACAS formed to take away
Standard- Setting powers, rotation of auditors through a top secret
report under Modi 1.0, Modiji makes legendary comments at the ICAI event
in 2017, CAs stopped from giving valuation report2/certifications under a few laws and adding other professions in place of CAs3,
NFRA formed to discipline errant firms, reduction of bank audit
branches/quantum of advances subjected to audits, tax audits and GST
audits removed significantly, NFRA ‘report’ on abolition of company
audits except about 3,600 companies, frivolous NFRA reports and
consultations and parliamentary panel report of 2022 on ICAI that makes
inroads into disciplinary powers. This leaves ICAI to be an educational,
licensing and registrar of members and students body. If you connect
the dots, and especially by this government, it is clear that there is a
certain aversion and clear invasion on self-regulation of ICAI. This is
akin to maximising government and minimising governance because lasting
governance comes from people who need to be governed.
_______________________________________________________________________

1. The tacit mechanism invented, nurtured and perpetuated by public servants
where things are complicated to the level where responsibility cannot be
ascertained, outcome remains sub optimal, and results are slowed.

The Parliament Debate: Seeing a string of BJP MPs shinning out during the parliamentary debate was memorable. One MP from Mumbai said there is a need to increase the pass percentage in CA exams. He said he is not able to understand what is the big technique in CAs4? Another HBS educated BJP MP from Jhansi said Indian audited statements are not accepted in NASDAQ,
and once this amendment act is passed, such financials will be globally
accepted. He even said that in CAG, there are no CAs and still they can
audit the entire country. He went over the top when he said some CA
firm he called Batliboi (he didn’t remember the full name), which used
to be a top firm, is finished when you compare it to EY5.
After listening to astute observations, I felt glad that none of the
ICAI council members have stellar qualification like 43% of winning BJP
MPs of 2019 elections who have criminal records!

________________________________________________________________________

2   Under the Income Tax
Rule 11U and 11UA under DCF

3   DD for companies taking banking facilities

4  On the parliament website, his educational
qualification is ‘under matric’ and one wonders whether that is a qualification
to criticize those who clear one of the toughest exams on the planet.

5   In
case you meet the MP, do let him know that same or similar firm was taken over
by EY or calls itself EY


Statistics:
The PSC report says that between 2006 and 2021, 3832 cases were
resolved out of 5829 cases registered. Amongst the 1997 unresolved
cases, 574 (9.8% of total) cases are more than 3 years old and 81 cases
are stayed by the court. Removal from membership between 1-5 years was
done in 48 cases. Totally 267 removals were either permanent debarment
or between 0-5 years. Now compare this to PM Modi’s speech on 1st July
2017 where he said that in the last 11 years, proceedings have been
undertaken against only 25 CAs. You judge the difference between reality
and rhetoric. ICAI statistics are better than most departments, tribunals and even courts which are etymology of the word inefficiency.
The average pendency of normal cases is 2 to 3 years in ICAI. One
cannot deny the scope for improvement, yet it is better than other
judicial and disciplinary mechanisms in a country where decades old
cases are languishing.

Comparables: National Medical Commission has a medical practitioner as Chairman. Advocates Act 19616,
requires 2 out of 3 members of disciplinary committee from Bar Council
and all three have to be advocates. But CAs are treated differently. Could it because of special vengeance blended with arrogance?
As an MP from Kottayam put it: which Secretary has knowledge of
accounting standards and auditing standards to head disciplinary
mechanism? Assuming that few of the retired govt. nominees may read the
standards, how many of them would have applied it practically in audits
so as to understand the standards at the fundamental level so as to
apply the nuances involved for deciding the cases?

________________________________________________________________________
6. Section 9 of Advocates Act

Facts:
The fact is that government nominees are already on ICAI disciplinary
committee. And they are party to the process. All cases are generally
determined unanimously. To hasten the process, timelines could have been
included in the ICAI regulations. Imposing more babudom,
is a precursor to the advent of politicians (like you see politicians
and their siblings on sports bodies, temples, clubs and every other
place where there are assets, popularity and power) and those who have
no skin in the game.

There is nothing wrong in self-regulation so far as there is transparency, speed and appeal mechanism.
There are brilliant minds who understand the situation since they have
been in one, unlike one IIM Bangalore retired professor, to deliver a
balanced verdict in disciplinary matters. Talking about conflict of
interest, one MP from UP said don’t Babus judge themselves and punish themselves? How does the Army disciplinary system work? Government is the crown jewel of conflict of interest if you go by GOI’s logic. In fact, SRO, is an essential character of balanced oversight and not an impediment.

Fitting in: To fit in to the global scheme of things, GOI propounds its own ‘selective global best practices’.
Have frauds, scams, financial mismanagement reduced in other countries
from where these regulations are purported to be taken as global best
practices? If you look closely, this is done because of lack of original thinking for India. Therefore, the easy way is to import
and affix even that which has failed elsewhere and continue to
propagate colonial mindset to the detriment of local ground realities.
Self-governance is the epitome of democracy and responsibility. Perhaps until the west does it, babudom and in turn mantri mandal won’t believe in it.

ICAI Reforms: Does ICAI need reforms? Yes, of course! Which institution doesn’t with changing times? However, true reform is like true health that comes from inside – cleansing from within, not by inserting artificial objects or tubes permanently. This half-baked government action seems hazy, hasty and hazardous!

IIA: An idea mooted by the PSC also speaks of IIA. Competition does raise the bar. To call statutory responsibility as a monopoly is nothing short of ignorance unless it is malice!
Rigour of education, exams and practical training are critical to
create public accountants. Currently, and gladly, the ICAI is not based
on a regressive reservation model that mocks merit. Nor has ICAI gone
with a begging bowl to the government for funds. It does much work for
backward and dull-witted government bodies. One would be wiser to use
ICAI set up, and create categories of accountants majoring in various
skillsets rather than creating alleged ‘competition’. I am sure ICAI
would be happy to partner with industry and real-life people on the
ground to create this new set of accountants.

President
Kalam said CAs are partners in nation building. And no Bill can take
that away. Like Kautilya said, destiny follows the words of the wise
souls. ICAI’s destiny will surely follow those words.

CELEBRATING 75 YEARS OF INDEPENDENCE KHUDIRAM BOSE

In India’s glorious history of freedom struggle, the landmark case was of the Muzaffarpur bomb blast. The hero was Khudiram Bose, who, at the tender age of 19 years, climbed the gallows with a smiling face, chanting the mantra of Vande Mataram. The first-ever bomb attack on the British empire in India goes to the credit of this young man.

He was born on the 3rd of December, 1889, in the Medinipur district of Bengal. His father, Trailokyanath Basu, was a tehsildar at Nandzol village in Medinipur. Mother Lakshmipriyadevi was a pious housewife. Unfortunately, Khudiram lost both his parents at the age of just six. He was then brought up by his sister Anurupadevi and her husband, Amritlalji. Although Khudiram was very bright in his studies, he never enjoyed school education. His sole obsession was the independence of our country. He believed that the most severe disease of all Indians was slavery under British rule.

In February 1906, the Britishers had organised an exhibition for glorifying the ‘success’ of British rule. Khudiram was then just 17. He distributed circulars in protest of the tyrannical Government and shouted the slogan of Vande Mataram. A policeman beat him, but he retaliated, hit back at the policeman and ran away. He was arrested but let out on the grounds of his age.

Khudiram was highly influenced by the novel Anandmath by Bankim Chandra Chattopadhyay. This novel contained the song ‘Vande Mataram’ that inspired thousands and lakhs of Indians to fight for independence. Khudiram’s mind was filled with patriotism and the thought of supreme sacrifice for the country’s independence. Vande Mataram proved dreadful for the Britishers.

Khudiram voluntarily joined a group of revolutionaries. The revolutionaries admitted him after due testing. In 1905, Lord Curzon, the then Governor-General, planned for partition to cause a divide between Hindus and Muslims. The people very strongly resisted this.

Khudiram learnt the use of knives and pistols. Kolkata’s Chief President Magistrate was Kingsford, a merciless and cruel person who ordered harsh punishments to all freedom fighters and even the nationalist common person. Bipin Chandra Pal founded the Daily ‘Vande Mataram’ to spread the spirit of patriotism. Maharshi Aurobindo was its editor. The British Government filed a suit against the Daily. Thousands of youth gathered outside the court chanting Vande Mataram. Policemen were brutally beating some of them. One 15 year boy Sushilkumar Sen could not tolerate this scene, and he hit back at the policeman. He was arrested for beating the policemen. The Magistrate, Kingsford, ordered a flogging of Sushilkumar.

The revolutionaries planned to kill Magistrate Kingsford. Aurobindo Ghosh and other leaders attended the meeting. Many youths volunteered to kill Kingsford. But the task was entrusted to Khudiram. Another boy of 19, Prafulla, was to help him.

On 30th of April, 1908, Khudiram and Prafulla hid near the Europe Club, Muzaffarpur. When Kingsford’s baggi (house-cart) came on the road, Khudiram threw a bomb. After that, both of them ran away. Khudiram ran overnight about 25 to 30 km along the railway line. He reached Veni station. The news of the first-ever bomb attack had already spread. Khudiram, who was very hungry, sitting in a restaurant, heard people talking about the incident. He learnt that Kingsford was not there in the baggi and did not die. Instead, two of his family members died. The manner in which he expressed surprise on Kingsford surviving raised suspicion in the minds of people, especially the shopkeeper. Khudiram was a new and unfamiliar face in that locality. So, with the greed of a reward, the shopkeeper called the police. The police found two pistols in his pocket. At another location, Prafulla also realised that he would be arrested. So he shot himself, ending his life.

In the Court, a lawyer Kalidas Bose, voluntarily pleaded the case since Khudiram had not engaged any lawyer. The two-month trial ended in an inevitable result – the death sentence for Khudiram.

Khudiram listened to it smilingly without the slightest of fear. The Judge also was surprised. When asked whether he wanted to say anything, Khudiram expressed the desire to narrate how to make a bomb! The Judge obviously refused that.

Advocate Kalidas Bose on his own filed an appeal in the high court against the death sentence. The result was obvious.

Finally, on 19th August, 1908, he was crucified – a smile on his face and Vande Mataram in his mouth!

Kingsford, though he survived, found it risky to continue and left the job. Eventually, he died due to this fear!

Namaskaars to this very young revolutionary – Khudiram!

VACCINATION

Today, corona and vaccination are hitting the front pages of all newspapers. Of course, of late Sachin Waze has started taking precedence over these two. But the main topic of discussion among the general public is still corona and vaccination.

Vaccination stock is over!
Mismanagement at corona vaccination camps;
Vaccine not effective!
Man catches corona despite vaccination;
Bogus and adulterated vaccination stocks held!
Long queues at vaccination centres.

All these reports revolve around the corona virus. And people are flocking to the centres to avail of the facility offered by the Government.

People are taking leave from work, keeping aside other important tasks, to get vaccinated. However, one particular community has no time to take the vaccine. For them, certain things are more important than even their lives and health. This community is engaged in commercial activity but functions like NGOs.

They were keen to keep their offices open even during the pandemic. They incurred heavy expenditure to ensure that their staff should be able to work from home. They worked day and night to meet the deadlines for their clients. Of course, their clients always take it for granted that this community’s charges are never to be paid promptly. And the NGOs consider it inhuman to ask for fees during the pandemic. As soon as the lockdown was relaxed and the unlocking process started, the same clients travelled for ‘outings’. Clients were sure that the NGO would be slogging for them and sacrifice everything for the clients. Not only that, the clients were also sure that since the fees are not received, the NGOs would borrow from banks to run their show. On top of it, the alma mater of these NGOs would tie up with banks and other financial institutions to offer credit facilities for them. And the NGOs kept on slogging, forgetting everything happening around them.

After some time, the Government conducted a review and felt that almost every citizen of the country should get vaccinated. So, it announced the date for closure of vaccination centres.

Suddenly, the NGO community woke up and started representing to the Government for extension of time. They started begging, praying and a few of them even thought of filing writ petitions. They could produce the Object clause of the constitution of many NGOs which prohibited doing things in time. Their object was to start the work only at the eleventh hour, issue certificates based on inadequate data, risk their own licence, work without asking for payment of fees and so on.

Their ‘incidental’ object was to carry all tensions for their clients, sacrifice their personal lives and health, lose their sleep and fight for getting extension of time.

These NGOs are always making some ‘submission’ or other. In the process, they suffer from the virus of ‘submissiveness’. They have lost the energy to be assertive.

The researchers should come out with a new vaccine for the NGOs to make them immune from this virus called ‘submissiveness’.

Note: In case the NGOs described in this article resemble any professional group, it is only a coincidence.

TRIBUTE ARVIND H. DALAL

ARVIND H. DALAL

(2nd July, 1929 – 15th March, 2021)

In the passing away of Shri Arvindbhai Dalal we have lost a great professional. My association with him started more than six decades back. He had a soft corner for junior members of our profession and whenever a junior wanted his help, he was always available.

He served our profession in many different capacities. He was Chairman of WIRC in 1962-63, President of the BCA Society in 1963-64 and President of ICAI in 1989-90. He was also a Founder Trustee of the BCAS Foundation. During his association with all these professional bodies, he rendered exemplary service to the profession.

Some CA friends used to meet every Thursday to discuss the developments in the fields of taxation, accounting, auditing and other professional subjects. And Arvindbhai used to attend these meetings regularly. I came in close contact with him at these meetings. Even when his health was not good, he tried to attend these meetings and gave us the benefit of his knowledge.

He used to attend almost all the lecture meetings, seminars, conferences, and Residential Reference Courses organised by the WIRC, the BCAS, the ICAI and other professional bodies either as a paper writer, speaker or a participant. He always believed that by such participation we can share our knowledge with other professionals and also gain some knowledge. His pet subject was ‘Charitable Trusts’. In fact, he has authored the book ‘Taxation of Charitable Trusts’ published by the BCAS. He has argued several cases of Charitable Trusts before the Income-tax Appellate Authorities.

In 1998, the Golden Jubilee Year of the ICAI, the ICAI Council entrusted the work of writing the history of the accounting profession to me along with Arvindbhai and Shri Harishbhai Motiwala. We had to cover the period from 1973 to 1999 within one year. We completed the task in record time and the book ‘History of the Accounting Profession in India – Vol. II’ was published in January, 2000. Arvindbhai took great care in going through the draft of this publication, which records the achievements of our profession in these 25 years.

It is difficult to believe that Shri Arvindbhai is no more with us. All of us professionals will feel his absence. We pray that this noble soul rests in eternal peace.

– P.N. Shah, Past President, BCAS and ICAI
_____________________________________________

Shri Arvindbhai became known to me as a worthy senior of stature from the day I joined the BCAS. It was indeed a privilege for me to have been, in the years to follow, associated with him at the BCAS, at the ICAI and also at the personal level. In him we have lost a fatherly figure to whom any junior could turn for guidance without any fear.

He was a great human being. He maintained high ethical standards as a professional all through. In his dealings with all he was soft-spoken and humble. His devotion to the Society and to the profession hardly had any parallel. He contributed as much to the development as to the academic profile of the profession. He remained active with the Society almost till the end, despite his uneven health during the last few years. It was so pleasing to see him participate in the lecture meetings as a keen learner till even very recently. In him we have lost a giant personality. He will always be remembered by all those around him.

May the members of his family have courage to bear this loss and may the noble soul rest in peace.

– Pinakin D. Desai, Past President, BCAS
_____________________________________________

Shri Arvindbhai Dalal passed away peacefully on 15th March, 2021.We have lost a genuine well-wisher of the Society and a senior, disciplined guardian of the profession who was always extremely concerned about the image of our profession. His selfless and invaluable contribution with utmost devotion to the development of the profession in various aspects was self-evident and does not require any recognition. His commitment and dedicated approach in this regard were extremely remarkable and for this he remained active till his last days. I still recall that he last participated, despite his advanced age and health challenges, in the virtual post-Budget meeting of the BCAS Taxation Committee on 18th February, 2021, and even prior to that, he kept on checking with me about the BCAS Annual Budget Booklet of which he was one of the main pillars. I salute his dedication and passion for the development of our profession in general and the Society in particular.

I still can’t forget my initial introduction to him during one of the RRCs in the early 1980s at Matheran where I was innocently raising many questions during the reporting session as one of the young group leaders in his paper and the patience with which he was responding and encouraging me in the process. What was even more noteworthy was his approach during the General Assembly Session while giving his replies where, at appropriate relevant stages, he referred to such questions with my name and that shocked me as I had never expected such encouragement for a very junior member from such a senior professional. Of course, subsequently, I also learned that this kind of culture was nurtured by such pillars of the RRCs. This made me an integral part of the Society’s close academic circle, immensely benefiting me in making my academic career in the profession. For me, since then, in addition to a few others, Arvindbhai became a role model.

While I have many personal experiences to share, it is impossible to describe his innumerable qualities and his selfless contribution to the profession here. But I can’t resist mentioning one or two episodes. I still remember when we were revising the Tax Audit Manual of the BCAS around 1989; for that purpose we stayed in a hotel in Mumbai along with the late Shri Narayanbhai to complete the work in a short time – the kind of dedication and humility that I witnessed during that stay and the personal encouragement given to me are both unforgettable and remain etched in my mind even today.

He was a rare human being with such outstanding qualities. On the ethical front, I still recall his extreme resistance to my request to be a Faculty at the seminar following that Tax Audit Manual at Patkar Hall on the ground that since he is the Chairman of the Organising Committee, he can’t be a Faculty. It took a lot of time and effort to persuade him with the help of the late Narayanbhai in the evening discussion session in that hotel room to effectively thrust on him this responsibility for the benefit of the large number of members attending that seminar from various parts of the country. I had similar experiences as part of the Golden Jubilee Celebration Committee of the Society of which he was Chairman, as well as during my association with him as his Co-Chairman of the Taxation Committee.

On a personal note, I was fortunate to have had the privilege of working closely with him in the Society as well as at a personal level and to learn a lot from him, especially on the ethical front. I will be missing travelling with him regularly for punctually attending various BCAS and other meetings and our discussions on various subjects.

On his departure I feel like I have lost an elderly friend, philosopher and guide. He used to mostly call me on my wife’s mobile and would always first affectionately ask her, ‘Ilaben, kem cho?’ We will miss all this now. We sincerely pray to the Almighty that his soul rest in eternal peace.

– Kishor Karia, Past President, BCAS, Editorial Board
_____________________________________________

I was fortunate to have come in contact with Arvindbhai in my formative years of practice, a time when he was the doyen of the profession. The association established then, in the early 80s, continued till God recalled him for better things. He was one of the very few persons who shaped and moulded my professional career and beyond. In recent years, since the passing away of my father, I relied on him as a source of inspiration in many matters of life.

The long association, full of fascinating and inspiring instances, is difficult to express in words; surely not in a note that is limited by the number of words. He was a kind of hand-holder for me who was around silently, throughout, without being physically present, and guided my thoughts, at times without expressly communicating it in words. The way he conducted himself and carried on with his life became guiding posts for me.

I first met him in his chamber at Nariman Point when he was already the Past President of the ICAI, a humbling experience which has stayed with me for long; a very unassuming place and the decorum and the person’s all-attentive stance and willingness to help with no desire to impress, in spite of his scholarly insight into the subjects of accounts, auditing and taxation. I was guided by his precision in writing; in editing any text, he would not hesitate to devote long hours to fine-tune any text on complex technical matters and would ensure that the final product is delivered within the deadline. Anyone who has sat with him in meetings of professional associations would have witnessed his immense contribution with humility, patience and persistence; all of these encouraged me to request him to join the Chamber’s Managing Committee. He not only honoured our request but guided the Chamber with exemplary leadership. Dignity was natural to him and those who were present at numerous full court conferences addressed by him would confirm this with respect.

We come across people who inspire our faith in them; but he was one who inspired one’s faith in one’s own abilities. I will always remember him for this. He was not ‘all work and no play’; he was witty and full of Surti humour and was fun to be with. The best example of his dedication to BCAS is that he attended the last meeting of the BCA Foundation.

I had the benefit of presenting several papers under his chairmanship and I have no hesitation in stating that those were the best of the times, where he would very politely but firmly correct mistakes, share valuable suggestions and at times be a shield and would still ensure that he claimed no credit for the same.

I conclude with a fervent hope that his life continues to guide the profession in the right direction and
his soul enlightens our path by being a torchbearer for long.

– Pradip Kapasi, Past President, BCAS
_____________________________________________

Rare are the people who are calm reservoir of knowledge and experience and are generous with it. Rarer are those who inspire those qualities in others with their life example. In spite of many achievements and stature, they remain approachable and accessible. Arvindbhai was such a person ever since I have known him since I was a young boy. Author, speaker, guide, past president of BCAS and ICAI and a friend and elder to so many.

We would have asked several times questions on charitable trust matters and taken his counsel for our clients. At the BCAS he was someone you could call upon and count on. Today many people are very busy and have little time to spare. He shared his time and so his life for the BCAS. At RRCs and on overnight train travels especially, it was a treat to hear him chit chat. He often shared stories of his times. At lecture meetings, one saw him sitting in the first row listening attentively and patiently. As a Chairman of sessions, his words were measured and his comments were not taxing. We will miss his benign demeanor, meticulous counsel. However, above all we will have one person less to go to and look upon as an elder.

– Editor, BCAJ
_____________________________________________

Shri Arvind Bhai Dalal was one of the best but unassuming chartered accountants I have seen. I had the pleasure of working with him in Central Council for six years. As President of Institute, he had initiated far-reaching steps for the growth of the professional. He will be missed by the profession.

– Anand Rathi, Central Council Member, ICAI – 1985 to 1991, Ex President, BSE

A LEG-UP FOR INDEPENDENT DIRECTORS – WILL SEBI’S PROPOSALS IMPROVE CORPORATE GOVERNANCE?

SEBI has proposed several changes to the rules relating to corporate governance, mainly to strengthen the status of Independent Directors. The major changes include giving a bigger role to minority shareholders in the appointment / removal of such directors, proposing higher remuneration to them, strengthening the Audit Committee / Nomination and Remuneration Committee (‘NRC’) even further, etc. Views have been sought from the public at large through the release of a Consultation Paper.

The Consultation Paper notes how the requirements relating to corporate governance, introduced formally for the first time in 1999, have, over the years, seen several expert reviews and amendments in law to successively upgrade the requirements. As the paper notes, the Companies Act, 2013 / Rules made thereunder too have corporate governance requirements generally for specified listed and unlisted companies, many of them overlapping with the SEBI requirements. Hence, the fresh proposals are yet another step in that direction, though this time more focused on Independent Directors.

Independent Directors are seen as a pillar that balances the interests of all stakeholders with the primary focus on those of the minority shareholders vis-à-vis promoters. The worry is that promoters with their controlling stake should not be able to usurp the interests of others. This requires that they should not be able to influence the watchdog group – the Independent Directors.

APPOINTMENT AND REMOVAL OF INDEPENDENT DIRECTORS
The first of these important proposals looks at how Independent Directors are appointed and removed. At present, they are usually recommended by the NRC. The next step is appointment by the Board and the validity of their tenure is till the next annual general meeting. At such annual general meeting, the appointment is placed and confirmed by approval of the majority of shareholders who vote. Their removal is also by majority shareholder approval.

It is seen that the promoters who usually have a controlling stake can influence – perhaps decisively – the process at every step. This would mean that at every step they have a direct say and even decision-making ability. Thus, there are fair concerns that their independence may be influenced by the promoters. Hence, adopting the UK model almost wholly, it is proposed that this be corrected and that the appointment at shareholder level should pass two tests; first, approval by a majority of all shareholders including the promoters, and second, approval by the majority of the minority shareholders. Minority shareholders for this purpose would mean shareholders other than the promoters.

Let us understand this better through an example. Say, the promoters of a company hold 60% equity shares. The first test would be achieved when 50.01% of all shareholders approve (the percentage in each case is of shareholders who actually vote). Since promoters hold 60%, they would control this outcome. The second test is majority of the public (40%) shareholding and thus more than half of these – say 20.01% of the total – would also have to approve. If either of these tests fails, the appointment is rejected. There are then two ways out for the management. The first is that it can propose a new person as Independent Director and put him through these tests. Or, it can put the same candidate through a slightly different agni pariksha of sorts after a cooling period of 90 days, but before 120 days. If at least 75% of shareholders (including the promoters) approve, the appointment would be through. A similar process is proposed for the removal of Independent Directors. This ensures a significant role for the public shareholders and the strong influence of the promoters is mitigated to an extent.

SHORTLISTING OF INDEPENDENT DIRECTORS TO BE MORE TRANSPARENT
Even the shortlisting of Independent Directors is given a fillip by requiring more disclosures on how they came to be shortlisted. The process and requirements have to be laid down first and thereafter it is to be seen how each candidate fits these requirements. There have to be extensive disclosures to the shareholders, too.

Higher proportion of Independent Directors in the NRC
Moreover, the NRC that recommends Independent Directors will now have a higher proportion (two-thirds) of Independent Directors instead of just a majority as at present. A higher 67% ratio of Independent Directors would mean even more say to them in the NRC.

Appointment of new Independent Directors only by shareholders
At present the appointment of Independent Directors is made first by the Board and it is only at the later annual general meeting that shareholders get a chance to approve. During this period – which could be as long as a year – the Independent Director functions in office. To avoid this even interim say of the promoters on such appointments, it is now proposed that the appointment of Independent Directors shall only be by shareholders. If an Independent Director resigns / dies, his replacement too has to be made by shareholders, now within three months.

Resignation of Independent Directors to be more transparent and subject to restrictions
Concerns are often expressed that some Independent Directors having issues with the company may prefer to exit quietly without creating a fuss. To tackle this, several proposals have been made. Firstly, the complete resignation letter is required to be published by the company.

Further, if an Independent Director resigns stating ‘personal reasons’, ‘other commitments’ or ‘preoccupation’, he won’t be able to join any other Board for a year. This obviously makes sense since one cannot claim being busy, resign and then promptly join elsewhere. This may encourage them to be more forthright, if that was the real issue.

There is another concern. The management may have offered full-time employment to an Independent Director. This may be for bona fide reasons such as the management being impressed with his work. But obviously there are also concerns that this would affect his independence. A new proposal now states that if an Independent Director desires to join the company as a Wholetime Director, he will have to wait for one year after his resignation. Interestingly, as we will see later, the cooling period to become an Independent Director after having been an employee or KMP is three years, while in this case only one year’s cooling period is given.

Audit Committee to have no promoter / nominee directors or executive directors
The Audit Committee has an important role in approving related party transactions, accounts, etc. At present it is required that two-thirds of the committee should be Independent Directors and the rest can be any director, including promoter directors. Now, several categories are excluded even for the balance one-third of the committee. These may be non-independent directors but cannot be executive directors, nominee directors or those related to the promoters. The influence of both promoters and management is thus sought to be removed.

Excluding further categories of Key Managerial Persons
Persons who may have, in the immediate past, been employees / Key Managerial Persons (or their relatives) of the company and its holding / associate / subsidiary companies, or having material pecuniary relationships with them, may still have loose ties and may be subject to influence, and hence there may be concerns about their independence. Therefore, cooling periods are prescribed whereby they can join as Independent Directors only after specified periods. Two changes are now proposed. Firstly, now, past employees / KMPs of even promoter group companies will have to be subject to the cooling period. Secondly, the cooling period for all categories would now be uniform at three years.

ENHANCED REMUNERATION OF INDEPENDENT DIRECTORS
Finally, there is the proposal to enhance the remuneration of Independent Directors. The dilemma here is that if you pay too little, the Independent Director does not have the incentive to devote sufficient time to the affairs of the company. And if you pay too much, the concern is about him being influenced by the remuneration which may affect his independence. At present, a maximum Rs. 1 lakh per meeting is permitted as sitting fees. Commission based on profits is allowed but this has issues for loss-making companies. Besides, commission linked to profits has obvious concerns of conflict in approving accounts since there is a link between higher profits and higher commission.

A compromise of sorts is now proposed in two ways. One is by increasing the sitting fees, but this would have to be decided by the Ministry of Corporate Affairs. Hence, this proposal would be forwarded to them for their consideration.

The second is by permitting grant of employees stock options (‘ESOPs’) with at least five years vesting period. Thus, those who stay on for five years can possibly be rewarded through appreciation in the value of shares. However, this solution may not resolve the issue well. ESOPs are generally not very common in companies. Apart from this, a waiting period of five years could be too long and many may not benefit.

CONCLUSION
All in all, the changes are positive. However, much more is needed to be done. The powers and liabilities of Independent Directors have not been touched upon. Individually, Independent Directors have very little power. But the liability, on the other hand, is significant and the enhanced status may raise it even more. The remuneration of Independent Directors is still not resolved satisfactorily on at least two counts. First, the amount would still be decided by the Board and thus the promoters would still have a significant, often decisive, say. Second, the amount and manner may still be found to be insufficient to attract the best of talent. The proposal of dual approval tests giving minority shareholders a bigger role could also be applied for appointment of auditors who represent another pillar of safeguards.

It will also have to be seen how companies are required to transition to the new requirements. Will the provisions be effective immediately? Whether only large companies will be required first to change, with later dates being given for successive categories of smaller companies? Will the existing directors be allowed to complete their terms or will they have to be subject to this test immediately?

It is also seen that two laws – the SEBI LODR Regulations and the Companies Act, 2013 – have simultaneous requirements of corporate governance which overlap and even conflict. Perhaps the first step could be to require that listed companies would be regulated in this regard only by SEBI.

There is also another thought. Many principles of corporate governance are borrowed from the West, including a few significant ones from the UK, even in these proposals. India is different in a very vital way. Promoters typically hold a very significant stake, often more than 50%. Investors traditionally invest on the faith of the reputation and entrepreneurship of the promoters, though there would be cases where this trust is broken. While a check on them is always advisable, it should not happen that adopting a relatively alien concept tilts the balance so much that it actually becomes a hindrance.

GIFTS FROM ‘GIFT CITY’

INTRODUCTION

The Gujarat International Financial Tec-City (‘GIFT City’) in Gujarat is India’s first International Financial Service Centre (‘IFSC’). Many nations such as Singapore, the UAE, etc., have successfully developed IFSCs which have become financial service hubs and have attracted foreign investments. India aims to do so through the GIFT City. Several sops have been provided for setting up financial service intermediaries in the GIFT City both by the RBI and by SEBI. While GIFT City is a subject which merits a publication to itself, this article only looks at some of the key features and benefits available to financial service intermediaries for setting up an entity in the GIFT City.

REGULATORY REGIME
Instead of multiple financial services regulators such as SEBI, RBI and IRDA, the GIFT City is regulated by only one body – the International Financial Services Centres Authority set up under the Finance Ministry. The IFSC Authority is based in Gujarat. The unified IFSC Authority aims to ease the business environment for the intermediaries. However, multiple legislations continue to impact the GIFT City.

Units set up in the IFSC are treated as SEZ Units set up under the Special Economic Zones Act, 2005. Accordingly, units set up in an IFSC must conform to the provisions of the SEZ Act and its regulations.

Some of the key regulations pertaining to the setting up of financial institutions in the GIFT City are:

  •  Special Economic Zones Act, 2005
  •  Foreign Exchange Management (International Financial Services Centre) Regulations, 2015
  •  International Financial Services Centres Authority Act, 2019
  •  International Financial Services Centres Authority (Banking) Regulations, 2020
  •  Securities and Exchange Board of India (International Financial Services Centre) Guidelines, 2015
  •  SEBI’s Operating Guidelines for Alternative Investment Funds in International Financial Services Centres of 2018
  •  IFSCA’s Guidelines of 2020 for AIFs in IFSCs.

PERSON RESIDENT OUTSIDE INDIA
One of the most salient features of the GIFT City is that any entity set up here would be treated as a Person Resident Outside India under the Foreign Exchange Management Act, 1999. Thus, even though the unit is physically incorporated in India, it would be treated as if it is a non-resident under the FEMA. A financial institution is an entity engaged in rendering financial services or carrying out financial transactions and includes banks, NBFCs, insurance companies, brokerages, merchant bankers, securities exchanges, mutual funds, etc. On the other hand, a financial service is defined to mean any activity allowed to be carried out by SEBI / RBI / IRDA or any authority empowered to regulate the financial institution.

Consequently, a financial institution set up in the GIFT City must conduct business only in foreign currency and not in Indian Rupees. This feature has certain unique consequences which are explained below.

Any SEBI-registered intermediary may provide financial services relating to the securities market in the IFSC without forming a separate company.

FOREIGN PORTFOLIO INVESTORS
SEBI has liberalised the regime for foreign investors operating in the GIFT City as well as for FPIs to operate in it. Any applicant incorporated in the GIFT City shall be deemed to be appropriately regulated for the purposes of being registered as an FPI with SEBI. Hence, such an entity can apply for registration as a Category-I FPI.

Eligible Foreign Investors (EFIs) operating in IFSCs / GIFT City shall not be treated as entities regulated by SEBI. Further, SEBI-registered FPIs shall be permitted, without undergoing any additional documentation and / or prior approval process, to operate in the IFSC. The following are eligibility and KYC norms for EFIs:

Eligibility norms: EFIs are those foreign investors who are eligible to invest in IFSCs by satisfying the following conditions:
a) the investor is not resident in India,
b) the investor is not resident in a country identified in the public statement of the Financial Action Task Force as a deficient jurisdiction, and
c) the investor is not prohibited from dealing in the securities market in India.

KYC norms: An intermediary operating in an IFSC needs to ensure that the records of its clients are maintained as per the Prevention of Money-Laundering Act, 2002 and the rules made thereunder. The following KYC norms may be made applicable to EFIs:

  •  In case of participation of an EFI, not registered with SEBI as an FPI but desirous of operating in the IFSC, a trading member of the recognised stock exchange in the IFSC may rely upon the due diligence carried out by a bank which is permitted by RBI to operate in the IFSC during the account opening process of the EFI.
  •  In case of EFIs that are not registered with SEBI as FPIs and also not having bank accounts in the IFSC, KYC as applicable to Category-II FPI as per the new FPI categorisation shall be made applicable. However, PAN shall not be applicable for KYC of EFIs in the IFSC.
  •  In case of participation of FPIs in the IFSC, due diligence carried out by a SEBI-registered intermediary during the time of account opening and registration shall be considered.

Segregation of accounts: FPIs who operate in the Indian securities market and also propose to operate in the IFSC shall be required to ensure clear segregation of funds and securities. The custodians shall, in turn, monitor compliance of this provision for their respective FPI clients. Such FPIs shall keep their respective custodians informed about their participation in the IFSC.

AIFs IN THE GIFT CITY
Alternative Investment Funds (AIFs) are investment vehicles set up in India which privately pool funds / monies from domestic as well as foreign investors and invest such funds / monies in securities as per a defined investment policy. In India, an AIF along with its constituents is regulated by SEBI under the SEBI (AIF) Regulations, 2012 (SEBI AIF Regulations). SEBI has provided several incentives for setting up an AIF in the GIFT City / IFSCs. The IFSC Authority has further liberalised the framework for setting up AIFs in the GIFT City. The combined regulations for setting up an AIF are explained below.

Incorporation of the AIF
Any trust / LLP / company set up in the IFSC can be registered with SEBI as an AIF. If the sponsor / manager of an Indian AIF wishes to set up an AIF in the IFSC, it must first set up a branch / company in the IFSC which will act as the sponsor / manager of the AIF. Thus, the Indian sponsor cannot directly sponsor the IFSC AIF. It must first set up a foreign branch / foreign company in the IFSC. The investment in the IFSC sponsor would be treated as an overseas direct investment in a Joint Venture / Wholly-Owned Subsidiary under the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (FEMA No. 120/RB-2004). Since this would be an investment in the Financial Services Sector, the provisions of Regulations 6 and 7 of these Regulations would need to be adhered to.

The SEBI IFSC guidelines along with the SEBI AIF Regulations recognise the following types of AIFs:
(a) Category-I AIF: Funds which invest in startups, early-stage ventures, social ventures, small and medium enterprises, infrastructure sector, etc. These include Venture Capital Funds.
(b) Category-II AIF: Residual category, i.e., other than Category I and III AIFs and which do not undertake leverage other than to meet day-to-day operational requirements as per SEBI AIF Regulations. These include Private Equity Funds / Debt Funds.
(c) Category-III AIF: Funds which employ diverse or complex trading strategies and leverage including through investments in listed or unlisted securities / derivatives. These would include Hedge Funds.

Each scheme of the AIF shall have a corpus of at least US $3 million. The manager or sponsor shall have a continuing interest in the AIF of not less than 2.5% of the corpus or US $750,000, whichever is lower, in the form of investment in the AIF and such interest shall not be through the waiver of management fees. Further, for Category-III AIFs the continuing interest shall be not less than 5% of the corpus or US $1.5 million, whichever is lower. The AIF must raise money only in foreign currency and not in Indian Rupees.

Investments permissible by the AIF
SEBI has harmonised the provisions governing investments by AIFs incorporated in IFSCs with the provisions regarding investments applicable for domestic AIFs. Accordingly, AIFs set up in the IFSC can invest in

  •  Securities which are listed in the IFSC
  •  Securities issued by companies incorporated in the IFSC
  •  Securities issued by companies in India or belonging to foreign jurisdictions
  •  Units of other AIFs located in India as well as in the IFSC
  •  Any company, Special Purpose Vehicle or Limited Liability Partnership or body corporate or Real Estate Investment Trust or Infrastructure Investment Trust in which a domestic AIF can make an investment
  •  It can also co-invest in a portfolio company through a segregated portfolio by issuing a separate class of units. However, the investments by such segregated portfolios shall, in no circumstances, be on terms more favourable than those offered to the common portfolio of the AIF and appropriate disclosures must be made in the placement memorandum regarding creation of the segregated portfolio.

AIFs operating in India are subject to leverage restrictions under the SEBI Regulations. Accordingly, AIF Category-I cannot borrow, while Category-II can only borrow for meeting daily expenses. However, these restrictions have been removed for AIFs set up in the GIFT City. An AIF in an IFSC may borrow funds or engage in leveraging activities without any regulatory limit, subject only to the following conditions:
(a) The maximum leverage by the AIF, along with the methodology for calculation of leverage, shall be disclosed in the placement memorandum;
(b) The leverage shall be exercised subject to consent of the investors;
(c) The AIF employing leverage shall have a comprehensive risk management framework appropriate to the size, complexity and risk profile of the fund.

Further, AIFs operating in India have a maximum investment diversification rule. Thus, under the SEBI Regulations a Category-I AIF can invest a maximum of  25% of its investible funds in one investee company. Similarly, a Category-II AIF can invest a maximum of 10% of its investible funds in one investee company. The guidelines for AIFs in the IFSC have removed these diversification rules. Accordingly, they shall not apply to AIFs in IFSCs, subject to the conditions that appropriate disclosures have been made in the placement memorandum and the investments by the AIFs are in line with the risk appetite of the investors.

Most offshore financial centres do not have restrictions on leveraging or diversification guidelines. This is a very welcome move since now AIFs in IFSCs can set up tailor-made schemes for investing in a very select pool of companies. These guidelines should encourage more foreign institutions to set up AIFs in India.

Lastly, Indian AIFs are subject to a monetary limit when they want to invest abroad. AIFs set up in the IFSC are exempt from this limit since they are treated as set up in an offshore jurisdiction.

Nature of Indian investments by the AIF
Under the FEM (Non-Debt Instruments) Rules, 2019 an AIF is treated as an Investment Vehicle. If the control and management of the sponsor and manager of the AIF are ultimately with resident Indian citizens, then the entire investment made in India by such an AIF is treated as a domestic investment. It does not then matter whether the corpus of the scheme is foreign or Indian. Thus, if the AIF in the GIFT City is set up by and managed by another Indian entity which in turn is ultimately controlled and managed by resident Indian citizens, then the downstream investment by such an AIF in Indian entities would be treated as domestic investment. Such investment would then be outside the purview of the FEMA Regulations and would not be subject to pricing / sectoral conditions / sectoral caps under the FEM (Non-Debt Instruments) Rules, 2019 even if the entire corpus is raised from non-residents.

Eligible investors in the AIF
The following persons can make investments in an AIF operating in the IFSC:

  •  A person resident outside India;
  •  A non-resident Indian;
  •  Institutional investor resident in India who is eligible under FEMA to invest funds offshore, to the extent of outward investment permitted;
  •  A person resident in India having a net worth of at least US $1 million during the preceding financial year who is eligible under FEMA to invest funds offshore, to the extent  allowed in the LRS (US $250,000) of RBI. The minimum investment by an investor in an AIF is US $40,000 for employees or directors of the AIF or its manager and US $150,000 for all other investors.

The RBI has recently expressly allowed resident individuals to make remittances under LRS to IFSCs set up in India. Resident individuals may also open non-interest-bearing Foreign Currency Accounts (FCAs) in IFSCs for making the above permissible investments under LRS. Any funds lying idle in the account for a period up to 15 days from the date of receipt into the account shall be immediately repatriated to the domestic Rupee account of the investor in India. This is an example of express round-tripping being permissible by the RBI ~ Indian money under LRS would go abroad to an offshore AIF (although physically the AIF is in India) and could be routed back into India since such an AIF can invest in Indian companies!

Under the International Financial Services Centres Authority (Banking) Regulations, 2020 Qualified Resident Individuals (meaning an individual who is a person resident in India having net worth not less than US $1 million or equivalent in the preceding financial year) are permitted to open, hold and maintain accounts in a freely convertible foreign currency, with a banking unit, for undertaking transactions connected with or arising from any permissible transaction specified in the Liberalised Remittance Scheme of the Reserve Bank of India. The IFSCA has clarified that the net worth criteria shall not be applicable for an individual, being a person resident in India who opens an account with the bank for the purpose of investing in securities under the LRS. This is because of the fact that the purpose of such remittance under the LRS is investment in securities and the opening of a bank account with a banking unit is incidental to the same.

Triple role of the AIF
The AIF set up in the IFSC can also invest in India under the FDI Route, the FPI Route or the Foreign Venture Capital Investor (FVCI) Route. If it desires to come under the FPI or the FVCI Route, then it must get a separate registration for the same with SEBI. All such investments would be subject to the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 administered by the RBI and the relevant SEBI Regulations.

CONCLUSION
The GIFT City at Gujarat is an excellent idea to attract foreign investment and foreign financial institutions to set up shop in India. Along with the regulatory concessions provided to AIFs, there are several income-tax benefits which are also afforded to AIFs established in the IFSC. While the Government has given a strong impetus to the GIFT City, it remains to be seen whether financial institutions actually set up shop.

 

CLASSIFICATION CONUNDRUM

INTRODUCTION
The charging section for the levy of GST provides that the tax shall be levied on supply of goods / services or both. This entails the need for determination of whether a particular activity undertaken by a supplier is for supply of goods or supply of services? While dealing with this question, one may need to refer to the principles of composite supply or mixed supply as defined u/s 2 of the CGST Act, 2017 to determine whether the supply is that of goods or of services.

Once the determination of the nature of supply is done, the next question that arises is the rate applicable on such supply. There is a lot of confusion about the entry under which a particular goods / service should be classified in view of conflicting rates prescribed under the respective Rate Notifications, coupled with conflicting rulings by the Authority for Advance Ruling from different locations. This, despite the Rate Notifications specifically providing that rules for the interpretation as provided for under the Customs Tariff Act, 1975 shall also apply for the interpretation of headings covered under the said Notification.

In one of our earliest articles, ‘Principles of Classification’ (BCAJ, November, 2017), we had discussed in detail the subject of Classification under GST. In this article, we have attempted to identify a few instances dealing with Classification – both of a supply as goods vs. services, and the applicable rate on a supply along with conflicting AARs’ which add fire to this controversy.

GOODS VS. SERVICES – INTANGIBLES
The perennial controversy about determining what constitutes goods and what constitute services, although settled by the Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh [2004 (178) ELT 22 (SC)] (the ‘TCS case’), used to be a burning issue under the earlier regime and continues to be so even under the new GST regime. This is because the definition of the said terms u/s 2 of the CGST Act, 2017. Section 2 (52) defines ‘goods’ to mean every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to, or forming part of the land which are agreed to be severed before supply or under a contract of supply. Similarly, section 2(102) defines ‘services’ to mean anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged.

The first controversy which pertains to the issue of goods vs. services is in relation to intangibles. The issue of whether software, being an intangible property, is goods or service was already settled by the Apex Court in the TCS case wherein the Hon’ble Court had laid down the conditions for treating an intangible property as goods. Keeping that in mind, in view of the provision of Schedule II of the CGST Act, 2017, if the supply results in transfer of title in goods, the same would constitute supply of goods; while if there is transfer of right in goods without transfer of title thereof, the same would constitute supply of services. However, while dealing with this aspect another recent decision of the Supreme Court in the case of Engineering Analysis Centre of Excellence Private Limited vs. The Commissioner of Income Tax [Civil Appeal Nos. 8733-8734 of 2018], though in the context of income-tax, will always have an important bearing. In this case, the Court had held that licenses granted by way of End-User License Agreements were nothing but sale of goods. The relevant extracts of the decision are reproduced below for reference:

52. There can be no doubt as to the real nature of the transactions in the appeals before us. What is ‘licensed’ by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services vs. State of A.P., 2005 (1) SCC 308 (see paragraph 27).

In view of the above decision, an issue arises in case of import / export transactions through online mode. Such import / export transactions are not regulated through the Customs channel, and therefore, when payment is made for import of software or received for export of software, the nature of the transaction, i.e., whether the same pertains to purchase / sale of goods or service becomes particularly important. For example, if a person purchases all the rights which subsist in an intangible property / a license, the same would undoubtedly amount to supply of goods. The question that would arise in case of import of such goods is whether GST would be payable treating the same as ‘import of services’ or the same would be liable to tax under the proviso to section 5 of the IGST Act, 2017, i.e., the tax would be levied and collected under the Customs Act, 1962? If the latter view is taken, perhaps such transaction would not attract any IGST since there is no mechanism for levy of tax on intangibles under the Customs Act.

An even larger issue may crop up in the case of export transactions, especially when supply is under payment of IGST where there is a system for automated refund. Since the supply of intangibles is not routed through the customs system, the refund for such transactions may not be automatically processed and would therefore necessitate such exporters to file separate refund applications which can give rise to challenges as the Jurisdiction Officer may reject the refund claim on the simple ground that the same falls within the purview of Customs who may not at all be aware of the entire transaction.

GOODS VS. SERVICES – SALE VS. SERVICE
Entry 3 of Schedule II presumes an activity of job-work as service. While under the earlier regime job-work was defined to mean any activity amounting to manufacture, GST law defines the same to mean any treatment or process undertaken by a person on goods belonging to another registered person and the expression ‘job worker’ shall be construed accordingly. However, it would be incorrect to read this definition on a standalone basis, especially when the statute provides for concepts relating to composite supply / mixed supply which needs to be used when determining the nature of supply. Based on this, one would need to arrive at a conclusion whether a particular activity amounts to supply of goods or supply of service as job-work.

This discussion becomes important since there are specific instances where if the activity is treated as supply of goods, the same attracts tax at a different rate, while when treated as supply of service the applicable rate is different. At times where credit is not available fully, this would also involve cost ramifications. One such instance is observed in the context of newspapers. Supply of newspaper attracts nil rate of tax. However, the activity of printing of newspaper, which is classified as service, attracts tax @ 5%. Therefore, it becomes important to determine whether the supply being made is classifiable as supply of goods / services. Of course, while the answer to this question would depend on the facts of each case, the issue becomes more controversial in view of Circular 11/11/2017-GST dated 20th October, 2017 wherein the Board has clarified as under:

4. In the case of printing of books, pamphlets, brochures, annual reports and the like, where only content is supplied by the publisher or the person who owns the usage rights to the intangible inputs, while the physical inputs including paper used for printing belong to the printer, supply of printing [of the content supplied by the recipient of supply] is the principal supply and therefore such supplies would constitute supply of service falling under heading 9989 of the scheme of classification of services.
5. In case of supply of printed envelopes, letter cards, printed boxes, tissues, napkins, wall paper, etc. falling under Chapter 48 or 49, printed with design, logo etc. supplied by the recipient of goods but made using physical inputs including paper belonging to the printer, the predominant supply is that of goods and the supply of printing of the content [supplied by the recipient of supply] is ancillary to the principal supply of goods, and therefore such supplies would constitute supply of goods falling under respective headings of Chapter 48 or 49 of the Customs Tariff.

While in the first case the Board has clarified that the supply of printing service is the principal service, in the second case it has been clarified that supply of goods is the predominant supply. It is difficult to fathom how both the transactions can be dealt with differently as in both the cases the intention of the recipient is to receive back printed material from the job-worker. It is common for publishers to outsource printing activity and the dominant intention is to receive the printed content which is used by them to further supply such printed content.

In fact, this Circular also appears to be contrary to the principles of job-work which have been laid down by the Supreme Court in the case of Prestige Engineering (India) Ltd. vs. CCE Meerut [1994 (73) ELT 497 (SC)] which explained what shall and what shall not constitute job work. The primary rule laid down by the Court was that job work should not be narrowly understood as requiring the job worker to return the goods in the same form as this would render the Notification itself redundant since the definition specifically contemplated ‘a manufacturing process’, but it also cannot be so widely interpreted as to allow an arrangement where the process involved substantial value addition. It is imperative for the readers to note that the above clarification has also been followed by the Authority for Advance Ruling in the case of Sri Venkateswara Enterprises [2019 (30) GSTL 83 (AAR – GST)]. However, in another case, that of Ashok Chaturvedi [2019 (21) GSTL 211 (AAR – GST)], the Authority has held that the principal supply was that of goods and therefore the printed content would be classified under Chapter 49 and taxed accordingly.

A similar issue exists in the hospitality sector where there is confusion as to whether tobacco products such as cigarettes, hookah, etc., supplied and consumed in a restaurant shall be classified as supply of goods or supply of service as a part of restaurant services? The Advance Authority has, in the case of MFAR Hotels & Resorts Private Limited [2020 (42) GSTL 470 (AAR – GST – TN)], held that cigarettes supplied in the restaurant will be treated as supply of goods as the same is not naturally bundled with the service of the restaurant. However, it would appear that the ruling has not taken into consideration Entry 6(b) of Schedule II which deems a composite supply by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink as supply of service. If aerated beverages, which also attract the higher rate of tax as well as compensation cess supplied in a restaurant can be treated as supply of service, there is no logical reasoning to not extend the same benefit to tobacco as the same also falls within the basket of goods supplied for human consumption, irrespective of whether or not the same is injurious to health!

RATE CLASSIFICATION – GOODS
As discussed in the earlier article also, the Rate Notifications under GST provide that the classification of any goods / services in a particular rate / exemption entry shall be done applying the rules for interpretation as provided for under the Customs Tariff Act, 1975. The said rules were discussed in detail in the said article. However, since the introduction of GST there have been several items the classification of which has continued to be under dispute. In this article, we have attempted to identify and discuss such cases.

The first class of goods which has seen substantial classification dispute is ‘tobacco’ which comes in different forms and varied rates have been notified depending on the nature of the product. The following table summarises the different rates applicable to different types of tobacco:

Schedule

Entry
No.

HSN

Description
of product

Rate

I

109

2401

Tobacco Leaves

5%

IV

13

2401

Unmanufactured tobacco; tobacco refuse [other
than tobacco leaves]

28%

IV

15

2403

Other manufactured tobacco and manufactured
tobacco substitutes; ‘homogenised’ or ‘reconstituted’ tobacco; tobacco
extracts and essences [including ‘biris’]

28%

A particular area of dispute has been as to what constitutes tobacco leaves. The Board has, vide Circular 332/2/2017 – TRU clarified that tobacco leaves shall mean leaves of tobacco as such, broken tobacco leaves and stems. This issue has been examined in detail in the context of Central Excise. The Tribunal has, in the case of Yogesh Associates vs. CCE, Surat II [2006 (195) ELT 196 (Tri – Mum)] wherein the Tribunal held that raw leaf treated with tobacco solution Quimam and other flavours including saffron water did not result in the leaf undergoing any irreversible change and the same continued to remain raw, unmanufactured tobacco leaf. This decision was also approved by the Apex Court in 2006 (199) ELT A221 (SC). However, there have been conflicting decisions from the Authority for Advance Ruling in the context of GST w.r.t. classification of tobacco products in different forms.

In the case of Shailesh Kumar Singh [2018 (13) GSTL 373 (AAR – GST)] and Pragathi Enterprises [2018 (19) GSTL 327 (AAR – GST)]), the Authority has held that dried tobacco leaves which have undergone the process of curing are not covered under Schedule I Entry 109 but will be covered under Schedule IV Entry 13. In Sringeri Yogis Pai [2019 (31) GSTL 357 (AAR – GST)] the Authority has further held that cured tobacco leaves would also get covered under Schedule IV Entry 13.

However, in Suresh G. [2019 (023) GSTL 0483 (AAR – GST)], the Authority has held that sun-cured tobacco leaves would get covered under Schedule I and therefore attract GST at 5%. The Authority held as under:

‘6. It is well-known fact that the fresh or green leaves are having no commercial marketability. Only after the long process of curing the tobacco leaves become capable for marketing. Therefore legislature imposed tax only on cured tobacco leaves which are capable of being traded. As per serial number 13 of Schedule-IV of Notification No. 1/2017-Central Tax (Rate), dated 28-6-2017 “un-manufactured tobacco” is brought under 28% taxable category. But the entry itself clearly specified that unmanufactured tobacco, tobacco refuse (other than tobacco leaves) is taxable at the rate of 28%. Since tobacco leaves are specifically excluded from Schedule-IV Sl. No. 13 it will squarely come under Schedule-I of Sl. No. 109 and taxable at the rate of 5%. Therefore tobacco leaves including the leaves cut from plant, dry leaves, cured leaves by applying natural process ordinarily used by the farmers to make them fit to be taken to market shall qualify for 5% tax rate. It is common knowledge that without curing tobacco leaves cannot be consumed. The curing in relation to tobacco leaves means removal of moisture from the tobacco leaves. Section 2(c) of the Central Excise Act, 1944 specified that the term “curing” includes wilting, drying, fermenting and any process for rendering an unmanufactured product fit for marketing or manufacture. Hence, the unavoidable process of curing of tobacco leaves to make it fit for marketing will qualify the word “curing” mentioned in Chapter 24 of the Customs Tariff Act, 1975.’

The above view has also been followed in the case of Alliance One Industries Private Limited [2020 (32) GSTL 216 (AAR – GST – AP)] and K.S. Subbaih Pillai & Co. (India) Pvt. Ltd. [2020 (32) GSTL 196 (AAR – GST – AP)].

It is therefore clear that there is a lot of confusion with regard to the correct classification of tobacco under GST. Further, with tobacco being liable to tax under Reverse Charge also, the need for a correct solution becomes more important since if a wrong classification is applied there will be an effect on both fronts, outward supplies as well as inward supplies. It therefore becomes more important for the taxpayer to determine the correct classification of the product being dealt with by him to avoid future litigation. In other words, it would be safe to say that applying a wrong classification would not only be injurious to customers’ health, but also to the taxpayers’ health!

The next controversy revolves around classification of fryums. This is because while there is no specific entry for fryums under GST, Entry 96 of Notification 2/2017 – CT (Rate) exempts papad, by whatever name known, from GST except when served for human consumption. On the other hand, there are different entries in the Rate Notification so far as namkeen is concerned. The following table summarises the different rates applicable to namkeen in different forms:

Schedule

Entry
No.

HSN

Description
of product

Rate

I

101A

2106 90

[Namkeens, bhujia, mixture, chabena and
similar edible preparations in ready for consumption form, other than those
put up in unit container and, –

(a)…. bearing a registered brand name; or

(b)…. bearing a brand name on which an
actionable claim or enforceable right in a court of law is available (other
than those where any actionable claim or any enforceable right in respect of
such brand name has been voluntarily foregone, subject to the conditions as
specified in the Annexure)]

5%

II

46

2106 90

[Namkeens, bhujia, mixture, chabena and
similar edible preparations in ready for consumption form (other than roasted
gram), put up in unit container and, –

(a)…. bearing a registered brand name; or

(b)…. bearing a brand name on which an
actionable claim or enforceable right in a court of law is available (other
than those where any actionable claim or any enforceable right in respect of
such brand name has been voluntarily foregone,

12%

II
[continued]

46

2106 90

subject to the conditions as specified in
the Annexure)]

12%

III

23

2106

[Food preparations not elsewhere specified
or included (other than roasted gram, sweetmeats, batters including idli /
dosa batter, namkeens, bhujia, mixture, chabena and similar edible
preparations in ready for consumption form, khakhra, chutney powder, diabetic
foods)]

18%

Therefore, the questions which need deliberation are:
* Whether fryums can be treated as papad?
* If not, under which entry will fryums qualify?

The reason behind the need to determine whether fryum can be classified as papad or namkeen arises in view of the decision of the Tribunal in the case of Commissioner of Central Excise vs. TTK Pharma Ltd. [2005 (190) ELT 214 (Tri – Bang)]. The Tribunal had held that fryums can be marketed as namkeen only after they are fried, just like papad. However, the tax implication if this classification is not accepted is substantial because if fryums are classified as papad, the same are exempted from GST, while if classified as namkeen, the same would get classified under Schedule III and become liable to GST at 18%. Thus, the difference is substantial and therefore one needs to be careful while deciding the classification of fryums.

This aspect has also been dealt with by the AAR in the case of Sonal Products [2019 (23) GSTL 260 (AAR – GST)] and Alisha Foods [2020 (33) GSTL 474 (AAR – GST)]. In both instances, the Authority has held that fryums are classifiable as namkeen and not papad and therefore the same would be taxable at 18%. The Authority relied on the decision in the case of TTK Pharma Ltd. vs. Collector of Central Excise [1993 (63) ELT 446 (Tribunal)]. However, it has failed to appreciate that the Tribunal had used the word namkeen / papad interchangeably while dealing with the applicability of an exemption Notification. The Authority further referred to the decision in the case of Commissioner of Commercial Taxes, Indore vs. TTK Healthcare Ltd. [2007 (21) ELT 0197 (SC)]. However, the Authority has again failed to appreciate that the dispute in the said case was whether or not fryums could be treated as cooked food. The Authority has further concluded that the classification was to be done as per the meaning construed in the popular sense and as understood in common language.

It is important to note that the Authority has failed to appreciate that the process followed for making of papad / fryums is similar. In fact, both become ready for human consumption only when fried and when fried, both rather partake the character of namkeen. In this sense, the decision of the Authority to not treat fryums as papad appears to be on shaky ground.

The next item which has seen its fair share of controversy is parantha. Entry 97 of Notification 2/2017-CT (Rate) exempts bread (branded or otherwise) from tax, except when served for consumption, and pizza bread. Bread is something which is generally an accompaniment with the main meal of the day and is cooked in different styles using different ingredients. It is known by different names across the globe. If one does a search for ‘List of Breads’ on Wikipedia, it can be seen that even the roti, chapati, naan, kulcha, dosa, etc., which are consumed in different parts of India and known by different names are also types of bread. However, there is a separate entry for plain chapati or roti under Schedule I of Notification 2/2017-CT (Rate) and the same is taxed at 5%. But other forms of Indian bread do not find a specific entry in the Rate Notifications. This gives rise to the classification issue.

The first such issue reported was in the classification of ‘Classic Malabar parota’ or ‘Whole Wheat Malabar parotta’. The Authority for Advance Ruling has in the case of Modern Food Enterprises Private Limited [2018 (18) GSTL 837 (AAR – GST)] held that there is a substantial distinction between parotta and bread in terms of preparation, use and digestion and, therefore, exemption given to bread cannot be extended to parotta. However, in Signature International Foods India Private Limited [2019 (20) GSTL 640 (AAR – GST)], the Authority has held that paratha was similar to roti and therefore classifiable under Schedule I of Notification 1/2017-CT (Rate) and therefore attracts GST @ 5%. Surprisingly, in this case the Authority proceeded to conclude that naan / kulcha which were not defined anywhere would be classifiable under the residuary entry in Schedule III of Notification 1/2017-CT (Rate) and therefore attract GST @ 18%.

RATE CLASSIFICATION – SERVICES
Let us now look at similar issues while determining the applicable tariff entry for services. The first issue which arises is with classification of certain services provided to Government, whether Central Government, State Government, Union Territory, a local authority, a Governmental Authority or a Government Entity. The relevant entry for discussion is Entry 3(vi) of Notification 11/2017-CT (Rate) which provides for tax at 12% on composite supply of works contract as defined in clause (119) of section 2 of the Central Goods and Services Tax Act, 2017 provided to the Central Government, State Government, Union territory, a local authority or a Governmental Authority or a Government Entity by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works meant predominantly for use other than for commerce, industry, or any other business or profession. Vide the explanation, it has also been clarified that the term ‘business’ shall not include any activity or transaction undertaken by the Central Government, State Government or any local authority in which they are engaged as public authorities.

Despite the above clarification, there has been substantial confusion as to when a service would be classified under this entry, because when services are being provided to Government it is difficult to distinguish whether the service is for use other than for commerce, industry or any other business or profession. There have been conflicting AARs on this issue as well. In A2Z Infra Engineering Ltd. [2018 (18) GSTL 760 (AAR – GST)], the Authority held that services provided to a Power Distribution Company would be covered under the scope of ‘for use other than for commerce, industry, or any other business or profession’ and therefore concessional tax rate would not be applicable in such a case. A similar view was also followed in the case of Madhya Pradesh Madhya Kshetra Vidyut Vitaran Company Limited [2019 (020) GSTL 0788 (AAR – GST)] as well. In fact, in a recent decision the Appellate AAR in the case of Vijai Electricals Ltd. [2020 (42) GSTL 153 (App. AAR)] wherein despite the appellants submitting an opinion from the Government Departments that the activities of the recipient were non-commercial in nature, the denial of benefit of concessional rate of tax was upheld.

In the case of Tata Projects Limited [2019 (24) GSTL 505 (AAR – GST)], service provided to the Nuclear Fuel Complex engaged in the manufacture and enrichment of nuclear fuel for production of electricity which is a business and commercial activity, the concessional rate of 12% will not be available.

However, the Appellate AAR has in the case of ITD Cementation India Limited [2019 (25) GSTL 315 (AAAR)] set aside the order of the AAR and held that supply of service for construction of multi-modal terminal was for infrastructural development of waterways of India and not meant for commerce and business. A similar view was taken in the case of Vikram Sarabhai Space Centre [2019 (25) GSTL 129 (AAR – GST)] also.

There are many taxpayers who are providing service of this kind to Government and in many cases the contract values are inclusive of GST. Prompt clarification on what constitutes ‘commerce, industry, business or profession’ would be most welcome as there would be severe financial consequences if the end conclusion is not beneficial to the taxpayers.

Another burning issue in the context of services provided to Government is what constitutes ‘pure services’? Entry 3 of Notification 12/2017-CGST (Rate) provides exemption to pure services (excluding works contract service or other composite supplies involving supply of any goods) provided to the Central Government, State Government or Union territory, or local authority, or a Governmental authority, or a Government Entity by way of any activity in relation to any function entrusted to a Panchayat under Article 243G of the Constitution, or in relation to any function entrusted to a Municipality under Article 243W of the Constitution. However, what constitutes ‘pure service’ has not been defined either under the Notification or the Act / Rules.

This has resulted in substantial confusion since taxpayers intend to claim the benefit of the exemption Notification while the tax authorities look at ways to deny the same. In fact, the AAR has on multiple occasions held that only such service where there is no involvement of even an incidental supply of goods would be covered within the scope of ‘pure service’. In fact, in the case of Harmilap Media (P) Limited [2020 (33) GSTL 89 (AAR – GST)], while determining whether or not advertising service would classify as pure service, the Authority held in the negative since there is an element of supply of goods involved, though not material. Fortunately, this anomaly has been sought to be removed by way of insertion of Entry 3A to the Notification which now provides that the exemption shall extend to composite services also, provided that the value of goods involved in the supply is not more than 25% of the total value. This amendment will perhaps put the dispute to rest.

The next dispute revolves around classification of services relating to transport of goods. There are two rates notified for the service of GTA, one being 5% in case the service provider opts to not claim ITC and 12% where the service provider opts to claim ITC. What constitutes ‘GTA’ has been defined to mean any person who provides service in relation to transport of goods by road and issues a consignment note, by whatever name called. The first controversy which prevails is whether for classification as a GTA is the supplier compulsorily required to issue a consignment note? A perusal of the Rate Notification does indicate towards the same. However, the Appellate AAR has in the case of K.M. Trans Logistics Private Limited [2020 (35) GSTL 346 (AAAR -– GST)] while dealing with this issue held that once the possession of goods is transferred to the transporter, irrespective of whether the consignment note is issued or not, he becomes a GTA and would therefore be liable to tax accordingly.

However, in the case of Liberty Translines [2020 (41) GSTL 657 (App. AAR – GST)], in a case involving sub-contracting in transportation business, the Authority held that issuance of a consignment note by the sub-contractor transporter to the main transporter would not make him a GTA and the service would be classified under the entry of ‘renting of vehicles’ and would therefore attract tax at 18%, irrespective of whether the main contractor opts to pay tax under the 5% scheme / 12% scheme, thus involving substantial cost implications for the main contractor. It is, however, important to note that in the case of Saravana Perumal [2020 (33) GSTL 39 (AAR – Kar)] involving a similar fact matrix, the AAR has held that the services provided by the sub-contracting transporter to the main transporter would also get classified as GTA.

CONCLUSION
The above discussion clearly indicates that the classification issue will continue even under the GST regime. Of course, the same will be on multiple fronts, ranging from classifying an activity as that of goods or service or none, and then proceeding to determine the correct tariff classification. The controversy will get more pronounced with conflicting decisions from the AAR which will only add fuel to the fire. However, the taxpayers will need to be more cautious and careful, especially where there is confusion on the classification, because incorrect classification may have serious ramifications on the business.

REVENUE ADJUSTMENT ON ACCOUNT OF TRANSFER PRICING

BACKGROUND
The finalisation of transfer price between an assessee and the Income-tax Authorities with respect to related party transactions could take several years. In the meantime, the related party transactions are priced on a provisional basis. This article deals with the accounting of the adjustments required when there is finality on the transfer pricing between the assessee and the Income-tax Authorities.

ISSUE

  •  An Indian subsidiary bills the parent and recognises revenue for services provided @ 10% margin;
  •  Three years later, the Income-tax Department settles transfer pricing @ 15% margin as per the Advance Pricing Agreement (APA);
  •  The parent contributes to the subsidiary the 5% difference for the past three years, let’s say, INR 100;
  •  Whether INR 100 is an equity contribution by the parent to the subsidiary in the books of the subsidiary under AS?
  •  What are the disclosures required in the financial statements of the subsidiary?


REFERENCES

Paragraph 11 Ind AS 32 – Financial Instruments: Presentation
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Paragraph 51 Ind AS 115 – Revenue from Contracts with Customers
An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. The promised consideration can also vary if an entity’s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event. For example, an amount of consideration would be variable if either a product was sold with a right of return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.

Ind AS 12 Appendix C – Uncertainty over Income-tax treatments
4. This Appendix clarifies how to apply the recognition and measurement requirements in Ind AS 12 when there is uncertainty over income-tax treatments. In such a circumstance, an entity shall recognise and measure its current or deferred tax asset or liability applying the requirements in Ind AS 12 based on taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates determined applying this Appendix.

Ind AS 115 – Revenue from Contracts with Customers
118  An entity shall provide an explanation of the significant changes in the contract asset and the contract liability balances during the reporting period. The explanation shall include qualitative and quantitative information. Examples of changes in the entity’s balances of contract assets and contract liabilities include any of the following:
(a) …….;
(b) cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained) or a contract modification;
(c) ………………….;
(d) ………………….; and
(e) …………………….

119 An entity shall disclose information about its performance obligations in contracts with customers, including a description of all of the following:
(a) …………..;
(b) the significant payment terms (for example, when payment is typically due, whether the contract has a significant financing component, whether the consideration amount is variable and whether the estimate of variable consideration is typically constrained in accordance with paragraphs 56 – 58);
(c) ………………..;
(d) …………………; and
(e) ……………………

122 An entity shall explain qualitatively whether it is applying the practical expedient in paragraph 121 and whether any consideration from contracts with customers is not included in the transaction price and, therefore, not included in the information disclosed in accordance with paragraph 120. For example, an estimate of the transaction price would not include any estimated amounts of variable consideration that are constrained (see paragraphs 56 – 58).

126  An entity shall disclose information about the methods, inputs and assumptions used for all of the following:
(a) determining the transaction price, which includes, but is not limited to estimating variable consideration, adjusting the consideration for the effects of the time value of money and measuring non-cash consideration;
(b) assessing whether an estimate of variable consideration is constrained;
(c) allocating the transaction price, including estimating stand-alone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable); and
(d) ………………..

RESPONSE


The APA between the Indian subsidiary and the Income-tax Authorities will require the Indian subsidiary to raise an invoice for the amounts under-invoiced earlier. The Indian subsidiary will now have to bill the difference in margin of 5% to the parent entity, i.e., INR 100. The parent entity will have to remit this amount to the Indian subsidiary. If the parent does not remit this amount to the subsidiary, it would be treated as a deemed loan to the parent in the hands of the subsidiary, and the subsidiary will have to pay tax on deemed interest income.

As per paragraph 11 of Ind AS 32, an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. They are, therefore, non-reciprocal in nature. In the fact pattern, the invoicing of the incremental 5% margin, INR 100, is not a non-reciprocal transfer. The parent is transferring INR 100 to the Indian subsidiary because it was under-invoiced in the past. In accordance with paragraph 51 of Ind AS 115, this would constitute variable consideration and the billing by the subsidiary to the parent company would be included in the current year revenue of the subsidiary as a cumulative catch-up adjustment. This will not constitute a prior-period error as there was no error in the given fact pattern. The earlier years invoicing was provisional and the final invoicing, once a conclusion was reached with the Income-tax Authorities, was based on the contractual arrangement between the parent and the subsidiary. The final billing of an additional INR 100 reflected the arrangement between the parent and the subsidiary as a supplier and a customer, rather than in the capacity as a shareholder.

Appendix C of Ind AS 12 – Uncertainty over Income-tax treatments applies when the uncertainty is with respect to income-tax treatment by Income-tax Authorities. From the perspective of the subsidiary, there is no uncertainty over income-tax treatments since it is fully compensated by the parent as per their agreement. However, there is uncertainty over variable consideration. Therefore, from a disclosure perspective in the financial statements of the subsidiary, the disclosure as required by paragraphs 118, 119, 122 and 126 of Ind AS 115 will be required.

ISSUES IN TAXATION OF DIVIDEND INCOME, Part – 1

The Finance Act, 2020 has reintroduced the classical system of taxation on dividends moving away from the Dividend Distribution Tax (‘DDT’) system. The DDT tax system was first introduced by the Finance Act, 1997, abolished by the Finance Act, 2002 and reintroduced by the Finance Act, 2003 before being abolished in 2020. This reintroduction of the earlier, traditional system of taxation, while not necessarily more beneficial to a resident shareholder, can be more favourable to a non-resident shareholder on account of the benefit of the tax treaty as compared to the erstwhile DDT system of taxing dividends. For example, under the DDT regime the dividends were subject to tax at the rate of 15% plus surcharge and education cess. Under the classical system of taxation, this rate of tax can now be reduced to a lower DTAA rate, depending on the DTAA.

Article 10 of the DTAAs, dealing with dividends, was not of much significance in the past. However, now one would need to understand the intricacies of the benefits available for dividends in tax treaties and the various issues arising therefrom. It is important to note that the Multilateral Instrument (MLI), of which India is a signatory and which modifies various Indian DTAAs, also contains certain clauses which impact the taxation of dividends. In this two-part article we seek to analyse part of the international tax aspects of the taxation of dividends. In the first part we analyse the taxation of dividends under the domestic tax law and the construct of the DTAAs in the case of dividend income. The second part would contain various specific issues arising in the taxation of dividends in an international tax scenario.

1. INTRODUCTION

Debt and equity are two main options available to a company to raise capital, with various forms of hybrid instruments having varying degrees of characteristics of each of these options. The return on investment from such capital structure is generally termed as ‘dividend’ or ‘interest’ depending on the type of structure, i.e., whether classified as a primarily equity or a debt instrument.

‘Dividend’ in its ordinary connotation means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum distributed. Dividend taxation in a domestic scenario typically involves economic double taxation – the company is taxed on the profits earned and the shareholders are taxed on such profits when they are distributed by the company by way of dividends.

While DTAAs generally relieve juridical double taxation, some DTAAs also relieve economic double taxation to a certain extent, in cases where underlying tax credit is provided.

The ensuing paragraphs evaluate various domestic tax as well as DTAA aspects of inbound as well as outbound dividends, specifically from the international tax perspective. In other words, tax implications on dividends paid by a foreign subsidiary to an Indian resident and on dividends paid by Indian companies to foreign shareholders are sought to be analysed.

Most DTAAs as well as both the Model Conventions – the OECD as well as the UN Model – follow a similar pattern in terms of the language of the article on dividends. For the purposes of this article, the UN Model Convention (2017) is used as a base.

2. TAXATION OF DIVIDEND AS PER DOMESTIC TAX LAW

There are various options available to a country while formulating its tax laws for taxation of dividends. In the past India was following the DDT system of taxing dividends. From A.Y. 2021-22 India has moved to the classical system of taxing dividends. Under the classical system of taxation, the company is first taxed on its profits and then the shareholders are taxed on the dividends paid by the company.

2.1    Definition of the term ‘dividend’
The term ‘dividend’ has been defined in section 2(22) of the Income-tax Act, 1961. It includes the following payments / distributions by a company, to the extent it possesses accumulated profits:
a.    Distribution of assets to shareholders;
b.    Distribution of debentures to equity shareholders or bonus shares to preference shareholders;
c.    Distribution to shareholders on liquidation;
d.    Distribution to shareholders on capital reduction;
e.    Loan or advance given to shareholder or any concern controlled by a shareholder.

The domestic tax definition of dividend as compared to the definition under the DTAA has been analysed subsequently in this article.

2.2    Outbound dividends
Dividend paid by an Indian company is deemed to accrue or arise in India by virtue of section 9(1)(iv).

Section 8 provides for the period when the dividend would be added to the income of the shareholder assessee. It provides that the interim dividend shall be considered as income in the year in which it is unconditionally made available to the shareholder and that the final dividend shall be considered as income in the year in which it is declared, distributed or paid.

The timing of the taxation of interim dividend as per the Act, i.e., when it is made unconditionally or at the disposal of the shareholder, is similar to that provided in the description of the term ‘paid’ above. However, the timing of the taxation of the final dividend may not necessarily match with that of the description of the term.

For example, in case of final dividend declared by an Indian company to a company resident of State X in September, 2020 but paid in April, 2021, when would such dividends be taxed as per the Act?

In this regard, it may be highlighted that the source rule for taxation of dividends ‘paid’ by domestic companies to non-residents is payment as per section 9(1)(iv) and not declaration of dividend. The Bombay High Court in the case of Pfizer Corpn. vs. Commissioner of Income-tax (259 ITR 391) held that,

‘….but for 9(1)(iv) payment of dividend to non-resident outside India would not have come within 5(2)(b). Therefore, 9(1)(iv) is an extension to 5(2)(b)……. in case where the question arises of taxing income one has to consider place of accrual of the dividend income. To cover a situation where dividend is declared in India and paid to non-resident out of India, 5(2)(b) has to be read with 9(1)(iv). Under 9(1)(iv), it is clearly stipulated that a dividend paid by an Indian company outside India will constitute income deemed to (be) accruing in India on effecting such payment. In 9(1)(iv), the words used are “a dividend paid by an Indian company outside India”. This is in contradiction to 8 which refers to a dividend declared, distributed or paid by a company. The word “declared or distributed” occurring in 8 does not find place in 9(1)(iv). Therefore, it is clear that dividend paid to non-resident outside India is deemed to accrue in India only on payment.’

Therefore, one can contend that dividend declared by an Indian company would be considered as income in the hands of the non-resident shareholder only on payment.

Earlier, dividends declared by an Indian company were subject to DDT u/s 115O payable by the company declaring such dividends. The rate of DDT was 15% and in case of deemed dividend the DDT rate from A.Y. 2019-20 (up to A.Y. 2020-21) was 30%. Further, section 115BBDA, referred to as the super-rich tax on dividends, taxed a resident [other than a domestic company, an institution u/s 10(23C) or a charitable trust registered u/s 12A or section 12AA] earning dividends (from Indian companies) in excess of INR 10 lakhs. In case of such a resident, the dividend in excess of INR 10 lakhs was taxed at the rate of 10%.

From A.Y. 2021-22, dividends paid by an Indian company to a non-resident are taxed at the rate of 20% (plus applicable surcharge and education cess). Further, with the dividend now being taxed directly in the hands of the shareholders, section 115BBDA is now inoperable.

Payment of dividend to non-residents or to foreign companies would require deduction of tax at source u/s 195 at the rates in force on the sum chargeable to tax. The rates in force in respect of dividends for non-residents or foreign companies as discussed above is 20% (plus applicable surcharge or education cess) or the rate as per the relevant DTAA (subject to fulfilment of conditions in respect of treaty eligibility), whichever is more beneficial.

2.3    Inbound dividends
Dividends paid by foreign companies to Indian companies which hold 26% or more of the capital of the foreign company are taxable at the rate of 15% u/s 115BBD. Further, such dividends, when distributed by the Indian holding company to its shareholders, were not included while computing the dividend distribution tax payable u/s 115O. However, section 80M also provides such a pass-through status to the dividends received to the extent the said dividends received by an Indian company have been further distributed as dividend within one month of the date of filing the return of income of the Indian company. The tax payable would be further reduced by the tax credit, if any, paid by the recipient in any country.

Let us take an example, say F Co, a foreign company in country A distributes dividend of 100 to I Co, an Indian company which further distributes 30 as dividend to its shareholders (within the prescribed limit). Assuming that the withholding tax on dividends in country A is 10, the amount of tax payable would be computed as below:

 

Particulars

Amount

A

Dividend received from F Co

100

B

(-) Deduction u/s 80M for dividends distributed by I Co

(30)

C

Dividend liable to tax (A-B)

70

D

Tax u/s 115BBD (C * 15%)

10.5

E

(-) Tax credit for tax paid in country A (assuming full tax
credit available)

(10)

F

Net tax payable (D-E) (plus applicable surcharge
and education cess)

0.5

Dividends received by other taxpayers are taxable at the applicable rate of tax (depending on the type of person receiving the dividends).

2.4 Taxation in case the Place of Effective Management (‘POEM’) of foreign company is in India
a. Dividend paid by foreign company having POEM in India to non-resident shareholder
As highlighted earlier, section 9(1)(iv) deems income paid by an Indian company to accrue or arise in India. In the present case, as the deeming fiction only refers to dividend paid by an Indian company, one may be able to take a position that the deeming fiction should not be extended to apply to foreign companies even if such foreign companies are resident in India due to the POEM of such companies in India. One may be able to argue that if the Legislature wanted such dividend to be covered, it would have specifically provided for it as done in respect of the existing source rules for royalty and fees for technical services in section 9, wherein a payment by a non-resident would deem such income to accrue or arise in India. Accordingly, the dividend paid by the foreign company to a non-resident shareholder may not be taxable in India even though the foreign company, declaring such dividend, is considered as a resident of India due to the POEM of the foreign company in India.

b. Dividend paid by foreign company having a POEM in India to resident shareholder
Such dividend would be taxed in India on account of the recipient of the dividend being a resident of India. Further, section 115BBD provides a lower rate of tax on dividends paid by a foreign company to an Indian company, subject to the Indian company holding at least 26% in nominal value of the equity share capital of the foreign company. Accordingly, such lower rate of tax would apply to dividends received by an Indian company from a foreign company (subject to the fulfilment of the minimum holding requirement) even if such foreign company is considered as a resident in India on account of its POEM being in India.

c. Dividend received by a foreign company
The provisions of section 115A apply in the case of receipt by a non-resident (other than a company) and a foreign company. Accordingly, dividend received by a foreign company would be taxed at the rate of 20% (plus applicable surcharge and education cess) even if the foreign company is considered as a tax resident of India on account of its POEM being in India.

3. ARTICLE 10 OF THE UN MODEL CONVENTION OR DTAAs DEALING WITH DIVIDENDS
As discussed above, dividends typically give rise to economic double taxation. However, the dividends may also be subject to juridical double taxation in a situation where the income, i.e., dividend is taxed in the hands of the same shareholder in two different jurisdictions. Article 10 of a DTAA typically provides relief from such juridical double taxation.

Article 10 dealing with taxation of dividends is typically worded in the following format:
a.    Para 1 deals with the bilateral scope for the applicability of the Article;
b.    Para 2 deals with the taxing right of the State of source to tax such dividends and the restrictions for such State in taxing the dividends;
c.    Para 3 deals with the definition of dividends as per the DTAA or Model Convention;
d.    Para 4 deals with dividends paid to a company having a PE in the other State;
e.    Para 5 deals with prohibition of extra-territorial taxation on dividends.

4. ARTICLE 10(1) OF THE UN MODEL CONVENTION OR DTAAs
Article 10(1) of a DTAA typically provides the source rule for dividends under the DTAA and also provides the bilateral scope for which the Article applies.

Article 10(1) of the UN Model (2017) reads as under: ‘Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.’

4.1. Bilateral scope
Paragraph 1 deals with the bilateral scope for applicability of the Article. In other words, for Article 10 to apply the company paying the dividends should be a resident of one of the Contracting States and the recipient of the dividends should be a resident of the other Contracting State.
4.2. Source rule
Paragraph 1 also provides the source rule for the dividends, which helps in identifying the State of source for the Article. The paragraph is applicable to dividends ‘paid by a company which is a resident of a Contracting State’. Therefore, the State of source in the case of dividends shall be the State in which the company paying the dividends is a resident.
4.3. The term ‘paid’
Article 10 provides for allocation of taxing rights of dividends paid by a company. Therefore, it is important to understand the meaning of the term ‘paid’.

The description of the term in the OECD Commentary is as follows, ‘The term “paid” has a very wide meaning, since the concept of payment means the fulfilment of the obligation to put funds at the disposal of the shareholder in the manner required by contract or by custom.’

The issue of ‘paid’ is extremely relevant in the case of a deemed dividend u/s 2(22).

Section 2(22)(e) provides that the following payments by a company, to the extent of its accumulated profits, shall be deemed to be dividends under the Act:
a.    Advance or loan to a shareholder who holds at least 10% of the voting power in the payee company;
b.    Advance or loan to a concern in which the shareholder is a member or partner and holds substantial interest (at least 20%) in the recipient concern.

While a loan or advance to a shareholder, constituting deemed dividend u/s 2(22)(e), would constitute dividend ‘paid’ to the shareholder and, therefore, covered under Article 10(1) (subject to the issue as to whether deemed dividend constitutes dividend for the purposes of the DTAA, discussed in subsequent paragraphs), the question arises whether, in case of advance or loan given to a concern in which the shareholder has substantial interest, would be considered as ‘dividend paid by a company’.

Let us take the following example. Hold Co, a company resident in Singapore has two wholly-owned subsidiaries in India, I Co1 and I Co2. During the year, I Co1 grants a loan to I Co2. Assuming that neither I Co1 nor I Co2 is in the business of lending money, the loan given by I Co1 to I Co2 would be considered as deemed dividend.

The Delhi High Court in the case of CIT vs. Ankitech (P) Ltd. & Ors. (2012) (340 ITR 14) held that while section 2(22)(e) deems a loan to be dividend, it does not deem the recipient to be a shareholder. This view was upheld by the Supreme Court in the case of CIT vs. Madhur Housing & Development Co. & Ors. (2018) (401 ITR 152).

Therefore, the deemed dividend would be taxed in the hands of the shareholder, i.e., Hold Co in this case, and not I Co2, being the recipient of the loan, as I Co2 is not a shareholder. Would the dividend then be considered to be ‘paid’ to Hold Co as the funds have actually moved from I Co1 to I Co2 and Hold Co has not received any funds?

The question to be answered here is how does one interpret the term ‘paid’? In this context, Prof. Klaus Vogel in his book, ‘Klaus Vogel on Double Tax Conventions’ (2015 4th Edition), suggests,

‘“Payment” cannot depend on the transfer of money or “monetary funds”, nor does it depend on the existence of a clearly defined “obligation” of the company to put funds at the disposal of the shareholder; instead, in order to achieve consistency throughout the Article, it has to be construed so as to cover all types of advantages being provided to the shareholder covered by the definition of “dividends” in Article 10(3) OECD and UN MC, which include “benefits in money or money’s worth”. It has been argued that the term “payment” requires actual benefits to be provided to the shareholder, so that notional dividends would automatically fall outside the scope of Article 10 OECD and UN MC. This view has to be rejected, however, in light of the need for internal consistency of the provisions of the OECD and UN MC, which rather suggests that the terms “paid to”, “received by” and “derived from” serve only the purpose to connect income that is dealt with in a certain Article to a certain taxpayer, so that any income that falls within the definition of a “dividend” of Article 10(3) OECD and UN MC needs to be considered to be so “paid”. Indeed, it would make little sense to define a “dividend” with reference to domestic law of the Source State only to prohibit taxation of certain such “dividends” because they have not actually been “paid”.’

Accordingly, one may take a view that in such a scenario dividend would be considered as ‘paid’ under the DTAA.

4.4.    The term ‘may be taxed’
The paragraph provides that the dividend ‘may be taxed’ in the State of residence of the recipient of the dividends. It does not provide an exclusive right of taxation to the State of residence.

The interpretation of the term ‘may be taxed’ still continues to be a vexed issue to a certain extent even after the CBDT Notification No. 91 of 2008 dated 28th August, 2008. This controversy would be covered by the authors in a subsequent article.

5. ARTICLE 10(2) OF THE UN MODEL CONVENTION OR DTAAs
Article 10(2) of a DTAA typically provides the taxing right of the State of source for dividends under the DTAA.

Article 10(2) of the UN Model (2017) reads as under:
‘However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:
a. __ per cent of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends throughout a 365-day period that includes the day of the payment of the dividend (for the purpose of computing that period, no account shall be taken of changes of ownership that would directly result from a corporate reorganisation, such as a merger or divisive reorganisation, of the company that holds the shares or pays the dividend);
b. __ per cent of the gross amount of the dividends in all other cases.
The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations.
This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.’

While the UN Model does not provide the rate of tax for paragraphs 2(a) and 2(b) and leaves the same to the individual countries to decide at the time of negotiating a DTAA, the OECD Model provides for 5% in sub-paragraph (a) and 15% in sub-paragraph (b).

5.1. Right of taxation to the source State
Paragraph 2 provides the right of taxation of dividends to the source State, i.e., the State in which the company paying the dividends is a resident. The first part provides the right of taxation to the source State and the second part of the paragraph restricts the right of taxation of the source State to a certain percentage on the applicability of certain conditions.
5.2. The term ‘may also be taxed’
Paragraph 2 provides that dividends paid by a company may also be taxed in the State in which the company paying the dividends is a resident.
5.3. Beneficial owner
The benefit of the lower rate of tax in the source State is available only if the beneficial owner is a resident of the Contracting State. Therefore, if the beneficial owner is not a resident of the Contracting State, the second part of the paragraph would not apply and there would be no restriction on the source State to tax the dividends.

The beneficial ownership test is an anti-avoidance provision in the DTAAs and was first introduced in the 1966 Protocol to the 1945 US-UK DTAA. The concept of beneficial ownership was first introduced by the OECD in its 1977 Model Convention. However, the Model Commentary did not explain the term until the 2010 update.

The term ‘beneficial owner’ has not been defined in the DTAAs or the Model Conventions.

However, the OECD Model Commentary explains the term ‘beneficial owner’ to mean a person who, in substance, has a right to use and enjoy the dividend unconstrained by any contractual or legal obligation to pass on the said dividend to another person.

In the case of X Ltd., In Re (1996) 220 ITR 377, the AAR held that a British bank was the beneficial owner of the dividends paid by an Indian company even though the shares of the Indian company were held by two Mauritian entities which were wholly-owned subsidiaries of the British bank. However, the AAR did not dwell on the term beneficial owner but stressed on the fact that
the Mauritian entities were wholly-owned by the British bank.

Some of the key international judgments in this regard are those of the Canadian Tax Court in the cases of Prevost Car Inc. vs. Her Majesty the Queen (2009) (10 ITLR 736) and Velcro Canada vs. The Queen (2012) (2012 TCC 57) and of the Court of Appeal in the UK in the case of Indofood International Finance Ltd. vs. JP Morgan Chase Bank NA (2006) (STC 1195).

In the case of JC Bamford Investments vs. DDIT (150 ITD 209), the Delhi ITAT held (in the context of royalty) that the ‘beneficial owner’ is he who is free to decide (i) whether or not the capital or other assets should be used or made available for use by others, or (ii) on how the yields therefore should be used, or (iii) both.

Similarly, the Mumbai Tribunal in the case of HSBC Bank (Mauritius) Ltd. v. DCIT (International Taxation) (2017) (186 TTJ 619) has explained the term ‘beneficial owner’, in the context of interest as, ‘“Beneficial owner” can be one with full right and privilege to benefit directly from the interest income earned by the bank. Income must be attributable to the assessee for tax purposes and the same should not be aimed at transmitting to the third parties under any contractual agreement / understanding. Bank should not act as a conduit for any person, who in fact receives the benefits of the interest income concerned.’

The question that arises is, how does one practically evaluate whether the recipient is a beneficial owner of the dividends? In this case, generally, dividends are paid to group entities wherein it is possible for the Indian company paying the dividends to evaluate whether or not the shareholder is merely a conduit. A Chartered Accountant certifying the taxation of the dividends in Form 15CB can ask for certain information such as financials of the non-resident shareholder in order to evaluate whether the recipient shareholder is a conduit company, or whether such shareholder has substance. In the absence of such information or such other documentation to substantiate that the shareholder is not a conduit company, it is advisable that the benefit under the DTAA is not given. It is important to highlight that an entity, even though a wholly-owned subsidiary, can be considered as a beneficial owner of the income if it can substantiate that it is capable of and is undertaking decisions in respect of the application of the said income.

6. ARTICLE 10(3) OF THE UN MODEL CONVENTION AND DTAAs
Article 10(3) of a DTAA generally provides the definition of dividends.

Article 10(3) of the UN Model (2017) reads as under: ‘The term “dividends” as used in this Article means income from shares, “jouissance” shares or “jouissance” rights, mining shares, founders’ shares or other rights, not being debt claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.’

Therefore, the term ‘dividends’ includes the income from the following:
a.    Shares, jouissance shares or jouissance rights, mining shares, founders’ shares;
b.    Other rights, not being debt claims, participating in profits;
c.    Income from corporate rights subjected to the same tax treatment as income from shares in the source State.

6.1 Inclusive definition
The definition of the term ‘dividends’ in the DTAA as well as the OECD and UN Model is an inclusive definition. Further, it also gives reference to the definition of the term in the domestic law of the source State. The reason for providing an inclusive definition is to include all the types of distribution by the company to its shareholders.

6.2 Meaning of various types of shares and rights
The various types of shares referred to in the definition above are not relevant under the Indian corporate laws and, therefore, have not been further analysed.

6.3 Deemed dividend
The OECD Commentary provides that the term ‘dividends’ is expansively defined to include not only distribution of profits but even disguised distributions. However, the question that arises is whether such deemed dividend would fall under any of the limbs of the definition of dividends in the Article.

The Mumbai ITAT in the case of KIIC Investment Company vs. DCIT (2018) (TS – 708 – ITAT – 2018) while evaluating whether deemed dividend would be covered under Article 10(4) of the India-Mauritius DTAA (having similar language to the UN Model), held,

‘The India-Mauritius Tax Treaty prescribes that dividend paid by a company which is resident of a contracting state to a resident of other contracting state may be taxed in that other state. Article 10(4) of the Treaty explains the term “dividend” as used in the Article. Essentially, the expression “dividend” seeks to cover three different facets of income; firstly, income from shares, i.e. dividend per se; secondly, income from other rights, not being debt claims, participating in profits; and, thirdly, income from corporate rights which is subjected to same taxation treatment as income from shares by the laws of contracting state of which the company making the distribution is a resident. In the context of the controversy before us, i.e. ‘deemed dividend’ under section 2(22)(e) of the Act, obviously the same is not covered by the first two facets of the expression “dividend” in Article 10(4) of the Treaty. So, however, the third facet stated in Article 10(4) of the Treaty, in our view, clearly suggests that even “deemed dividend” as per Sec. 2(22)(e) of the Act is to be understood to be a “dividend” for the purpose of the Treaty. The presence of the expression “same taxation treatment as income from shares” in the country of distributor of dividend in Article 10(4) of the Treaty in the context of the third facet clearly leads to the inference that so long as the Indian tax laws consider “deemed dividend” also as “dividend”, then the same is also to be understood as “dividend” for the purpose of the Treaty.’

Therefore, without dwelling on the issue as to whether deemed dividend can be considered as income from corporate rights, the Mumbai ITAT held that deemed dividend would be considered as dividend under Article 10 of the DTAA.

In this regard it may be highlighted that the last limb of the definition of the term in the India-UK DTAA does not include the requirement of the income from corporate rights and therefore is more open-ended than the OECD Model. It reads as follows, ‘…as well as any other item which is subjected to the same taxation treatment as income from shares by the laws …’

7. ARTICLE 10(4) OF THE UN MODEL CONVENTION AND DTAAs


Article 10(4) of a DTAA provides for the tax position in case the recipient of the dividends has a PE in the other Contracting State of which the company paying the dividends is resident.

Article 10(4) of the UN Model (2017) reads as under, ‘The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply.’

The difference between the OECD Model and the UN Model is that the OECD Model does not provide reference to Article 14 as the Article dealing with Independent Personal Services is deleted in the OECD Model.

7.1 Need to tax under Article 7 or Article 14
The paragraph states that once the bilateral scope in Article 10(1) is met, if the beneficial owner of the dividends has a PE in the source State and the holding in respect of which the dividends are paid is effectively connected to such PE, then the provisions of Article 7 or Article 14 shall override the provisions of Article 10.

To illustrate, A Co, resident of State A, has a subsidiary, B Co, as well as a branch (considered as a PE in this example) in State B. If the holding of B Co is effectively connected to the branch of A Co in State B, Article 7 of the A-B DTAA would apply and not Article 10.

The reason for the insertion of this paragraph is that once a taxpayer has a PE in the source State and the dividends are effectively connected to such PE, they would be included in the profits attributable to the PE and taxed as such in accordance with Article 7 of the DTAA. Therefore, taxing the same dividends on a gross basis under Article 10 and on net basis under Article 7 would lead to unnecessary complications in State B. In order to alleviate such unnecessary complications, it is provided that the dividends would be included in the net profits attributable to the PE and taxed in accordance with Article 7 and not Article 10.

7.2 The term ‘effectively connected’
The OECD Model Commentary provides a broad
guidance as to when the holdings would be considered as being ‘effectively connected’ to a PE and provides the following circumstances in which it would be considered so:
a.    The economic ownership of the holding is with the PE;
b.    Under the separate entity approach, the benefits as well as the burdens of the holding (such as right to the dividends attributable to ownership, potential exposure of gains and losses from the appreciation and depreciation of the holding) is with the PE.

8. ARTICLE 10(5) OF THE UN MODEL CONVENTION AND DTAAs
Article 10(5) of a DTAA deals with prevention of extra-territorial taxation.

Article 10(5) of the UN Model (2017) reads as under, ‘Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.’

Each country is free to draft source rules in its domestic tax law as it deems fit. Paragraph 5, therefore, prevents a country from taxing dividends paid by a company to another, simply because the dividend is in respect of profits earned in that country, except in the following circumstances:
a.    The company paying the dividends is a resident of that State;
b.    The dividends are paid to a resident of that State; and
c.    The holding in respect of which the dividends are paid is effectively connected to the PE of the recipient in that State.

Let us take an example where A Co, a resident of State A, earns certain income in State B and out of
the profits from its activities in State B (assume constituting PE of A Co in State B), declares dividend to X Co, a resident of State C. This is provided by way of a diagram below.

While State B would tax the profits of the PE of A Co, State B can also seek to tax the dividend paid by A Co to X Co as the profits out of which the dividend is paid is out of profits earned in State B. In such a situation, the DTAA between State C and State B may not be able to restrict State B from taxing the dividends if the Article dealing with Other Income does not provide exclusive right of taxation to the country of residence. In such a scenario, Article 10(5) of the DTAA between State A and State B will prevent State B from taxing the dividends on the following grounds:
a.    A Co, the company paying the dividends, is not a resident of State B;
b.    C Co, the recipient of the dividends, is not a resident of State B; and
c.    The dividends are not effectively connected to a PE of C Co (the recipient) in State B.

9. CONCLUSION
With the return to the classical system of taxing dividends, dividends may now be a tax-efficient way of distributing the profits of a company, especially if the shareholder is a resident of a country with a favourable DTAA with India. In certain cases, distribution of dividend may be a better option as compared to undertaking buyback on account of the buyback tax in India.

However, it is important to evaluate the anti-avoidance rules such as the beneficial ownership rule as well as the MLI provisions before applying the treaty benefit. As a CA certifying the remittance in Form 15CB, it is extremely important that one evaluates the documentation to substantiate the above anti-avoidance provisions and, in the absence of the same, not provide benefit of the DTAA to such dividend income. In the next part of this article, relating to international tax aspects of taxation of dividends, we would cover certain specific issues such as whether DDT is restricted by DTAA, MLI aspects and underlying tax credit among other issues in respect of dividends.

Section 220 – Collection and recovery of tax – Assessee contended that total demand was to be kept in abeyance till disposal of appeal by CIT(A) – It was noted that said addition was made primarily on basis of statement – No cross-examine granted – Thus making additions to income of assessee was highly questionable – Financial hardship to meet demand even to extent of 20% – The entire demand was to be kept in abeyance till disposal of appeal on merits by CIT(Appeals)

2. Mayur Kanjibhai Shah vs. ITO-25(3)(1) [Writ Petition No. 812 of 2020, dated 12th March, 2020 (Bombay High Court)]

Section 220 – Collection and recovery of tax – Assessee contended that total demand was to be kept in abeyance till disposal of appeal by CIT(A) – It was noted that said addition was made primarily on basis of statement – No cross-examine granted – Thus making additions to income of assessee was highly questionable – Financial hardship to meet demand even to extent of 20% – The entire demand was to be kept in abeyance till disposal of appeal on merits by CIT(Appeals)

The assessee had filed his return of income for A.Y. 2012-13 on 28th September, 2012 declaring a total income of Rs. 5,05,981.00, which was processed u/s 143(3).

Subsequently, it was decided to reopen the assessment u/s 147 for which notice u/s 148 was issued. Following assessment proceedings on re-opening culminating in the assessment order passed u/s 143(3) r/w/s 147, the A.O. held that an amount of Rs. 3.25 crores was extended by the petitioner to one Nilesh Bharani which was treated as unexplained money u/s 69A and was added to the total income of the assessee.

Pursuant to the order of assessment, the A.O. issued notice of demand dated 21st December, 2019 to the assessee u/s 156 calling upon him to pay an amount of Rs. 2,17,76,850 within the period prescribed.

An appeal was preferred before the CIT(A)-37. Simultaneously, the assessee filed an application before the A.O. for complete stay of demand. Under an order passed u/s 220(6) the A.O. rejected the stay application, giving liberty to the assessee to pay 20% of the demand in which event it was stated that the balance of the outstanding dues would be kept in abeyance.

Aggrieved by the above order, the assessee filed the writ petition.

Revenue filed a common affidavit. Reopening of the assessment in the case of the petitioner for A.Y. 2012-13 was justified and it was contended that the said re-assessment order suffers from no error or infirmity. In paragraph No. 17 it was stated that summons u/s 131 was issued to Nilesh Bharani, but he, instead, had sent a copy of a letter dated 14th October, 2014 addressed to the Director of Income Tax-2, Mumbai.

The Court observed that the assessment order on reopening had been made primarily on the basis of certain entries (in coded language) made in the diary recovered from the premises of Nilesh Bharani in the course of search and seizure u/s 132. The finding that the petitioner had lent / provided cash amount of Rs. 3.25 crores to M/s Evergreen Enterprises / Nilesh Bharani was also reached on the statement made by Nilesh Bharani. Nilesh Bharani was not subjected to any cross-examination by the petitioner; rather, in the affidavit of the Revenue it is stated that Nilesh Bharani has retracted his statement. Prima facie, on the basis of coded language diary entries and a retracted uncorroborated statement of an alleged beneficiary, perhaps the additions made by the A.O. are highly questionable. In such circumstances, instead of taking a mechanical approach by directing the petitioner to pay 20% of the tax demand or providing instalments, the Revenue ought to have considered the case prima facie, balance of convenience and financial hardship, if any, of the petitioner.

In such circumstances, in the interest of justice the demand raised was kept in abeyance till disposal of the appeal by the CIT(A). The appeal should be decided by the CIT(A) within a period of four months from the date of receipt of an authenticated copy of the order. Till disposal of the appeal within the said period, notice of demand shall be kept in abeyance. Accordingly, writ petition is allowed.

Section 54F – Exemption cannot be denied merely because the sale consideration was not deposited in a bank account as per ‘capital gain accounts scheme’ when the investment in acquisition of a residential house was made within the time prescribed

1. Ashok Kumar Wadhwa vs. ACIT (New Delhi) Amit Shukla (J.M.) and O.P. Kant (A.M.) ITA No. 114/Del/2020 A.Y.: 2016-17 Date of order: 2nd March, 2021 Counsel for Assessee / Revenue: Raj Kumar Gupta and J.P. Sharma / Alka Gautam

Section 54F – Exemption cannot be denied merely because the sale consideration was not deposited in a bank account as per ‘capital gain accounts scheme’ when the investment in acquisition of a residential house was made within the time prescribed

FACTS

The assessee, along with a co-owner, sold a residential plot on 15th April, 2015 for Rs. 6.26 crores. He deposited the sale proceeds in a savings bank account maintained with Axis Bank. Subsequently, he purchased a residential house for a sum of Rs. 2.48 crores on 12th April, 2017 under his full ownership. The due date for filing of the return of income was 31st July, 2016, which was extended to 5th August, 2016, but the assessee filed his return of income belatedly on 5th June, 2017 u/s 139(4). In the said return, the assessee claimed exemption u/s 54F against capital gain on sale of property. But according to the A.O., the assessee was not entitled to the benefit of exemption because the sale consideration was not deposited in a bank account maintained as per the ‘capital gain accounts scheme’ before the due date of filing of return of income u/s 139(1), i.e. 5th August, 2016. On appeal, the CIT(A) confirmed the order of the A.O.

Before the Tribunal, the assessee submitted that he has made an investment in the residential house within the specified period of two years from the date of the sale of the property and thus he has substantially complied with the provision of section 54F(1). Therefore, exemption should be allowed. However, the Revenue relied on the orders of the lower authorities.

HELD


The Tribunal noted that the assessee had made an investment in a new house on 12th April, 2017, i.e., within the two years’ time allowed u/s 54F(1). The benefit was denied only because the assessee had failed to deposit the sale consideration in the specified capital gains bank deposit schemes by 5th August, 2016, i.e., the time allowed u/s 139(1), as required u/s 54F(4).

Analysing the provisions of section 54, the Tribunal observed that the provisions of sub-section (1) are mandatory and substantive in nature while the provisions of sub-section (4) of section 54F are procedural. According to it, if the mandatory and substantive provisions stood satisfied, the assessee should be eligible for benefit u/s 54F. For this purpose, the Tribunal relied on the decisions of the Karnataka High Court in the case of CIT vs. K. Ramachandra Rao (56 Taxmann.com 163) and of the Delhi Tribunal in the case of Smt. Vatsala Asthana vs. ITO (2019) (110 Taxmann.com 173). Therefore, the Tribunal set aside the findings of the lower authorities and directed the A.O. to allow the exemption u/s 54F.

NAMING OF BENEFICIARIES IN TRUST DEED – EXPLANATION TO SECTION 164(1)

ISSUE FOR CONSIDERATION
Section 160(1) treats the trustee as a representative assessee in respect of the income which he receives or is entitled to receive on behalf of or for the benefit of any person due to his appointment under a trust declared by a duly executed instrument in writing. Section 161 provides that tax on the income in respect of which the trustee is a representative assessee shall be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him, i.e., the beneficiary.

Section 164(1) provides an exception to this general rule of taxation of the income of a trust. It provides that the tax shall be charged at the maximum marginal rate in certain cases and not the tax that would have been payable had it been taxed in the hands of the beneficiaries. The taxability at maximum marginal rate in the manner provided in section 164(1) will get triggered in a case where the income (or any part thereof) is not specifically receivable on behalf of or for the benefit of any one person or where the individual shares of the persons on whose behalf or for whose benefit such income is receivable are indeterminate or unknown. Such trusts are commonly referred to as discretionary trusts. Further, the Explanation 1 to section 164 provides as follows:

• Where the person on whose behalf or for whose benefit the income (or any part thereof) is receivable during the previous year is not expressly stated in the instrument of the trust and is not identifiable as such on the date of such instrument, it shall be deemed that the income is not specifically receivable on behalf of or for the benefit of any one person.
• Where the individual shares of the persons on whose behalf or for whose benefit the income (or part thereof) is receivable are not expressly stated in the instrument of the trust and are not ascertainable as such on the date of such instrument, it shall be deemed that the individual shares of the beneficiaries are indeterminate or unknown.

An issue has arisen about the applicability of the provisions of section 164(1) read with the aforesaid Explanation in the case of trusts (such as venture capital funds or alternative investment funds) where the persons who contribute the capital (contributors) under the scheme become beneficiaries of the income derived by the trust in proportion to the capital contributed by them. In such cases it is not possible to identify the beneficiaries and their share in the income of the trust at the time when the trust has been formed. Therefore, the trust deed does not list out the names of the beneficiaries and their respective shares in the income of the trust. Instead, it provides for the mechanism on the basis of which the beneficiaries and also their shares in the income of the trust can be identified from time to time.

The Bengaluru Bench of the Tribunal has held that it is sufficient if the basis to identify the beneficiaries and their share in the income of the trust is specified in the trust deed and it is not left to the discretion of the trustee or any other person. As against this, the Chennai Bench took the view that the income of the trust would be liable to tax at the maximum marginal rate in the absence of identification of the beneficiaries and their share in the income in the trust deed at the time of its formation.

THE INDIA ADVANTAGE FUND CASE

The issue had first come up for consideration of the Bengaluru Bench of the Tribunal in the case of DCIT vs. India Advantage Fund – VII [2015] 67 SOT 5.

In this case, the assessee was a trust constituted under an instrument of trust dated 25th September, 2006. The settlor (ICICI Venture Funds Management Company Limited) had, by the said instrument, transferred a sum of Rs. 10,000 to the trustee (The Western India Trustee and Executor Company Limited) as initial corpus to be applied and governed by the terms and conditions of the indenture of trust. The trustee was empowered to call for contributions from the contributors which were required to be invested by the trustee in accordance with the objects of the trust. The objective of the trust was to invest in certain securities called ‘mezzanine instruments’ and to achieve commensurate returns for the contributors. The trust was to facilitate investment by the contributors who should be resident in India and achieve returns for such contributors. The trust deed provided that the contributors to the fund would also be its beneficiaries.

For the assessment year 2008-09, the trust filed its return declaring income of Rs. 1,81,68,357 and, further, submitted a letter to the A.O. that it had declared the income out of extreme precaution and in good faith to provide complete information and details about the income earned by it but offered to tax by the beneficiaries. It was claimed that the income declared had been included in the return of income of the beneficiaries and offered to tax directly by them pursuant to the provisions of sections 61 to 63 of the Act, which mandated that the income arising from revocable transfers was to be taxed in the hands of the transferors (i.e., the contributors). Accordingly, the Fund had not offered the same to tax again in its hands.

The A.O. was of the view that the individual shares of the persons on whose behalf or for whose benefit the income was received or was receivable by the assessee, or part thereof, were indeterminate or unknown. He was also of the view that the mere fact that the deed mentioned that the share of the beneficiaries would be allocated according to their investments in the Fund, did not make their shares determinate or known. Accordingly, the A.O. invoked the provisions of section 164(1) and held that the assessee would be liable to be assessed at the maximum marginal rate on its whole income. Apart from that, the A.O. also held that the assessee and the beneficiaries joined in a common purpose or common action, the object of which was to produce income, profits and gains, and therefore constituted an AOP. On that count also, the income was brought to tax in the hands of the assessee in the status of an AOP and charged at the maximum marginal rate.

The assessee raised the following contentions before the CIT(A):
1. It should not have been treated as an AOP as there was no inter se arrangement between one contributory / beneficiary and the other contributory / beneficiary, as each of them had entered into separate contribution arrangements with the assessee. Therefore, it could not be said that two or more beneficiaries had joined in a common purpose or common action;

2. The beneficiaries could not be said to be uncertain so long as the trust deed gave the details of the beneficiaries and the description of the person who was to be benefited. Reliance was placed on the CBDT Circular No. 281 dated 22nd September, 1980 wherein it was clarified that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the instrument of trust on the date of the instrument. With regard to ascertainment of the share of the beneficiaries, it was contended that it was enough if the shares were capable of being determined based on the provisions of the trust deed and it was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. Attention was drawn to the relevant clauses of the trust deed where it was specified who would be the beneficiaries and the formula to determine the share of each beneficiary.

3. The assessee was set up as a revocable trust as the trustees were given power to terminate the trust at any time before the expiry of the term. Therefore, the income of the trust had to be assessed in the hands of the beneficiaries, being the transferors.

The CIT(A) treated the assessee trust as a revocable trust and held that it need not be subjected to tax as the tax obligations had been fully discharged by the beneficiaries of the assessee trust. Aggrieved by the order of the CIT(A), the Revenue preferred an appeal to the Tribunal.

Before the Tribunal, the Revenue, apart from reiterating its stand as contained in the assessment order, drew attention to Circular No. 13/2014 whereby the CBDT had clarified that Alternative Investment Funds which were subject to the SEBI (Alternative Investment Funds) Regulations, 2012 which were not venture capital funds and which were non-charitable trusts where the investors’ name and beneficial interest were not explicitly known on the date of its creation – such information becoming available only when the funds started accepting contribution from the investors – had to be treated as falling within section 164(1) and the fund should be taxed in respect of the income received on behalf of the beneficiaries at the maximum marginal rate. It was claimed that the case of the assessee would fall within the above CBDT Clarifications and therefore the action of the A.O. was correct and had to be restored.

On behalf of the assessee, however, attention was drawn to the clause of the trust deed which contained the following definition:
‘“Contributors” or “Beneficiaries” means the Persons, each of whom have made or agreed to make Contributions to the Trust, in accordance with the Contribution Agreement.’

It was claimed that it was possible to identify the beneficiaries and their share on the basis of the mechanism provided in the trust deed. Reliance was placed on CBDT Circular No. 281 dated 22nd September, 1980 and the decisions in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad); CIT vs. Manilal Bapalal [2010] 321 ITR 322 (Mad); and Companies Incorporated in Mauritius, In re [1997] 224 ITR 473 (AAR). Insofar as the Circular No. 13/2014 relied upon by the Revenue was concerned, it was argued that it was not applicable for the assessment year under consideration and reliance was placed on the decision of the Bombay High Court in the case of BASF (India) Ltd. vs. W. Hasan, CIT [2006] 280 ITR 136 wherein it was held that Circulars not in force in the relevant assessment year cannot be applied.

The assessee also raised the issue of the nature of the trust being revocable and, hence, the income could be assessed only in the hands of the transferors in terms of the provisions of section 61. As far as the status of the trust as an AOP was concerned, the assessee relied upon several decisions including that of the Supreme Court in the case of CIT vs. Indira Balakrishnan [1960] 39 ITR 546 and claimed that the characteristics of an AOP were completely absent in its case.

After considering the contentions of both the parties, the Tribunal inter alia held as follows:
• The trust deed clearly laid down that beneficiaries means the persons, each of whom have made or agreed to make contributions to the trust in accordance with the Contribution Agreement. This clause was sufficient to identify the beneficiaries. It was clarified by Circular No. 281 dated 22nd September, 1980 that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the order of the instrument of trust on the date of such instrument.

• It was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. It was enough if the shares were capable of being determined based on the provisions of the trust deed. In the case of the assessee, the clause details the formula with respect to the share of each beneficiary and the trustee had no discretion to decide the share of each beneficiary. Reliance was placed on the decision of the AAR in the case of Companies Incorporated in Mauritius, In re (Supra) wherein it was held that the persons as well as the shares must be capable of being definitely pinpointed and ascertained on the date of the trust deed itself without leaving these to be decided upon at a future date by a person other than the author either at his discretion or in a manner not envisaged in the trust deed. Even if the trust deed authorised the addition of further contributors to the trust at different points of time, in addition to the initial contributors, then the same would not make the beneficiaries unknown or their share indeterminate. Even if the scheme of computation of income of beneficiaries was complicated, it was not possible to say that the share income of the beneficiaries could not be determined or known from the trust deed.

• CBDT’s Circular No. 13/2014 dated 28th July, 2014 was not in force in the relevant assessment year for which the assessment was made by the A.O. The Circulars not in force in the relevant A.Y. cannot be applied as held by the Bombay High Court in the case of BASF (India) Ltd. (Supra).

On the basis of the above, the Tribunal held that the income of the assessee trust was determinate; its income could not be taxed at the maximum marginal rate; the income was assessable only in the hands of the beneficiaries as it was a revocable transfer; and that there was no formation of an AOP.

TVS INVESTMENTS IFUND CASE

Thereafter, the issue came up for consideration before the Chennai Bench of the Tribunal in the case of TVS Investments iFund vs. ITO (2017) 164 ITD 524.

In this case, the assessee was a trust which was formed to receive unit contributions from High Net-Worth Individuals (HNIs) towards the capital amount committed by them as per the terms of Contribution Agreements and provided returns on such investments. For the A.Y. 2009-10, the assessee declared Nil income by treating itself as a representative assessee and claimed that the entire income was taxable in the hands of the beneficiaries. However, the A.O. subjected the entire receipts to tax. He concluded that the assessee was not a Determinate Trust and when not found eligible for deduction u/s 10(23FB) as an alternative investment fund, it could not be extended the benefit of section 164. The ‘pass-through’ status was denied since the assessee was neither a determinate trust nor a non-discretionary trust and therefore the income was taxed in the hands of the representative assessee and not in the hands of the beneficiaries.

In appeal, the CIT(A) held that the assessee trust could not be categorised as a Determinate Trust so as to gain pass-through status. Further, pass-through status was available only when the trust was an approved fund u/s 10(23FB). When the assessee was not a SEBI-approved Alternate Investment Fund, it could not claim pass-through status. The CIT(A) opined that if every trust were to become eligible for pass-through status automatically, then there was no need for an enactment under the Act in the form of 10(23FB) r.w.s. 115U. Accordingly, the CIT(A) dismissed the appeal of the assessee. On being aggrieved, the assessee went in further appeal before the Tribunal.

The Tribunal held that the income of the trust would be chargeable to Maximum Marginal Rate if the trust does not satisfy two tests, i.e., the names of the beneficiaries are specified in the trust deed and the individual shares of the beneficiaries are ascertainable on the date of the trust deed. If the trust has satisfied these tests, then the trust would be treated as a pass-through conduit subject to the provisions of section 160. For getting pass-through treatment the trust should be a determinate and non-discretionary trust. In order to form a determinate trust, the beneficiaries should be known and the individual share of those beneficiaries should be ascertainable as on the date of the trust deed. But in the case under consideration the beneficiaries were not incorporated in the trust deed. The identities of the contributors / beneficiaries were unknown. The investment manager gathered the funds from the contributors and the benefit was passed on to the contributors based on the proportion of their investments in the assessee trust. The exception to this rule, and providing pass-through status to a Trust, even though the contributing beneficiaries were not mentioned in the deed of trust, was only extended to AIF(VCF) which were registered with SEBI and eligible for exemption u/s 10(23FB) r.w.s. 115U.

The Tribunal distinguished the decision of the Madras High Court in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 which was relied upon by the assessee on the ground that in that case the beneficiaries were incorporated on the day of institution of the trust deed and, moreover, they did not receive any income in that year. Further, the individual share of the beneficiaries was also ascertainable on the date of the trust. As against this, in the assessee’s case neither the names of the beneficiaries were specified in the trust deed nor were the individual shares of the beneficiaries ascertainable on the date of the institution of the trust. Therefore, the Tribunal upheld the order of the A.O. taxing the income of the assessee trust at the maximum marginal rate under the provisions of section 164(1).

OBSERVATIONS


The taxation of discretionary trusts at maximum marginal rate was introduced in section 164(1) by the Finance Act, 1970 with effect from 1st April, 1970. The objective behind its introduction was explained in Circular No. 45 dated 2nd September, 1970 which is reproduced below:

Private discretionary trusts. – Under the provisions of s. 164 of the IT Act before the amendment made by the Finance Act, 1970, income of a trust in which the shares of the beneficiaries are indeterminate or unknown, is chargeable to tax as a single unit treating it as the total income of an AOP. This provision affords scope for reduction of tax liability by transferring property to trustees and vesting discretion in them to accumulate the income or apply it for the benefit of any one or more of the beneficiaries, at their choice. By creating a multiplicity of such trusts, each one of which derives a comparatively low income, the incidence of tax on the income from property transferred to the several trusts is maintained at a low level. In such arrangements, it is often found that one or more of the beneficiaries of the trust are persons having high personal incomes, but no part of the trust income being specifically allocable to such beneficiaries under the terms of the trust, such income cannot be subject to tax at a high personal rate which would have been applicable if their shares had been determinate.

Thus, it can be seen that the objective was to curb the practice of forming multiple trusts, whereby each of them derived minimum income, so that it did not fall within the higher tax bracket.

Thereafter, the Explanation was added by the Finance (No. 2) Act, 1980 with effect from 1st April, 1980 deeming that, in certain situations, beneficiaries shall be deemed to be not identifiable or their shares shall be deemed to be unascertained or indeterminate or unknown. The legislative intent behind insertion of this Explanation has been explained in the Circular No. 281 dated 22nd September, 1980 which is reproduced below:

Under the provisions as they existed prior to the amendments made by the Finance Act, the flat rate of 65 per cent was not applicable where the beneficiaries and their shares are known in the previous year although such beneficiaries or their shares have not been specified in the relevant instrument of trust, order of the court or wakf deed. This provision was misused in some cases by giving discretion to the trustees to decide the allocation of income every year and in several other ways. In such a situation, the trustees and beneficiaries were able to manipulate the arrangements in such a manner that a discretionary trust was converted into a specific trust whenever it suited them tax-wise. In order to prevent such manipulation, the Finance Act has inserted Explanation 1 in section 164 to provide as under:

a. any income in respect of which the court of wards, the administrator-general, the official trustee, receiver, manager, trustee or mutawalli appointed under a wakf deed is liable as a representative assessee or any part thereof shall be regarded as not being specifically receivable on behalf or for the benefit of any one person unless the person on whose behalf or for whose benefit such income or such part thereof is receivable during the previous year is expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed. [For this purpose, it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed, all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed;]

b. the individual shares of the persons on whose behalf or for whose benefit such income or part thereof is receivable will be regarded as indeterminate or unknown unless the individual shares of such persons are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed.

As a result of the insertion of the above Explanation, trust under which a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will all be regarded as discretionary trusts and assessed accordingly.

The following points emerge from a combined reading of both the Circulars, clarifying the objective behind amending the provisions of section 164(1) to provide for taxability of discretionary trusts at the maximum marginal rate and inserting the Explanation providing for deemed cases of discretionary trust:

• There was a need to tax the income of the discretionary trusts at the maximum marginal rate to curb the practice of creating multiple trusts and thereby avoiding tax by ensuring that they earn low income, so that they do not get taxed at the maximum marginal rate.
• To overcome this issue, the provisions of section 164(1) were amended to provide that the income of the discretionary trust (where the beneficiaries or their share are not known or determinate) is liable to tax at the maximum marginal rate.
• Even after providing for taxability of such discretionary trusts at the maximum marginal rate in section 164(1), the practice of avoiding it continued in some cases, as there was no requirement under the law that the beneficiaries or their shares should have been specified in the relevant instrument of trust, order of the court or wakf deed.
• Although the discretion was given to the trustees to decide the allocation of income every year, the affairs of the trusts were so arranged whereby it was claimed that the beneficiaries and their shares were known in the concerned previous year and, therefore, the provisions of section 164(1) were not applicable to that previous year.
• To plug this loophole, the Explanation was inserted to provide that the beneficiaries and their shares should be expressly stated in the relevant instrument of trust, order of the court or wakf deed.
• It has been expressly clarified that it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed and all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed.
• Only cases where a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will be regarded as discretionary trusts and assessed accordingly.

In the background of these legislative developments, it can be inferred that the requirement is not to name the beneficiaries in the instrument of trust but to provide for the identification of the beneficiaries on an objective basis. This has been made expressly clear in the aforesaid Circular itself. These aspects had not been pointed out to the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra). The Bengaluru Bench of the Tribunal considered the legislative intent and the aforesaid Circulars to hold that it would be sufficient if the trust deed provided that the contributors would be beneficiaries and further it provided for the formula to arrive at the individual share of each beneficiary.

It may be noted that both the above decisions of the Tribunal had been challenged before the respective High Courts. The Revenue had filed an appeal before the Karnataka High Court against the decision of the Bengaluru Bench in the case of India Advantage Fund (Supra). Before the High Court it was contended on behalf of the Revenue that the exact amount of share of the beneficiaries and its quantification should have been possible on the date when the trust deed was executed or the trust was formed. If such conditions were not satisfied, then the shares of the beneficiaries would turn into non-determinable shares. The High Court rejected this argument by holding as under:

10. In our view, the contention is wholly misconceived for three reasons. One is that by no interpretative process the Explanation to section 164 of the Act, which is pressed in service can be read for determinability of the shares of the beneficiary with the quantum on the date when the Trust deed is executed, and the second reason is that the real test is the determinability of the shares of the beneficiary and is not dependent upon the date on which the trust deed was executed if one is to connect the same with the quantum. The real test is whether shares are determinable even when or after the Trust is formed or may be in future when the Trust is in existence. In the facts of the present case, even the assessing authority found that the beneficiaries are to share the benefit as per their investment made or to say in other words, in proportion to the investment made. Once the benefits are to be shared by the beneficiaries in proportion to the investment made, any person with reasonable prudence would reach to the conclusion that the shares are determinable. Once the shares are determinable amongst the beneficiaries, it would meet with the requirement of the law, to come out from the applicability of section 164 of the Act.

11. Under the circumstances, we cannot accept the contention of the Revenue that the shares were non-determinable or the view taken by the Tribunal is perverse. On the contrary, we do find that the view taken by the Tribunal is correct and would not call for interference so far as determinability of the shares of the beneficiaries is concerned.

12. Once the shares of the beneficiaries are found to be determinable, the income is to be taxed of that respective sharer or the beneficiaries in the hands of the beneficiary and not in the hands of the trustees which has already been shown in the present case.

Thus, the view of the Bengaluru Bench of the Tribunal was affirmed by the Karnataka High Court.

The decision of the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra) was challenged by the assessee before the Madras High Court. Before deciding the issue, the Madras High Court had already dealt with it in the case of CIT vs. TVS Shriram Growth Fund [2020] 121 taxmann.com 238 and decided it in favour of the assessee by relying on its own decision in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad). It was noted by the Madras High Court that the Chennai Bench had wrongly disregarded the decision in the case of the P. Sekar Trust. The relevant observations are reproduced below:

In fact, the Tribunal ought to have followed the decision of the Division Bench of this Court in the case of P. Sekar Trust (Supra). However, the same has been distinguished by the Tribunal in the case of TVS Investments iFund (Supra) by observing that the said judgment is not applicable to the facts of the case because in it, the beneficiaries are incorporated on the day of the institution of the Trust Deed and, moreover, they did not receive any income in that year. Unfortunately, the Tribunal in the case of TVS Investments iFund (Supra), did not fully appreciate the finding rendered by the Hon’ble Division Bench of this Court and post a wrong question, which led to a wrong answer.

The Madras High Court in this case concurred with the view of the Karnataka High Court in the case of India Advantage Fund (Supra) and decided the issue against the Revenue. The same view was then followed by the Madras High Court in the case of TVS Investments iFund and overruled the decision of the Chennai Bench of the Tribunal.

A similar view had been taken by the Authority for Advance Rulings in the case of Companies Incorporated in Mauritius, In re (Supra).

The better view of the matter therefore is the view taken by the Bengaluru Bench of the Tribunal in the case of India Advantage Fund, as affirmed by the Karnataka and Madras High Courts, that it is not necessary to list out the beneficiaries and their exact share in terms of percentage in the trust deed. It is sufficient if the trust deed provides both for the manner of identification of the beneficiaries as well as a mechanism to compute their respective shares in the income of the trust for any year, without leaving it to the discretion of the trustee or any other person.

Reserve credited in the books of amalgamated company on account of acquisition of assets and liabilities in a scheme of amalgamation is in the nature of capital reserve only and not revaluation reserve

7. (2020) 82 ITR (T) 557 (Del)(Trib) Hespera Realty Pvt. Ltd. vs. DCIT ITA No.: 764/Del/2020 A.Y.: 2015-16 Date of order: 27th July, 2020

Reserve credited in the books of amalgamated company on account of acquisition of assets and liabilities in a scheme of amalgamation is in the nature of capital reserve only and not revaluation reserve

FACTS

The assessee company took over (acquired) certain other companies under a scheme of amalgamation. The assets and liabilities were taken over at fair value which was higher than their cost in the books of the amalgamating companies. The difference was recorded in the assessee’s books as ‘capital reserve’. These also included shares of Indiabulls Housing Finance Limited. Some of the said shares acquired in the scheme of amalgamation were sold by the assessee company at a profit. While accounting for the said profit in the books, the assessee company considered the cost of acquisition as the actual cost at which they were acquired in the course of amalgamation, which value was necessarily the fair value of the shares (calculated at closing price on NSE on the day prior to the appointed date for the amalgamation).

It was the contention of the Revenue that the scheme of amalgamation was a colourable device to evade tax on book profits u/s 115JB. The A.O. held that the reserve credited in the books was not capital reserve and was essentially revaluation reserve which ought to be added back while computing book profits in view of clause (j) to Explanation 1 of section 115JB. Thus, the difference between the cost of shares in the books of the amalgamating company and their fair value was added back in the hands of the assessee while computing book profits (pertaining to sale of shares).

The CIT(A) concurred with the findings of the A.O. and upheld his order.

Aggrieved, the assessee preferred an appeal before the ITAT.

HELD


The ITAT observed that a ‘Revaluation Reserve’ is created when an enterprise revalues its own assets, already acquired and recorded in its books at certain values. In the instant case, the assessee has not revalued its existing assets but has only recorded the fair values of various assets and liabilities ‘acquired’ by the assessee from the transferor / ‘amalgamating companies’ pursuant to the scheme of amalgamation as its ‘cost of acquisition’ in accordance with the terms of the Court-approved scheme of amalgamation and the provisions of AS 14.

The ITAT examined the provisions of section 115JB vis-à-vis accounting treatment of capital reserve / revaluation reserve.

It was observed that section 115JB requires an assessee company to prepare its P&L account in accordance with the provisions of Parts I and II of Schedule III of the Companies Act, 2013. The section further says that for computing book profits under the said section, the same accounting policy and Accounting Standards as are adopted for preparing the accounts laid before the shareholders at the Annual General Meeting in accordance with the provisions of section 129 of the Companies Act, 2013 (corresponding to section 210 of the Companies Act, 1956) shall be adopted.

Section 129 of the Companies Act provides that the financial statements of the company shall be prepared to give a true and fair view of the state of affairs and the profit or loss of the company and shall comply with the Accounting Standards as prescribed by the Central Government.

As per the above provisions, for accounting for amalgamation, AS 14 is applicable. As per AS 14 pooling of interest method and purchase method are recognised. In the instant case, as per sections 391 to 394 of the Companies Act, amalgamation was regarded as amalgamation in the nature of purchases and hence purchase method of AS 14 is applicable to the assessee.

As per AS 14 ‘If the amalgamation is an “amalgamation in the nature of purchase”, the identity of the reserves, other than the statutory reserves dealt with in paragraph 18, is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and dealt with in the manner stated in paragraphs 19-20. If the result of the computation is positive, the difference is credited to Capital Reserve.’

Based on the above examination of the requirements of AS 14 and the provisions of section 115JB, the ITAT ruled in favour of the assessee by holding that the reserve credited in the books of the assessee is not in the nature of revaluation reserve but is a capital reserve. In doing so, the Tribunal relied on the order of the co-ordinate Bench in the case of Priapus Developers Pvt. Ltd. 176 ITD 223 dated 12th March, 2019 which had made similar observations on the issue of reserve arising out of the purchase method adopted in the scheme of amalgamation.

Where receipt of consideration was dependent upon fulfilment of certain obligations, the income cannot be said to have accrued in the year in which relevant agreement is entered

6. (2020) 82 ITR (T) 419 (Mum)(Trib) ITO vs. Abdul Kayum Ahmed Mohd. Tambol (Prop. Tamboli Developers) ITA No.: 5851/Mum/2018 A.Y.: 2009-10 Date of order: 6th July, 2020

Where receipt of consideration was dependent upon fulfilment of certain obligations, the income cannot be said to have accrued in the year in which relevant agreement is entered

FACTS

The assessee, an individual, civil contractor, transferred certain development rights for a total consideration of Rs. 3.36 crores vide agreement dated 23rd July, 2008 out of which Rs. 1 crore was received during F.Y. 2008-09. The assessee calculated business receipts after deducting expenditure incurred in connection with the above and finally offered 8% of the net receipts as income u/s 44AD. The A.O. brought to tax the entire consideration of Rs. 3.36 crores on the basis that, as per the terms of the agreement, the assessee parted with development rights and the possession of the land was also given. Therefore, the transfer was completed during the year and the taxability of business receipts would not be dependent upon actual receipt thereof. On further appeal to the CIT(A), the latter concluded the issue in the assessee’s favour. Aggrieved, the Revenue filed an appeal before the ITAT.

HELD

The whole controversy in this matter pertained to year of accrual of the afore-mentioned income and consequent year of taxability of the income. The ITAT took note of an important fact that only part payment, as referred to above, accrued to the
assessee in the year under consideration since the balance receipts were conditional receipts which were payable only in the event of the assessee performing various works, obtaining requisite permissions, etc. The payments were, thus, subject to fulfilment of certain contractual performance by the assessee. The said facts were confirmed by the payer, too, in response to a notice u/s 133(6).

The ITAT also confirmed the view of the CIT(A) that the term ‘transfer’ as defined in section 2(47)(v) would not apply in the case since the same is applicable only in case of capital assets held by the assessee. The development rights in the instant case were held as business assets. The assessee had also offered to tax the balance receipts in the subsequent years. It concluded that since the balance consideration was a conditional receipt and was to accrue only in the event of the assessee performing certain obligations under the agreement, the same did not accrue to the assessee.

Thus, the ITAT dismissed the appeal of the Revenue.

Section 54F of the Income-tax Act, 1961 – Exemption to be granted even if investment in new residential property is made in the name of legal heir – Section 54F does not require investment to be made in assessee’s name

5. 125 taxmann.com 110 Krishnappa Jayaramaiah IT Appeal No. 405 (Bang) of 2020 A.Y.: 2016-17 Date of order: 22nd February, 2021

Section 54F of the Income-tax Act, 1961 – Exemption to be granted even if investment in new residential property is made in the name of legal heir – Section 54F does not require investment to be made in assessee’s name

FACTS

The assessee filed his return of income showing, among other things, income under capital gains from sale of a property acquired on account of partition of the HUF. The assessee claimed a deduction u/s 54F by investing the sale consideration in a new residential property purchased in the name of his widowed daughter. The assessee’s daughter had no independent source of income and was entirely dependent on him. The A.O. denied the claim of deduction to the assessee and determined the total assessed income at Rs. 2,07,75,230. The CIT(A) upheld the A.O.’s order. Aggrieved, the assessee filed an appeal with the Tribunal.

HELD

It was held that there is nothing in section 54F to show that a new residential house should be purchased only in the name of the assessee. The section merely says that the assessee should have purchased / constructed a ‘residential house’. Noting that purposive consideration is to be preferred as against literal consideration, the Tribunal held that the word ‘assessee’ should be given a wide and liberal interpretation and include legal heirs, too. Thus, the A.O. was directed to grant exemption u/s 54F to the assessee for the amount invested in the purchase of a residential house in his daughter’s name.

The assessee’s appeal was allowed.

 

Sections 250, 251 – The appellate authorities are obligated to dispose of all the grounds of appeal raised before them so that multiplicity of litigation may be avoided – There can be no escape on the part of the CIT(A) from discharging the statutory obligation cast upon him to deal with and dispose of all the grounds of appeal on the basis of which the impugned order has been contested by the assessee before him

4. TS-48-ITAT-2021 (Mum) DCIT vs. Tanna Builders Ltd. ITA No. 2816 (Mum) of 2016 A.Y.: 2011-12 Date of order: 19th January, 2021

Sections 250, 251 – The appellate authorities are obligated to dispose of all the grounds of appeal raised before them so that multiplicity of litigation may be avoided – There can be no escape on the part of the CIT(A) from discharging the statutory obligation cast upon him to deal with and dispose of all the grounds of appeal on the basis of which the impugned order has been contested by the assessee before him

FACTS

For A.Y. 2011-12, the assessee company, engaged in the business of builder, masonry and general construction contractor, filed its return of income declaring a total income of Rs. 26,41,130. The assessee had constructed two buildings, viz. Tanna Residency (Phase I) and Raheja Empress. The assessee had made buyers of units / houses shareholders of the company and allotted shares of Rs. 10 each to them. The assessee had issued debentures to those purchasers / shareholders equivalent to the value of the sale consideration of the units / houses sold. Debentures with a face value of Rs. 1,00,000 each were issued and an amount of Rs. 99,990 was collected on each debenture and shown as a liability in the Balance Sheet of the company. This was the case for all the 27 allottees / purchasers of the houses / units in the two buildings on the date of commencement of the respective projects.

During the year under consideration the assessee issued debentures of Rs. 4.20 crores towards the sale of certain units / spaces. The A.O. held that the assessee had been accounting the sale proceeds of its stock as a liability in its Balance Sheet instead of as sales in the P&L account. He called upon the assessee to explain why the amounts received on issuing the debentures during the year under consideration may not be taxed as sales and be subjected to tax. The assessee submitted that it continued to own the buildings and the construction cost had been raised through the shareholders by issuing unsecured redeemable debentures to them. It was also submitted that issuing of debentures by the company and raising money therefrom was neither held as sale of units nor sale of parking spaces by the Department while framing its assessments of preceding years. It was submitted that the assessee has issued 60 debentures to International Export and Estate Agency (IEEA) on the basis of holding 180 shares of the assessee company. On the basis of this holding, the assessee company had given IEEA the right to use, possess and occupy 60 basement parking spaces in its building. Debentures were issued pursuant to a resolution passed in the Board of Directors meeting held on 4th October, 2010 and the resolution passed by the shareholders in the Extraordinary General Meeting held on 29th October, 2010.

The A.O. held that the assessee has sold the units / houses in the aforesaid buildings to the shareholders / debenture holders who were the actual owners of the said properties and the claim of the assessee that it was the owner of the buildings and the debentures / shares were issued for raising funds was clearly a sham transaction that was carried out with an intent to evade taxes. The A.O. also held that the amount received by the assessee company by issuing shares / debentures to the purchasers of the houses / units / spaces was supposed to have been accounted by it as its income in its P&L account. He treated the amount of Rs. 4.20 crores received by the assessee on issuing debentures / shares during the year as the sales income of the assessee company.

Aggrieved, the assessee preferred an appeal to the CIT(A) who found favour with the contentions advanced by the assessee and vacated the addition.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

HELD


The Tribunal observed that the assessee had, in the course of appellate proceedings before the CIT(A), raised an alternative claim that the A.O. erred in not allowing cost of construction against the amount of Rs. 4.20 crores treated by him as business income. The assessee had filed additional evidence in respect of corresponding cost of parking space. In view of the fact that the CIT(A) had deleted the addition of Rs. 4.20 crores made by the A.O., he would have felt that adjudicating the alternative claim would not be necessary. The Tribunal held that in its opinion piecemeal disposal of the appeal by the first Appellate Authority cannot be accepted.

The Tribunal held that as per the settled position of law the appellate authorities are obligated to dispose of all the grounds of appeal raised by the appellant before them so that multiplicity of litigation may be avoided. For this view it placed reliance on the decision of the Madras High Court in the case of CIT vs. Ramdas Pharmacy [(1970) 77 ITR 276 (Mad)] that the Tribunal should adjudicate all the issues raised before it.

The Tribunal restored the matter to the file of the CIT(A) with a direction to dispose of the alternative ground of appeal that was raised by the assessee before him.

Sections 2(24), 45, 56 – Compensation received by the assessee towards displacement in terms of Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment

3. 2021 (3) TMI 252-ITAT Mumbai Smt. Dellilah Raj Mansukhani vs. ITO ITA No.: 3526/Mum/2017 A.Y.: 2010-11 Date of order: 29th January, 2021

Sections 2(24), 45, 56 – Compensation received by the assessee towards displacement in terms of Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment

FACTS

During the course of appellate proceedings the CIT(A) found, on the basis of details forwarded by M/s Calvin Properties, that the assessee has been given compensation for alternative accommodation of Rs. 2,60,000 as per the terms of the Development Agreement. According to the CIT(A), the amount received was over and above the rent actually paid by the assessee and, therefore, the same has to be taxed accordingly. The CIT(A) having issued notice u/s 251(2) qua the proposed enhancement and considering the reply of the assessee that she received monthly rental compensation during the year aggregating to Rs. 2,60,000 for the alternative accommodation which is a compensation on account of her family displacement from the accommodation and tremendous hardship and inconvenience caused to her, the said compensation is towards meeting / overcoming the hardships and it is a capital receipt and therefore not liable to be taxed.

The assessee relied on the decision of the co-ordinate Bench in the case of Kushal K. Bangia vs. ITO in ITA No. 2349/Mum/2011 for A.Y. 2007-08 wherein the A.O. did not tax the displacement compensation as it was held to be a receipt not in the nature of income. The CIT(A) rejected the contentions of the assessee and enhanced the assessment to the extent of Rs. 2,60,000 by holding that the assessee has not paid any rent.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal held that compensation received by the assessee towards displacement in terms of the Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment. It observed that in a scenario where the property goes into redevelopment, the compensation is normally paid by the builder on account of hardship faced by owner of the flat due to displacement of the occupants of the flat. The said payment is in the nature of hardship allowance / rehabilitation allowance and is not liable to tax. It observed that the case of the assessee is squarely supported by the decision of the co-ordinate Bench in the case of Devshi Lakhamshi Dedhia vs. ACIT ITA No. 5350/Mum/2012 wherein a similar issue has been decided in favour of the assessee. The Tribunal in that case held that the amounts received by the assessee as hardship compensation, rehabilitation compensation and for shifting are not liable to tax. Accordingly, the Tribunal set aside the findings of the CIT(A) and directed the A.O. to delete the addition made of Rs. 2,60,000.

Sections 120 and 250 – CIT(A) has no jurisdiction to pass orders after a direction from DGIT(Inv.) not to pass any further orders during the pendency of the explanation sought from him on the lapses in adjudicating the appeals – The order passed by him contrary to the directions of the superior officer cannot be said to be an order passed by a person having proper jurisdiction

2. TS-90-ITAT-2021 (Bang) DCIT vs. GMR Energy Ltd. ITA No. 3039 (Bang) of 2018 A.Y.: 2014-15 Date of order: 22nd February, 2021


 

Sections 120 and 250 – CIT(A) has no jurisdiction to pass orders after a direction from DGIT(Inv.) not to pass any further orders during the pendency of the explanation sought from him on the lapses in adjudicating the appeals – The order passed by him contrary to the directions of the superior officer cannot be said to be an order passed by a person having proper jurisdiction

 

FACTS

In the appeal under consideration filed by the Revenue and 82 other appeals and cross-objections filed before the Tribunal, the Revenue requested by way of an additional ground that the orders impugned in these appeals which had all been passed by the CIT(A)-11, Bengaluru should be held to be orders passed without proper jurisdiction and should be set aside and remanded to the CIT(A) for fresh decision by the CIT(A) with competent jurisdiction.

 

It was stated that the CIT(A)-11, Bangalore who passed all the impugned orders committed serious lapses and he was directed by the Director-General of Income-tax, Investigation, Karnataka & Goa, Bengaluru by direction dated 18th June, 2018 not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals. It was the plea of the Revenue that all the orders impugned in these appeals were passed after 18th June, 2018 and are therefore orders passed without jurisdiction and on that ground are liable to be set aside.

 

Without prejudice to the above contention, it was the further plea of the Revenue that by Notification dated 16th July, 2018, issued u/s 120 by the Principal Chief Commissioner of Income-tax, Karnataka & Goa, the appeals pending before the CIT(A)-11 were transferred to the CIT(A)-12, Bengaluru.

 

It was the case of the Revenue that

(i) the CIT(A)-11, disregarding the directions issued by the Principal CCIT, has passed orders that are impugned in all these appeals;

(ii) though the impugned orders are purported to have been passed on dates which are prior to 16th July, 2018, they were in fact passed after those dates but were pre-dated. In support of this claim, the Revenue relied on the circumstance that the date of despatch of the impugned orders has not been entered in the dispatch register maintained by the CIT(A)-11;

(iii) in view of the fact that the date of dispatch is not specifically entered during the period when CIT(A)-11 was directed not to pass any orders, the only inference that can be drawn is that the impugned orders were passed after the appeals were transferred u/s 120 to the CIT(A)-12. By implication, the Revenue contended that the orders impugned were back-dated so as to fall before or on the cut-off date of 16th July, 2018;

(iv) since the orders passed in all these appeals are dated after 18th June, 2018 when the DGIT (Investigation), Karnataka & Goa, Bengaluru directed the then CIT(A)-11, Bengaluru not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals, therefore the orders passed after 18th June, 2018 are illegal and are orders passed without jurisdiction and liable to be set aside.

 

HELD

It is undisputed that the impugned orders in all the appeals were passed after 18th June, 2018. The order by which the DGIT (Investigation), Karnataka & Goa, Bengaluru directed the then CIT(A)-11, Bengaluru not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals was dated 18th June, 2018. The CIT(A)-11 thus had no jurisdiction to pass any orders in appeal on or after the aforesaid date. The orders passed by him contrary to the directions of the superior officer cannot be said to be orders passed by a person having proper jurisdiction. The Tribunal noted that the CBDT has in paragraph 7 of its instruction dated 8th March, 2018 [F. No. DGIT (Vig.)/HQW/SI/Appeals/2017 – 18/9959] instructed all Chief Commissioners of Income-tax to conduct regular inspections of the CIT(A)s working under them and keep a watch on the quality and quantity of orders passed by them. The instructions further lay down that failure on the part of the Chief Commissioners of Income-tax to do so would be viewed adversely by the CBDT.

 

The Tribunal held that the very action of then CIT(A)-11 in ignoring the binding directions given by the DGIT and proceeding to pass orders resulted in a serious lapse on his part in administering justice. The Tribunal noticed that all the orders impugned in these appeals had been passed between the 5th and the 13th of July, 2018; they numbered around 50 orders, involving different assessees and different issues, which was a difficult task for any appellate authority. The Tribunal agreed with the submission of the standing counsel that the interests of Revenue were prejudiced by the said action of the then CIT(A)-11. The Tribunal held that all these factors vitiate the appellate orders passed by him after 18th June, 2018, even if the allegation of pre-dating of orders is not accepted / proved.

 

Following the decision of the Delhi Bench of the Tribunal in the case of ACIT vs. Globus Constructions Pvt. Ltd. (ITA No. 1185/Delhi/2020; AY 2015-16; order dated 8th January, 2021) on almost similar facts, the Tribunal set aside the orders of the CIT(A) to the respective jurisdictional CIT(A) to decide the appeals afresh in accordance with law after due opportunity of hearing to the parties.

Section 37 – Input service tax credit is deductible u/s 37(1) when such Input Tax Credit is written off in the books of accounts

1. TS-113-ITAT-2021 (Chny) FIH India Private Limited vs. DCIT ITA No. 1184 (Chny) of 2018 A.Y.: 2010-11 Date of order: 8th February, 2021

Section 37 – Input service tax credit is deductible u/s 37(1) when such Input Tax Credit is written off in the books of accounts

FACTS

The assessee engaged in the business of manufacturing, assembling and trading of parts and accessories for mobile phones operated from two units, both located in SEZs. The assessee filed its return of income after setting off brought-forward losses and unabsorbed depreciation under normal provisions of the Act and book profit of Rs. 80,25,61,835 under the provisions of section 115JB.

The assessee followed the method of accounting wherein expenses were debited to the Profit & Loss account excluding service tax. The service tax paid on expenses was shown as ITC adjustable against output service tax payable on the services rendered by it. Since output services rendered by the assessee were exempt from service tax, the assessee made a claim for refund. Upon the rejection of the claim of refund by the Service Tax Department, the assessee reversed the ITC and debited the P&L account with a sum of Rs. 51,65,869 towards service tax written off and claimed it as an expenditure u/s 37(1). The A.O. called upon the assessee to explain why service tax written off should not be disallowed u/s 37(1).

The A.O. was of the opinion that
(i) rejection of the claim of refund of service tax credit cannot impact the P&L account;
(ii) even if it is to be treated as a P&L account item, it was never treated as income at any point of time for it to be written off;
(iii) if the same is treated as claim of deferred expenditure, the same pertains to earlier years and is therefore a prior period item which is not eligible to be claimed as an item of expenditure.

For the above-stated reasons, the A.O. rejected the claim of Rs. 51,65,869 made by the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the A.O. The assessee then preferred an appeal to the Tribunal.

HELD


The Tribunal observed that the A.O. has not disputed the fact that the assessee has not debited the service tax component paid on input services into the P&L account. Therefore, there is no merit in his observation that it is not an item of P&L account. The assessee has paid service tax on input services and hence the question of treating the said service taxes as an item of income does not arise because any taxes paid on purchase of goods or services is part of the cost of goods or services which can be either debited to the P&L account when the assessee has not availed ITC, or if the assessee avails ITC then the service tax component is taken out from the P&L account and treated as current assets pending adjustment against output taxes payable on goods or services.

When the application filed by the assessee for refund was rejected by the Department, the assessee had written off the said ITC and debited it to the P&L account. Therefore, the second observation of the A.O. also fails. When the input service tax credit is carried forward from earlier financial year to the current financial year, it partakes the nature of taxes paid for the current financial year and hence deductible as and when the assessee has debited it into the P&L account.

Further, it is a well-settled principle of law by the decision of various Courts and Tribunals that ITC / CENVAT is deductible u/s 37(1) when such ITC is reversed or written off in the books of accounts. The Tribunal relied upon the decision of the Gujarat High Court in the case of CIT vs. Kaypee Mechanical India (P) Ltd., (2014) 223 taxmann 346 and the decision of the Ahmedabad Bench of the Tribunal in the case of Girdhar Fibres (P) Ltd. vs. ACIT in ITA No. 2027/Ahd/2009. The Tribunal held that input service tax credit is deductible u/s 37(1) when such ITC is written off in the books of accounts.

The Tribunal set aside the issue to the file of the A.O. for the limited purpose of verification of the claim of the assessee regarding rejection of refund claim.

COVID IMPACT AND TAX RESIDENTIAL STATUS: THE CONUNDRUM CONTINUES

The last 12 months have resulted in people facing challenges and difficulties coming at them from all sides, and often all at once. At the very inception of the lockdown in late March, 2020, a panic had set in amongst a large number of NRIs and PIOs stuck in India, despite wishing to leave the country to avoid becoming tax resident in India.

The CBDT came out with a welcome Clarification on 8th May, 2020 vide Circular No. 11/2020 and provided relief to such persons becoming accidental and unintentional residents. The accompanying press release, dated 9th May, 2020, provided further assurance from the Government that relief for F.Y. 2020-21 would be given in due course of time.

‘Further, as the lockdown continues during the Financial Year 2020-21 and it is not yet clear as to when international flight operations would resume, a Circular excluding the period of stay of these individuals up to the date of normalisation of international flight operations, for determination of the residential status for the previous year 2020-21, shall be issued after the said normalisation.’

By the time of the actual normalisation of international flight operations, the 182-day mark had already been crossed, thereby resulting in a situation in which a non-resident who was stranded in India due to the lockdown became a tax resident for F.Y. 2020-21. There was indeed a pressing need for a proactive step from the Government to provide a breather to such people stranded in India, or to instruct the CBDT to issue the necessary guidelines for them. However, our Government, recognising tax as a major source for revenue, felt it appropriate to leave the matter untouched and was busy in other priority matters not concerning the hardship that people would face. Accordingly, people had to make several representations to the Government for clarity, since the so-called commitment to issue a relief-granting Circular was never met, nor any statement or indication given by the Government as to its plans.

Finally, after multiple representations to the Government, an SLP had to be filed before the Supreme Court. While hearing the SLP filed by an NRI who gained involuntary residency in India, the Court pronounced that the CBDT was the appropriate body to grant relief and directed it to issue a Circular within three weeks. But despite all these efforts, the CBDT came out with an ineffective Circular and reasoning. On the international platform, the Government is trying to co-operate with OECD countries to tackle tax nuances whereas, on the other hand, this action of the Government reflects its fickle mind-set in relation to tax levy. It is important for the Government to understand that ‘trust is earned when actions meet words’. They should learn from the ancient days when kings collecting bali from the people were considerate not to collect such bali during the periods of drought / floods.

Circular No. 2/2021 was issued on 3rd March, 2021 and instead of granting any relief or concession, as was expected, it was merely a summarisation of the existing provisions of section 6 of the Income-tax Act, 1961 (‘ITA’) and a short explanation of how Articles 4 and 16 of the India-US tax treaty work, amongst other things.

What was the CBDT trying to clarify through this Circular – the provisions of the ITA and the Tax treaty, or guidelines for stranded people in India? It is a perfect example of how CBDT easily discharged its obligation without considering the practical applicability of the Circular. No relief through this Circular means that non-residents have to again make representations and file SLPs before the due date to file returns in India, resulting in prolonged litigation for these NRIs. It is believed that this Circular will severely harm NRIs stranded in India.

On an examination of the reasons in the Circular for not granting any relief, the following points emerge:

ONE. There is no ‘short-stay’ in India
The first reason given by the Circular for not granting relief was that a ‘Short stay will not result in Indian residency’. This reason shows that the CBDT has not considered the situation that by the time international flights were normalised and stranded NRIs could leave the country and return to their country of usual residence, they had already exceeded the threshold of 183 days’ stay in India and become residents. Therefore, for most persons who were stranded in India as on 1st April, 2020 the terminology of a ‘short stay’ in India during F.Y. 2020-21 introduced by the CBDT is highly irrelevant, especially as it was evident that NRIs were forced to remain in India till at least July (when limited flights to the US and France were commenced) and in most other cases till October. Further, in case of several other countries such as Hong Kong and Singapore, flights have yet not resumed.

TWO. Possibility of dual non-residency is no reason for not granting relief
The Circular, while further explaining the rationale for not granting relief, raised an issue which has become a hot topic and a sore point for the Indian Government – the inequity and injustice of double non-taxation. The Indian Government has been focused on non-residents, especially NRIs, avoiding tax in India by ‘managing’ their residential status to remain outside India. Section 6 was significantly amended to tackle this scourge on the Indian exchequer. The Circular states that granting relief for the forced period of stay in India could result in a situation where ‘a person may not become a tax resident in any country in F.Y. 2020-21 even after staying for more than 182 days or more in India resulting in double non-taxation and end up not paying tax in any country.’ Therefore, the Government deems it fit to not grant any general relief.

Never mind that this aspect was not considered relevant while granting relief for F.Y. 2019-20, or that the Government had already committed to granting relief in May, 2020.

Coming back to the reasoning, even if a person ends up becoming a ‘stateless’ person (if relief were hypothetically provided), they would then be unable to seek recourse to any beneficial position under a tax treaty and have all their India-sourced income subject to tax in India anyway. The only tax revenue that the Indian Government would forgo would be in respect of foreign-sourced income, which anyway it has no right to tax. The reasoning defines the intention of the CBDT to tax global income of the NRI stranded in India due to the lockdown. Is the Indian Government morally right to levy tax on such foreign-sourced income under the ‘residence-based’ taxation rules?

Clearly, the answer to this must be an emphatic ‘No’. However, the knife is in the hands of the Indian Government and they would try to tax (i.e., cut) everything which comes their way in the name of legitimate tax collection. Just because NRIs have got stranded in India due to the lockdown by virtue of which they became residents in India satisfying the condition of section 6, the Government feels it has the right to tax their worldwide income. This shows that the Government interprets Indian laws as per its convenience. Further, if the source-country has ‘source-based’ taxation rules like India, then it will levy tax on such income, irrespective of the fact that the income-earner is a non-resident there. If the source-country has given up its right to tax such income arising and originating therein, then that should be of no concern to the Indian Government and remain a matter solely relevant to that Sovereign State.

It is also unfair for the involuntary period of stay in India to be considered while determining residential status. The Delhi High Court in its decision in CIT vs. Suresh Nanda [2015] 375 ITR 172 has articulated this point very well as follows:

‘It naturally follows that the option to be in India, or the period for which an Indian citizen desires to be here, is a matter of his discretion. Conversely put, presence in India against the will or without the consent of the citizen should not ordinarily be counted adverse to his chosen course or interest, particularly if it is brought about under compulsion or, to put it simply, involuntarily. There has to be, in the opinion of this Court, something to show that an individual intended or had the animus of residing in India for the minimum prescribed duration. If the record indicates that – such as for instance omission to take steps to go abroad, the stay can well be treated as disclosing an intention to be a resident Indian. Equally, if the record discloses materials that the stay (to qualify as resident Indian) lacked volition and was compelled by external circumstances beyond the individual’s control, she or he cannot be treated as a resident Indian.’

Besides, the newly-inserted section 6(1A) should have automatically addressed the concerns of the Indian Government of double-non-taxation of ‘stateless’ Indian citizens, if that is the thinking behind non-granting of relief.

The Indian Government seems to be taking a position that because some persons may get too much of a benefit, no relief should be granted to anyone, a position which is both disingenuous and inconsistent. By granting relief, the Indian Government would not have done any favour; instead, it would simply be forgoing a right it normally would, and should, never have had in the first place.

In addition to exposing the income of stranded foreign residents to tax in India, they shall be burdened with the additional responsibility of the disclosures and compliances in India as applicable to residents. In case the foreign assets’ disclosures are not made by such persons, then the Indian Assessing Officer has been given unfettered powers under the Black Money Act wherein he can levy penalties and prosecutions.

Further, they would also lose the benefit of concessional or beneficial tax provisions available to non-residents both under the ITA and a tax treaty. And, if they are engaged in a business or profession outside India or take part in the management of a company or entity outside India, they would risk the income arising to them through such business or profession becoming taxable in India, or the company being considered a resident in India by virtue of its place of effective management being in India. Compliances with tax audit provisions, transfer pricing provisions, etc., also become applicable to such persons and their business transactions when they become resident in India. Additionally, whatever payments such persons would make, whether personal in nature or for their business or profession, would also be subject to evaluation for taxability in India – for example, if a person who becomes resident in India due to being stuck here during the lockdown makes royalty payments in respect of his foreign business to a non-resident, then such royalty would be deemed to accrue and arise in India and be chargeable to tax in India.

These follow-on consequences of becoming a resident are completely ignored by the Government while evaluating the impact of not granting relief, since there is nothing which is going from its pocket instead of falsely piling up the case for taxing such income.

THREE. No tie to break
The Circular explains that the tie-breaker test under tax treaties will come to the rescue of dual-residents. This clarity completely misses its own stand as stated in the Circular in the earlier section, that if someone becomes a resident of India by virtue of their period of stay in India, they will not be able to access the tie-breaker test of the tax treaty because they may not qualify as residents of the country of their usual or normal tax residency. So, how would the tie-breaker test come to the rescue? The Government should take the trouble to explain in detail the difference in stand taken by it in the same Circular. Was the Circular drafted by two different persons applying their minds independently? Further, India does not have a tax treaty with each and every country and any person who is resident of such a country with which India does not have a tax treaty would have no such recourse available, even if he were to become a dual resident. In case of any non-compliance, the Government comes with retrospective clarifications to tax such people. Isn’t this a kind of tax terrorism?

The Circular further states that: ‘It is also relevant to note that even in cases where an individual became resident in India due to exceptional circumstances, he would most likely become not ordinarily resident in India and hence his foreign sourced income shall not be taxable in India unless it is derived from business controlled in or profession set up in India.’

If this is indeed the case, and eventually relief will anyway be granted by operation of the tie-breaker test or MAP (Mutual Agreement Procedure), or foreign source income will anyway not be subject to tax in India, then there should be no reason for the Indian Government to not grant relief pre-emptively and reduce the genuine hardship and burden on accidental residents. By the very reasoning adopted in the Circular, granting relief will not confer any additional benefit upon anyone and therefore the Government should not have had any reluctance and objection to granting such relief.

The issue of tie-breaker also raises the practical difficulty in claiming tax treaty based on non-residential status while filing the return of tax (‘ITR’) in India. There is no provision in the ITR for individuals to claim status as tax treaty non-residents if they are residents under the provisions of the ITA. It has become mandatory to provide details of period of stay in India in the ITR and, therefore, issues shall arise in cases where stay in India exceeds 182 days but the tie-breaker results in non-residence in India.

In such cases, the options are that the filer simply claims all foreign source income as exempt even though his status is disclosed as a resident, or the filer does not fill in the period of stay and files as a non-resident. Filing as a resident may expose him to the need to make unnecessary additional disclosures and compliances, such as in respect of foreign assets. However, if such disclosures are rightly not made, this may attract additional scrutiny and also the potential for proceedings under the Black Money law. Even if the proceedings may not eventually result in any consequence, the nuisance and additional effort and financial burden due to the scrutiny will nonetheless arise. Filing as a non-resident without providing details of period of stay may result in the ITR being considered defective, which has its own consequences. In the absence of any changes to the ITR or clarification on this subject from the CBDT, the fact that such difficulty has not been addressed will add to the anguish and confusion.

FOUR. Employment income
The Circular reiterates the current legal position that employment-related income of an accidental resident will only be subject to tax in India if his stay exceeds 183 days in India or if a PE of the foreign employer bears the salary.

Therefore, the Circular itself acknowledges the fact that many persons will be in India for 183 days or more when it talks about dual non-residency, (but) it ignores this very aspect while discussing taxation of salary and wages.

The salary structure of any employee is designed based on the applicable taxation and labour laws of the jurisdiction where the employee was expected to be exercising his employment. The tax deductions and taxability of perquisites, employment benefits such as pension, social security and retirement benefit contributions, stock options and similar reward schemes, etc., vary greatly from country to country and the calculation is extremely sensitive to the specific tax considerations under which the remuneration package was designed.

Therefore, all those persons stuck in India and exercising their employment in India will unnecessarily have their employment income subjected to tax in India. While there may not be an instance of double taxation, there surely will be instances of unforeseen and unexpected tax consequences on account of differing tax treatments and employment-related tax breaks not being available in India as against the jurisdiction of the employer.

Not merely this, the rates of tax applicable in India may be much higher than the rates of tax applicable in the person’s home country, and given the relatively weaker purchasing power of the Indian Rupee, it is likely that a major portion of the employment-related income would be subject to tax under the 30% tax slab, while the income would not have been subject to such high rates of tax in the home country. This will have a serious cash flow impact due to the additional tax liability to be borne in India.

FIVE. No credit-worthiness
This brings up the next matter which the Circular addressed, i.e., credit of foreign taxes. The Government’s argument is that even if there is a case of double taxation, credit of foreign taxes would be available in India as per Rule 128.

This ignores the concern of many of the accidental residents, that the real problem may not be double taxation but the overall rate of taxation. If the foreign tax liability and effective rate of tax is greater that the Indian rate of tax, there would be no concern. However, in most cases the Indian rate of tax is higher due to which even after eliminating double taxation there would be an additional tax cost borne in respect of Indian taxes. In this respect, the CBDT in its Circular could have clarified that such additional burden shall be refunded to the people taxed overly. On a serious note, if you want to tax people considering a certain scenario, then the Tax Department should also consider a scenario in which it has to refund money to them.

Apart from this, the elimination of double taxation through tax credit is irrelevant to the many Indian emigrants living and working abroad in lower tax or zero-tax rate countries such as the UAE, Bahrain, Oman, Qatar, Kuwait, Bahamas, Singapore, Cyprus, Mauritius, Hong Kong, etc. In such a scenario, the Indian Government is taxing something which it never had the right to tax. Clearly, the Government is taking undue advantage of the pandemic by deriving revenue from the stranded people.

SIX. International inexperience
The Circular then goes on to quote from the OECD Policy Responses to Coronavirus (Covid-19), which stated that the displacement that people would face would be for a few weeks and only temporary and opined that acquiring residency in the country where a person is stranded is unlikely.

This reference to the OECD’s analysis is of 3rd April, 2020, less than a week into India’s lockdown. The Circular relying on a projection in April, 2020 of people being stranded for a few weeks only is absurd given that this Circular is issued in March, 2021 and it is abundantly clear that people were stranded for several months (or even a year) and in almost all cases acquired residency in India.

A majority of OECD countries are in Europe where inter-country and cross-continental travel by road is fairly common and convenient due to the short distances involved. If a person working in France gets stranded in the Netherlands or Belgium, he could simply travel back to France by his own private car – this convenience is surely not available to a person working in the US and stranded in India.

If the Government really did want to rely on international experience to justify its actions, it should have fallen back on something more recent, which considers the situation as it is today, not on what it was in April, 2020 and definitely not an invalidated forecast from the past.

The Circular then mentions what other countries have done and states that the UK and the USA have provided an exclusion or relief of 60 days, subject to fulfilment of certain conditions, while some countries have not provided any relief or have undertaken to provide relief based on the circumstances of each case. The Indian tax authorities often argue that India is not bound by the actions, decisions and interpretations of other countries. This is done especially while denying benefits or adopting positions that are not aligned with the international experience and best practices. Conveniently in this case, the CBDT has taken its cue from international experience!

What is also relevant is the difference in circumstances between India and the other countries. A large number of Indians normally reside and work in other countries – estimated to be more than 13 million NRIs / PIOs globally. The US, the UK, Germany or Australia are more likely to host foreign citizens than have their own citizens working and living overseas. Therefore, these countries are less likely to be concerned about their emigrants accidentally re-acquiring residency under their domestic tax laws from being stranded due to the lockdown. The Indian Government, however, ought to have been more considerate to the plight of some of these 13 million people.

Another argument relied upon by the Circular is the position adopted by Germany which has held that ‘in the absence of a risk of double taxation, there is basically no factual inequity if the right to tax is transferred from one contracting state to another due to changed facts.’

However, this presumes that the taxation system and tax burden faced by the person in either jurisdiction will be similar or comparable. As has been argued above, there are real possibilities that accidental residents will suffer a much greater tax burden as compared to what they would have suffered had they continued to reside in the country of normal residence.

CONCLUSION
The position of the Government is correct to the extent that there are reduced chances of double taxation and that double taxation through dual residency can be mitigated and relieved through operation of tax treaties and credit for foreign taxes. The Circular also provides that persons suffering double taxation and not receiving relief can make an application to the CBDT for specific relief. It, however, ignores several other issues.

It neither acknowledges nor addresses the concerns of the large number of NRIs and PIOs who are normally residing in lower tax or zero-tax jurisdictions and will suffer a much higher tax burden only because an unforeseen global lockdown forced them to be physically present in India. It also ignores the implications arising out of residency in India that go beyond being subject to tax in India.

There would be a large number of persons who were resident in India previously but have recently emigrated to another country, but they become not just resident but also ordinarily resident in India because of their current year’s presence along with their past status and stay. This exposes their global income to tax in India, which is patently unfair.

Such forced residential status may also require them to disclose all their foreign assets in India and if they are unable to do so accurately and exhaustively, it exposes them to implications under Black Money law and severe non-disclosure related penalties. It will also restrict their access to beneficial tax provisions available to non-residents under the ITA simply because they were stranded in India.

Most importantly, however, none of the arguments made by the CBDT in the Circular are new or were not already known before. They were also known in May, 2020 when the Government provided relief for F.Y. 2019-20 and explicitly committed that it would issue a Circular to provide relief in respect of the period of stay in India till the normalisation of international flights.

The second petition filed against the Circular before the Supreme Court by the same NRI who had filed the original SLP makes the argument that the Government is obligated to provide relief based on its earlier promise. It relies on the Supreme Court’s ruling in the case of Ram Pravesh Singh vs. State of Bihar that there was a legitimate expectation of relief based on the fact that under similar facts relief had been provided for F.Y. 2019-20 and it had been promised for F.Y. 2020-21. The doctrine of ‘legitimate expectations’, although not a right, is an expectation of a benefit, relief or remedy that may ordinarily flow from a promise or established practice. The expectation should be legitimate, i.e., reasonable, logical and valid. Any expectation which is not based on established practice, or which is unreasonable, illogical or invalid cannot be a legitimate expectation. It is a concept fashioned by courts for judicial review of administrative action. It is procedural in character based on the requirement of a higher degree of fairness in administrative action, as a consequence of the promise made, or practice established. In short, a person can be said to have a ‘legitimate expectation’ of a particular treatment if any representation or promise is made by an authority, either expressly or impliedly, or if the regular and consistent past practice of the authority gives room for such expectation in the normal course.

In addition to this, the petition argues that the Circular is unconstitutional because it violates the principle of equality before law under Article 14 – there is inconsistency in not granting relief for F.Y. 2020-21, although under similar circumstances relief had been granted for F.Y. 2019-20. Another argument is that not granting relief from being a non-resident violates Article 19 because it interferes with the freedom to practice a trade or profession and places undue restrictions on the same. Lastly, it argues that the Constitution guarantees protection to life and personal liberty and the lockdown was a force majeure situation, where the appellant was forced to remain in India in order to protect his life and liberty – the Circular penalises him for merely exercising this Constitutional right because, if not for the pandemic, he would have travelled back to the UAE and not remained in India.

The fresh petition makes other arguments which have also been made here to seek justice from the Supreme Court in the matter. The CBDT was also possibly aware that it may have to provide additional relief since it has stated in the Circular that based on the applications that will be received it shall examine ‘whether general relaxation can be provided for a class of individuals or specific relaxation is required to be provided in individual cases’. We can only hope that given the almost universally negative response to the Circular, the CBDT relents and provides the much needed, and previously promised, general relief and exclusion. Else, the soon-to-be-heard petition seems to be the last resort for any equitable relief for the NRI and PIO community.

UNDERSTANDING PREPACK RESOLUTION

BACKGROUND OF IBC AND NECESSITY OF PREPACKING THE RESOLUTION
The Insolvency and Bankruptcy Code, 2016 (IBC) was passed four years ago with the objective ‘to consolidate and amend the laws relating to reorganisation and insolvency resolution in a time-bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith and incidental thereto.’ The NCLAT in Binani Industries Limited vs. Bank of Baroda & Anr. laid down the objective of the code as ‘reorganisation and insolvency resolution of Corporate Debtor (CD), maximising value of assets of the company and promoting entrepreneurship, availability of credit and balancing the interests of all stakeholders’.

Since then, the IBC has moved on and benefited with the help of the rich source of knowledge as provided by jurisprudence. After all, it was time for Government to take steps that would further improve the ease of doing business. Especially with the impact of the pandemic, there is every possibility that businesses will suffer from greater stress due to external reasons beyond their control. This could also put many businesses into greater trouble, making them go through the stress of insolvency through the Courts.

The IMF, through its ‘Special Series on Covid’, identifies three potential phases of the crisis, viz., a first phase where there is a need for interim measures to halt insolvency and debt enforcement activity; a second phase, in cases of severe crisis, where transitional measures may be required to respond to the wave of insolvency cases, including special out-of-court restructuring mechanisms; and a third phase in which countries strengthen their regular debt resolution tools to address the remaining debt overhang and support economic growth.

While the harsh truth of such turmoil is flailing and failing businesses, the pressing need is to allow genuine businesses to sustain themselves and provide options for them to recoup and bounce back. Legislative options may create a lucrative, conducive environment to rescue those affected in these challenging times. ‘Prepack’ emerges in the midst of all this as a decoction which combines the formal and informal option to lessen the burden. Addressing this necessity, the Ministry of Corporate Affairs constituted a sub-committee on 24th June, 2020 to propose a detailed scheme for implementation of prepacked and prearranged resolution processes.

As of today a company in stress in India has four options: the Compromise and Arrangement scheme under the Companies Act, 2013; the Corporate Insolvency Resolution Process (CIRP) under the IBC; RBI’s prudential framework for early recognition, reporting and time-bound resolution of stressed assets; and fourth, the out-of-court settlement framework. The then Finance and Corporate Affairs Minister, the Late Mr. Arun Jaitley, once said, ‘I think today may not be the right time to go in for this discussion (informal option) because of the huge rush of companies coming to the insolvency process, but once this rush is over over the next couple of years, and business comes back to usual, honest creditor-debtor relationship is restored on account of IBC, a situation may arise when we may then have to consider a need to marry the two processes together so they may well exist simultaneously’. Thus, the necessity to introduce an ecosystem of informal options was foreseen at the time of legislation of the IBC and prepack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings1.

GETTING TO KNOW ABOUT PREPACK
Prepack is a process to conclude in advance an agreement by a company which is stressed before moving for statutory administration of the same. This provides it an opportunity to continue its business as a going concern and enables the promoter to rationally decide the options, and to save the time and money cost, along with erosion of goodwill, had this been routed through the CIRP channel.

The United Nations Commission on International Trade Law (UNCITRAL) in its ‘Legislative Guide on Insolvency’ uses the word ‘Expedited reorganisation proceedings’ and Paragraph 76 defines prepack as ‘to involve all creditors of the debtor and a reorganisation plan formulated and approved by creditors and other parties in interest after commencement of the proceedings. Reorganisation may also include, however, proceedings commenced to give effect to a plan negotiated and agreed by affected creditors in voluntary restructuring negotiations that take place prior to commencement, where the insolvency law permits the court to expedite the conduct of those proceedings’.

The USA was the first to introduce prepack in the Bankruptcy Reform Act of 1978. It soon gained momentum with more than 20% of the bankruptcies going through prepack2.The plan ‘is negotiated, circulated to creditors and voted on before the case is filed’3.

With a slight variation, the United Kingdom requires an administrator to conclude the sale. The Insolvency Practitioners Association issued a Statement of Insolvency Practice which defines prepack sale as ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an Administrator and the Administrator effects the sale immediately on, or shortly after, appointment.’

In Singapore, the Insolvency, Restructuring, and Dissolution (Amendment) Bill, 2020 proposes to introduce a new prepack scheme for micro and small companies in the Covid-19 environment. An automatic moratorium would come into play when a company is accepted into the scheme. There would be no requirement to convene a meeting of the company’s creditors. Instead, the Court can approve the scheme, provided that the company can satisfy it that if a meeting had been called a majority representing at least two-thirds in value of the creditors would have approved the proposed scheme.

BENEFITS OF PREPACK
Faster resolution and cost effective: The greatest advantage of prepack lies in early disposal of the case. A majority of the terms are negotiated at the stage before the same are administered by the courts, which allows sufficient time for the debtor to fructify the negotiations. The time taken in courts reduces substantially, together with an increase in the possibility of a resolution. This eventually reduces the cost of administrator / Insolvent Professional (IP) consultant. On the other hand, increase in the time involved in the process of resolution would mean that the CD may have to sustain the stress until the resolution, which in turn reduces the value of the business and also the overall chances of resolution. After introduction of the IBC, the time for resolving insolvency also came down significantly from 4.3 years to 1.6 years. Now, prepack intends to bring it down even further. In countries which are in advanced stages of implementation of the insolvency law, such as the UK and the USA, the time of resolution in prepack can be as low as a few hours!

Goodwill retention and value maximisation: The threat to any business during the resolution process is the disruption that it causes on its normal business, which eventually threatens and hampers its goodwill. Even the Act tries to resolve this concern by introducing a moratorium on admission of CIRP, but the concern is that of loss of goodwill which would otherwise impact the right resolution options. Prepack as an option would enable the CD to safeguard the goodwill which otherwise would be impacted in the formal process.

Increases the possibility of resolution: Once a debtor opts for CIRP, he loses control of the decision-making process which goes to the creditors. It is believed that the defaulting debtor must not be in control of the decision-making process, but then this reduces the possibility of resolution and leads to liquidation. The incidental option for a defaulting debtor in CIRP is that of liquidation, but the statistics reveal that debtors that stay long at CIRP are more prone to end in liquidation. Liquidation is a consequence of failed resolution and a non-desirable situation for the debtor, the creditors, the employees, etc. With prepack invoking informal methods, the chances of resolution increase with intent to move with commercial wisdom, which the debtor can assist and resolve.

Less reliance on courts: The report of the sub-committee of the Insolvency Law Committee on prepacked Insolvency Resolution process mentions withdrawal of applications filed for initiation of CIRP in respect of 14,510 Corporate Debtors at pre-admission stage, closure of CIRPs of 218 CDs u/s 12A of the Code, 27 terminations of CIRPs by the Adjudicating Authority (AA), closure of CIRPs on taking note of settlement recorded by the mediator, and even settlements at the level of the Apex Court. The volume of cases is testimony to the success of out-of-court settlements which if nurtured and guided can enable courts to decide and resolve.

CONCERNS IN PREPACK
Transparency: In the existing CIRP, section 29A of the IBC, 2016 imbibes the importance of transparency and concern of involvement of the related party in the process. Over the concerns of serial prepacking or phoenix companies hangs the fear of failure of prepack. This may also necessitate the Government to work the whole process in a controlled environment to ensure that any unscrupulous elements do not fail the process.

Defaulting debtor in decision-making: The process of CIRP shifts the decision-making power from the CD to professionals who are independent and work for the common commercial good of all. This ensures that the CD is not in control of but only a part of the decision-making process. The RP and the COC decide the course of action which is further supervised by the Courts. Prepack in contract empowers the defaulting corporate to decide on the course of resolution, whereas administrator / RP / IP have a limited role in the resolution process, that of overseeing and approval. This ensures that the CD does not hijack the resolution in his favour if left unchecked.

Framework on prepackaged Insolvency Resolution Process as suggested by the sub-committee
Different jurisdictions have legislated prepack under insolvency with various options; but it is necessary to make a law which is country-specific because one size may not fit all. The three principles that the sub-committee suggested to guide the design of the prepack framework are,
(i)    the basic structure of the Code should be retained;
(ii)  there should be no compromise of the rights of any party; and
(iii) the framework should have adequate checks and balances to prevent any abuse.

The report mentions the following as the main features of prepack:

  •  Prepack as an option must be part of the same law which governs IBC and also part of the same legislation.
  •  Prepack as an option must be available to all CDs for any stress, pre-default and post-default.
  •  The CD shall initiate prepack with consent of simple majority of (a) unrelated FCs and (b) its shareholders. No two proceedings – prepack and CIRP – shall run in parallel.
  •  Promoters and management of the CD to be in control of the decision-making process, except for decisions on matters enumerated u/s 28 of the Code, including interim finance, which shall be taken by the CD with the approval of the CoC.
  •  List of documents and reports like outstanding claims, including contingent and future claims, and a draft Information Memorandum, etc., shall be prepared by the CD and certified by the MD.
  •  The moratorium u/s 14 shall be available from the Prepack Commencement Date (PCD) till closure or termination of the process.
  •  IP shall be appointed by unrelated FC’s who shall not run the business like in CIRP but only administer / conduct the process of prepack.
  •  Similar to CIRP, RP shall make public announcements but on electronic platform, he shall verify the claim, constitute CoC (Committee of Creditors), get valuation report, conduct due diligence, make application to AA (Adjudication Authority) in case of avoidance transaction, etc.
  •  As in CIRP, the CoC shall take decisions with regard to approval by majority of votes except that of liquidation which requires 75% vote.
  • ? Section 29A related to persons not eligible to be resolution applicants to remain sacrosanct even in the prepack process.
  •  Prepack to have the Swiss challenge method to counter the first offer to ensure better proposals. Two-option approach: (i) without Swiss challenge but no impairment to Operational Creditors (OCs), and (ii) with Swiss challenge with rights of OCs and dissenting FCs subject to minimum provided u/s 30(2)(b). Prepack should allow 90 days for market participants to submit the resolution plan to the AA and 30 days thereafter for the AA to approve or reject it.

BRIEF ABOUT THE PREPACK INSOLVENCY RESOLUTION PROCESS (PIRP) PASSED BY ORDINANCE DATED 4TH APRIL, 2021


The Government, aware of the urgent need for prepack, has inserted a Prepackaged Insolvency Resolution Process (PIRP) under Chapter III-A in Part II of the IBC through the ordinance route. The following is a brief, along with some highlights, about the process:

  •  An application for initiating a PIRP may be made in respect of a CD classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.
  •  Restrictions have been placed on the CDs who have recently concluded CIRP / PIRP within three years or are undergoing CIRP, or those against whom liquidation order is passed u/s 33.
  •  An FC, not being a related party of more than 66% in value, has to propose an IP to be appointed as the Resolution Professional (RP). The CD shall also obtain approval for filing the PIRP from its FC not being its related parties representing not less than 66% in value of the financial debt due to such creditors.
  •  The majority of directors / partners have to declare that the CD shall file an application for PIRP within the timeframe not exceeding 90 days along with other declarations as required u/s 54A(2)(f).
  •   The special resolution in case of companies should have three-fourths of the total number of partners approving for filing the PIRP.
  •  The IP to be appointed as RP in PIRP is duty-bound to confirm whether the CD confirms the eligibility requirement for application under PIRP.
  •  Fees paid to the IP to perform his duties shall form part of the PIRP costs.
  •  The AA shall, within a period of 14 days of the receipt of the application under PIRP, either accept or reject it after providing seven days’ time to rectify the defects, if any.
  •  The PIRP shall commence from the date of admission of the application by the AA. The PIRP shall be completed within 120 days from its commencement and the RP shall submit the resolution plan within 90 days from the prepackaged insolvency commencement date. If the resolution plan is not approved by the CoC within the stipulated time, then the RP shall file for termination of the PIRP.
  •  Moratorium as provided in sub-section (1) read with sub-section (3) of section 14 shall be applicable and shall cease to exist upon termination of PIRP.
  •  CD shall submit within two days of commencement of PIRP a list of claims and preliminary information memorandum relevant to formulate the Resolution Plan.
  •  Unlike in CIRP, the management of affairs shall vest with the Board of Directors. However, the management may be handed over to the RP if the Committee by a vote of not less than 66% of the voting share in value decides to do so, or the AA is of the opinion that the affairs had been conducted in a fraudulent manner or there has been gross mismanagement.
  •  The CoC shall be constituted within seven days of the prepackaged insolvency commencement date and its first meeting shall be held within seven days of its constitution.
  •  The CD shall submit the base resolution plan, referred to in clause (c) of sub-section (4) of section 54A, to the RP within two days of the prepackaged insolvency commencement date and the RP shall present it to the CoC.
  •  The CoC may approve the base resolution plan for submission to the AA if it does not impair any claims owed by the CD to the operational creditors.
  •  The RP shall invite prospective resolution applicants to submit a resolution plan or plans, to compete with the base resolution plan, in such manner as may be specified.
  •  Sub-section (2) section 14, sub-section 2A of 14, section 14(3(c), section 17, section 19(3), section 18 clause g to e, section 19(2), section 21, section 25(1), clauses (a) to (c) and clause (k) of sub-section (2) of section 25, section 28, section 29, sub-sections (1), (2) and (5) of section 30, sub-sections (1), (3) and (4) of section 31, sections 24, 25A, 26, 27, 28, 29A, 32A, 43 to 51, provisions of Chapters VI and VII of Part II have been applied mutatis mutandis to the PIRP.
  •  If the AA is satisfied that the resolution plan as approved by the CoC under sub-section (4) or sub-section (12) of section 54K, as the case may be, subject to the conditions provided therein, meets the requirements as referred to in sub-section (2) of section 30, it shall, within 30 days of the receipt of such resolution plan, by order approve the resolution plan.

Prepack is a great way if India can take a leaf out of the book of countries which have legislated, administered and have learnt from experience. It may also be necessary to implement the law in a controlled environment but with the caution of not excessively restricting the eco-system which the law would promulgate. This law would stretch to the fullest strength when it is allowed to resolve the stress, provided that it is allowed to be experimented with within the framework, with little interference from courts. Excess legislation and restrictions may dilute the intent of faster resolution; this requires that those involved in the process of prepack are sensitive to the consensus-building mechanism of debtors and creditors. This also means that creditor-debtor must also act maturely during this process as they must realise that the success of this process depends on its negotiation and approval of the same. On the point of restriction, such as the one in section 29A, views are divided on transparency and genuine related-party buyer.

References
1 Bo Xie (2016), Comparative Insolvency Law: The Prepack Approach in Corporate Rescue, Edward Elgar Publishing
2 Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd ed., Cambridge University Press, 2009) 454
3 John D. Ayer et al, ‘Out-of-court Workouts Prepacks and Pre-arranged Cases, a Primer’, (April, 2005), ABI Journal <https://www.abi.org/abijournal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer> [2] (2020) 8 Supreme Court Cases 531

REVISITING AUDITING STANDARDS

EXECUTIVE SUMMARY

Section 149(3) of the Companies Act, 2013 makes a short statement to the effect that, ‘Every auditor shall comply with the Auditing Standards’. This proviso legalised the necessity for auditors to follow Auditing Standards. The recent reports of the National Financial Reporting Authority (NFRA) on the work of the auditors raise a lot of questions about how (and also whether they should) Regulators look at Auditing Standards and whether the expectations of the Regulators from the auditing fraternity are changing.

Background to Auditing Standards

As mentioned earlier, section 143(9) of the Companies Act states that ‘Every auditor shall comply with the Auditing Standards’. This is followed by section 143(10) which clarifies that the Institute of Chartered Accountants of India, in consultation with the National Financial Reporting Authority (NFRA) would recommend Auditing Standards for adoption by the Central Government. Till that time, the Auditing Standards issued by the ICAI would have to be followed.

The ICAI has issued 40 Auditing Standards segregated into seven different areas:

Sl. No.

Area

No. of standards

1

General
principles and responsibilities

9

2

Risk
assessment and response to assessed risks

6

3

Audit
evidence

11

4

Using
the work of others

3

5

Audit
conclusions and reporting

6

6

Specialised
areas

3

7

Standards
on review engagements

2

 

Total

40

These standards cover an eclectic variety of areas and are comprehensive in their coverage to enable auditors of any type of entity to discharge their duty with confidence. The standards within the above broad areas are detailed below:

General principles and responsibilities

The nine Auditing Standards on general principles and responsibilities lay down the foundation for the Auditing Standards on other topics. These Standards cover an eclectic array of areas such as the terms of the audit engagement, quality control, documentation and the auditor’s responsibilities relating to fraud. In addition, they also provide guidance on consideration of other laws and regulations, communicating with Those Charged With Governance (TCWG) and communicating deficiencies in internal control. These are considered to be the general responsibilities of the auditor. While the terms of the audit engagement are best left to the auditor and the client, there should not be a situation where there is no engagement entered into at all just because of familiarity. In a similar vein, both the quality and quantity of the audit documentation maintained are equally important for the audit.

Risk assessment and response to assessed risks

One of the greatest risks in the preparation and presentation of financial statements is that of material misstatement. The six Auditing Standards on risk assessment and response to the risks that have been assessed by the auditor mandate planning the audit of financial statements and understanding the entity and its environment to assess risks of material misstatement. Since no audit can cover a comprehensive review of all transactions, one of the Auditing Standards covers the concept of materiality. It is also important that the auditor conduct some procedures as a response to the risks that he has assessed. The auditor would also have to evaluate the action to be taken on misstatements that have been identified during the audit.

Audit evidence

The importance of reviewing and retaining evidence that has been gathered during an audit can never be over-emphasised. The series of Auditing Standards on audit evidence describes what is audit evidence and provides specific considerations for specific items. External confirmations (such as bank balances and balances of trade receivables) would have to be obtained. As there would be a lot of audit evidence available regarding the entity being audited, the auditor has to use analytical procedures and sampling techniques to ascertain the quantum of evidence that he would need. The set of Auditing Standards on audit evidence provides guidance on transactions with related parties, subsequent events, assessing the going concern concept and obtaining written permissions.

Using the work of others

Many a time during an audit, the auditor has to use the work of other auditors such as Internal Auditors, Concurrent Auditors and Stock Auditors. It is also possible that the auditor may have to use the work of experts such as fair valuers for land and building and financial assets. These areas have been covered in the three Auditing Standards on using the work of others.

Audit conclusions and reporting

The finished product or the end result of an audit assignment is the issuance of the Audit Report. The Audit Report contains different paragraphs such as forming an opinion and reporting on the financial statements, communicating Key Audit Matters in the independent auditors’ report, communicating matters that in the opinion of the auditors need emphasis (Emphasis of Matter) and modification to the opinion in the Independent Auditors’ Report. All of the above areas have been covered in separate Auditing Standards.

Specialised areas

Often, auditors are engaged to attest financial statements prepared in accordance with special purpose frameworks. For example, the Securities and Exchange Board of India (SEBI) mandates auditors to attest the financial statements presented in the draft red herring prospectus that precedes an IPO. The 800 series of Auditing Standards provides guidance on how these should be conducted and reported.

Standards on review engagements

On some occasions, auditors are asked to review historical financial statements and review interim financial information. SEBI requires auditors to perform a limited review of the quarterly results of listed companies. The standards on review engagements have been issued with the intention of enabling auditors to carry out these engagements. Since the review engagements are not audits, it is necessary that the Audit Report states these facts – these and other matters have been covered in the standards on review engagements.

The opinion of the auditors in their Audit Report is based on their conducting the audit on the basis of Auditing Standards prescribed by section 143(10) of the Companies Act, 2013.

In the present environment where business transactions are becoming complex and technology drives almost everything, the task of auditing becomes riskier. Recently, Regulatory investigations and interventions have also focused on compliance with Auditing
Standards.

IS THERE A CHANGE IN THE EXPECTATIONS OF AUDITORS FROM USERS OF FINANCIAL STATEMENTS?

One of the contexts in which the importance of Auditing Standards needs to be viewed is whether there is a change in the expectations of auditors from users of financial statements. In 1896, Justice Lopez ruled in the case of Kingston Cotton Mills that the auditor is a watchdog and not a bloodhound. Those days are long gone. To take an analogy from cricket, auditors these days are more like an umpire who needs to report on anything that needs to be reported by the laws or regulations without fear or favour. Auditing Standards are the tools that the auditor will use to report. Although there is a vast array of Auditing Standards, the users of financial statements cannot expect the auditor to detect well-conceived fraudulent transactions. However, the auditor would be able to sensitise the users of financial statements on areas that are of concern to him. It is up to the management to take note of these and ensure that corrective action is taken. Using Key Audit Matters, Emphasis of Matter and other paragraphs permitted by Auditing Standards, the auditor should be able to red-flag issues that could snowball into a crisis later.

AUDIT RISKS

In the present environment, audit risks have increased manifold. Over the last decade or so, most Regulators all over the world have had to issue negative comments on auditors who failed to report on entities that were deteriorating rapidly and ultimately had to either apply for bankruptcy or be sold at a bargain. A leading real estate company in the UK and a company in the infrastructure development and financing space in India are cases in point. In both these cases, auditors were auditing these companies for a very long time and hence were aware of the pain points. Yet, they failed to report on these. An extract from the report of the NFRA on the auditors of one of the companies reads:

‘This AQR has the objective of verifying compliance with the Requirements of Standards on Auditing (SAs) by the audit firm relevant to the performance of the engagement. The AQR also has the objective of assessing the Quality Control System of the audit firm and the extent to which the same has been complied with in the performance of the engagement.’

As a part of the conclusion, the report states:

‘The instances discussed below of failure to comply with the requirements of the SAs are of such significance that it appears to the NFRA that the audit firm did not have adequate justification for issuing the Audit Report asserting that the audit was conducted in accordance with the SAs. In this connection, the NFRA wishes to draw attention to Response 12 in the ICAI’s Implementation Guide on Reporting Standards (November, 2010 edition) that says that “A key assertion that is made in this paragraph is that the audit was conducted in accordance with the SAs”; and that “If during a subsequent review of the audit process, it is found that some of the audit procedures detailed in the SAs were not in fact complied with, it may tantamount to the auditor making a deliberately false declaration in his report and the consequences for the auditor could be very serious indeed”. It bears emphasis that the very serious consequences referred to would ensue irrespective of whether such non-compliance was or was not associated with a proved financial reporting misstatement. Failure to comply with any of the requirements of applicable SAs indicates that the audit firm has failed to achieve the central purpose of the audit and that there was not an adequate basis to issue the report that it did.’

Even if we assume that such cases should be treated as an exception, the conclusions reached by the NFRA should be a matter of concern to the auditing fraternity.

An issue that needs to be discussed is whether Regulators and Government agencies should be given the power to prescribe Auditing Standards and also review whether auditors have followed these standards. Auditing Standards are a part of the Companies Act, 2013 and auditors who do not comply with these Standards are violating the Act. The Act itself has a number of penal provisions for non-compliance. Hence, getting other Regulators also to penalise auditors would not only result in multiplication of roles but also cause confusion as to who takes the action first. Auditing Standards are best left to the Institute of Chartered Accountants and taking action for non-compliance is best left to the Companies Act.

COVERAGE OF AUDITING STANDARDS

As can be seen from the list tabulated above, Auditing Standards cover an eclectic variety of topics from audit risks to documentation to sampling. If applied in toto, the present set of Auditing Standards should be able to cover all risks that an auditor may face during the audit – the standards would also enable auditors to minimise their risks. However, since Regulators seem to be raising their expectations from the auditors, auditors would need to take extra care to ensure that the audit team has followed all Auditing Standards.

CONCLUSION

From the above discussion it can be concluded that auditors need to focus their attention on the applicability of Auditing Standards to the entity under audit and how they have documented the manner in which the requirements of the particular Auditing Standard have been carried out. The Public Company Accounting Oversight Board (PCAOB) in the United States carries out regular inspections in accordance with the provisions of the Sarbanes Oxley Act. A cursory analysis of their reports reveals that auditors have two options to prove that they have followed all Auditing Standards in an audit:

  •  Maintain and produce documentary evidence that they have followed all auditing standards; and

 

  •  Produce persuasive other evidence, other than oral assertions and explanations.

 

ROLLING OUT ‘COACHING’ IN PROFESSIONAL SERVICES FIRMS

In today’s world of information overload and entertainment addiction, the attention span of most of the younger generation and our grandkids is going down. They are amazingly tech-savvy, smarter and faster than us and even those before us. The ones joining / doing their professional courses are also very clear on the balance between work and life. Those who are joining these professional courses now are comparatively more affluent with time. They are also clear on the need to set aside space to grow.

The earlier understanding of in-depth knowledge and rattling off the sections, sub-sections, clauses and explanations is no longer in vogue. Practical problem-solving in the shortest time is the call of the day.

The advanced world is adapting rapidly to the needs of being able to empower the students to be able to meet the unknown future. The ability to communicate and present effectively have been the most-sought-after skills in the past decade. This decade is seeing ‘coaching / mentoring’ as the most important key to success in the workplace, be it in services, startups, or in professional firms. Lakhs of life coaches are available today on commercial basis but a few do it out of passion. Mentors are few and far between. Readers may Google for the difference between them. Suffice it to say that mentoring is normally longer term and may not be specific to ‘growth’ or ‘profession’ and could be said to lean towards the ‘gurukul’ system.

There can be different coaches for different aspects like profession, sport, life itself.

This article attempts to provide some thoughts on ‘how to’ take up steps that one can adopt for putting a coaching plan in action in a CA firm. It is based on the exercise undertaken in the past two decades with the concentration being on the last year. (The ongoing pandemic gives us the time for both sides!)

WHO CAN BE COACHED?
Anyone can be coached if they are willing. However, most employees / partners may opt out as they see it as an exercise for additional responsibility, intrusion into their privacy, etc. The advantages of getting coached to be more effective (smart), fast-track their growth and reach their potential early could reduce the resistance.

There can be no coaching without the student / professional (hereinafter called student) being convinced that they need to be coached and by that particular person. Their view that distinguished seniors / friends may not be ideal as they could be carrying baggage which can come in the way of open listening needs to be assuaged. Suggestions would include the need to change their thought process, take on disciplined habits which would need them to step out of their comfort zone. The resistance can come in the implementation of suggestions like ‘deliberate gratitude’ where they may need to have open oral acknowledgements with their parents / others.

The objective could be to be able to reach limitation due to past / present events, reframe the ‘stories’ to recognise that they were mere events and nothing more… rather, they were a guide for a broader ‘world view’. It is important to ensure that it is not mixed up with the objective of being advantageous to the firm.

It may also be important to set (a) the purpose, (b) the limits and (c) have a broad agreement on how it would go along as it is a strong commitment of time and proactive effort on both sides.

If there is too much resistance then the student may have to be encouraged to find out more by watching various coaching videos, read articles / books on the subject and learn like ‘Eklavya’.

WHO CAN COACH?
There is no one born to coach but those having good interpersonal skills and compassion could find it easier. Both these skills can be cultivated and one can learn about them on the internet. The competencies which can be focused on and which are needed to be a coach / mentor could be:

1) Listening deeply to what is being shared without distractions, disturbances and interruptions. The coach should even be able to catch some of the unsaid things.
2) Learning to ask the appropriate questions to understand the student / professional’s mental make-up and possible ‘block’ which they cannot see (reading between the lines, as they say). Avoid judging in the interaction.
3) Be aware of the general characteristics of the generation (a result of the environment) but not to be judgmental while listening. Understand Maslow’s Hierarchy of needs for arriving at the real reasons for decisions taken.
4) Get to understand possible and available ‘tools’ such as workbooks for coaching.
5) Understand that even managers / partners have a need to be loved, belonging, worthiness, constant validation and at times feeling that they are not enough.
6) Dealing with coaching setbacks with the belief that one is striving to make a difference.
7) Need to be self-motivated as well as motivating all the time and avoid blame and complaints about the students.
8) A coach who is in a rush or insists on completion of one stage can get a student disconnected.
9) If possible, the coach should have mindfulness (being aware of his feelings, thoughts and sensations), heartfulness (being sincere and warm in feelings / emotions) and soulfulness (expressing deep feelings and emotions).

ALTERNATE WAYS / MEANS OF COACHING
The need to understand the ways and means (tools) to coach gives us the needed confidence to take up this onerous contributing exercise. Some of the ways could be as under:

I   Learning to be a good coach as explained above is most important;
II  Listen to clients – are they holding back – past, present or future? Where excited, sad, body language, listen for frustrations / challenges / what is holding them back, demotivating factors;
III Thinking to spark ideas / alternatives for them to be even better. Insightful real self-stories along with well-known stories of others could strike a chord. Use of metaphors is found relatable and acceptability is high;
IV Communicating – how we reply (judging vs. empathetic); absolute truth vs. relative truth – circumstances / environment being considered;
V  Long-term habits / behaviour changes and sticking to it by journaling, habit tracker, daily empowering routine can be emphasised;
VI Emotional Awareness / Mapping: +ive / -ive emotions ranked. Those below the average improved (issue may be self-esteem, negative environment, meaning given to events) and those with high marks also sharpened;
VII    Emotional Training.

All emotions to be detailed as and when felt – not vague. Once labelled, suggestions could be:
1. Distance self from the incident / communication – as if it is happening to someone else;
2. If in five years it would not mean anything, do not spend more than five minutes on it;
3. Look at the incident from the other person’s point of view if something keeps coming back.

POSSIBLE METHODOLOGY OF COACHING (HOW TO?)
a) Categorise the professional into the five major types of human beings to be able to customise the coaching. (A = Director; B = Socialiser; C = Thinker; D = Supporter; and X = Combination of two or more.)

b) Understand the past, present with possibly a strength / weakness assessment.

c) Understand / agree on the need for coaching and acceptability of the coach.

d) Establish ‘connect’ by listening actively.

e) Set framework and periodicity as per mutual convenience of the student / professional.

f) In the physical meeting (preferred) or virtual one be open and transparent as a coach and if some resistance is observed, do not hurry or decide, probe sensitively – give time.

g) Getting the understanding of the emotional intelligence which rules each and every one of us by self and later the students’ / professionals’ ranking. This could lead to self-realisation and the beliefs / areas where one may like to focus to be more balanced.

h) Ability to reframe the issue by placing for consideration the possibilities is vital. The shame, incompetence, helplessness expressed to be presented that one is enough, one is as good as the next or the opportunity to grow, respectively.

i) Guide in the setting up of SMART goals by looking at ‘wow’ goals, why that goal is important (three to five reasons), sub-goals to achieve the goal, how one needs to ‘be’ to achieve the goals. Finally, how to achieve to-dos with timelines on yearly, quarterly, monthly, weekly and daily action points.
(a)    This is a crucial part where sharing of incidents in one’s life, being vulnerable connects one better.
(b)    Arriving at achievable goals with areas of ‘higher calling’ may be vital: envisioning a better world, being an inspirational person, believing that small daily acts can lead to the astounding results that one wants.

j) Look at facilitating the goals set with genuine positive celebratory acknowledgements for the improvement as perceived by the student / professional is a key to continuation.

k) Seek out the challenges and see the alternatives as identified by the student. Do not be in a hurry to provide the solutions. Rather, guide them to the answers to ensure ownership of the solution.
l) Proven technologies such as focus on being rather than doing, deliberate gratitude, regular exercise, breathing properly, meditation, journaling, letting go of the past and learning to forgive could be part and parcel of this coaching.

m) Follow through at least for six months to one year on a monthly basis to get the desired results.

n) Much more by involving and growing in coaching.

CONCLUSION
The world, India and our profession, all of them need heroes. Everyone has the capacity and potential to be that in at least one area. One cannot think of a better contribution / legacy than leaving the world better off  with committed, professional global citizens / leaders. Coach yourself and coach all at the office for an empowered and happy office with no limits on growth of the individual or firm.

COGNIZANCE OF THE OFFENCE OF MONEY-LAUNDERING

INTRODUCTION
.
Newspaper reports show that, on an average, every week in two to three cases a businessman, politician, banker or bureaucrat is booked under the Prevention of Money-Laundering Act (PMLA). Apart from attachment of property and freezing of bank accounts, another action started simultaneously against such a person is initiation of criminal proceedings. On a complaint made u/s 44 of the PMLA, investigation commences and the Special Court may take cognizance of the offence of money-laundering.

However, the terms ‘cognizance of offence’ and ‘cognizable offence’ are not defined in the PMLA. Indeed, section 65 provides that the provisions of the Code of Criminal Procedure, 1973 (CrPC) shall apply insofar as they are not inconsistent with the provisions of the PMLA for arrest, search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Accordingly, in the absence of any provision in the PMLA, one may refer to the provisions of the CrPC on a given aspect such as the definition of ‘cognizable offence’. This
term is defined in section 2(c) of the CrPC as follows:

‘Cognizable offence’ means an offence for which, and ‘cognizable case’ means a case in which, a police officer may, in accordance with the First Schedule or under any other law for the time being in force, arrest without warrant.

From a review of the above-mentioned definition one can see that where the offence is covered under the First Schedule of the CrPC or under any other law for the time being in force, the police officer may arrest without a warrant.

A reference to the First Schedule shows that it provides the following classification of offences:
• cognizable or non-cognizable,
• bailable or non-bailable, and
• the court which will try the offence.

Part II of the First Schedule refers to ‘classification of offences under other laws’. It provides that offences punishable with imprisonment for more than three years would be cognizable and non-bailable.

A reference to section 4 of the PMLA shows that the offence of money-laundering is punishable with rigorous imprisonment for more than three years which may extend up to seven years (ten years in the case of NDPS offences).

Accordingly, on the basis of the criteria specified in the First Schedule of the CrPC, the offence of money-laundering is cognizable.

WHETHER THE OFFENCE OF MONEY-LAUNDERING IS COGNIZABLE?
The issue whether the offence of money-laundering is cognizable had come up for consideration before the Courts in the following cases:
•  Jignesh Kishorebhai Bhajiawala vs. State of Gujarat [2018] 90 taxmann.com 320 (Guj);
• Rakesh Manekchand Kothari vs. UoI (Manu/Guj/0008/2015);
• Chhagan Chandrakant Bhujbal vs. UoI [2017] 78 taxmann.com 143 (Bom);
• Vakamulla Chandrashekhar vs. ED [2019] 356 ELT 395 (Del);
• Virbhadra Singh vs. ED (Manu/Del/1813/2015);
• Moin Akhtar Qureshi vs. Union of India [2017] 88 taxmann.com 66 (Del);
• Rajbhushan Omprakash Dixit vs. Union of India [2018] 91 taxmann.com 324 (Del).

The Courts gave views which were divergent and in many cases the matter was carried to the Supreme Court by way of SLPs which are pending.

However, an Explanation to section 45 has now settled the issue. The Explanation was added to section 45 w.e.f. 1st August, 2019 to clarify the meaning of ‘offence to be cognizable and non-bailable’. It reads as follows:

‘Explanation. – For the removal of doubts, it is clarified that the expression “Offences to be cognizable and non-bailable” shall mean and shall be deemed to have always meant that all offences under this Act shall be cognizable offences and non-bailable offences notwithstanding anything to the contrary contained in the Code of Criminal Procedure, 1973 (2 of 1974), and accordingly the officers authorised under this Act are empowered to arrest an accused without warrant, subject to the fulfilment of conditions under section 19 and subject to the conditions enshrined under this section’.

Thanks to this clarification, the controversies faced by the Courts in the above-mentioned decisions have been put to rest.

COGNIZANCE OF THE OFFENCE OF MONEY-LAUNDERING – PRECONDITION

There are two provisions which refer to the precondition to take cognizance of the offence of money-laundering.

Section 44(1)(b) of the Prevention of Money-Laundering Act, 2002 (PMLA) provides that, notwithstanding anything contained in the CrPC, a Special Court may take cognizance of the offence of money-laundering upon a complaint made by an authority authorised in this behalf under the Act, without the accused being committed to it for trial.

The second Proviso to section 45(1) lays down the basic precondition for taking cognizance of an offence punishable u/s 4. It categorically provides that the Special Court cannot take such cognizance except upon a written complaint by the Director or any officer of the Central or State Government authorised by a general or special order.

‘Taking cognizance of’ – connotation of
The expression ‘taking cognizance of’ is not defined or explained in the PMLA. In section 44, too, there is no clarification as regards the meaning of this expression. However, its meaning has been examined by the Supreme Court and the High Courts in various decisions. The propositions laid down by the Courts may be reviewed as follows:

• Whether a Magistrate has taken cognizance of an offence depends on the facts and circumstances of each case and no rule of universal application can be laid down on this issue1.
• Taking cognizance means cognizance of an offence and not of an offender. ‘Cognizance’ indicates the point of time when a Magistrate takes judicial notice of an offence. It is different from initiating a proceeding. Rather, it is a condition for initiating a proceeding2.
• Taking cognizance does not involve any formal action but occurs as soon as a Magistrate applies his mind to the suspected commission of an offence and takes first judicial notice of an offence on a complaint or police report or on his own information.3
• The Magistrate takes cognizance once he makes himself fully conscious and aware of the allegations made in the complaint and decides to examine or test the validity of the said allegation4.
• At the stage of taking cognizance, only the prima facie case is to be seen. It is not open to the Court to appreciate the evidence at this stage with reference to the material5.
• For taking cognizance of an offence, the Court has to merely see whether prima facie there are reasons for issuing process and whether the ingredients of an offence are on record6.
• ‘Taking cognizance of offence’ means taking notice of an offence which would include the intention of initiating judicial proceedings. It is not the same thing as issuance of process. It is entirely different from initiation of judicial proceedings; rather, it is a condition precedent to the initiation of proceedings by the Magistrate7.

Private complainant has no locus standi
Having regard to the provisions of section 44(1)(b) and section 45 of the PMLA dealing with a complaint to the Special Court to take cognizance of an offence punishable under the PMLA, an important question that frequently arises is whether a complaint filed by a private complainant can be entertained by the Special Court.

This question was addressed by the Delhi High Court in the Raman Sharma case8. While answering it in the negative, the High Court made the following observations:

‘The question before the learned Trial Court was whether the Trial Court can entertain a complaint filed by a private party for the offence committed under the Prevention of Money-Laundering Act. On this issue, section 44(b) of the Act clearly stipulates that the Special Court may, upon a complaint made by an authorised person in this behalf under this Act, take cognizance of an offence under section 3. Further, the second Proviso to section 45 makes it clear that the Special Court shall not take cognizance of offence except upon a complaint in writing made by the Director, or any officer of the Central Government or State Government authorised in writing in this behalf by the Central Government.

_________________________________________________________________________________

1   Nupur Talwar vs. CBI [2012] 1 SCC (Cr) 711

2   Ajit Kumar vs. State of WB; AIR 1963 SC 765

3   Anil Sawant vs. State of Bihar (1995) 6 SCC 142; R.R. Chari vs.
State of
UP 1951 CrLJ 775(SC); Darshan Singh Ram Kishan vs. State of Maharashtra 1971
CrLJ 1697 (SC)

4   Narayandas Bhagwandas Madhavdas vs. State of WB; 1959 CrLJ
1368(SC)

5   Kishan Singh vs. State of Bihar 1993 CrLJ 1700 SC

6   Chief Enforcement Officer vs. Videocon International Ltd.
[2008] 2 SCC 492

7   State of Karnataka vs. Pastor P. Raju: AIR 2006 SC 2825; State
of WB vs. Mohd Khalid AIR 1995 SC 785

8   Raman Sharma vs. Director, Directorate of Enforcement (2020)
113
taxmann.com 114 (Del)

Accordingly, the learned Trial Court opined that the aforesaid two provisions make it clear that the Court cannot entertain a complaint filed by a private complainant for the offence committed under the Act’.

Cognizance of supplementary complaint
In the context of a supplementary complaint, a question arises whether cognizance is required to be taken again on the filing of a supplementary complaint? This question has been addressed by the Delhi High Court in Yogesh Mittal vs. Enforcement Directorate (2019) 105 taxmann.com 336 (Del). While answering it in the negative, the Delhi High Court made the following observations:

‘It is thus trite law that cognizance is taken of the offence and not the offender. It is also well settled that cognizance of an offence / offences once taken cannot be taken again for the second time. Since this Court has already taken a view that a supplementary complaint on additional evidence qua the same accused or additional accused who are part of same larger transactions / conspiracy is maintainable, however, with the leave of the Court and cognizance is taken of the offence / offences, not the offender and in case no new offence is made out from the additional material collected during further investigation, supporting an earlier offence on which cognizance has already been taken or additional accused are arrayed, no further cognizance is required to be taken’.

Procedural aspect of the cognizance of the offence of money-laundering
Apart from the above-mentioned substantive aspects of cognizance of the offence of money-laundering, it is equally necessary to be aware of procedural aspects relating to the same. Such procedural aspects are not specified in the PMLA.

Section 65 of the PMLA provides that the provisions of the CrPC shall apply, insofar as they are not inconsistent with the provisions of the PMLA, for search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Hence, a reference may be made to Chapter XII of the CrPC [Information to the Police and their Powers to Investigate]. This Chapter lays down the procedure to be followed for investigation of cognizable or non-cognizable offences.

A reference may be made to the following provisions relating to a cognizable offence:
• Section 154 – Information in case of cognizable offence,
• Section 157 – Procedure for investigation of cognizable offence,
• Section 158 – Report to Magistrate, how submitted,
• Section 159 – Power to hold investigation or preliminary inquiry,
• Section 160 – Police officer’s power to require attendance of witnesses,
• Section 161 – Examination of witnesses by Police,
• Section 167 – Procedure when investigation cannot be completed in twenty-four hours,
• Section 172 – Diary of proceedings in investigation,
• Section 173 – Report of police officer on completion of investigation.

A review of the above-mentioned provisions of the CrPC in the context of certain provisions of the PMLA would show that the PMLA does contain the following provisions which are analogous to corresponding provisions of the CrPC:
• Section 19 of the PMLA empowers the ED to arrest a person u/s 19 if, on the basis of material in its possession, it has reason to believe that a person is guilty of an offence punishable under the PMLA.
• Proviso to section 44(1)(b) of the PMLA (inserted w.e.f. 1st August, 2019) requires that upon completion of investigation where it is found that no offence of money-laundering was committed, just like section 173 of the CrPC, the ED is required to submit a closure report to the Special Court.
• However, in respect of the other provisions of Chapter XII of the CrPC, such as filing of FIR, maintaining a case diary, etc., the PMLA does not contain analogous provisions.

CONCLUSION
Often, clients approach their chartered accountants with the show cause notice received by them from an Enforcement Officer alleging that an offence under the PMLA has been committed. The clients seek advice on the manner of giving a reply. That apart, a number of questions are raised by clients in respect of the consequences of various actions under the PMLA, such as provisional attachment of property, arrest, search and seizure, etc.

To advise clients on the proper course of action it is necessary for us to familiarise ourselves with basic knowledge of the main provisions of the PMLA. This will facilitate proper steps to be taken by the client during adjudication and other proceedings under the PMLA and briefing the arguing Counsel engaged by the client for representation before the Special Court.

I HAD A DREAM

The intensity was brewing slowly in the court. Spectators were biting their nails, not knowing which shot will be fired next. Both players were not letting their guard down. The crowd was silent, the referee’s movement oscillated with the player’s delivery and the linesman kept a check on every movement. The match was telecast live on various channels. Young aspirants were seeing their heroes showcasing their skills – and just then the siren went berserk.

I woke up shaking, shut the alarm and realised that it was a dream. Although it might have seemed like that, but it was not a match at the Australian Open, rather, it was two learned tax experts arguing their case in the Income Tax Appellate Tribunal. It was telecast live on the ITAT’s channel and subscribers could watch any hearing going on across the country. ‘What a dream’, I whispered to myself, considering that it might have been the after-effect of the recent budget proposal of turning the ITAT faceless. However, instead of ruminating on the bizarre story, I thought about daydreaming and penned down my thoughts on my wish list for the future of the Income Tax Appellate Tribunal (ITAT).

The ITAT was established in 1941 and has been the torch-bearer of judicial fairness in the country. It can be compared to cricketer M.S. Dhoni in his heydays. It is the last fact-finding authority (the finisher), the first appellate authority outside the Income Tax Department (the ’keeper) and has led the way for being the Mother Tribunal of all the other tribunals in the country (the Captain). And the fact that the Department winning ratio in ITAT is just 27%1, it overturns many high-pitched assessments (the DRS winner) and it keeps on doing its work without making much of a fuss (the cool-headed).

I still remember the first day when I entered the Tribunal as a first-year article assistant. Though my only contribution to the paper book at that time was numbering the pages, I realised the holiness of the inner sanctum of the Tribunal when my manager insisted that I be meticulous on page numbering and he even reviewed the same after I finished it. The showdown was spectacular and I was awestruck by the intellect and inquisitiveness shown by the Honourable Tribunal members.

_______________________________________________________________________________
1    Economic Survey, 2017-18
That was the story of the past; now let’s focus back on the dream. The ITAT has stood the test of time and it is only possible because it is agile and adaptive to changes. Keeping with that spirit, I present my 7-point wish list for the future of the ITAT.

1. Less-Face and not Face-Less: Changes which might not have been sought by a Chief Technical Officer of an entity in a decade have been brought by Covid-19. Companies adapted and learnt to work from home and now are seeing multiple ways of saving costs through technical upgradation. Similarly, all cases in the Tribunal should be categorised into three: (a) Basic – Does not require a hearing and can be judged just based on submission; (b) Complex – Requires video hearing; and (c) Complex and high value – Requires in-person hearing. This will be cost and time-efficient for the Tribunal, the tax practitioners and the clients. Since in-person attendance will not be required, it will open a lot of opportunities for tax practitioners from tier-2 and tier-3 cities to grow their litigation practice.

2. One Nation – One Law – One Bench: In spite of numerous benches, currently there is a huge backlog of cases (88,0002). With the technological upgradation (mentioned at point 1 above) in place, Tribunal members from across the country could preside over hearings related to any jurisdiction. This will not only reduce the workload from overloaded benches but will also reduce the hectic travelling of Tribunal members who go on a tour to set up benches in several locations. This may also result in a spurt in the setting up of additional benches and Tribunals which can work in two shifts, having separate members if required.

3. Jack of all trades and master of one: A decade back, the accounting profession was mostly driven by general practitioners who were masters in all subjects. With rising complexities and frequent changes in the law, very few can now deal with all the intricacies of even a single income tax law. Most of the big firms have separate teams for Transfer Pricing, International Taxation, Individual Taxation, Corporate Taxes and so on. Owing to these complexities, the Honourable Tribunal members must spend a lot of time studying minute details of every case. If a ‘dynamic jurisdiction’ is in place (see point 2), judges of a specialised area / section can preside over all similar cases. This will ensure detailed, in-depth discussion on each topic and the results will be similar and swifter.

_______________________________________________________________________________
2

https://timesofindia.indiatimes.com/business/india-business/88000-appeals-pending-before-income-tax-appellate-tribunal-chairman/articleshow/74322517.cms

4. OTT platform: Online telecasts of Tribunals can be done for viewers which will not only help tax practitioners and students learn some technical aspects, but will also help them to learn court craft. This will give confidence to newcomers and more lawyers and chartered accountants would be inclined to join litigation practice.

5. ETA: Currently, a lot of the time of a professional is spent waiting for his hearing. Once full digitisation kicks in with video conferencing facility, an ETA (Expected Time of Appeal!) could be provided. This would help tax professionals to schedule their day better.

6. Error 404 – Page not found: Many times, digitisation leads to further problems rather than solutions. A robust internal technical system which allows uploading of documents without size limit, writing of replies without word limit and allowance of documents to and from in the hearing would help the cause of e-hearing. Additionally, the facility of explaining through a live digital whiteboard and PowerPoint presentation would be the cherry on the cake.

7. Circular reference: Often, a case is remanded back to the Assessing Officer for finding the facts. Then, the whole circular motion of the A.O., CIT(A) and ITAT starts once again, which delays the decision-making. With the help of technological advancement, if a special cell is created at the ITAT level to finalise the facts and present them to the bench, it would surely ensure speedy justice.

The list can go on and on with the emphasis on technological upgrading and efficient utilisation of resources. However, the one thing that I don’t want to be changed is the way in which ITAT has upheld the principle of natural justice. This is one thing by which I was mesmerised as a young kid and I want any other person joining the profession to feel the same. I would be extremely grateful if some portion of my dream does come true.

Jai Hind! Jai Taxpayers!

INTRODUCTION AND BACKGROUND OF MLI, INCLUDING APPLICABILITY, COMPATIBILITY AND EFFECT

The development and roll-out of Multilateral Instruments or MLI is the latest global tax transformational process under the BEPS initiative. The BCAJ, in this Volume 53, will run a series of articles by practitioners to bring out basic concepts, de-jargonise terminology and bring out practical implications and deal with hurdles that they bring in our day-to-day practice. We would welcome your comments and suggestions and even generic questions which can be taken up by the authors.

A. INTRODUCTION TO MLI
1. The Action Plan on Base Erosion and Profit Shifting (the BEPS Action Plan), published by the Organisation for Economic Co-operation and Development (OECD) at the request of the G20, identified 15 actions to address BEPS in a comprehensive manner and set deadlines to implement those actions. Action 15 of the BEPS Action Plan provided for the development of a Multilateral Instrument (MLI).

2. As per the Explanatory Statement to the MLI, its object is to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting i.e., tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.

3. FAQ 1 of Frequently Asked Questions on MLIs explains that the MLI helps fight BEPS by implementing the tax-related treaty measures developed through the BEPS Project in existing bilateral tax treaties in a synchronised and efficient manner. These measures will prevent treaty abuse, improve dispute resolution, prevent the artificial avoidance of permanent establishment status and neutralise the effects of hybrid mismatch arrangements.

B. IMPORTANT EVENTS OF MLI AND MLI STATISTICS
1. Background of MLI – from conception to entry-into-effect1: On 12th February, 2013 the report ‘Addressing Base Erosion and Profit Shifting’ (BEPS) was published recommending the development of an ‘Action Plan’ to address BEPS issues in a comprehensive manner. In July, 2013 the OECD Committee on Fiscal Affairs (CFA) submitted the BEPS Action Plan to the G20 identifying 15 actions to address BEPS in a comprehensive manner and set out deadlines to implement those actions. Action Plan 15 interim report provided for an analysis of the possible development of a Multilateral Instrument (MLI) to implement tax treaty-related BEPS measures. Based on the Action 15 interim report, a mandate was developed by the CFA in February, 2015 to set up an Ad hoc Group for the development of an MLI which was also endorsed by the G20 Finance Ministers and the Governors of Central Banks. The development of MLI was open for participation of all interested countries on an equal footing. On 24th November, 2016 the Ad hoc Group concluded the negotiations and adopted the text of the MLI as well as its accompanying Explanatory Statement which was signed by representatives of over 70 governments on 7th June, 2017 at a high-level signing ceremony in Paris. Thus, on 1st July, 2018, the MLI began its legal existence. However, the MLI would enter into force with respect to each of its parties on the first day of the month following three calendar months after the deposit of their instrument of ratification, acceptance or approval.

2. Applicability of MLI: As stated earlier, the MLI and its explanatory statement were adopted by the Ad hoc Group on 24th November, 2016 and MLI began its legal existence on that date. The first high-level signing ceremony took place on 7th June, 2017 when India signed the MLI by depositing its provisional document of notifications and ratifications. Thereafter, it filed its final document of notifications and ratifications on 25th June, 2019. As on 18th February, 2021, 95 tax jurisdictions are signatories to the MLI as per the website2 of OECD. Out of these, the MLI has come into effect qua 57 tax jurisdictions, including India. With reference to India, as per the MLI Matching database available on the OECD website3, out of its 90 tax treaties with other countries, 60 tax treaties are Covered Tax Treaties (CTAs). In other words, 60 tax treaties would stand modified by the MLI. Out of the said 60 treaties, MLI has already come into effect or is to come into effect qua India with respect to 42 tax treaties as the treaty partners have already deposited their final instrument of notifications and ratifications. Thus, with regards to the other 18 treaties (60 minus 42), the MLI would come into effect only when the necessary procedures with regard to deposit of final instruments of notifications and ratifications are complied with by the treaty partners.

1   https://www.oecd.org/tax/treaties/multilateral-instrument-BEPS-tax-treaty-information-brochure.pdf

  1. Global list of countries in respect of which MLI has come into effect as on 18th February, 2021:As stated earlier, MLI has already come into effect qua 57 countries globally as on 18th February, 2021. To get a detailed list of countries and to be updated with the latest position, one may go to the OECD website4 and click on ‘Signatories and Parties (MLI Position)’.

4. Countries with which MLI is in effect qua India or is to come into effect for India5:


Sl. No.		 Contracting jurisdiction Entry into effect with respect to withholding Entry into effect with respect to other taxes Sl. No. Contracting jurisdiction Entry into effect with respect to withholding Entry into effect with respect to other taxes
1 Albania 01.04.2021 01.07.2021 22 Latvia 01.04.2020 01.08.2020
2 Australia 01.04.2020 01.04.2020 23 Lithuania 01.04.2020 01.04.2020
3 Austria 01.04.2020 01.04.2020 24 Luxembourg 01.04.2020 01.04.2020
4 Belgium 01.04.2020 01.04.2020 25 Malta 01.04.2020 01.04.2020
5 Canada 01.04.2021 01.06.2020 26 Malaysia 01.04.2022 01.12.2021
6 Croatia 01.04.2022 01.12.2021 27 Netherlands 01.04.2020 01.04.2020
7 Cyprus 01.04.2021 01.11.2020 28 New Zealand 01.04.2020 01.04.2020
8 Czech Republic 01.04.2021 01.03.2021 29 Norway 01.04.2020 01.05.2020
9 Denmark 01.04.2021 01.07.2020 30 Poland 01.04.2020 01.04.2020
10 Egypt 01.04.2021 01.07.2021 31 Portugal 01.04.2021 01.12.2020
11 Finland 01.04.2020 01.04.2020 32 Qatar 01.04.2020 01.10.2020
12 France 01.04.2020 01.04.2020 33 Russia 01.04.2021 01.04.2020
13 Georgia 01.04.2020 01.04.2020 34 Saudi Arabia 01.04.2021 01.11.2020
14 Iceland 01.04.2021 01.07.2020 35 Serbia 01.04.2020 01.04.2020
15 Indonesia 01.04.2021 01.02.2021 36 Singapore 01.04.2020 01.04.2020
16 Ireland 01.04.2020 01.04.2020 37 Slovak Republic 01.04.2020 01.04.2020
17 Israel 01.04.2020 01.04.2020 38 Slovenia 01.04.2020 01.04.2020
18 Japan 01.04.2020 01.04.2020 39 Ukraine 01.04.2020 01.06.2020
19 Jordan 01.04.2021 01.07.2021 40 United Arab Emirates 01.04.2020 01.04.2020
20 Kazakhstan 01.04.2021 01.04.2021 41 United Kingdom 01.04.2020 01.04.2020
21 Korea 01.04.2021 01.03.2021 42 Uruguay 01.04.2021 01.12.2020

2   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

3   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

4   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

5              https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

  1. India’s significant treaties which are not CTAs under the MLI:
Sl. No. Country Remarks
1 Mauritius Kept India out of its CTA list
2 China Though no CTA, but treaty with China amended recently on lines of MLI
3 United States of America MLI not signed
4 Germany Kept India out of its CTA list
  1. ENTRY INTO EFFECT OF MLI, i.e., EFFECTIVE DATE OF APPLICABILITY OF MLI BETWEEN INDIA AND ITS TREATY PARTNER
  2. MLI 34 deals with ‘entry into force’ and MLI 35 deals with ‘entry into effect’. There is a difference between the two. ‘Entry into force’ indicates the date of adoption of the MLI by a country which is determined with reference to the date of filing the instrument of ratification by it. By itself, ‘entry into force’ does not make MLI applicable. It only signifies the MLI position adopted by a particular country. On the other hand, ‘entry into effect’ indicates the date of applicability of MLI between two countries. The ‘entry into effect’ makes MLI applicable and effective qua the two contracting states. The ‘entry into effect’ is determined by taking into consideration the dates of ‘entry into force’ of two contracting states.

2. MLI 35(1)(a) and (b) provide for different timelines for entry into effect of MLI in respect of taxes withheld at source and entry into effect of MLI in respect of all other taxes, respectively. The application of different timelines for withholding and other taxes could vary based on the interpretation of principles of levy of tax and its recovery and the domestic tax laws of contracting states dealing with the levy and recovery of tax.

3. We may consider one possible interpretation while being mindful of contrary views. In the Indian context, withholding in respect of payments to non-residents u/s 195 would apply in respect of all sums which are chargeable to tax. Ordinarily, chargeability to tax and withholding are inseparable. The obligations of a non-resident do not get discharged merely because taxes are liable to withholding. Recourse can be had to non-resident where tax is not withheld or short withheld. Compliance obligations like filing return and other reporting requirements would apply to such non-resident as well as be subject to specific exceptions, viz., sections 115A(5), 115AC(4) and 115BBA(2).

4. This may not be the position in case of India’s DTAA partner country. In such DTAA partner country, the domestic law may have two ‘boxes’ of incomes. The ‘first box’ would consist of incomes which are subject to withholding by the payer with no recourse to the recipient in case of non- / short deduction. The ‘second box’ consists of incomes which are not subject to withholding but are liable to be taxed directly in the hands of the person earning the income. The first box would be similar to the case of equalisation levy version 1 introduced by the Finance Act, 2016 which levies tax on a non-resident but enforces the same through deduction by the resident payer. The second box would be similar to the case of equalisation levy version 2 introduced by the Finance Act, 2020 whereby the liability is on the non-resident to pay the levy directly.

5. In this regard, reference may be made to Paragraph 4 of the OECD Commentary on Article 31 (Entry into force) of the OECD Model Tax Convention, 2017. The said Paragraph recognises that the relevant Article dealing with ‘entry into force’ of certain treaties provides, as regards taxes levied by deduction at the source, a date for the application or termination which differs from the date of application of the treaty to taxes levied by assessment. This would indicate that there may be countries whose domestic laws may have two boxes of incomes as referred to in the previous paragraph.

6. Consider Article 30(2)(a) of the Indo-USA DTAA which provides for a different time point for entry into effect of the DTAA in respect of taxes withheld as compared to other taxes. This may be because as per the US domestic taxation law, income of a non-resident in the US that is effectively connected with the conduct of a trade or business in the US is not subject to NRA withholding.[Source: https://www.irs.gov/individuals/international taxpayers/withholding-on-specific-income.]

At this juncture, a reference may be made to Paragraph 60 of the recent judgment of the Supreme Court in the case ofEngineering Analysis Centre of Excellence Private Limited vs. CIT [2021] 125 taxmann.com 42 (SC) where, after referring to the OECD Model Commentary and Article 30(2)(a) of the Indo-USA DTAA, the Court concluded that adoption of such different dates for application of the treaty was for reasons connected with USA’s municipal taxation laws.

7. Now, consider a case where the MLI has come into effect only in respect of taxes withheld. In such a case, the CTA as amended by the MLI may be applied by the DTAA partner country for determining the taxes to be withheld (incomes of first box). However, the CTA amended by the MLI cannot be applied by the DTAA partner country in respect of incomes not subject to withholding but that are taxed directly in the hands of the person earning the income (incomes of second box). In such cases, the provisions of the CTA unamended by MLI will be applied till such time as the MLI comes into effect for the purposes of all other taxes.

8. Thus, in the Indian context the different timelines would not be relevant as non-residents earning Indian income are subject to comprehensive obligations. However, in a given case, from the DTAA partner country’s context, different timelines would matter.

D. SYNTHESISED TEXTS

  • Every CTA will have to be read along applicable protocol and applicable portions of the MLI. The said exercise would be complex and cumbersome particularly when the applicability of the MLI depends on reservations and notifications by contracting states.

2. The OECD encourages the preparation of consolidated texts or synthesised texts which would reproduce the
text of each CTA as modified by the MLI. The same has been explained in Paragraph 1 at Page 9 of the ‘Guidance for the development of synthesised texts’ issued by OECD.

3. However, the parties to the MLI are under no obligation to prepare synthesised texts. This has been clarified in Paragraph 13 of the Explanatory Statement on the MLI. This paragraph is referred to in Paragraph 4 at Page 9 of ‘Guidance for the development of synthesised texts’ issued by OECD.

4. In Paragraph 3 at Page 9 of the ‘Guidance’, it has been noted that the purpose of synthesised texts is to facilitate the understanding of the MLI. However, for legal purposes the provisions of the MLI must be read alongside Covered Tax Agreements as they remain the only legal instruments to be applied, in light of the interaction of the MLI positions of the contracting jurisdictions.

5. Thus, the synthesised texts would only help the users in better understanding of the CTA as modified by the MLI. In case of conflict between the synthesised text and the CTA read independently with applicable portions of the MLI, the latter would prevail.

6. As of date, India has synthesised texts in respect of tax treaties with the following jurisdictions:

Sl. No. Country Sl. No. Country Sl. No. Country
1 Australia 11 Latvia 21 Slovak Republic
2 Austria 12 Lithuania 22 Slovenia
3 Belgium 13 Luxembourg 23 UAE
4 Canada 14 Malta 24 UK
5 Cyprus 15 Netherlands 25 Ukraine
6 Czech Republic 16 Poland 26 France
7 Finland 17 Portuguese Republic
8 Georgia 18 Russia
9 Ireland 19 Serbia
10 Japan 20 Singapore
  1. MINIMUM STANDARDS
  2. In the final BEPS Package, in order to combat the issues relating to Base Erosion and Profit Shifting, it was agreed that a number of BEPS measures are minimum standards, meaning that countries have agreed that the standard must be implemented. Thus, countries which are parties to the OECD / G20 inclusive framework on BEPS are required to comply with the following five minimum standards:
  •  Action Plan 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments (Adoption of a fixed ratio rule which limits an entity’s net deductions for interest to a percentage of EBITDA to entities in a multinational group is a minimum standard as per the Executive Summary to this Action Plan, AP4);
  •  Action Plan 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance;
  •  Action Plan 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances;
  •  Action Plan 13: Transfer Pricing Documentation and Country-by-Country Reporting;
  •  Action Plan 14: Making Dispute Resolution Mechanisms More Effective.
  1. While some of these minimum standards in BEPS Actions 6 and 14 have been implemented through MLI, others have been implemented via domestic amendments.

3. The following are the minimum standards implemented by way of domestic amendments:

Section of IT Act Particulars BEPS Action Plan
94B Thin capitalisation – Limitation on interest deduction Action Plan 4
115BBF Patent box regime Action Plan 5
90/90A (India has entered Tax Information Exchange Agreements with several non-DTAA jurisdictions) Exchange of information on tax rulings Action Plan 5
286 Country-by-country reporting Action Plan 13
  1. The following are the minimum standards implemented through MLI:
Article Provision
6(1) Preamble text to tax treaties
7(1) Principal Purpose Test (PPT)
16(1) to 16(3) Improving dispute resolution through Mutual Agreement Procedure (MAP)
17(1) Corresponding adjustment
  1. Paragraph 14 of the Explanatory Statement to the MLI explains the flexibility with respect to the provisions relating to minimum standards. It has been stated that opting out of provisions that reflect minimum standards is possible only in limited circumstances where the provisions of the Covered Tax Agreement already meet the minimum standard. However, it clarifies that where a minimum standard can be met in several alternative ways, the convention gives no preference to any particular way of meeting such minimum standard.6. MLI 6(1) dealing with the ‘preamble text’ is a minimum standard. Opting out is possible only if the CTA already contains the text which is equal to or broader than the said ‘preamble text’. Therefore, MLI 6(4) provides for an exit option only where the CTA already contains preamble language which is similar to the preamble text of MLI 6(1) or is broader than the said preamble text of MLI 6(1).7. MLI 7(1) dealing with the ‘Principal Purpose Test (PPT)’ is also a minimum standard. Opting out is possible only if parties to the CTA intend to reach a mutually satisfactory solution which meets the minimum standard, or if the CTA already contains a PPT. MLI 7(15)(a) provides an exit option where parties to a CTA intend to reach a mutually satisfactory solution which meets the minimum standard for preventing treaty abuse under the OECD / G20 BEPS package. MLI 7(15)(b) provides for an exit option only where the CTA already contains a PPT.8. MLI 17(1) dealing with the ‘corresponding adjustments’ is another minimum standard. Opting out is possible only if the CTA already contains a provision providing for corresponding adjustment or on the basis that it shall make appropriate corresponding adjustment as referred to in MLI 17(1), or that its competent authority shall endeavour to resolve the case under the provisions of the CTA. This is accordingly provided in MLI 17(3).

    9. India has reserved its right under MLI 17(3)(a) for the entirety of MLI 17 not to apply to those of its CTAs that already contain a provision described in MLI 17(2).

    10. India has notified the list of DTAAs which contain a provision for corresponding adjustment. One such example is Canada where Article 9(2) of the DTAA already provides for corresponding adjustment. Hence, the same would remain unamended by MLI 17(1). One may notice this from the synthesised text of the Indo-Canada DTAA published by the CBDT.

    11. One may also take note of the DTAA between India and France. Article 10 of the DTAA which deals with ‘Associated Enterprises’ does not provide for corresponding adjustment. Hence, India has not notified the DTAA with France under MLI 17. Thus, in the absence of a provision providing for corresponding adjustment, MLI 17(1) would get added to Article 10 of the Indo-France DTAA. This may be observed from the synthesised text of the Indo-France DTAA published by the CBDT.

    F. COMPATIBILITY

  2. MLI provisions may either be newly added into CTA or may overlap with the existing provisions of CTA. While in the former the provisions of the MLI can be applied without any conflict with the provisions of the CTA, in the latter there is a conflict between the provisions of the MLI and the provisions of the CTA.

2. In order to address such conflicts, the provisions of the MLI contain compatibility clauses which may, for example, describe the existing provisions which the Convention is intended to supersede, as well as the effect on CTAs that do not contain a provision of the same type. This has been explained in Paragraph 15 of the Explanatory Statement to the MLI.

3. The Glossary to the Frequently Asked Questions on the Multilateral Instrument defines ‘compatibility clause’ as ‘clauses which define the relationship between the provisions of the MLI and existing tax treaties in objective terms and the effect the provisions of the MLI may have on Covered Tax Agreements.’

4. We may understand the application of compatibility clauses with reference to MLI 4:

4.1 MLI 4(1) deals with tie-breaker test in the case of dual-resident entities (person other than individual). MLI 4(2) provides that the text of MLI 4(1) would apply in place of or in absence of a clause in the existing text of the CTA which provides for a tie-breaker in the case of person other than individuals.

4.2 MLI 4(3) provides various reservations including reservation of right for the entirety of MLI 4 not to apply to the CTAs, under MLI 4(3)(a).

4.3 MLI 4(4) provides for notifications by the parties to the Depository where reservations under MLI 4(3)(a) have not been made. It provides that the text of MLI 4(1) would replace the existing provision of CTA where all parties have made such a notification. In all other cases, the provisions of the CTA would be superseded by the text of MLI 4(1) only to the extent that those provisions are incompatible with MLI 4(1).

4.4 If both the parties to the CTA notify the same Article number of the CTA, the text of MLI 4(1) would replace the existing text of such Article. Otherwise, the text of MLI 4(1) would supersede the text of the CTA only to the extent that those provisions are incompatible with MLI 4(1). The latter situation may arise, for example, when there is a mismatch in the notification of Articles by the parties.

4.5 In the Indian context, the applicability of MLI 4 is as per the following table:

Row Labels Count of Article 4
A.4(3) would be replaced by Article 4(1). 22
Article 4 would not apply. 34
The last sentence of Article 4(1) would be replaced with the text described in Article 4(3)(e). A.4(2) would be replaced by Article 4(1). 1
Japan

The last sentence of Article 4(1) would be replaced with the text described in Article 4(3)(e). A.4(3) would be replaced by Article 4(1).

 1

3
Australia

Fiji
Indonesia

 1

1

1
Grand Total 60

4.6 As may be seen from the above table, there is no notification mismatch. Therefore, there is no compatibility issue.

4.7 MLI 4(1) deals with cases of persons other than individuals. However, some CTAs may contain a common tie-breaker test in respect of both individuals and non-individuals. In such a case, Paragraph 52 of the Explanatory Statement to the MLI observes that where a single tie-breaker rule exists in the tax treaty for both individuals and persons other than individuals, the text of MLI 4(1) shall modify only that portion of the rule which deals with determination of residence for persons other than individuals. In other words, that portion of the tie-breaker rule dealing with individuals would remain unaltered or unaffected by MLI 4(1). One such example is Article 4(2) of the Indo-Japan DTAA. One can observe from the synthesised text of the Indo-Japan DTAA that the text of Article 4(2) would remain modified by the text of MLI 4(1) only to the extent that it deals with tie-breaker tests in the case of non-individuals.

5. We can understand the application of compatibility clauses with reference to MLI 6:

5.1 MLI 6(2) provides that the text of MLI 6(1) would apply in place of or in the absence of the preamble language of the Covered Tax Agreement referring to an intent to eliminate double taxation, whether or not that language also refers to the intent not to create opportunities for non-taxation or reduced taxation.

5.2 Paragraph 81 of the Explanatory Statement to the MLI explains that the preamble text in MLI 6(1) replaces the existing preamble language of CTAs that refers to an intent to eliminate double taxation (whether or not that language also refers to an intent not to create opportunities for non-taxation or reduced taxation), or is added to the preamble of CTAs where such language does not exist in the preamble of the Covered Tax Agreements.

5.3 MLI 6(5) provides that each party shall notify the Depository of whether each of its CTAs, other than those that are within the scope of a reservation under MLI 6(4), contains preamble language described in MLI 6(2), and if so, the text of the relevant preamble paragraph. Where all contracting jurisdictions have made such a notification with respect to the preamble language, such preamble language shall be replaced by the text described in MLI 6(1). In other cases the text described in MLI 6(1) shall be included in addition to the existing preamble language.

5.4 It may be noted that India has not made a reservation under MLI 6(4). India has also not made any notification under MLI 6(5). Other contracting states may have notified the existing preamble texts. For example, France has notified the existing preamble text with its treaty with India. Thus, there is a notification mismatch (i.e., India has not notified while France has notified). In such a case, the text of MLI 6(1) being a minimum standard would be added to the existing preamble text contained in the CTAs.

5.5 We may also refer to some of the following CTAs of India where the text of MLI 6(1) has been added to the text of the CTA:

5.5.1 Indo-Luxembourg DTAA:

DTAA LUXEMBOURG – Preamble – Relevant Extract
Existing The Government of the Republic of India and the Government of the Grand Duchy of Luxembourg, desiring to conclude an Agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital and with a view to promoting economic co-operation between the two countries, have agreed as follows:
Added ‘Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),’

5.5.2 Indo-Japanese DTAA:

DTAA JAPAN – Preamble – Relevant Extract
Existing The Government of Japan and the Government of the Republic of India,

Desiring to conclude a new Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income,

have agreed as follows:
Added ‘Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),’

  1. RESERVATION
    1. It would be pertinent to note that the MLI cannot impinge upon the sovereign taxing rights of a contracting jurisdiction.

2. Thus, where a substantial provision of the MLI does not reflect a minimum standard, a party (contracting jurisdiction) is given the flexibility to opt out of the provision entirely, or in some cases partly.

3. Reservation means a party opts out of a provision of the MLI. When reserved, the relevant provision of the MLI so reserved would not amend the CTA. A reservation of an MLI provision would thus mean the CTA provision applies as it is. More and more of reservation means less and less of MLI affecting the CTA.

4. However, a reservation is not permitted for a minimum standard unless the CTAs contain clauses which meet the minimum standard. This has been dealt with in Paragraphs E6-E11 above.

5. It may be noted that MLI 28 deals with reservations. MLI 28(5) provides that reservations shall generally be made at the time of signature or when depositing the instrument of ratification, acceptance or approval, subject to certain exceptions. After such deposit, no further reservation is permissible. This would prevent further dilution of the impact of MLI by subsequent reservations.

6. At the same time, MLI 28(9) permits a party to withdraw a reservation made earlier at any time or to replace it with a more limited reservation. This would mean that it is permissible to further enhance the impact of MLI by subsequent withdrawal of reservations.

7. On reservation, in the Indian context, an example is the reservation made by India under MLI 3(5)(a). By virtue of this, India has reserved its right for MLI 3 not to apply in entirety to its CTAs. Thus, irrespective of whether contracting jurisdictions choose to apply MLI 3 qua India, the provisions of MLI 3 would not amend the provisions of India’s CTAs.

8. Consider the impact of reservation under MLI 12(4) by Australia on Article 5(PE) of the Indo-Australia DTAA. Though India has notified the relevant article numbers of the Indo-Australia DTAA under provisions of MLI 12(5) and MLI 12(6), Article 5 of the Indo-Australia DTAA would remain unamended by MLI 12 as Australia has reserved the application of MLI 12 in its entirety with respect to all its CTAs.

9. A party cannot make a reservation with respect to a particular CTA. It has to either be across-the-board or with respect to a subset of CTAs based on an objective criterion. This has been taken note of at Page 5 of the Explanatory Statement to the MLI. In other words, reservations cannot be country-centric but must be parameter-centric.

10. A country may still achieve the desired result in certain cases in light of specific reservation clauses. One such example could be of MLI 4(3)(f) which enables a party to reserve the right for MLI 4 not to apply in its entirety to those of its CTAs where the other party to the CTA has opted for MLI 4(3)(e). Thus, where a reservation is made under MLI 4(3)(f) it would only seek to target those treaties where the treaty partners exercise option under MLI 4(3)(e).

11. It may be noted that qua India, three countries, namely, Australia, Fiji and Indonesia, have exercised reservation under MLI 4(3)(e). If India wished it could have exercised reservation under MLI 4(3)(f). However, India has not chosen to make such a reservation.

H. NOTIFICATION

  • Notification represents an expression of choice of option by a party to the MLI or it ensures clarity about existing provisions that are within the scope of compatibility clauses.

2. This is clear from Page 11 of the FAQs to the MLI which provides that it is the information submitted to the Depository to ensure clarity and transparency on the application of alternative or optional provisions of the MLI and on the application of provisions of the MLI, and on the provisions that supersede or modify specific types of existing provisions of a CTA.

3. Notification is thus a communication by a contracting state who is party to the MLI. Notifications are issued for expressing reservations or exercising options or indicating the provisions of CTA to be amended by MLI.

I. INDIA’S MLI POSITION AS ON 18TH FEBRUARY, 2021

  1. India’s MLI position as per the MLI Matching Database available on the OECD Website6 stands as follows:
Particulars Count of countries
Agreements that would be CTAs:
1. Notification mismatch. Need to check whether both jurisdictions have identified the same agreement 10
2. The agreement would be CTA with an amending instrument in force:

 

Austria

Belgium

Morocco

Spain

 4
3. The agreement would be a CTA 46
Sub-total (A) = 1 + 2 + 3 60
Agreements that would not be CTAs:
4. The agreement would not be a CTA because Germany has not included it in its notification 1
5. The agreement would not be a CTA because Hong Kong (China) has not included it in its notification 1
6. The agreement would not be a CTA because Mauritius has not included it in its notification 1
7. The agreement would not be a CTA because neither jurisdiction has included it in its notification 28
8. The agreement would not be a CTA because neither jurisdiction has included it in its notification

 

Bahrain

 1
9. The agreement would not be a CTA because Oman has not included it in its notification 1
10. The agreement would not be a CTA because Switzerland has not included it in its notification 1
Sub-total (B) = (4) + (5) + (6) + (7) + (8) + (9) + (10) 34
Total (A) + (B) 94
  1. As per MLI 2(1)(a)(ii), in order for a tax treaty to be a CTA, it will have to be notified by each party to such treaty. From the above table it is clear that in the case of ten tax treaties there seems to be a notification mismatch as to the relevant tax treaty sought to be modified by the MLI. Thus, one will have to check whether both India and the corresponding treaty partner have notified the same treaty sought to be modified by the MLI before applying the MLI.

6   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions.

  1. CONCLUSION

MLI is a reality and is in effect or is to come into effect in respect of treaties with 42 jurisdictions qua India. While examining the tax consequences under the treaty one will have to be mindful of the provisions of the MLI and the interaction between the provisions of the MLI and the provisions of the treaty. In doing so, one will have to refer to the compatibility clauses. One may also have to refer to the Explanatory Statement to the MLI which would explain each provision of the MLI and the object behind such insertion, the BEPS Actions which have formed the basis for conclusion of the MLI, the Frequently Asked Questions on MLI, the OECD Model Tax Conventions and Commentaries thereon.

Highlights of Volume 52 (YE March 31, 2021)

BCAJ

THE BOMBAY CHARTERED ACCOUNTANT JOURNAL

• 70 Articles / Surveys in addition to our 24 regular features
• Special Issue on ‘Impact of Covid-19’ [May 2020]
• Annual Special Issue – ‘Risk and Technology Challenges for Professionals’ [July 2020]
• New Section on Technology under the title ‘Practice Management and Technology’ from November 2020
• Regulatory Referencer: Feature in new avatar bringing a curated set of changes in Tax, Company Law, Accounting and Audit, and FEMA
At a Glance: Listing of Articles Published in Volume 52

Direct Taxes
•    Remuneration by a Firm to Partners: Section 194J Attracted? [April 2020]
•    Domestic Tax Considerations Due to Covid-19 [May 2020]
•    Specified Domestic Transactions; Retrospective Operability of Omission of Clause (I) To Section 92Ba(1) on GST [June 2020]
•    Tax and Technology: Are Tax Professionals at Risk? [July 2020]
•    The Finance Act, 2020 [September 2020]
•    Report: Role of the Professional in a Changing Tax Landscape [September 2020]
•    New TCS Provisions – An Analysis [October 2020]
•    Taxability of Transfer Fee Received by a Co-Operative Housing Society [November 2020]
•    Taxability of Forfeiture of Security Deposit [November 2020]
•    Taxability of Private Trust’s Income [February 2021]

International Tax
•    The Impact of Covid-19 on International Taxation [May 2020]
•    Covid-19 and Transfer Pricing – Top 5 Impact Areas [May 2020]
•    Transfer Pricing Databases – Requirements, Usage and Review [November 2020]
•    Taxing the Digital Economy – The Way Forward [January 2021]
•    The Conundrum of ‘May be Taxed’ in a DTAA [January 2021]
•    OECD’s Pillar One Proposals: A Solution Trapped in Web of Complexities [March 2021]

Indirect Taxes
•    Operational Impact of Coronavirus Outbreak on GST [May 2020]
•    GST on Payments Made to Directors [June 2020]

Accountancy & Audit

•    Financial Reporting and Auditing Considerations on Account of Covid-19 [May 2020]
•    Governance & Internal Controls: The Touchstone of Sustainable Business – Part II [June 2020]
•    Internal Audit Analytics and AI [June 2020]
•    Financial Reporting Dossier [June 2020]
•    The Run Up to Audit in the 2030s [July 2020]
•    Learnings for Audit firms in the Era of PCAOB and NFRA [July 2020]
•    Data Driven Internal Audit -1 [August 2020]
•    Data Driven Internal Audit -II Practical Case Studies [September 2020]
•    Fraud Analytics in Internal Audit [October 2020]
•    Provisioning for Expected Credit Losses for
Financial Institutions and NBFCs Post Covid-19 [October 2020]
•    Integrated Reporting – A Paradigm Shift in Reporting [December 2020]
•    Value Addition in Internal Audit [December 2020]
•    CARO 2020 – Enhanced Auditor Reporting Requirements [December 2020]
•    Fraud Risk Management in Internal Audit
[January 2021]
•    The Long Form Audit Report for Banks Gets Even Longer [February 2021]

Corporate and Other Laws

•    Overview of Amendments to the Arbitration and Conciliation Act 1996: One Step Forward and Two Steps Back [April 2020]
•    Transition to Cash Flow Based Funding [April 2020]
•    Housekeeping for Bhudevi [April 2020]
•    Covid-19 and the Reshaping of the Global Geopolitical order [April 2020]
•    Impact of Covid-19 on Corporate and Allied Laws [May 2020]
•    Some Reflections on Covid-19 and the Economy: Reset Time [May 2020]
•    Covid-19 Impact on Indian Economy and the Financial Markets [May 2020]
•    Possible Solution to the Problem of Stressed Assets [June 2020]
•    Current Themes in Corporate Restructurings and M&As [July 2020]
•    Mutually Assured Destruction in Corporate Lending [August 2020]
•    Corporate Law in India Promoting Ease of Doing Business without Diluting Stakeholder Interests [December 2020]
•    Statement Recorded Under PMLA and Other Laws: Whether Admissible as Evidence? [December 2020]
•    PFUTP Regulations – Background, Scope and Implications of 2020 Amendment [January 2021]
•    Offence of Money Laundering: Far-reaching Implications of Recent Amendment [January 2021]
•    ‘Proceeds of Crime’ – PMLA Definition Undergoes Retrospective Sea Change [February 2021]
•    CSR Rules Amendment – An Analysis [March 2021]
•    Daughter’s Right in Coparcenary – Part VI [March 2021]

Practice Management and Technology
•    Self-Quarantine your mind whilst working from Home [April 2020]
•    Overcoming the Challenge of Risk Management in Professional Services [July 2020]
•    Working Capital Challenges for CA Firms in Covid Times [July 2020]
•    Excel in What you Do – Some Personal Tips [August 2020]
•    ‘Collaborate to Consolidate’ – A Growth Model for Professional Services Firms [September 2020]
•    Benefits for SMPs Under MSME Act & Other Statutes [October 2020]
•    Executive Presence [October 2020]
•    Whether Practising CAs can Deal in Derivatives on Stock exchanges [November 2020]
•    Personal Data Protection [November 2020]
•    Effective use of Quora for a Professional [January 2021]
•    Digital Marketing? Naah, It’s Digital Branding [February 2021]
•    Initiatives During Pandemic – Personal Experiences [February 2021]
•    Podcasting – The Novel Mode of Storytelling for Your Professional Brand [March 2021]
•    Strategy: The Heart of Business – Part I (March 2021)

Others

•    How to Restart the Engine after the Lockdown [May 2020]
•    India: The Land of Creativity [August 2020]
•    The New Edge Banking [November 2020]
•    WHO Controversy: Lack of Global Leadership in Corona Crisis [September 2020]

Surveys


•    Impact of Covid-19 on Chartered Accountant Firms [May 2020]
•    Digital Gearing of Chartered Accountant Firms [October 2020]

Offences and prosecution – Sections 276C, 277 and 278 – Wilful attempt to evade tax – False verification in return – Abetment of false returns – Condition precedent for application of sections 276C and 277 – Incriminating material or evidence of wilful attempt to evade tax must emanate from assessee – Evidence unearthed during search and survey operations of third persons – No evidence of connection between such material and assessee – Mere denial of allegation will not amount to incriminating evidence – Abetment denotes instigation to file false return – Complaint filed by Director of Income-tax – Not justified – Prosecution not valid

8. (1) Karti P. Chidambaram and (2) Srinidhi Karti Chidambaram vs. Dy. DIT (Investigation) [2021] 431 ITR 261 (Mad) Date of order: 11th December, 2020 A.Ys.: 2014-15 and 2015-16

Offences and prosecution – Sections 276C, 277 and 278 – Wilful attempt to evade tax – False verification in return – Abetment of false returns – Condition precedent for application of sections 276C and 277 – Incriminating material or evidence of wilful attempt to evade tax must emanate from assessee – Evidence unearthed during search and survey operations of third persons – No evidence of connection between such material and assessee – Mere denial of allegation will not amount to incriminating evidence – Abetment denotes instigation to file false return – Complaint filed by Director of Income-tax – Not justified – Prosecution not valid

The assessees were husband and wife. For the A.Y. 2014-15, K filed his return on 29th July, 2014 declaring profit from the sale of immovable property as long-term capital gains. His wife filed her return for the A.Y. 2015-16 and disclosed long-term capital gains. Neither K nor his wife disclosed cash payments received as part of the consideration. These facts came to light in a survey u/s 133A carried out in the case of a company A Ltd. and other entities on 1st December, 2015 by the Income-tax Department and the Enforcement Directorate. In the course of the search several hard disks were retrieved by the Department and the ED. Further search and seizure were also conducted in the case of another company AE Ltd. in the year 2018 and certain notebooks were seized from the cashier of the purchaser company and their statements also recorded. A private complaint was filed by the Deputy Director of the Income-tax Department against K for the offences u/s 276C and 277. Similarly, another complaint was filed against his wife under sections 276C(1), 277 and 278.

After the Court had taken cognizance of the complaint, the assessees filed petitions to discharge them from the prosecution mainly on the ground that the documents alleged to have been seized during the search conducted in the two companies were inadmissible and the alleged cloning of the electronic records was not done by any experts and those documents also were not admissible due to non-compliance with section 65B of the Indian Evidence Act, 1872. Similarly, the person who was said to have given a statement as to the cash transaction had not been examined by the Court while taking cognizance. Hence, without any evidence in this regard there were no materials to proceed against the assessees. It was further submitted that the Deputy Director of the Income-tax Department was not a competent person to file a complaint for the false declaration. Only the A.O. before whom the returns were filed was competent to file any complaint for false returns or evidence. The trial court dismissed the petition.

The Madras High Court allowed the revision petitions filed by the assessees and held as under:

‘i) Section 276C deals with wilful attempt to evade tax. In order to attract the provisions of section 276C the following ingredients must be available: the person (a) wilfully attempts to evade any tax; or (b) wilfully attempts to evade any penalty; or (c) wilfully attempts to evade any interest chargeable or imposable under this Act; or (d) under-reports his income. The Explanation further indicates that the expression “wilfully attempts” employed in the provision is an inclusive one. The Explanation makes it very clear that to maintain the prosecution, the false entry or statement containing the books of accounts or other documents ought to have been in the possession or control of such person and such person should have made any false entry or statement in such books of accounts or other documents or wilfully omitted or caused to be omitted any relevant entry or statement in such books of accounts or other documents, or caused any other circumstance to exist which will have the effect of enabling such person to evade any tax, penalty or interest chargeable or imposable under this Act.

ii) The essential ingredients of the sections make it clear that any statements or incriminating materials either should come from the accused or very strong material unearthed during search or survey is required to maintain prosecution u/s 276C or 277. The very Explanation provided u/s 276C makes it clear that incriminating materials and documents ought to have been seized from the accused. Unless strong materials are seized from the accused or any incriminating statement recorded from the accused, the prosecution has to wait till the finding recorded by the A.O. Reassessment or assessment order has to be passed only based on the materials seized during the search. On such assessment, when the A.O. comes to the conclusion that there is a wilful suppression to evade tax or under-reporting, etc., the complaint is maintainable. Though the offences u/s 276, 277 and 278 are distinct offences and the Deputy Director can launch the prosecution as per section 279, merely because the power was conferred to the Deputy Director to launch a complaint or sanction merely on the basis of some materials said to have been collected from third parties, the prosecution will not be maintainable.

iii) The intention of the Legislature is to prosecute only where concrete materials are unearthed during the search or survey. It is stated in Circular No. 24 of 2019 [2019] 417 ITR (St.) 5 that the prosecution u/s 276C(1) shall be launched only after the confirmation of the order imposing penalty by the Appellate Tribunal. The object of the statute discernible u/s 276 is that to maintain a complaint by the Deputy Director, the material seized or collected during search should unerringly point towards the accused.

iv) All the proceedings before the Income-tax Officer, particularly assessment proceedings, are deemed to be civil proceedings in terms of section 136. When all the proceedings before the A.O. under the Act are deemed to be judicial proceedings and the officer is deemed to be a civil court, if any false declaration or false return is filed before the A.O. such act of the assessee is certainly punishable u/s 193 of the Indian Penal Code, 1860. In such a case the fact that the statement given by the assessee during the assessment proceedings was false has to be recorded by the officer concerned. Without such a finding recorded, the prosecution cannot be launched merely on the basis of some statements said to have been recorded from third parties.

v) The Income-tax search proceedings have also been held to be judicial proceedings and such authority is deemed to be a judicial authority within the meaning of sections 193 and 196 of the Indian Penal Code, 1860. Even the raiding officer is deemed to be a civil court and the proceedings before him are judicial proceedings and if any offence is committed before such authority, the complaint can be lodged only following the procedure u/s 195 of the Code of Criminal Procedure, 1973.

vi) The entire reading of the complaint made it clear that the assessees never incriminated themselves in the statements recorded by the raiding officers at any point of time. The search was said to have been carried out in AE Ltd., the so-called purchaser of the property. The complaint was silent about whether the assessee, i. e., the accused, were either directors or had control over the firms. Mere denial of the prosecution version could not by any stretch of imagination be construed as incriminating evidence.

vii) Admittedly, returns were filed before the A.O. by the assessees and the verification was also done by them while filing the returns. Whether such verification was false or not had to be decided by the A.O. before whom such verification was filed. Neither the false return nor any false statement or verification was done before the Deputy Director of Income-tax to invoke section 195 of the Code of Criminal Procedure, 1973. Prosecution was launched for the alleged offence under sections 276C and 277. There must be material to show that there was wilful attempt to evade tax, penalty, interest or under-report, etc. Merely because search had been conducted and some third parties’ statements were recorded, and further they had also not been examined, and there was no finding recorded by the A.O. as to a wilful attempt to evade tax or filing of false verification, the complaint filed by the Deputy Director was not maintainable.

viii) Showing of ignorance by one of the assessees by maintaining that only her husband was aware of the return… such conduct could not be construed as abetment to attract the offence u/s 278. The prosecution of K and his wife was not sustainable.’

Non-resident – Taxability in India – Royalty – Consideration received for sale of software products under contract with customers in India – Assessee opting to be governed by provisions of DTAA – Meaning of royalty in agreement not amended to correspond with amended definition in Act – Receipts not royalty – Not liable to tax – Section 9(1)(vi), Explanation 4 – Articles 3(2), 13 of DTAA between India and UK

7. CIT (International Taxation) vs. Micro Focus Ltd. [2021] 431 ITR 136 (Del) Date of order: 24th November, 2020 A.Ys.: 2010-11 and 2013-14

Non-resident – Taxability in India – Royalty – Consideration received for sale of software products under contract with customers in India – Assessee opting to be governed by provisions of DTAA – Meaning of royalty in agreement not amended to correspond with amended definition in Act – Receipts not royalty – Not liable to tax – Section 9(1)(vi), Explanation 4 – Articles 3(2), 13 of DTAA between India and UK

The assessee, a company incorporated in the United Kingdom, developed and distributed software products. It sold software products in India either through its distributors or directly to customers. The assessee entered into contracts with its customers on principal-to-principal basis and sale of software licences was concluded outside India (off-shore supplies). For the A.Ys. 2010-11 and 2013-14 the A.O. passed final orders u/s 144C(3) holding that the receipts of income from the sale of software products in India were taxable under the head ‘royalty’ under the provisions of section 9(1)(vi) read with article 13 of the DTAA between India and the United Kingdom and, accordingly, brought the receipts of the assessee as royalty income at 10%.

The Tribunal held that the consideration received by the assessee from various entities on account of sale of software was not royalty within the meaning of article 13 of the DTAA and that there was no corresponding amendment to the definition of the term ‘royalty’ in article 13(3) of the DTAA as carried out in the definition of royalty u/s 9(1)(vi).

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

‘i) The Tribunal did not err in holding that the receipts of the assessee from the sale of software were not taxable as royalty under the DTAA. The payment made by the reseller for the purchase of software for sale in Indian market could not be considered as royalty.

ii) The Tribunal was right in holding that Explanation 4 to section 9(1)(vi) would not apply to the DTAA between India and United Kingdom.

iii) The Tribunal did not err in holding that the receipt of the assessee was not royalty though u/s 14(b)(ii) of the Indian Copyright Act, 1957 selling or giving on commercial rent any copy of computer programme was copyright.’

Income from other sources – Section 56(2)(vii) – Property received without consideration or for consideration less than its fair market value – Scope of section 56(2)(vii) – Bonus shares – Fair market value of bonus shares not normally assessable as income from other sources

6. Principal CIT vs. Dr. Ranjan Pai [2021] 431 ITR 250 (Karn) Date of order: 15th December, 2020 A.Y.: 2012-13


 

Income from other sources – Section 56(2)(vii) – Property received without consideration or for consideration less than its fair market value – Scope of section 56(2)(vii) – Bonus shares – Fair market value of bonus shares not normally assessable as income from other sources

 

The assessee was an individual engaged in the medical profession. For the A.Y. 2012-13, the A.O. found that the assessee had received 1,00,00,000 bonus shares issued by M Ltd. The A.O. invoked section 56(2)(vii) and treated the receipt of bonus shares as income from other sources and assessed the fair market value of the bonus shares as income of the year.

 

The Tribunal held that the provisions of section 56(2)(vii) were not attracted to the fact situation of the case and deleted the addition.

 

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

 

‘i) A careful scrutiny of section 56(2)(vii) contemplates two contingencies; firstly, where the property is received without consideration, and secondly, where it is received for consideration less than the fair market value. The issue of bonus shares by capitalisation of reserves is merely a reallocation of the company’s funds. There is no inflow of fresh funds or increase in the capital employed, which remains the same. The total funds available with the company remain the same and the issue of bonus shares does not result in any change in respect of the capital structure of the company. In substance, when a shareholder gets bonus shares, the value of the original shares held by him goes down and the market value as well as the intrinsic value of the two shares put together will be the same or nearly the same as per the value of the original share before the issue of bonus shares. Thus, any profit derived by the assessee on account of receipt of bonus shares is adjusted by depreciation in the value of equity shares held by him. Hence, the fair market value of bonus shares is not normally assessable as income from other sources.

 

ii) There was no material on record to infer that bonus shares had been transferred with an intention to evade tax. The provisions of section 56(2)(vii)(c) were not attracted to the fact situation of the case.

 

iii)   In view of the preceding analysis, the substantial question of law framed by a Bench of this Court is answered against the Revenue and in favour of the assessee. In the result, we do not find any merit in this appeal, the same fails and is hereby dismissed.’

 

Housing project – Special deduction u/s 80-IB(10) – Condition regarding extent of built-up area – Some flats conforming to condition – Proportionate deduction can be granted

5. CIT vs. S.N. Builders and Developers [2021] 431 ITR 241 (Karn) Date of order: 7th January, 2021 A.Y.: 2009-10


 

Housing project – Special deduction u/s 80-IB(10) – Condition regarding extent of built-up area – Some flats conforming to condition – Proportionate deduction can be granted

 

The assessee was a firm engaged in the development of real estate and construction of apartments. For the A.Y. 2009-10 the assessee claimed deduction u/s 80-IB(10) on the profits determined by applying the percentage completion method. A survey u/s 133A was carried out during which it was found that the built-up area of 26 flats exceeded 1,500 square feet. The A.O. completed the assessment rejecting the claim of the assessee for deduction u/s 80-IB(10).

 

The Commissioner (Appeals) held that derivation of profits based on the percentage completion method by the assessee was correct and the assessee was entitled to proportionate deduction u/s 80-IB(10) in respect of those flats which conformed to the limits prescribed under the relevant provisions of the Act. This was upheld by the Tribunal.

 

On appeal by the evenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

 

‘i) The Tribunal was correct and the assessee was entitled to the benefit of proportionate deduction u/s 80-IB(10) in respect of flats which conformed to the limits under the relevant provisions of the Act.

 

ii) The Institute of Chartered Accountants has issued a clarification that revised Accounting Standard 7 is not applicable to the enterprises undertaking construction activities. The assessee was right in following the project completion method of accounting in terms of Accounting Standard 9.’

Exempt income – Disallowance u/s 14A – Disallowance of expenditure relating to exempt income – Scope of section 14A and rule 8D – Disallowance cannot exceed non-taxable income

4. Principal CIT vs. Envestor Ventures Ltd. [2021] 431 ITR 221 (Mad) Date of order: 18th January, 2021 A.Y.: 2015-16

Exempt income – Disallowance u/s 14A – Disallowance of expenditure relating to exempt income – Scope of section 14A and rule 8D – Disallowance cannot exceed non-taxable income

Dealing with the scope of section 14A, the Madras High Court held as under:

‘i) The disallowance u/s 14A read with rule 8D of the Income-tax Rules, 1962 of the expenditure incurred to earn exempted income has to be computed in accordance with rule 8D which in essence stipulates that the expenditure directly relatable to the earning of such exempted income can alone be disallowed u/s 14A. The assessing authority has to mandatorily record his satisfaction that the proportionate disallowance of expenditure u/s 14A as made by the assessee is not satisfactory and therefore the same is liable to be rejected for such cogent reasons as specified and, thereafter, the computation method under rule 8D can be invoked to compute the quantum of disallowance. It is well settled that the Rules cannot go beyond the main parent provision. Therefore, what has been provided as computation method in rule 8D cannot go beyond the roof limit of section 14A itself under any circumstances.

ii) The Tribunal was right in restricting the disallowance u/s 14A to the extent of exempt income earned during the previous year relevant to the A.Y. 2015-16.’

Business expenditure – Disallowance u/s 40(a)(i) – Depreciation – Scope of section 40(a)(i) – Depreciation is not an expenditure and is not covered by section 40(a)(i)

3. Principal CIT vs. Tally Solutions Pvt. Ltd. [2021] 430 ITR 527 (Karn) Date of order: 16th December, 2020 A.Y.: 2009-10

Business expenditure – Disallowance u/s 40(a)(i) – Depreciation – Scope of section 40(a)(i) – Depreciation is not an expenditure and is not covered by section 40(a)(i)

The assessee was engaged in the business of software development and sale of software product licences, software maintenance and training in software. For the A.Y. 2009-10, the A.O. disallowed a sum of Rs. 6,70,94,074 in respect of depreciation on intellectual property rights u/s 40(a)(i).

The Commissioner (Appeals) held that there being an irrevocable and unconditional sale of intellectual property and the transfer being absolute, it was an outright purchase of a capital asset and, therefore, section 40(a)(i) could not be invoked. This was confirmed by the Tribunal.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

‘i) From a close scrutiny of section 40(a)(i) it is axiomatic that an amount payable towards interest, royalty, fee for technical services or other sums chargeable under the Act on which tax is deductible at source shall not be deducted while computing the income under the head profits and gains of business or profession where such tax has not been deducted. The expression “amount payable” which is otherwise an allowable deduction refers to expenditure incurred for the purpose of business of the assessee and, therefore, the expenditure is a deductible claim. Thus, section 40 refers to the outgoing amount chargeable under the Act and subject to tax deduction at source under Chapter XVII-B. The deduction u/s 32 is not in respect of an amount paid or payable which is subjected to tax deduction at source, but it is a statutory deduction on an asset which is otherwise eligible for deduction of depreciation.

ii) Section 40(a)(i) and (ia) provides for disallowance only in respect of expenditure, which is revenue in nature, and does not apply to a case of the assessee whose claim is for depreciation which is not in the nature of expenditure but an allowance. Depreciation is not an outgoing expenditure and therefore the provisions of section 40(a)(i) and (ia) are not applicable. Depreciation is a statutory deduction available to the assessee on an asset, which is wholly or partly owned by the assessee and used for business or profession.

iii) The Commissioner (Appeals) had held that the payment had been made by the assessee for an outright purchase of intellectual property rights and not towards royalty. This finding had rightly been affirmed by the Tribunal. The findings recorded by the Commissioner (Appeals) as well as the Tribunal could not be termed perverse. Depreciation was allowable. In any case, the amount could not be disallowed u/s 40(a)(i).’

Business expenditure – Section 37 – Assessee company taking over business of another company – Scheme for voluntary retirement of employees of such company – Amount paid under scheme was for purposes of business – Deductible expenditure

2. CIT vs. G.E. Medical Systems (I) (P) Ltd. [2021] 430 ITR 494 (Karn) Date of order: 18th November, 2020 A.Y.: 2000-01

Business expenditure – Section 37 – Assessee company taking over business of another company – Scheme for voluntary retirement of employees of such company – Amount paid under scheme was for purposes of business – Deductible expenditure

GE was incorporated in Singapore and EI in India. The two companies entered into a joint venture agreement on 9th December, 1993 as a result of which the assessee came into existence with the object of carrying on the business of manufacturing and distribution of X-ray equipment. The agreement also provided that the assessee company would take over certain assets of EI and 184 of its employees. A separate agreement termed ‘equipment sales and employees absorption agreement’ was executed between the assessee and EI. This agreement was part of the share purchase agreement. Under the agreement, the employees were given a choice of continuity of service. The assessee introduced a scheme under which it paid a sum of Rs. 4,33,67,658 as retirement benefit to employees who availed of the benefit of the scheme. The amount paid under the scheme was claimed as a deduction u/s 37. The claim was rejected by the A.O.

The Commissioner (Appeals) and the Tribunal allowed the claim.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

‘i) The sum was paid as retirement benefit to employees who availed of the benefit of the scheme. Under the scheme, compensation was paid not only for past services but also for the remaining years of service with the company. The employees had also filed a complaint against the assessee under the labour laws and, therefore, the assessee had to offer a scheme to avoid any kind of future problems. The scheme was sanctioned by the Chief Commissioner for the exemption u/s 10(10C) of the Act and it was a contractual obligation and was an ascertained liability.

ii) The genuineness of the scheme was not doubted by any of the authorities, rather it had been approved by the Chief Commissioner. The expenditure incurred by the assessee under the scheme had been incurred solely and exclusively for the purposes of business and was eligible for deduction u/s 37(1).’

Appeal to ITAT – Sections 253, 254 and 254(2) of ITA, 1961 – Ex parte order – Application for recall of order – Limitation – Assessee not served with notice of hearing before Tribunal though change of address intimated by assessee in Form 35 – Rejection of application for recall of order on ground of bar of limitation – Order unsustainable – Ex parte order in appeal and order rejecting application u/s 254(2) quashed and set aside – Matter remanded to Tribunal

1. Pacific Projects Ltd. vs. ACIT [2021] 430 ITR 522 (Del) Date of order: 23rd December, 2020

Appeal to ITAT – Sections 253, 254 and 254(2) of ITA, 1961 – Ex parte order – Application for recall of order – Limitation – Assessee not served with notice of hearing before Tribunal though change of address intimated by assessee in Form 35 – Rejection of application for recall of order on ground of bar of limitation – Order unsustainable – Ex parte order in appeal and order rejecting application u/s 254(2) quashed and set aside – Matter remanded to Tribunal

The assessee filed an application u/s 254(2) of the Income-tax Act, 1961 before the Tribunal for recall of the ex parte order remanding the matter to the Assessing Officer to decide the matter afresh after examining all the documents, including additional evidence as well as books of accounts, bills and vouchers, etc. The Tribunal held that it had no power to condone the delay in filing the application u/s 254(2) as the assessee had filed the application after six months from the end of the month in which the ex parte order had been passed.

The assessee filed a writ petition and challenged the order of the Tribunal contending that it had changed its address and shifted to new premises and this fact was mentioned in the appeal filed by the assessee in Form 35 against the order passed by the Deputy Commissioner and the assessee was never served in the appeal filed by the Department before the Tribunal. The Delhi High Court allowed the writ petition and held as under:

‘i) The course adopted by the Tribunal at the first instance by dismissing the appeal for non-prosecution and then refusing to entertain the application filed by the assessee u/s 254(2) for recall of the order, could not be sustained. The address of the assessee mentioned in the appeal before the Tribunal by the Department was the assessee’s former address and not the new address, which had been mentioned in the appeal filed before the Commissioner (Appeals) in Form 35. The assessee was never served in the appeal filed by the Department before the Tribunal.

ii) The Tribunal had erroneously concluded that the miscellaneous application filed by the assessee was barred by limitation u/s 254(2) inasmuch as the assessee had filed the application within six months of actual receipt of the order. If the assessee had no notice and no knowledge of the order passed by the Tribunal, the limitation period would not start from the date the order was pronounced by the Tribunal. The order dismissing the application filed by the assessee u/s 254(2) was quashed and on the facts the ex parte order whereby the matter was remanded to the Assessing Officer was set aside. The Tribunal is directed to hear and dispose of the appeal on the merits.’

Sections 90 and 91, read with Article 24 of DTAA and section 37 of the Act – FTC cannot be granted in India in absence of tax liability in India – There is no provision in the Act for grant of refund in India of foreign tax paid abroad though non-creditable foreign tax can be claimed as business expenditure

1. [2021] 125 taxmann.com 155 (Mum)(Trib) Bank of India vs. ACIT ITA No.: 869/Mum/2018 Date of order: 4th March, 2021

Sections 90 and 91, read with Article 24 of DTAA and section 37 of the Act – FTC cannot be granted in India in absence of tax liability in India – There is no provision in the Act for grant of refund in India of foreign tax paid abroad though non-creditable foreign tax can be claimed as business expenditure

FACTS

The assessee is an Indian bank having branches globally1. It earns income from branches outside India and also dividend on shares of its foreign associate companies. It paid taxes on income in accordance with the domestic tax laws of the countries in which it earned income. Further, wherever applicable, it had also availed benefit under the DTAA of the respective country. Computation of global income of the assessee in India had resulted in net loss. In its return of income in India, the bank claimed refund of foreign tax paid abroad. Alternatively, it claimed deduction of foreign tax as business expenditure. Since no income tax was payable by the assessee in India, the A.O. denied the claim for refund of foreign tax2. In the appeal, the CIT(A) upheld the order of the A.O.

Being aggrieved, the assessee appealed before the Tribunal. Generally, Article 24 of a DTAA mentions the mechanism to grant foreign tax credit (‘FTC’). However, the language of Article 24 may vary between different DTAAs. The three variants considered by the Tribunal in the present case were the DTAAs with Namibia, the UK and the US. It also relied on the views expressed by several authors and also the decisions of Courts in foreign jurisdictions and reached similar conclusions in respect of all the three variants.

HELD

Refund in India of tax paid abroad
* Article 24(2) of the India-UK DTAA mentions the following conditions in respect of grant of FTC: (a) FTC should be subject to the domestic law of India; (b) Income in respect of which FTC can be given should have been ‘subjected to tax’ in both the jurisdictions, i.e., the UK and India; (c) Only so much of FTC in respect of doubly-taxed income should be given as is proportionate to income chargeable to tax in India.
* Income earned in the UK could not be subjected to tax in India since the assessee did not have taxable income in India due to loss after aggregation of income at an overall level.
* FTC was available only against Indian tax payable on doubly-taxed income. Since no Indian tax was payable in respect of foreign income, there was no doubly-taxed income. Therefore, no FTC was available to the assessee.
* Referring to several commentaries on international tax, the Tribunal concluded that under none of the DTAAs can the FTC for taxes paid in the source jurisdiction exceed the actual income tax payable in the residence jurisdiction in respect of such doubly-taxed income.
* The Tribunal also did not accept the contention of the assessee that there was double jeopardy because foreign income reduced its losses in India which, otherwise, could have been carried forward and set off against future income, and further, credit for FTC for foreign taxes paid on such income was also not granted against future incomes.
* The Tribunal held that such difficulty referred to as ‘double jeopardy’ (i.e., a taxpayer who but for foreign tax income could have enjoyed higher set-off) had not arisen in the current year though it may arise in subsequent years in which the assessee may enjoy restricted set-off. But such eventualities may also be contingent as losses may not effectively be set off within the permissible limit. Besides, FTC rules make the claim of FTC prescriptive and do not contemplate carry-forward of such tax credit to future years. The Tribunal, however, kept the issue open for adjudication in subsequent years. It distinguished the decision of the Karnataka High Court in the case of Wipro Ltd.3 on the ground that it was applicable only in a situation where the foreign source income was eligible for profit-linked deduction, but the taxpayer had sufficient taxable income against which it could claim FTC of foreign taxes paid on such income. However, the said decision was not an authority for granting refund of foreign taxes by the Indian exchequer. Even otherwise, since it was a ruling by a non-jurisdictional High Court, it may only have a persuasive effect, unlike the binding effect of a jurisdictional High Court.
* Section 91 grants FTC in respect of ‘doubly-taxed income’ arising in a non-treaty country. However, if there was no tax liability in India on account of loss at an overall level, the condition of ‘doubly-taxed income’ was not satisfied.

Business expense deduction for tax paid abroad
* Relying on the jurisdictional High Court decision in the case of Reliance Infrastructure Limited vs. CIT4, the Tribunal granted tax paid as a deduction by way of business expenditure.

Note: The Tribunal dealt with various principles of interpretation of tax treaty and domestic law. Readers may gainfully refer to the decision for detailed reading.

________________________________________________
1    Assessee had branches in several countries, including countries with which India had entered into DTAAs as well as countries with which India had not entered into a DTAA
2    For the relevant year, Rule 128 (Foreign tax credit rules) inserted with effect from 1st April, 2017 was not applicable

Item (c) of the Explanation to section 115JB – Reduction of provision of doubtful debts written-back from book profit allowed, even when in the year when provision was made and the tax was paid under normal provisions of the Act, while computing book profit, the same was not added to book profit

2. BOB Financial Solutions Ltd. vs. DCIT (Mumbai) Mahavir Singh (V.P.) and Manoj Kumar Aggarwal (A.M.) I.T.A. No. 1207/Mum/2019 A.Y.: 2014-15 Date of order: 15th March, 2021 Counsel for Assessee / Revenue: Kishor C. Dalal / Rahul Raman

Item (c) of the Explanation to section 115JB – Reduction of provision of doubtful debts written-back from book profit allowed, even when in the year when provision was made and the tax was paid under normal provisions of the Act, while computing book profit, the same was not added to book profit

FACTS

While computing book profits u/s 115JB, the assessee reduced ‘provision of card receivables written-back’ amounting to Rs. 19.30 crores. According to the A.O., the provision made for card receivable, in earlier years, was not added back to compute book profits, hence, the same cannot be reduced from book profit in the current year. The assessee explained that in the earlier years the same was disallowed while computing total income under the normal provisions of the Act. In those years, the assessee had business losses and, therefore, as advised by its consultant, the book profit was shown as ‘Nil’ without making any adjustment as required u/s 115JB as it had no impact on his tax liability. However, the A.O. disallowed the said reduction of Rs. 19.30 crores from the book profit. The CIT(A), on appeal, confirmed the A.O.’s order.

HELD

The Tribunal noted that a similar issue had arisen before it in the assessee’s own case in A.Y. 2012-13 (ITA No. 4485 & 4297/Mum/2017 order dated 7th May, 2019) which was decided in favour of the assessee. In the said case also, the assessee had book losses and even after adding back the said write-offs, the resultant figure would have still been a negative figure and the assessee would not have any liability to pay tax u/s 115JB. Following the same, the Tribunal held that the assessee was entitled for deduction of write-back while computing book profit u/s 115JB.

DESTRUCTION BY DISTRACTION

As you hold this issue of the BCAJ in your hands, it’s a new F.Y.! Perhaps the most uncertain and traumatic year of our lives is finally behind us. Each one of us has come out stronger. From teamwork to IT infra to client interface – every facet was challenged and most of us would have inoculated our professional practice with greater resilience and therefore become more immune than we were in March, 2020.
Just as the seasons turn, so will this phase pass. Let’s remember these precious words of Maya Angelou: We need Joy as we need air. We need Love as we need water. We need each other as we need the earth we share. The ‘Formula for LIFE’ is that simple.
However, the environment around us puts immense pressure to keep things complex, and sometimes in the name of making them simple! I have realised that if one were to engage in bare minimum socio-economic activity, one will be swamped by the need for keeping timelines, dealing with emails, passwords and OTPs and so much coordination. I looked at my situation for a middle-class SMP practitioner with a typical family size of five to six.
I have perhaps twenty passwords / MPINs / numbers to remember – from banks / credit cards, DPs, to emails, portals (electricity, municipality, mutual funds [MFs], digital magazines, etc.) to social media. Add to that family members’ passwords, especially for older parents. Take the example of CAS (common account statement) – one email ID can be used for only three CASes. So if you have senior parents, children and an HUF, you will need quite a few email IDs and mobile numbers.
Then there is ‘stalking’ by deadlines. If you paid advance tax, then there is the KYC deadline, then a membership fees renewal timeline. And then a mediclaim is due, and then PT. Earlier, Profession Tax (which is nothing short of a nuisance for an income-tax payer and should rather be taken with income tax) could be paid for five years, but it is now allowed only for one year.
And then when I look at my mobile phone I see an incessant stream of SMSes – we are paying your FD interest on ‘ddmmyy’, we have paid your FD interest, we have issued TDS Certificate on the interest paid to you. I recently bought something and I received eight SMSes before the product arrived, telling me all about the order received, removal from the shelf, about to be shipped, just shipped, soon reaching my city and so on.
Then there are OTPs. Even a courier delivery requires an OTP before it parts with it. And for a festival such as Holi I receive a message (SMS and email) from M&M, HDFC to Zandu – whether I had dealt with them for FD or Chyavanprash – they want to wish me for Holi and help me to remember them. (That’s about 10 to 20 vendors x 8 festivals / holidays). While India has reached the Moon and Mars, its DND still doesn’t work!
While many wish to just remind you, there are others who convey that you have missed a timeline. Mumbai PUC sent an SMS minutes before the expiry of the PUC to share the bad news that I will wake up to a day of violating PUC norms.
I guess we are today a sum total of numbers, passwords, OTPs, and timelines to keep. Without them, we are dysfunctional, non-entity, yet they make so much clutter and crowd our time and psyche. One can easily lose something big if one didn’t have a way to deal with them: reading-dealing-deleting, it could be simply overwhelming. Interruptions and distraction today are a form of destruction. Beware, for they are detrimental to deep work.
Wishing you a happy 2021-22!

 

Raman Jokhakar
Editor

MENTAL CANDY VS. MENTAL PROTEIN – A LESSON FROM BRIAN TRACY

What you feed your body decides how healthy it becomes.
What you feed your mind decides how you think and act.

Every time I listen to Brian Tracy, I only learn, I grow. I became a new person.
Don’t feed your brain with mental candy; instead, provide it with mental protein.

THE ELEPHANT ROPE
There is a story about a man who, as he passed some elephants, suddenly stopped, confused, because these enormous creatures were being held by only a small rope tied to their front legs. No chains, no cages. The elephants could break away from their bonds, but they did not.

He saw their trainer nearby and asked why these animals just stood there and did not get away. ‘Well,’ the trainer said, ‘when they are very young and much smaller, we use the same size rope to tie them, and at that age it’s enough to hold them. As they grow up, it conditions them to believe they cannot break away. They believe the rope can still hold them, so they never try to break free.’

It amazed the man. These animals could break free from their bonds, but because they believed they couldn’t, they were stuck right where they were!

How do you know that there is a ‘rope’ and it ties you?
•    When you consider that time is not enough.
•  If you consider all others except yourself as the reason for your problems.
•    If you see negativity around you.
•    If you are short of creativity.
•    If you are not investing in learning.

How to identify these ‘ropes’?
• Write down your current belief systems. Don’t judge. ‘What is that one belief which you think is holding you back from becoming the best version of yourself?’
•    Take feedback.
•    Listen. Don’t respond.
•    Read. Books are an excellent brain-opener.
•    Meditate. Spend time with yourself.

What are these ‘ropes’?
•    Fear of failure.
•    Self-doubt.
•    Prioritising money over time.
•    Allowing others to grip your attention.
•    An ‘I know all’ attitude.

How to break the ‘rope’?
That’s where advice – mental protein vs. mental candy – helps.

Once you feed the suitable protein to your mind, your mind grows and it extends in the right direction.

Mental candy – social media feeds, television, binge-watching, binge-eating, binge-shopping, constantly checking emails, flashy news.

Mental protein – books, e-books, audiobooks, online courses, meditation, physical exercise, adequate sleep, healthy food.

So what’s the sustainable way to feed your mind with mental protein?

Small and consistent efforts.
When I say small, I mean tiny efforts – just 1%.

Suppose you wish to start a reading habit. Target just five pages each day.

Suppose you wish to lose weight. Do short walks, five push-ups each day. Bring continuity. Then leap.
Suppose you wish to take an alternative career path. Start a side hustle instead. Test the waters.

How to end the urge for mental candies?
Once you make the transition from mental candies to mental protein, your brain cells will change. There will be realignment.

Small and consistent efforts will start showing results in a few days. If you make mistakes during this time, don’t be afraid; it’s better to be scared of ‘not’ making mistakes.

Don’t let your mind enter a shell with ‘big’ and ‘daunting’ changes. Such changes give you a ‘kick’ and ‘excitement’ on Day 1, but then the excitement dies its natural death the next day.

It’s not only essential to feed the physical body the suitable protein, but it’s also critical to provide the mind with adequate protein.

Sections 153A, 153C search assessments – A statement recorded u/s 132(4) has evidentiary value but cannot justify the additions in the absence of corroborative material – No opportunity to cross-examine the said witness

1. PCIT (Central) – 3 vs. Anand Kumar Jain (HUF) [Income-tax Appeal No. 23 of 2021 and other appeals; order dated 12th February, 2021 (Delhi High Court)]
[Arising from Anand Kumar Jain (HUF) vs. ACIT; ITA No. 5947/Del/2018, ITA No. 4723/Del/2018, ITA No. 5954/Del/2018, ITA No. 5950/Del/2018, ITA No. 5948/Del/2018 and ITA No. 5955/Del/2018, dated 30th July, 2019, Del. ITAT]

Sections 153A, 153C search assessments – A statement recorded u/s 132(4) has evidentiary value but cannot justify the additions in the absence of corroborative material – No opportunity to cross-examine the said witness

The assessee purchased shares of an unlisted private company in 2010. This unlisted company then merged with another unlisted company, M/s Focus Industrial Resources Ltd., and shares of this merged entity were allotted to the assessee. Subsequently, the merged entity allotted further bonus shares and thereafter it was listed on the Bombay Stock Exchange. The assessee sold these shares on the stock exchange in 2014 and earned a huge profit which was claimed as exempt income on account of being long-term capital gain.

A search was conducted u/s 132 on 18th November, 2015 at the premises of the assessee [being Anand Kumar Jain (HUF), its coparceners and relatives] as well as at the premises of one Pradeep Kumar Jindal. During the search, a statement of Pradeep Jindal was recorded on oath u/s 132(4) on the same date, wherein he admitted to providing accommodation entries to Anand Kumar Jain (HUF) and his family members through their Chartered Accountant. The A.O. framed the assessment order detailing the modus operandi as to how cash is provided to the accommodation entry operator in lieu of allotment of shares of a private company. Thereafter, when the matter was carried in appeal before the CIT(A), the findings of the A.O. were affirmed. However, in further appeal before the ITAT the said findings were set aside.

On further appeal before the High Court, the Revenue submitted that the ITAT has erred by holding that the assessee’s premises were not searched and therefore notice u/s 153A could not have been issued. It submitted that the ITAT ignored that the assessment order itself revealed that a common search was conducted at various places on 18th November, 2015 including at the premises of the entry provider and the assessee and thus assessment u/s 153A has been rightly carried out. It further said that the ITAT erred in setting aside the assessment order on the ground that no right of cross-examining Pradeep Jindal was afforded to the assessee. Further, there is no statutory right to cross-examine a person whose statement is relied upon by the A.O. so long as the assessee is provided with the statement and given an opportunity to rebut the statement of the witness. The assessee has been provided with a copy of the statement of Pradeep Jindal and the ITAT has wrongly noted to the contrary.

Furthermore, the assessee has failed to bring in any evidence to dispute the factual position emerging therefrom and has therefore failed to establish any prejudice on account of not getting the opportunity to cross-examine the witness. In view of the statement of Pradeep Jindal, it was incumbent upon the assessee to discharge the onus of proof which had been shifted on him. The Revenue has sufficient material in hand in the nature of the statements recorded during the search and, therefore, the assessee ought to have produced evidence to negate or to contradict the evidence collected by the A.O. during the course of the search and assessment proceeding which followed thereafter. It was also emphasised that the statement recorded u/s 132(4) can be relied upon for any purpose in terms of the language of the Act and thus action u/s 153A was justified.

The Court held that the assessment has been framed u/s 153A consequent to the search action. The scope and ambit of section 153A is well defined. This Court, in CIT vs. Kabul Chawla (2016) 380 ITR 573 concerning the scope of assessment u/s 153A, has laid out and summarised the legal position after taking into account the earlier decisions of this Court as well as the decisions of other High Courts and Tribunals. In the said case, it was held that the existence of incriminating material found during the course of the search is a sine qua non for making additions pursuant to a search and seizure operation. In the event no incriminating material is found during search, no addition could be made in respect of the assessments that had become final. Revenue’s case is hinged on the statement of Pradeep Jindal, which according to them is the incriminating material discovered during the search action. This statement certainly has evidentiary value and relevance as contemplated under the explanation to section 132(4). However, this statement cannot, on a standalone basis, without reference to any other material discovered during search and seizure operations, empower the A.O. to frame the block assessment. This Court in Principal Commissioner of Income Tax, Delhi vs. Best Infrastructure (India) P. Ltd. [2017] 397 ITR 82 2017 has inter alia held that:

‘38. Fifthly, statements recorded under section 132(4) of the Act do not by themselves constitute incriminating material as has been explained by this Court in Commissioner of Income Tax vs. Harjeev Aggarwal (2016) 290 CTR 263.’

Further, the Court noted that the A.O. has used this statement on oath recorded in the course of search conducted in the case of a third party (i.e., search of Pradeep Jindal) for making the additions in the hands of the assessee. As per the mandate of section 153C, if this statement was to be construed as an incriminating material belonging to or pertaining to a person other than the person searched (as referred to in section 153A), then the only legal recourse available to the Department was to proceed in terms of section 153C by handing over the same to the A.O. who has jurisdiction over such person. Here, the assessment has been framed u/s 153A on the basis of alleged incriminating material [being the statement recorded u/s 132(4)]. As noted above, the assessee had no opportunity to cross-examine the said witness, but that apart, the mandatory procedure u/s 153C has not been followed. The Court didn’t find any perversity in the view taken by the ITAT. Accordingly, the appeals, were dismissed.

Writ – Article 226 of Constitution of India and sub-sections 10(10C)(viii), 89(1), 154, 246A – Existence of alternative remedy not a bar to issue of writ where proceedings are without jurisdiction – Amounts received under voluntary retirement scheme – Denial of claim for deduction u/s 10(10C)(viii) and relief u/s 89(1) on basis of letter issued by CBDT – Decision of court quashing letter of Board – Order of denying relief – Proceedings without jurisdiction – Assessee entitled to relief

9. V. Gopalan vs. CCIT [2021] 431 ITR 76 (Ker) Date of order: 5th January, 2021 A.Y.: 2001-02

Writ – Article 226 of Constitution of India and sub-sections 10(10C)(viii), 89(1), 154, 246A – Existence of alternative remedy not a bar to issue of writ where proceedings are without jurisdiction – Amounts received under voluntary retirement scheme – Denial of claim for deduction u/s 10(10C)(viii) and relief u/s 89(1) on basis of letter issued by CBDT – Decision of court quashing letter of Board – Order of denying relief – Proceedings without jurisdiction – Assessee entitled to relief

The assessee claimed deduction u/s 10(10C)(viii) and under the provisions of section 89(1) on the amounts received by him under the voluntary retirement scheme of the State Bank of Travancore. The A.O. held that the assessee was not entitled to claim deduction u/s 10(10C)(viii) and also u/s 89(1).

The assessee filed an application u/s 264 for revision of the order but the Commissioner denied relief. Thereafter, the assessee filed an application to the Commissioner u/s 154 for rectification of his order relying on a decision in State Bank of India vs. CBDT [2006] (1) KLT 258 wherein the Court had held that the amounts received by employees under a voluntary retirement scheme were entitled to benefit u/s 89(1) in addition to the exemption granted u/s 10(10C)(viii) and quashed letter / Circular No. E.174/5/2001-ITA-I dated 23rd April, 2001 issued by the CBDT which held to the contrary. Since recovery proceedings were initiated in the meanwhile, the assessee paid certain amounts to the Department to satisfy the demand that arose out of the denial of relief u/s 89(1).

On a writ petition filed by the assessee, the single judge relegated the assessee to the alternative remedy of appeal u/s 246A. The Division Bench of the Kerala High Court allowed the appeal and held as under:

‘i) On the facts the assessee need not have been relegated to the alternative remedy of filing an appeal u/s 246A.

ii) Admittedly, the assessee had taken voluntary retirement in the year 2001. He had also claimed deduction u/s 10(10C)(viii) and benefit u/s 89(1) in his return of income for the relevant assessment year and the claim was rejected on the basis of the letter issued by the Board on 23rd April, 2001. The letter of the Board had been quashed by the Court in State Bank of India vs. CBDT. In that decision it was also declared that the assessee was entitled to deduction of amounts received under a voluntary retirement scheme u/s 10(10C)(viii) and u/s 89(1) simultaneously. That being the position, the entire proceedings initiated against the assessee were without jurisdiction.

iii) When the proceedings were without jurisdiction the existence of an alternative remedy was not a bar for granting relief under Article 226 of the Constitution. The assessee was entitled to deduction u/s 10(10C)(viii) and benefit u/s 89(1) (as the provision stood at the relevant point of time) in respect of the amounts received by him under the voluntary retirement scheme. If any amounts had been paid by the assessee pursuant to demands which arose on account of denial of deduction u/s 10(10C)(viii) and benefit u/s 89(1), such amounts should be refunded to the assessee.’

INTERMINGLING OF INCOME TAX AND GST

Tax laws are not made in a vacuum.
They are expected to be legislated keeping in mind the prevailing social,
economic and legal structure of a State. Yet, once legislated, taxing statutes
are to be implemented strictly and literally without consequences under other
tax laws. It is for the limited purposes of resolving any ambiguity over
undefined terms and / or unclear obligations of transaction where the Courts
have resorted to ancillary tax laws. It becomes imperative for tax subjects to
reconcile multiple laws prior to concluding transactions. This approach
involves a conceptual study and a cautious application of the respective laws
and their precedence.

 

Enactment of the Goods and Services
Tax laws in India would certainly have parallel implications under the existing
Income tax enactment. The business practices and accounting methodology under
the pre-existing enactments would need to be examined under the GST lens. We
are aware that gross income / receipts / turnover in the Profit and Loss
account of an Income tax return does not equate to aggregate turnover of a GSTR
annual return. Why is this so? Fundamentally, supply represents rendering of
service / sale of goods (outward obligation), while income is the consequence
flowing back from such supply (also called consideration); in other words,
supply of goods is the outward flow of a benefit and the consideration emerging
from such supply is termed as income.

 

 

Therefore, supply and income are two
facets of the same coin (one being the source and the other being the
consequence) and are to be viewed differently. They meet only when both
parameters, i.e., outward benefit and corresponding consideration are present
in a transaction; the absence of one any of these elements causes a divergence
in treatment under the respective laws. The other fundamental difference is the
geographical spread of the legislation – Income tax is a pan-India legislation
and GST is a hybrid of both national and State-level legislations.

 

An attempt has been made in this
article to identify variances and consistencies between both the tax enactments
from a conceptual perspective under four broad baskets: Charge, Collection,
Deductions / Benefits and Procedures.

 

A)  CHARGE OF TAX

Income
perspective

Income tax is a direct tax on the
income from a transaction (see pictorial representation). The tax can be said
to be outcome-based since it is imposed on the end result, i.e., net business
profit, net capital gains, net rental income, etc. The basis of charge of
Income tax is ‘accrual’ or ‘receipt’ of ‘income’ depending on the accounting
methodology or specific provisions. Income is a term of wide import and has
been defined in section 2(24) in a very wide manner. Its normal connotation
indicates a periodical money return with some sort of expected regularity from
a definite source. It implies the net take-away from a transaction or series of
transactions. Yet, this definition has been the subject matter of scrutiny at
all levels in judicial fora. Every passing Finance Act has only widened the
scope of this term to include artificial items which do not fall in the normal
connotation of income. Certain extensions to this definition overcome general
understanding such as capital receipts, chance-based (lotteries, etc.)
receipts, absence of consideration, etc. For instance, courts have held that
capital receipts do not fall within the natural scope of the definition of
income. As a consequence, compensation on destruction of capital assets was
held to be capital in nature and included in Income tax only by artificial
extension. Capital receipts are thus an extended feature of income, and
therefore any capital receipt not specified in the enactment is outside the net
of Income tax.

 

GST, on the other hand, is a
transaction-based indirect tax. Transaction of ‘supply’ forms the basis of
charge. However, the term supply appears to be widely defined; it is fenced
with the requirement of being in the nature of sale, lease, exchange, barter,
license, etc. in the course or furtherance of business. Business has been
extended to include occasional, set-up related and closure-related
transactions. The transaction of supply is not significantly influenced by the
intention behind holding the asset. The behavioural aspect may be with
reference to the contractual terms but not behind the ownership of the asset.
For instance, GST may not concern itself with the intention behind holding the
asset but would lay higher emphasis on whether, in fact, the asset was sold or
not. To elaborate this with an example, a manufacturer temporarily leasing an
asset during its construction phase prior to its set-up may not be considered
as generating an income from business but reducing its capital expenditure (a
capital receipt), though such transaction would still be liable to GST. GST
does not treat capital and revenue transactions too differently; sale of
capital assets (or even salvage value), though capital in nature, would be
taxable under the said law.

 

On the other hand, Income tax
permits deduction of bad debts since it follows the ‘income’ approach. As a
corollary, the write-back of a revenue liability is also income. Since the
charging event of GST ends with the completion of supply, recovery of the
consideration, though relevant for Income tax, may be inconsequential for GST.
On the other hand, there may be certain transactions which are supply but may
not result in any income to the supplier. Recovery of costs may not necessarily
impact the income computation as they are generally netted off, but the very
same transaction could have implications under GST (say, freight costs).

 

Schedule I transactions certainly
pose a challenge when juxtaposed between Income tax and GST. Take the example
of the movement of goods between principal and agents. While for Income tax
this movement would not have any implications in either hand, under GST this
would be treated as an outward supply from the principal to its agent and a
corresponding inward supply to the agent, akin to a sale and purchase between
these parties. This would be the case even for a transaction between principal
and job-worker crossing the statutory threshold. The principal would have to
forcefully record this as an outward supply but would not give any
corresponding effect in its Income tax records. Therefore, while all GST
consequences would follow, Income tax would refrain from recognising these
transactions, leading to permanent variance between two values for the
taxpayer; for example, Income tax books would report this as stock held with
the job-worker, while the goods would strictly not form part of inventory of
the principal for GST purposes.

 

Apart from such variances, the
general phenomena of income and supply would more or less reconcile with each
other. The net consequence of the above-cited difference is that a
comprehensive coverage of either Income tax or GST cannot be made only by
reviewing the Profit and Loss account or Income tax computation of the
taxpayer. Transactions beyond Income tax records would need to be examined from
a GST perspective as well.

 

Characterisation
perspective

The other linkage is the
characterisation of transactions under both laws. Income tax u/s 14 provides
for five broad heads of income: (a) salary, (b) income from house property, (c)
business or profession, (d) capital gains and (e) other sources. The Supreme
Court in the famous case of East Housing & Land Development Trust
Ltd. vs. Commissioner of Income Tax (1961) 42 ITR 49(SC) held that:

 

‘The classification of income
under distinct heads of income is made having regard to the sources from which
the income is derived. Moreover, Income tax is levied on total taxable income
of the taxpayer and the tax levied is a single tax on aggregate tax receipts
from all sources. It is not a collection of taxes separately levied under
distinct heads but a single tax’.

 

The distinct heads are for the
purpose of differential computation methodologies of income depending on the
source of income. Income tax would treat computation of gains on sale from
capital assets differently from that of gains on sale of a stock. In fact, any
conversion of capital assets into stock in trade or vice versa would
have Income tax implications but no GST implications. A trader reclassifying an
asset from one balance head to another would not have any GST implications. The
reason for this difference is probably that GST does not look through the
intention of supply; it rather looks at the fact of a supply taking place for
taxation.

 

Income resulting from an
employer-employee / master-servant relationship is separately taxable under the
head ‘Salaries’ under Income tax. The litmus test of master-servant
relationship would be the extent of supervisory control of the master over the
individual while rendering the said service – independence in functioning would
provide the extent of control exercised by the master [Ram Prashad vs.
CIT (1972) 86 ITR 122 (SC)]. Under Income tax, the definition of salary
includes wages, allowances, accretion to recognised provident funds, etc.
Though the definition of salary u/s 17(1) does not include ‘perquisites’ within
its fold, it is nevertheless taxable under the head ‘Income from salary’ u/s
17(2). The Supreme Court in Karamchari Union vs. Union of India (2000)
243 ITR 143 (SC) stated that the definition of salary itself includes
any allowance, perquisite, advantage received by an individual by reason of his
employment. The perquisites are valued based on the net benefit being provided
to the employee (i.e., gross value of benefit minus the recoveries, if any).

 

The above analogy could be extended
to GST in matters involving examination of services rendered between the
employer and the employee in the course of employment. From an employee’s
perspective, the commissions, bonuses, monetary / non-monetary benefits arising
on account of employment even received after termination would be excluded from
the net of GST. But one should be cautious to ascertain the capacity under
which the individual is rendering these services. A director, for instance, can
hold two capacities – as an employee and as a director (agent of the company).
Services rendered as an agent of the company would not fall within the
exclusion but those rendered out of a master-servant relationship would stand
excluded.

 

Under the GST law both employer and
employee are treated as related persons in terms of the explanation to section
15. Schedule I deems certain services between related persons as taxable even
in the absence of a consideration. Therefore, from an employer’s perspective,
in cases where he is providing services for a subsidised charge to an employee
on duty (say subsidised rent accommodation, transport facility, etc.), there
appears to be some ambiguity whether such transaction entails GST. This is
because Schedule III excludes services by an employee to an employer in the
course of, or in relation to, employment, but not the reverse.

 

Certain services by an employer to
his employee arise on account of the obligations he takes over as part of the
employment agreement (such as providing rented accommodation, transport,
medical facilities, etc.). In the view of the authors, such activity is in the
nature of a ‘self-service’ and the recovery if any is towards the costs of such
activity rather than an independent supply, or an outward flow of benefit to
the employee. We can view this as follows:

 

 

The employer provides such benefits
as a condition (express or implied) of the employment. Some activities may also
be gratuitous / implied in nature, such as serving tea during official hours.
Some activity may be either provided free of cost or chargeable at a subsidised
cost (factory lunch). The benefits which are made available to the individual
have emerged from the status of a master-servant relationship. These benefits
are provided by the employer as a means for improving efficiency, productivity,
retention, etc. for his business. Though these actions provide some benefit to
the employee, such benefits are not solely for exclusive personal consumption.
In such cases it can be stated that there is no independent supply from the
employer to the employee, rather, a non-monetary benefit provided to the
individual. Even in case an amount is charged (either at cost or subsidised
rate), it represents a cost recovery / reduction in the quantum of non-monetary
benefit, but not a supply.

 

Such a view resonates from the fact
that while computing the value of perquisites in the hands of the employee, any
costs recovered by the employer towards the provision of such non-monetary
benefit is reduced from the valuation of salary. Such costs are not treated as
an expense of the employee, rather, they are reduced from the gross value of
monetary benefit received during the course of employment. The employer also
does not treat this transaction as part of his income generation activity but
considers this a reduction of his salary costs.

 

We should distinguish the above
scenario from a case where an employer provides benefits beyond the contract of
employment, or renders exclusive benefits to individuals in their personal
capacity. 

 

Situs
perspective

Income tax is imposed on income
which accrues or arises or is received in India, or deemed to accrue or arise,
or received in India. The situs of accrual and receipt of such income
plays an important role in deciding the tax incidence under the Act. Indian
Income tax follows a hybrid of residence and source-based taxation and where
multiple sources exist, the principle of apportionment comes to the fore for
taxation. The Supreme Court in Ahmedbhai Umerbhai [1950] 18 ITR 472 (SC)
held that the place of accrual need not necessarily be the place where the sale
is consummated (i.e., the transfer of property in goods takes place) and income
can be attributed between different places depending on the acts committed at
these places.

 

Income tax has a recognised
principle of profit attribution where cross-border transactions are attributed
to each nation based on Transfer Pricing principles (involving functions
performed, assets employed and risks assumed). In Anglo-French Textile
Company Ltd. vs. Commissioner of Income-tax [1954] 25 ITR 27 (SC), the
Court stated that sale is merely a culmination of all acts to realise the
profit earned therefrom. The terms accrue and arise themselves have an inherent
principle of apportionment within them and in the absence of a specific
statutory provision (as it was then), general principles of apportionments
would be applicable; of course, subject to application of international treaty
covenants.

 

GST, on the other hand, taxes all
supplies in their entirety even if such supply takes place partly in India
(section 5-14 of the IGST Act). Being a transaction-based levy, the trigger of
supply takes place in terms of the place of supply provisions. Unlike the
Income tax law, the place of supply would be the particular place as stated in
the statute (rather than a spread) which would closely replicate the place of
probable consumption of the goods or services. Place of supply cannot be spread
across geographies and subjected to apportionment principles. For example, the
Indian branch of a foreign bank may be contracting for banking and financial services
with a multinational group directly but with active assistance from its
headquarters outside India. Income tax would require the profit from this
activity to be attributed to all the relevant jurisdictions based on a
functional analysis, but GST would treat this contractual consideration as
taxable entirely in India. It’s a different matter that the headquarters may
separately raise a GST invoice on the branch office to recover its costs.

 

IGST law has specific provisions for
identifying the location of supplier or recipient based on the business
establishments across jurisdictions. The term ‘business establishment’ is
defined to involve people, places and permanence and it forms the basis to
decide the location of supplier or recipient (usually residence-driven). The
terms ‘business establishment’ and ‘permanent establishment’ (business
connection) are on similar platforms to some extent. ‘Permanent establishment’
also uses these three parameters (such as a Fixed Place PE, Service PE,
Equipment PE, etc.) to decide the extent of income attributable to a
jurisdiction. The variance is because (a) Income tax has already experienced
significant evolution with changing business dynamics due to which the
permanent establishment concept is quite enlarged to agency functions, etc.;
(b) Income tax does not treat the condition of permanence, place or people as
cumulative and has, over the years, diluted this to significant economic
presence (say, presence of internet users). It may not be totally incorrect to
say that ‘business establishment’ under GST would necessarily entail a
permanent establishment for the overseas enterprise under Income tax, but the
reverse may not always be true.

 

B)  COLLECTION OF TAX

Income tax is an annual tax. It is
imposed for each year called the assessment year based on the income which is
accrued or received in the preceding year (called previous year). Section 4 of
Income tax prescribes a unique methodology of taxing income of a particular
year (previous year) in the subsequent assessment year. Taxes paid during the
previous year take the form of advance tax and the tax paid during the
assessment year is termed as final self-assessed tax. The liability to charge
arises not later than the close of the previous year but the liability to pay
tax is postponed based on the rates fixed by the yearly Finance Act after the
close of the previous year.

 

The Supreme Court in CIT vs.
Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC) held:

 

‘Income-tax is a levy on income. No
doubt, the Income-tax Act takes into account two points of time at which the
liability to tax is attracted, viz., the accrual of the income or its receipt;
but the substance of the matter is the income. If income does not result at
all, there cannot be a tax, even though in book-keeping an entry is made about
a “hypothetical income” which does not materialise. Where income has, in fact,
been received and is subsequently given up in such circumstances that it
remains the income of the recipient, even though given up, the tax may be payable.
Where, however, the income can be said not to have resulted at all, there is
obviously neither accrual nor receipt of income, even though an entry to that
effect might, in certain circumstances, have been made in the books of
account.’

 

Similarly in CIT vs. Excel
Industries 2013 38 taxmann.com 100 (SC) and Morvi Industries Ltd.
vs. CIT (Central), [1971] 82 ITR 835 (SC) the Court considered the
dictionary meaning of the word ‘accrue’ and held that income can be said to
accrue when it becomes due. It was then observed that: ‘……. the date of
payment ……. does not affect the accrual of income. The moment the income
accrues, the assessee gets vested with the right to claim that amount even
though it may not be immediately’.

 

GST is a transaction-based tax with
reporting and tax payments being made on a monthly basis. Time of supply
provisions (sections 12 and 13) fix the relevant month in which taxes are
payable. The leviability of GST is on supply of goods / services and charge of
tax is applicable even on an agreement of supply (section 7). In view of this,
goods sold but rejected on quality parameters prior to its acceptance itself,
may be a supply in terms of section 7 but would certainly not be an income to
the taxpayer. For example, the taxpayer has removed goods on 31st January
for sale which are subject to quality approval at the customer’s end for
payment; this would be a supply for the taxpayer for the month of January but
would be income for the very same taxpayer only when the goods are accepted by
the customer and the right to receive the consideration comes into existence in
favour of the supplier. It would be a different case that in case of rejection
the taxpayer can seek a refund of the GST already paid, but one would
appreciate that the GST law is distinct insofar as it imposes taxes and then,
subsequently, grants refund, while Income tax would refrain from imposing tax
itself.

 

Under Income tax the year of accrual
(other than specified exceptions) determines the relevant assessment year.
Importantly, each assessment year is a water-tight compartment and accruals
pertaining to a particular assessment year have to be considered in the
computation of Income tax for that year only and cannot be adopted in any other
assessment year. This is because Income tax is a single tax (refer preceding
discussion) of an assessment year and can be determined only when all incomes
are reporting in tandem. But GST is a transaction tax and reporting of each
transaction is independent of the other. GST, hence, has this peculiar feature
of permitting transactions of a tax period to cross over to other tax periods
and even financial years. Reporting of transactions in subsequent periods is
not fatal to taxation as each transaction is independent and does not impact
the overall taxability.

 

C)  DEDUCTIONS / BENEFITS

Income tax law is required to grant
deduction of expenses or costs as a matter of statutory limits and
Constitutional mandate. This is because the entry for taxation in terms of
Entry 82 is with reference to income and not receipts (for example, income by
way of diversion of overriding title would not be income in its true sense
though it may be received by the taxpayer). Section 28 levies a tax on the
‘profit and gains’ from business, section 45 taxes capital ‘gains’, etc.; no
doubt, the Legislature exercised its liberty in denying certain deductions
(penal expenses) and limiting the quantum of deductions (30% deduction in case
of house property income), but the law is drafted to ascertain the income and
not the gross receipts of a taxpayer. As a consequence, it may not be illegal
for assessing officers to grant deduction of expenses from the records
available even if the same were not availed by the taxpayer.

 

GST also grants a deduction in the
form of input tax credit – this benefit does not emerge from the Constitution
but from the underlying principle of value-added taxation and statutory
provisions made therefrom. The Legislature has a wider latitude insofar as
barring input tax credit on certain inputs (such as motor vehicle, building /
civil structures, etc.) as part of Legislative liberty and one cannot question
this discretion. A theoretical understanding of the statute may also suggest
that the Legislature may have the discretion to deny all input tax credit if it
decides to do so as a matter of policy. Given this, it may not be imperative
for the assessing authority to grant input tax credit if such a claim has not
been put forward. The statute believes that unavailed input tax credit
represents a tax burden passed on to the next person in the value-chain and
hence there is no obligation to grant input tax credit suo motu while
performing an assessment.

 

As regards the scope of deductions,
both these laws seem to have reconciled on the principle of business purpose.
Income tax permits deductions of business expenses while calculating profits
and gains from business or profession. Apart from specific deductions, there is
also a residuary category for claiming deduction of business expenses u/s 37. GST
has also followed a similar path and granted benefit of input tax credit on
most business inputs / expenses. Both the Income tax deduction and GST credit
are fettered with respective ancillary conditions, but these laws seem to have
aligned themselves as a matter of principle. Therefore, a disallowance u/s 37
on personal expenses may also result in a corresponding disallowance of input
tax credit and vice versa. On the capital assets front, while Income tax
grants depreciation on ownership and use of assets, GST does not concern itself
with ownership of assets and mere business use would be sufficient for claim of
input tax credit.

 

D)  PROCEDURES

Under Income tax the law prevailing
as on the first day of an assessment year would be the relevant law for taxability,
but in the case of GST the law prevailing as on the date of the transaction
would be the basis of chargeability.

 

Income tax has adopted a concept of
self-assessment on an annual basis. Being a Central legislation, state-level
reporting is not relevant and entity-level compliance has to be performed. GST
has adopted a monthly assessment methodology with registration-level compliance
for each State, respectively. This makes GST data much more granular in
comparison to the Income tax data collation.

 

On the assessment front, Income tax
has a tested system of summary assessment, scrutiny assessment, best judgement
assessment, reassessment, review, etc. A taxpayer can be assessed multiple
times for the same assessment year. GST has adopted a hybrid system of
adjudication and assessment (borrowed partially from Excise and VAT laws).
Unlike Income tax where the assessment involves both fact-finding and
adjudication of law, GST has kept the fact-finding exercise under audit
procedures which is independent of legal adjudication (show cause proceedings)
and probably performed by different officers.

 

CONCLUSION

Income and GST certainly meet and part at
multiple points. This diversity would cause variance in differential tax
treatments and hence need careful examination. Supply may or may not be backed
by an income and similarly an income may or may not arise from a supply. With
increasing interchange of information of GSTR9/9C and Income tax return
(comprising the P&L and balance sheet) between Government departments, it
is expected that taxpayers should reconcile these variances as a matter of
preparedness before assessing authorities under both laws. It is suggested that
Government implement exchange programmes among tax departments for field
formations in order to effectively administer these tax laws.

Article 13(4) of India-Mauritius DTAA – Capital gains exemption under pre-amended India-Mauritius DTAA is not available to shareholder Mauritius SPV upon transfer of shares of Indian company, as Mauritius SPV was set up as a tax-avoidance device, interposed solely for obtaining treaty benefit

4.       [2020]
114 taxmann.com 434 (AAR-Mum.)

Bid Services Division (Mauritius) Ltd., In re.

AAR No. 1270 of 2011

A.Y.: 2012-13

Date of order: 10th February, 2020

 

Article 13(4) of India-Mauritius DTAA – Capital gains
exemption under pre-amended India-Mauritius DTAA is not available to
shareholder Mauritius SPV upon transfer of shares of Indian company, as
Mauritius SPV was set up as a tax-avoidance device, interposed solely for
obtaining treaty benefit

 

FACTS

The Airports Authority of India (AAI)
undertook an international bidding process for the purpose of inviting bids to
acquire 74% stake in an Indian joint venture company (JV Co.) proposed to be
formed for the purpose of undertaking development, operation and maintenance of
airports at Mumbai and Delhi.

 

A South African entity (SA Co.),
together with other independent entities, formed a consortium and was
successful in acquiring the contract with AAI. The other two entities which
participated with SA Co. were incorporated in India and SA.

 

During the entire bidding process, it
was understood that SA Co. would be a direct investor in the shares of JV Co.
However, ten days prior to submission of final bids, SA Co., through its
wholly-owned subsidiary in South Africa, incorporated an entity in Mauritius
(Mau Co. / Applicant) and invested the funds in JV Co. through Mau Co. The
other two entities in the consortium also invested vide their group entities,
without change in jurisdiction of the entities, i.e., vide entities located in
India (I Co) and SA (SA Co. 2).

 

After a period of approximately five
years of holding, during the A.Y. 2012-13, Mau Co. transferred JV Co.’s shares
to the extent of 13.5% to another existing shareholder of JV Co. while
retaining the balance 13.5% of shares. Mau Co. earned capital gains upon such transfer.

 

A diagrammatic depiction of JV Co.’s
shareholding is as follows:

 

 

Mau Co. claimed that the amount of
capital gains arising from such transfer was not taxable in India by virtue of
exemption granted under Article 13(4) of the India-Mauritius DTAA (treaty).

 

The issue before the AAR was whether
Mau Co. was eligible to claim the capital gains exemption provided under the
treaty.

 

HELD

The AAR held that Mau Co. was not
entitled to treaty benefit as it was a device employed to carry out tax avoidance,
without any commercial substance.

 

®  Mau
Co. was set up close to the project being finalised and was not in existence
from the very start of the bidding process. The other joint venture parties
(including from SA and India) also did investments through their group
concerns, but there was no change in jurisdiction of the principal entities and
the investor entities, being SA Co. 2 and I Co., were from the same
jurisdiction, i.e., SA and India, respectively, unlike SA Co. which interposed
Mau Co. and there was a change in jurisdiction from SA to Mauritius;

®  Mau
Co. did not have any fiscal independence, i.e., no independent source of funds,
and it relied on its holding entity for the same. Further, Mau Co. had no
independent collaterals to secure the funds from third parties;

®  Mau
Co. did not have any independent source of income;

®  Mau
Co. did not have any tangible assets, employees, office space, etc.;

®  While SA Co. as a member of the consortium was to
provide strategic input, advice on various aspects such as structured finance,
ancillary services, corporate governance and cargo and logistics development
services, Mau Co., as its substitution, did not even employ any management
experts or financial advisers to carry out the same tasks;

®  Mau
Co. was not involved in the decision-making process w.r.t the development
process of the project or for resolving the implementation issues that were
encountered;

®  Mau
Co. was set up only to hold the investments in the JV Co.;

®  Mau
Co. merely endorsed the decisions taken by the SA Co.;

®  Mau Co. did not provide any value addition in the
JV Co.

The AAR also held that even if
investments were proposed to be carried out by the SA Co. vide setting up of an
individual SPV, commercially, it could have been set up in South Africa or
India, rather than a third jurisdiction, Mauritius, which was neither a
financial hub nor a provider of low-cost capital.

 

The AAR applied the doctrine of
‘substance over form’ and followed the observations of the Apex Court in the
case of Vodafone International Holdings BV (2012) 341 ITR 1 which
state that treaty benefits should be denied, if a non-resident achieves
indirect transfer through abuse of legal form and without reasonable business
purpose, which results in tax avoidance. In such a case, the tax authority can
re-characterise the equity transfer as per its economic substance and impose
tax directly on the non-resident rather than the interposed entity.

 

Accordingly, the AAR held that Mau Co. was
merely set up as a tax-avoidance device by the SA Co. without having any
independent infrastructure or resources and interposed for the dominant purpose
of avoiding tax in India; thus it cannot be granted any treaty benefits.

Article 12 and Article 5 read with Protocol of India-Swiss DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

3.       [2020]
114 taxmann.com 51 (Mum.)

AGT International GmbH vs. DCIT

ITA No. 7465/Mum/2018

A.Y.: 2015-16

Date of order: 31st January, 2020

 

Article 12 and Article 5 read with Protocol of India-Swiss
DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

 

FACTS

The assessee, a tax resident of
Switzerland, received fees for technical services from an Indian company and
offered the said income to tax @ 10% on gross basis under Article 12(2) of the
India-Swiss DTAA.

 

The Indian company had withheld tax @
42.024% on the entire amount.

 

The A.O. was of the view that the
services rendered by the assessee (by rendering services in India) did not
amount to fees for technical services as defined in Article 12 and that the
assessee had a Service PE in India. The A.O. computed the income by allowing
expenditure @ 40% on estimated basis and taxed the remaining 60% amount at the
normal income tax rates applicable to foreign companies. As against 10%, the
assessee was assessed effectively at 24% (being 40% of 60).

 

Aggrieved by the stand taken by the
A.O., the assessee raised objections before the DRP but without any success.
Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

The Tribunal referred to the Protocol
of the India-Swiss Treaty which states that furnishing of services covered by
sub-paragraph (l) of paragraph 2 (i.e., Service PE) shall be taxed according to
Article 7 or, on request of the enterprise, according to the rates provided for
in paragraph 2 of Article 12.

In light of the said Protocol, the Tribunal held
that the assessee has a choice to be taxed on gross basis at the rates provided
under article 12(2) or on net basis under article 7. A combined reading of the
above provision of article 5(2)(l) along with the related Protocol clause is
that on Service PE being triggered on account of rendition of services by a
Swiss entity in India, or vice versa, it can never make the assessee
worse off so far as the tax liability in source jurisdiction is concerned.
Unless the assessee has a lower tax on PE profits on net basis under article 7 vis-à-vis
taxability of FTS on gross basis under article 12(2), the PE trigger does not
trigger higher tax.

Article 13 of India-Belgium DTAA – Gain arising on indirect transfer of shares of Indian company not taxable in India as per Article 13(6) of India-Belgium DTAA

2.       TS-129-ITAT-2020

Sofina S.A. vs. ACIT

ITA No. 7241/Mum/2018

A.Y.: 2015-16

Date of order: 5th March, 2020

 

Article 13 of India-Belgium DTAA – Gain arising on indirect
transfer of shares of Indian company not taxable in India as per Article 13(6)
of India-Belgium DTAA

 

FACTS

The assessee is a tax resident of
Belgium and is a venture capital investor who invested in Startups in India
such as Myntra, Freecharge, etc.

 

The assessee owned 11.34% stake in
preference shares of Sing Co, a company tax resident of Singapore. In turn,
Sing Co held 99.99% shares in an Indian company (ICO). The assessee sold its
entire 11.34% stake in Sing Co to J, an unrelated Indian company. J, while
making the payment, deducted TDS u/s 195 of the Act. The assessee claimed refund
of TDS in its return of income relying on Article 13(6) of the India-Belgium
DTAA as per which gains arising from the alienation of shares of Sing Co are
taxable in the contracting state of which the alienator is a resident, i.e.,
Belgium.

 

The
A.O. held that the assessee carried out an indirect transfer of shares which is
taxable in India. As per Explanation 5 to section 9(1)(i) of the Act, shares of
Sing Co derived value substantially from ICO and therefore the shares of Sing
Co are deemed to be situated in India. The A.O. imported the Explanation 5 to
section 9(1)(i) in order to deem Sing Co as a company resident in India.
Accordingly, in his view, the transfer of shares of Sing Co was covered under
Article 13(5) and was taxable in India.

 

On appeal, the DRP approved the view
of the A.O. Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

Article 13(5) of the India-Belgium
Tax Treaty applies if the following two conditions are cumulatively satisfied:
(i) the transfer of shares should represent the participation of at least 10%
in the capital stock of the company; and (ii) the company whose shares are
transferred should be a resident of a contracting state. As the assessee
transferred shares of a Singapore resident company, the second condition is not
satisfied and, accordingly, Article 13(5) is not applicable.

 

Unlike Explanation 5 to section
9(1)(i) and Article 13(4) (providing for indirect transfer tax of company
deriving value from immovable property in India), Article 13(5) of the
India-Belgium Tax Treaty did not adopt a see-through approach. It does not
refer to ‘direct or indirect transfer’. Accordingly, the transfer of the shares
of Sing Co cannot be regarded as shares of its subsidiary ICO.

 

Explanation 5 to section 9(1)(i) of
the Act does not define residence of a person and only deems shares of a
foreign company to be located in India. In the absence of any provision for
deeming a Singapore resident company as a treaty resident of India either in
the DTAA between India and Singapore, or in the DTAA between India and Belgium,
Sing Co cannot be held to be a company resident of India so as to get covered
by Article 13(5).

 

The Tribunal upheld the assessee’s contention
that the transfer will be governed by residuary clause Article 13(6) and will
be taxable in the state of the alienator, i.e., Belgium.

Article 12 of India-US DTAA – Deputation of skilled employee results in making technology available and satisfies FIS article under India-US DTAA

1.      
[2020] 115 taxmann.com 129 (Mum.)

General Motors Overseas Corporation
vs. ACIT

ITA Nos. 1282 of 2009; 1986, 2787 of
2014; 381 (Mum.) of 2018

A.Ys: 2004-05, 2008-09 to 2010-11

Date of order: 6th March,
2020

 

Article 12 of India-US DTAA –
Deputation of skilled employee results in making technology available and
satisfies FIS article under India-US DTAA

 

FACTS

The assessee, a US resident company,
entered into a Management Provision Agreement (MPA) with its Indian group
company G engaged in the business of manufacture, assembly, marketing and sale
of motor vehicles and other products in India. Under the MPA, the assessee
agreed to provide executive personnel to assist G in its activities of
development of general management, finance, purchasing, sales, service,
marketing and assembly / manufacturing. Further, the assessee agreed to charge
salary and other direct expenses related to such personnel from G.

 

Past proceedings before AAR

The assessee had made an application
to AAR in the past to ascertain the tax liability of the amount received under
MPA. In the circumstances and on the basis of the facts on record, AAR had
concluded that the services are ‘managerial’ and not ‘technical or consultancy’
in nature and accordingly are not within the scope of charge of Article 12. AAR
had, however, indicated that the amount received by G may trigger taxation if
the assessee has a Permanent Establishment (PE) in India and accordingly the
receipts may constitute business profits. AAR had, however, caveated
(conditioned) its ruling by stating that it had no information or material to
indicate that the employees were rendering services of a nature falling beyond
the terms of the MPA and whether, in fact, there was a PE trigger. AAR also
clarified that the tax authorities can examine the factual position and take
appropriate action if they find the factual situation to be otherwise.

 

Assessment and appeal proceedings

During the course of assessment, the
facts noted by the A.O. were as follows:

(i)   The
assessee had deputed two employees, viz., (i) Mr. A – President and MD of G and
responsible for overall management and direction of G operations; and (ii) Mr.
S – Vice-President (Manufacturing), responsible for overall management of G
facilities to manufacture and assemble products of G according to required
standards;

(ii)   The
A.O. also called for a copy of the service agreement of the deputationists
which the assessee failed to produce. The A.O. held that the services rendered
by Mr. S satisfied the make-available requirement and constituted FIS;

(iii)
Seeking to follow the AAR ruling, the
A.O. concluded that the assessee had a PE in India and computed its business
profit by taxing gross receipt at 20% u/s 44D r.w.s. 115A without providing
deduction for any expenses;

(iv) On
appeal, the CIT(A) upheld the A.O.’s order. Being aggrieved, the assessee
preferred an appeal before the Tribunal.

 

HELD

Services rendered by Mr. A

It was not disputed by the parties
that the services rendered by Mr. A were managerial in nature and in the
absence of charge for managerial service in the FIS Article of the India-US
Treaty, the said payment did not constitute FIS and hence was not chargeable to
tax in India.

 

Services rendered by Mr. S

The ruling given by the AAR, although
binding on the Commissioner and income tax authorities subordinate to the
Commissioner, is, however, not binding on the Tribunal and only has a
persuasive value for the reason that the Tribunal is not an authority coming
under the Commissioner. However, the dispute can reach the Tribunal when the
authorities bound by the ruling do not follow the ruling for valid or invalid
reasons. Hence, the Tribunal is required to examine the reasons given by the
authorities for not following the AAR ruling.

 

The caveat portion of the AAR ruling
makes it clear that this ruling was not an absolute and unqualified one. The
AAR ruling on the services rendered by Mr. S was a general, non-conclusive
finding. The power was given to the tax authorities to examine the transaction
/ actual conduct of parties. In the absence of the assessee providing the
service agreement or other documents showing the actual services rendered by
Mr. S, the A.O. had no other option but to examine the MPA and determine the
scope of services provided by Mr. S.

 

Mr. S, Vice-President
(Manufacturing), was working with the assessee before being sent as an employee
to India. It was obvious that Mr. S had sufficient knowledge and experience of
the technology and its standards used by the assessee in the US. In the
automobile industry, assembly of products and the standards of the company are
patented / protected technology and the owner of the technology charges royalty
for the same. But in the present case no royalty had been charged by the
assessee from G because the assessee had sent its employee to India. This
person was an expert in the technology, experienced in the assembly of products
and well aware of the standards of the company.

 

The
technology / expertise lay in the technical mind of an employee/s and if key
employee/s having the requisite knowledge, experience and expertise of
technology are transferred from one tax jurisdiction to another tax
jurisdiction, then it is transfer of technology. By sending Mr. S, technology
was made available in India by the assessee.

 

Computation of income

As regards computation of business profits, the
Tribunal on a co-joint reading of Article 7(3) and section 44D, ruled that
profits need to be taxed at 20% on gross basis as section 44D prohibits
deduction for any expenses.

Section 10AA – Profit of eligible unit u/s 10AA should be allowed without set-off of loss of other units

2.      
Genesys
International Corporation Limited vs. DCIT –-Mum.

Members: G. Manjunatha (A.M.) and Ravish Sood (J.M.)

ITA No. 7574/Mum/2019

A.Y.: 2011-12

Date of order: 4th March, 2020

Counsel for Assessee / Revenue:
V. Chandrasekhar & Harshad Shah / V. Vinod Kumar

 

Section 10AA – Profit of eligible unit u/s 10AA should be
allowed without set-off of loss of other units

 

FACTS

The assessee had filed its
return of income declaring total loss at Rs. 3.20 crores. The assessment was
completed u/s 143(3) determining the total loss at Rs. 1.68 crores. The case
was subsequently reopened u/s 147 and the assessment was completed u/s 143(3)
r.w.s. 147 determining the total income at Nil
after set-off of loss from business against profit of eligible unit
u/s 10AA.

 

Before the CIT(A) the assessee, relying on the decision of
the Supreme Court in the case of CIT vs. Yokogawa India Ltd. (2017) 77
taxmann.com 41, contended that the profit of the eligible unit u/s 10AA
should be allowed without set-off of loss of other units. The CIT(A) rejected
the arguments of the assessee on the ground that the findings of the Supreme
Court were based on the computation of deduction provided u/s 10A, not on
computation of deduction provided u/s 10AA.

 

Revenue submitted before the Tribunal that the CIT(A) had
clearly distinguished the decision of the Supreme Court and, hence, the
findings of the Supreme Court are not applicable.

 

HELD

Referring to the decisions
of the Supreme Court in the case of CIT vs. Yokogawa India Ltd. and
of the Bombay High Court in the case of Black & Veatch Consulting
Pvt. Ltd. (348 ITR 72), the Tribunal held that the sum and substance of
the ratio laid down by the Supreme Court and the Bombay High Court is
that the profit of eligible units claiming deduction u/s 10A / 10AA, shall be
allowed without setting off of losses of other units. Therefore, it was held
that the lower authorities erred in set-off of loss of business from the profit
of eligible units claiming deduction u/s 10AA before allowing deduction
provided u/s 10AA. Accordingly, the appeal filed by the assessee was allowed.

Section 54 / 54F – Exemption not denied when the property was purchased in the name of the spouse instead of the assessee Two conflicting High Court decisions – In case of transfer of case between two jurisdictions, the date of filing of appeal is the material point of time which determines jurisdictional High Court

1.       Ramphal
Hooda vs. Income Tax Officer (Delhi)

Members: Bhavnesh Saini
(J.M.) and
Dr. B.R.R. Kumar (A.M.)

ITA No. 8478/Del/2019

A.Y.: 2014-15

Date of order: 2nd
March, 2020

Counsel for Assessee /
Revenue: Ved Jain & Umung Luthra / Sanjay Tripathi

 

Section 54 / 54F – Exemption not denied when the property
was purchased in the name of the spouse instead of the assessee

Two conflicting High Court decisions – In case of transfer
of case between two jurisdictions, the date of filing of appeal is the material
point of time which determines jurisdictional High Court

 

FACTS

During the year the assessee had earned long-term capital
gain of Rs. 1.42 crores on the sale of property. This gain had been invested in
purchasing another property for Rs. 1.57 crores in the name of his wife. The
assessee claimed exemption of long-term capital gains u/s 54 / 54F. Relying on
the judgment of the jurisdictional High Court, i.e., the Punjab and Haryana
High Court, in the case of CIT Faridabad vs. Dinesh Verma (ITA No. 381 of
2014 dated 6th July, 2015) wherein it was held that ‘the
assessee is not entitled to the benefit conferred u/s 54B if the subsequent
property is purchased by a person other than the assessee…’ the A.O. had
denied the exemption.

 

It was submitted before the CIT(A) that the case of the
assessee is covered by the judgment of the Delhi High Court in the case of CIT
vs. Kamal Wahal (351 ITR 4) wherein, on identical facts, the issue had
been decided in favour of the assessee. The CIT(A), however, noted that the
assessee had filed the return with the ITO, Rohtak and the assessment was also
framed at Rohtak. Therefore, the judgment of the Punjab and Haryana High Court
was binding on the assessee and the A.O. Accordingly, the appeal of the
assessee was dismissed.

 

The assessee submitted before the Tribunal that his PAN was
transferred from Rohtak to Delhi because he was residing in Delhi. The case of
the assessee had also been transferred to Delhi, therefore the jurisdictional
High Court should be the Delhi High Court. He relied upon the judgment of the Delhi
High Court in the case of CIT vs. AAR BEE Industries [2013] 357 ITI 542
wherein it was held that ‘It is the date on which the appeal is filed which
would be the material point of time for considering as to in which court the
appeal is to be filed’. He further pointed out that the appeal of the
assessee had been decided by the CIT(A)-28, New Delhi and the address of the
assessee was also in Delhi. Therefore, it was submitted that the Delhi High
Court is the jurisdictional High Court and its decisions are binding on the
CIT(A).

 

HELD

The Tribunal noted that the jurisdiction and PAN
of the assessee had been transferred to Delhi and the appeal was also decided
by the CIT(A), New Delhi. Therefore, the Tribunal accepted the submission of
the assessee and held that the CIT(A) was bound to follow the judgments of the
Delhi High Court. Accordingly, relying on the judgments of the Delhi High Court
in the cases of CIT-XII vs. Shri Kamal Wahal (Supra) and of CIT
vs. Ravinder Kumar Arora [2012] 342 ITR 38, the Tribunal allowed the
appeal of the assessee.

Section 143(2) – The statutory notice u/s 143(2) of the Act issued by the non-jurisdictional A.O. is void ab initio – If there are discrepancies in the details as per notice issued and details as per postal tracking report, then that cannot be considered as valid service of notice

5.       [2019]
76 ITR (Trib.) 107 (Del.)

Rajeev Goel vs. ACIT

ITA No. 1184/Del/2019

A.Y.: 2014-15

Date of order: 26th September, 2019

 

Section 143(2) – The statutory notice u/s 143(2) of the Act
issued by the non-jurisdictional A.O. is void ab initio – If there are
discrepancies in the details as per notice issued and details as per postal
tracking report, then that cannot be considered as valid service of notice

 

FACTS

The assessee’s case was selected for scrutiny by issuing
statutory notice u/s 143(2). The notice was issued by the non-jurisdictional
A.O., i.e., A.O. Circle 34(1), and without any order u/s 127 for transfer of
the case from one A.O. to another. Without prejudice to the assessee’s
contention that the notice was issued by non-jurisdictional A.O., notice u/s
143(2) was not served upon the assessee. While serving notice u/s 143(2), there
were discrepancies in the address stated in the notice and the address
mentioned in the tracking report of the post. The address mentioned in the
notice was with Pin Code 110034 and the Pin Code as per the tracking report was
110006.

 

The assessee had filed an affidavit before the A.O. claiming
that no notice u/s 143(2) was served upon him. He had produced all possible
evidences to prove that there were discrepancies while serving the said notice
and also that the assessment was initiated by non-jurisdictional A.O. These
contentions were not accepted by the A.O.

 

Aggrieved, the assessee preferred an appeal to the CIT(A)
claiming that the statutory notice u/s 143(2) was issued by the
non-jurisdictional A.O. and, thus, the assessment was void ab initio.
Without prejudice to this, the statutory notice u/s 143(2) was not validly
served upon the assessee. The CIT(A) held that the notice was served upon the
assessee and the assessee had failed to raise objections within the stipulated
period prescribed u/s 124(3) of the Act and hence dismissed the assessee’s
appeal.

Aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that there was a difference between the
address mentioned in the PAN database and the address mentioned in the return
of income filed by the assessee. The jurisdiction of the assessee as per his
address in the PAN database was with the A.O. Ward 39(1), whereas the
jurisdiction of the assessee as per his address in his return of income was
with A.O. Circle 47(1). However, the notice was issued by the A.O. Circle 34(1)
who had no jurisdiction over the assessee either on the basis of his
residential address or on the basis of his business address. Further, no order
u/s 127 of the Act was passed either by the Commissioner of Circle 34(1), or
the Commissioner of Circle 47(1) for transfer of the case from one A.O. to
another A.O. Thus, the notice issued by the A.O. Circle 34(1) was held to be void
ab initio as it was issued by the non-jurisdictional A.O.

 

Further, the Tribunal observed that even if the notice u/s
143(2) issued by the A.O. Circle 34(1) was considered to be valid, the notice
was not duly served upon the assessee. The address mentioned in the notice was
one of Delhi with Pin Code 110034, whereas the notice had been delivered to a
Delhi address with Pin Code 110006. As regards service of notice, the assessee
had filed an affidavit before the A.O. Circle 47(1) claiming that no notice u/s
143(2) was served upon him. The assessee had produced all possible evidences to
prove that there were discrepancies while serving notice u/s 143(2). Besides,
there was also a difference in the name mentioned in the notice which was
Rajeev Goel, whereas that mentioned in the tracking report was Ranjeev Goel.
Hence, on the basis of the aforementioned discrepancies, the notice was held to
be not validly served upon the assessee.

 

The Tribunal decided this ground of appeal in
favour of the assessee.

Section 153(1) r/w clause (iv) of Explanation 1 – Extension of time is provided to complete the assessment in a case where A.O. makes reference to the Valuation Officer only u/s 142A(1) – Where a reference is made to the Valuation Officer u/s 55A or 50C, there is no extension of time to complete the assessment

4.       [2019]
76 ITR (Trib.) 135 (Luck.)

Naina Saluja vs. DCIT

ITA No. 393/LKW/2018

A.Y.: 2013-14

Date of order: 25th October, 2019

 

Section 153(1) r/w clause (iv) of Explanation 1 – Extension
of time is provided to complete the assessment in a case where A.O. makes
reference to the Valuation Officer only u/s 142A(1) – Where a reference is made
to the Valuation Officer u/s 55A or 50C, there is no extension of time to
complete the assessment

 

FACTS

The assessee had sold her
two properties and derived income under the head ‘Capital Gains’ during the
relevant A.Y. 2013-14. While computing long-term capital gain, the assessee had
worked out the cost of acquisition on the basis of the circle rates as on 1st
April, 1981. For this purpose, the A.O. had referred the matter to the
Valuation Officer for estimating the correct fair market value of the properties
as on that date. In the meanwhile, the assessee had challenged the Stamp Duty
Value adopted and requested to refer the matter to the Valuation Cell for
valuation of the property as on the date of transfer. As the transaction was
falling under ‘capital gains’, the reference made by the A.O. to the Valuation
Officer was u/s 55A and the reference made by the assessee for valuation was
u/s 50C. The A.O. had received the second valuation report on 21st
March, 2016 and had thereafter called for objections from the assessee on the
second valuation report. The A.O. concluded the assessment and passed an
assessment order on 19th May, 2019 making an addition to the capital
gains on the basis of the said valuation report.

 

Aggrieved, the assessee preferred an appeal to the CIT(A)
claiming that the assessment completed was beyond the time period prescribed in
section 153 of the Act and, thus, the assessment order was barred by
limitation. However, the CIT(A) held that both the references were made u/s
142A of the Act and thereby concluded that the assessment order was not barred
by limitation. The CIT(A) upheld the assessment order and dismissed the
assessee’s appeal.

 

The assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that the reference to the Valuation
Officer u/s 142A can be made for the purpose of assessment or reassessment
where the valuation is required for the purpose of section 69, 69A, 69B or
section 56(2), whereas the references u/s 55A or u/s 50C are specific for the
purpose of computation of capital gains. The provisions of section 142A do not
govern the provisions of computation of capital gains.

 

The first reference to the Valuation Officer was made for
ascertaining the value of the asset as on 1st April, 1981 when it
was sold, and the second reference was made for valuation of property as on the
date of transfer which can only be made under the provisions of section 50C(2)
of the Act. Thus, neither of the references was made u/s 142A of the Act.

 

Further, as per the provision of section 153(1) r/w
Explanation 1, the provision for extension of time for completing the
assessment is available only if the reference is made to the Valuation Officer
u/s 142A. There is no provision for extension of time for completing the
assessment in case the reference is made u/s 55A or u/s 50C. Hence, the
assessment order was to be passed by 31st March, 2016 for the
relevant assessment year. The assessment order was, however, passed on 19th
May, 2016 which was beyond the period of limitation, hence the Tribunal quashed
the assessment order.

 

The Tribunal decided this ground of appeal in
favour of the assessee.

Sections 2(47), 45 – Amount received by assessee, owner of a flat in a co-operative housing society, from a developer under a scheme of re-development was integrally connected with transfer of old flat to developer for purpose of re-development, in lieu of which assessee received the said amount and a new residential flat – To be treated as income under head ‘capital gain’

3.       [2020]
115 taxmann.com 7 (Mum.)

Pradyot B. Borkar vs. ACIT

ITA No. 4070/Mum/2016

A.Y.: 2011-12

Date of order: 17th January, 2020

 

Sections 2(47), 45 – Amount received by assessee, owner of a
flat in a co-operative housing society, from a developer under a scheme of
re-development was integrally connected with transfer of old flat to developer
for purpose of re-development, in lieu of which assessee received the
said amount and a new residential flat – To be treated as income under head
‘capital gain’

 

FACTS

The assessee, an individual, filed his return of income
declaring total income of Rs. 32,30,000. The A.O., in the course of assessment
proceedings noted that the assessee has offered long-term capital gain of Rs.
31,12,638, towards sale of residential flats at C-20, 179, MIG, Bandra, Mumbai,
and has simultaneously claimed deduction u/s 54 of the Act.

 

The A.O. found that the
assessee owned a flat in the housing society which was given for development
under a scheme of re-development. As per the terms of the development agreement
between the housing society and its members, in addition to receiving a new
residential flat after re-development, each member was also entitled to receive
an amount of Rs. 53,80,500, comprising of the following:

 

Rs. 25,00,000

Compensation for
non-adherence by the re-developer to the earlier agreed terms and that the
member should be required to vacate the old flat.

 

 

Rs. 28,50,500

Beneficial right and interest
in corpus and income of the society and nuisance annoyance and hardship that
will be suffered by the members during the re-development.

 

 

Rs. 30,000

Moving or shifting cost.

 

 

The A.O. held that the amount received is not in any way related
to transfer of capital asset giving rise to capital gain. He assessed the
amount of Rs. 53,30,500 under the head ‘Income from Other Sources’.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) who
confirmed the action of the A.O. The assessee then preferred an appeal to the
Tribunal.

 

HELD

The Tribunal noted that in the return of income the assessee
has offered the amount of Rs. 53,50,500 as income from long-term capital gain.
But the A.O. has held that the amount is in the nature of compensation received
due to some specific factors and not related to transfer of capital asset. He
also observed that as per the terms of the development agreement, any capital
gain arising due to re-development would accrue to the housing society.
Therefore, the compensation received, Rs. 53,50,500, cannot be treated as
capital gain.

 

The Tribunal held that the amount of Rs. 53,50,500 was
received by the assessee only because of handing over the old flat for the
purpose of re-development. Therefore, the said amount is integrally connected
with the transfer of his old flat to the developer for re-development in
lieu of which he received the said amount and a new residential flat.
Therefore, the amount of Rs. 53,50,500 has to be treated as income under the
head ‘Capital Gain’. The Tribunal observed that the decision of the Co-ordinate
Bench in Rajnikant D. Shroff [ITA No. 4424/Mum/2014, dated 23rd September,
2016] supports this view. It held that the amount of Rs. 53,50,500 has
to be assessed under the head ‘Capital Gain’.

 

This ground of appeal filed by the assessee was allowed.

ACCUMULATION OF INCOME U/S 11(2) – STATEMENT OF PURPOSES

ISSUE FOR CONSIDERATION

A
charitable institution registered u/s 12A or 12AA of the Income-tax Act, 1961
can claim exemption of its income from property held for charitable or
religious purposes u/s 11(1) to the extent of such income applied or deemed to
be applied for charitable or religious purposes. In addition, exemption is also
available in respect of income not so applied but accumulated or set apart u/s
11(2), for such purposes for a period not exceeding five years, by filing a
statement of such accumulation in form No. 10. Section 11(2) requires the
institution to state the purpose for which the income is being accumulated or
set apart and the period for which the income is to be accumulated or set apart
in form No 10.

 

One of the longest running
controversies for the last 29 years has been about whether the purpose required
to be stated in form No. 10 can be general in nature, such as mere reference to
or reproduction of the objects of the trust, or that the statement has to be
specific in nature. In other words, should it be held to be a sufficient
compliance where the accumulation is stated to be for any medical and / or
educational purpose, or the statement should specify that the accumulation is
for the building of a hospital or a school, or anything else. While the
Calcutta and Madras High Courts have taken a view that a mention of a specific
purpose, and not just the general objects, is necessary, a majority of other
Courts, including the Delhi, Karnataka, Punjab and Haryana, Gujarat and Andhra
Pradesh and Telangana High Courts, have taken a contrary view holding that a
mere specification of the broad objects in the statement would suffice for this
purpose.

 

THE SINGHANIA CHARITABLE
TRUST CASE

The issue first came up for
discussion before the Calcutta High Court in the case of DIT(E) vs.
Trustees of Singhania Charitable Trust 199 ITR 819.

 

In this case, the assessee, a public
charitable trust, had claimed exemption u/s 11 for A.Y. 1984-85, including for
accumulation u/s 11(2), for which purpose it had filed form No. 10. In the said
form, as purposes of accumulation of income, the assessee had listed all the charitable
objects for which it was created.

 

These were:

(i) To
assist, finance, support, found, establish and maintain any institution meant
for the relief of the poor, advancement of education and medical relief;

(ii) To open, found, establish or finance, assist and contribute to the
maintenance of hospitals, charitable dispensaries, maternity homes, children’s
clinics, family planning centres, welfare centres, schools, colleges and / or
institutions for promotion of research and education in medical science,
including surgery;

(iii) To maintain beds in hospitals and make research grants for the
promotion and advancement of medical science in India;

(iv) To help needy people in marriage, funeral and cremation of the
dead;

(v) To
found, establish, maintain and assist leper asylums or other institutions for
the treatment of leprosy;

(vi)  To open, found, establish, assist and maintain schools, colleges
and boarding houses;

(vii) To open, found, establish contribute to the maintenance of
orphanages, widows’ homes, lunatic asylums, poor houses;

(viii) To open, found, establish and assist schools, colleges and
hospitals, for the physically or mentally handicapped, spastics, the blind, the
deaf and the dumb;

(ix) To distribute dhotis, blankets, rugs, woollen clothing,
quilts or cotton, woollen, silken or other varieties of clothes to the poor;

(x) To
grant fees, stipends, scholarships, prizes, books, interest-free loans and
other aid for pursuing studies, training or research;

(xi) To establish, found and maintain libraries, reading rooms for the
convenience of the public;

(xii) To establish scholarships, teaching and research chairs in Indian
universities and contribute towards installation of capital equipment in
educational and research institutes;

(xiii) To print, publish, distribute journals, periodicals, books and
leaflets for the promotion of the objects of the society;

(xiv) To establish or support or aid in the establishment or support
of any other associations having similar objects;

(xv) To assist, support and to give monetary help to any individual in
distress, poor or poor(s) for his or their medical treatment, advancement of
education;

(xvi) To start, maintain and assist in relief measures in those parts
of India which are subjected to natural calamities such as famine, epidemics,
fire, flood, dearth of water, earthquake.

 

The resolution passed by the Board
of Trustees of the trust was to the effect that the balance of unapplied income
of the year was to be accumulated and / or set apart for application to any one
or more of the objects of the trust as set out in item numbers (i) to (xvi)
under paragraph 1 of the deed of the trust.

 

Its
assessment was completed, allowing the exemption u/s 11, including accumulation
u/s 11(2). Subsequently, a notice was issued by the Commissioner for revision
u/s 263. According to the Commissioner, section 11(2) contemplated only
specific or concrete purposes and since those were not specified by the
assessee, the assessment order was erroneous and prejudicial to the interests
of the Revenue. The Commissioner called for the revision of the order of
assessment u/s 263, setting aside the assessment order and directing the A.O.
to redo the assessment taking into account the correct position of facts and
law. The Commissioner observed that it would be a mockery of the section if, in
the application for accumulation, all the objects of the trust were listed out
and the period was mentioned as ten years, which was the maximum then
permissible under law.

 

On appeal, the Tribunal held that on
an examination of the scheme of the Act since a plurality of charitable
purposes was not ruled out under it, no objection could possibly be taken to
the assessee’s listing out all the objects of the trust in form No. 10. The Tribunal
held the act of the assessee to be in compliance with the provisions of the Act
and disagreed with the findings of the Commissioner.

 

Before the Calcutta High Court, it
was contended on behalf of the assessee that one purpose of accumulation was
interlinked with the other and, therefore, the mention of all the purposes did
not make any difference and satisfied the requirements of section 11(2).

The Calcutta High Court observed
that the Tribunal’s decision overlooked the scheme relating to the accumulation
of income for a particular future use. It noted that section 11(1) itself
provided for marginal setting apart and accumulation of up to 25% (now 15%) of
the income of the trust. According to the High Court, section 11(1)
accumulation could be taken for the broad purposes of the trust as a whole and
that is why the statute in section 11(1) did not require an assessee to state
or specify the purpose. Such setting apart u/s 11(1) for any of the purposes of
the trust was, however, a short-term accumulation, in view of the Court, not to
exceed beyond the subsequent year. The High Court noted that it was sub-section
(2) which provided for the long-term accumulation of the income where it was
obvious that the long-term accumulation thereunder should be for a definite and
concrete purpose or purposes.

 

The High Court noted that the
assessee had sought permission to accumulate not for any determinate purpose or
purposes, but for the objects as enshrined in the trust deed in a blanket or
global manner which, in its view, was definitely not in the contemplation of
section 11(2) when it was construed in its setting. The High Court held that
accepting the assessee’s contention that saving and accumulation of income for
future application of the income was for the purposes of the trust in the
widest terms so as to embrace the entirety of the objects clause of the trust
deed, would render the requirement of specification of the purpose for
acquisition in that sub-section redundant.

 

The High Court observed that the
purpose of accumulation could not tread beyond the objects clause of the trust,
the legislature could not have provided for the period of accumulation if it
did not have in mind the particularity of the purpose or purposes falling
within the ambit of the objects clause of the trust deed. The High Court was of
the view that when section 11(2) required the specification of the purpose, it
did so with the objective of calling an assessee to state some specific purpose
out of the multiple purposes for which the trust stood; had it not been so,
there would have been no mandate for such specification since, in any case, a
charitable trust could, in no circumstances, apply its income, whether current
or accumulated, for any purposes other than the objects for which it stood; the
very fact that the statute required the purpose for accumulation to be stated
implied that such a purpose be a concrete one, an itemised purpose or a purpose
instrumental or ancillary to the implementation of its object or objects; the
very requirement of specification of purpose predicated that the purpose must
have an individuality.

 

According to the High Court, the
provision of section 11(2) was a concession provision to enable a charitable
trust to meet the contingency where the fulfilment of any project within its
object or objects needed heavy outlay calling for accumulation to amass
sufficient money to implement it and, therefore, specification of purpose as
required by section 11(2) admitted of no amount of vagueness about such
purpose.

 

The
High Court observed that it was not necessary that the assessee had to mention
only one specific object; there could be a setting apart and accumulation of
income for more objects than one, but whatever the objects or purposes might
be, the assessee must specify in the notice the concrete nature of the purposes
for which the application was being made; plurality of the purposes of
accumulation might not be precluded, but it must depend on the exact and
precise purposes for which the accumulation was intended; the generality of the
objects of the trust could not take the place of the specificity of the need
for accumulation.

 

The Calcutta High Court, therefore,
remanded the matter to the Tribunal to allow the assessee to adduce fresh
evidence, whether in the form of any resolution or otherwise, showing that the
specific purpose for which the trust required the accumulation of the income
existed and, if such resolution or evidence was placed before the Tribunal, the
Tribunal was directed to consider whether the obligation cast on the assessee
u/s 11(2) had been discharged and the exemption might accordingly be granted to
the assessee.

 

This decision of the Calcutta High
Court was referred to with approval by the Madras High Court in the case of CIT
vs. M. CT. Muthiah Chettiar Family Trust 245 ITR 400, though the Court
did not decide on the issue under consideration, since the issue before it
pertained to the taxation of the unutilised accumulation u/s 11(3), and it was
conceded by the Department that it was not in a position at a later date to
challenge that the form No. 10 filed in the year of accumulation was invalid
for not having stated a specified purpose for accumulation.

 

THE HOTEL AND RESTAURANT
ASSOCIATION’S CASE

The issue subsequently came up
before the Delhi High Court in the case of CIT vs. Hotel and Restaurant
Association 261 ITR 190.

In this case, pertaining to A.Y.
1992-93, the assessee, a company registered u/s 25 of the Companies Act, 1956
was also registered u/s 12A of the Income-tax Act. For the relevant year the
assessee accumulated its income for a period of ten years for fulfilment of the
objects for which it had been created. Notice to that effect was given by
filing form No. 10, giving particulars of the income sought to be accumulated.

 

During the assessment proceedings,
the A.O. declined to take into consideration the amount so accumulated on the
ground that in form No. 10 the specific object for which the income was sought
to be accumulated was not indicated. Accordingly, exemption in respect of such
accumulation was not allowed.

 

The Commissioner (Appeals) held that
the assessee was entitled to the exemption for the accumulation since the
assessee had passed a resolution to accumulate income so as to apply the same
in India in the next ten years to achieve the objects for which it had been
incorporated, and notice of this fact had been given to the A.O. in the
prescribed format. The Tribunal confirmed the view taken by the Commissioner
(Appeals).

 

Before the High Court, it was
submitted on behalf of the Revenue that the appellate authorities had failed to
appreciate that in the prescribed form the assessee had failed to indicate the
specific purpose for which the income was sought to be accumulated and,
therefore, the statutory requirement had not been strictly complied with,
disentitling the assessee from relief u/s 11(2).

 

The Delhi High Court, disagreeing
with the Revenue’s contentions, observed that while it was true that
specification of a certain purpose or purposes was needed for accumulation of
the trust’s income u/s 11(2), the purpose or purposes to be specified could not
have been beyond the objects of the trust; plurality of purposes of
accumulation was not precluded but depended on the precise purpose for which the
accumulation was intended.

 

The Delhi High Court noted that the
appellate authorities below had recorded a concurrent finding that the income
was sought to be accumulated by the assessee to achieve the objects for which
the assessee was incorporated. It further noted that it was not the case of the
Revenue that any of the objects of the assessee company were not for charitable
purposes. The findings of fact by the Tribunal gave rise to no question of law.
The Delhi High Court therefore declined to entertain the appeal.

This decision of the Delhi High
Court was followed in subsequent decisions of the same High Court and other
High Courts in the following cases:

 

(1) DIT(E)
vs. Daulat Ram Education Society 278 ITR 260 (Del.) – in this case, out
of 29 objects stipulated in the Memorandum of Association, the assessee had
specified eight objects;

 

(2) DIT(E)
vs. Mamta Health Institute for Mother and Children 293 ITR 380 (Del.) –
in form No. 10, the purpose of accumulation was stated to be as per the  resolution passed by the assessee; and in the
resolution the purpose specified was that of financing of the ongoing
programmes and of furtherance of the objects of the society;

 

(3) Bharat
Kalyan Pratishthan vs. DIT(E) 299 ITR 406 (Del.) – in this case the
resolution was to the effect that the amount accumulated be utilised for the
purposes of the trust, where the trust had only three objects, viz., medical
relief, help to the poor and educational purposes;

 

(4) DIT
vs. Mitsui & Co. Environmental Trust 303 ITR 111 (Del.) – in form
No. 10 it was mentioned that the amount accumulated would be utilised for the
objects of the trust;

 

(5) Bharat
Krishak Samaj vs. DDIT(E) 306 ITR 153 (Del.) – here, the accumulation
was for the objects of the trust;

 

(6) CIT
vs. National Institute and Financial Management 322 ITR 694 (P & H)
– the purpose of the accumulation stated was for expenditure on the building
fund and equipment fund;

 

(7) DIT(E)
vs. NBIE Welfare Society 370 ITR 490 (Del.) – in form No. 10, the
purpose stated for accumulation was for ‘further utilisation’;

 

(8) Samaj
Seva Nidhi vs. ACIT 376 ITR 507 (AP & T) – form No. 10 stated that
the accumulation was for general objects, but by a subsequent letter it was
stated that the amount was for the welfare of Scheduled Castes, Scheduled
Tribes, Vanvasis and socially and economically weaker sections of the society
as mentioned in a specific clause of the trust deed;

 

(9) DIT(E)
vs. Envisions 378 ITR 483 (Kar.) – in this case, three out of the 14
objects were reproduced in form No. 10, viz., conduct of various activities in
the field of academics, architecture, music and literature for preservation of
heritage; to run and maintain educational or other institutions for providing
and promoting education for the poor and weaker sections of society; and to
run, maintain or assist any medical institution to grant assistance to indigent
needy people for meeting the cost of medical treatment;

 

(10) CIT(E) vs. Gokula Education Foundation 394 ITR 236 (Kar.)
– in form No. 10, the purpose of accumulation stated was to improve / develop
the buildings of the trust and to conduct educational / charitable activities;
a special leave petition against the order of the High Court has been granted
to the Income Tax Department by the Supreme Court [248 Taxman 13(SC)];

 

(11) CIT(E) vs. Ohio University Christ College 408 ITR 352 (Kar.) –
three purposes were stated in form No. 10, which were all charitable, but
details of such purposes were not given;

 

(12) CIT(E) vs. Bochasanwasi Shri Akshar Purshottam Public Charitable
Trust 409 ITR 591 (Guj.) – in form No. 10, the purpose stated was for
providing medical facilities at various centres; the resolution had specified
purposes such as for future hospital of the trust, for purchase of necessary
equipment, ambulance van, furniture and fixtures and further expenditure for
modernisation of the hospitals.

 

OBSERVATIONS

Section 11(2) of the Income -tax Act
permits accumulation or setting apart of an income of a charitable institution
which is otherwise not applied or is not deemed to have been applied for the
charitable or religious purposes during the year. The income so accumulated or
set apart for application to such purposes is not included in the total income
for the year, provided the conditions specified in section 11(2) are complied
with. These conditions are:

 

(a) a
statement is furnished, in the prescribed form and manner, to the A.O. (form
No. 10 under Rule 17), stating therein the purpose for which the income is so
accumulated or set apart and the period for which the income is to be
accumulated or set apart and which period shall not exceed five years;

(b) the
money so accumulated or set apart is invested or deposited in the specified
form or mode;

(c) the
statement in form No. 10 is furnished by the due date for furnishing the return
of income u/s 139(1);

(d) form
No. 10 is furnished electronically under the digital signature or an electronic
verification code.

 

On
an apparent reading of the provision, it is gathered that an assessee, in cases
where the income is accumulated or set apart, is required to state the purpose
of accumulation and also state the period of accumulation in form No. 10. Once
this is dutifully complied with, no other prescription is provided for in the
Act. In other words, the assessee is to state the purpose of accumulation and
the period thereafter. The law apparently does not limit the purpose of
accumulation to a single purpose and further does not require such accumulation
for a dedicated project or a task within the objects of the institution. It
also does not call for passing of a resolution or enclosing of a copy of such
resolution with form No. 10.

 

There is no disagreement amongst the
High Courts about the need for a trust to spend its income, including the
accumulated income, only for those charitable or religious purposes specified
in its objects as per the Trust Deed. While granting registration u/s 12A/12AA,
the Commissioner would already have examined whether such objects qualify as
public charitable and religious purposes. It is also not in dispute that the
accumulation can be for more than one purpose; plurality of purposes is not
prohibited; there is no prohibition on a trust accumulating its income for all
of its activities. The obvious corollary to this undisputed position is that
while stating the purpose of accumulation in form No. 10, the assessee instead
of reproducing the list of all such activities, specifies that it is for its
objects, which have already been found to be charitable or religious in nature,
that should suffice for the purposes of section 11(2).

 

The 25% (now 15%) accumulation u/s
11(1) is not a short-term accumulation only for one year but is in fact for the
life-time of the trust and this factor should not have influenced the Calcutta High
Court to hold that for the purposes of section 11(2) accumulation there was a
need to state a specific purpose and not the general one by simply referring to
the objects clause.

 

If one examines the various types of
exemption u/s 11, one can see that all of these are for any of the objects of
the trust – the spending during the year u/s 11(1), the 15% accumulation u/s
11(1), the option to spend in the subsequent year under the explanation to
section 11(1). If that be the position, the legislature cannot be said to have
intended to restrict only the accumulation u/s 11(2) to a limited part of the
objects.

 

The requirement to specify the
purposes of accumulation can perhaps have been intended to ensure that the
accumulation is spent within the specified time and to tax it u/s 11(3) if it
is not spent within that time. But that purpose would be met even if all the
objects are specified for accumulation or setting apart.

 

In any case, almost all the High
Courts, except the Calcutta and the Madras High Courts, have held that so long
as the purpose of accumulation is clear from either the resolution or
subsequent correspondence or surrounding circumstances, that should suffice as
specification of the objects. This also seems clear from the fact that while
the Supreme Court has admitted the special leave petition against the Karnataka
High Court decision in Gokula Education Foundation (Supra), it
has rejected the special leave petition against the decision of the Gujarat
High Court in the case of Bochasanwasi Shri Akshar Purshottam Public
Charitable Trust (Supra).

 

The Tribunal in the case of Associated
Electronics Research Foundation 100 TTJ 480 (Del.) has held that it
would be a sufficient compliance of section 11(2) where the purpose of
accumulation can be gathered from the minutes of the meeting wherein a decision
to accumulate is taken and such decision is recorded in the minutes.

 

In the end, the assessee, in the
cases of deficiency or failure, may consider the possibility of making up for
such deficiency or failure by prescribing the purpose of accumulation or
setting apart during the course of assessment or before or thereafter. The
Gujarat High Court in the case of Bochasanwasi Shri Akshar Purshottam
Public Charitable Trust (Supra) has permitted the institution to
specify and to state the purpose of accumulation, subsequent to the filing of
the return of income. The special leave petition filed by the Income-tax
Department has been rejected by the Supreme Court in 263 Taxman 247 (SC).

 

The Calcutta High Court view seems to require
reconsideration, or should be read in the context of the matter, and the view
taken by the other High Courts seems to be the better view. One can only hope that the Supreme Court speedily decides this long-standing controversy which
has resulted in litigation for so many trusts.

C: CORONA ! C: CYBER CRIME !! C: CAREFUL !!!

With new
technological innovations all over the place, when I heard for the first time
about corona I thought it was a system virus. Somewhere, I correlated corona
with computers. My interest to know about the coronavirus increased when I saw
in the news that it’s a disease born in China. Now I’m afraid of the letter ‘C’
as it denotes ‘Corona’, ‘China’ and so on.

 

I went back to
the history behind this virus and something interesting came out of it. This
virus is similar to SARS (Severe Acute Respiratory Syndrome) born in China in
2003. SARS-COV-1 was a virus from the animal kingdom, generally bats, that
spread to other animals and impacted humans as well. Corona-2019 is quite
similar to SARS-2003.

 

How it is
going to impact companies or individuals and why we must all be extra vigilant
and careful in this situation.

 

Someone’s fear
becomes an opportunity for someone else. But who? Any views?

 

it’s cyber
criminals!

 

It’s very
obvious that in the environment of fear about corona which came up suddenly in
December, 2019, people will be eager to know about the cure for corona disease,
the medicines, treatments and so on.

 

Suddenly,
millions of people started searching cures for the disease and these searches
gave an opportunity to cyber criminals to earn money out of this fear. Cyber
criminals are always a step ahead of the general public. And coronavirus is an
excellent opportunity for them to launch their nefarious activities while the
world is busy searching for a cure for the disease.

 

How will the
cyber criminals achieve their objectives?

 

Through phishing
and malware.

 

Phishing is a cyber crime in which a target or targets are contacted by
email, telephone or text message by someone posing as a legitimate institution
to lure individuals into providing sensitive data such as personally
identifiable information, banking and credit card details and passwords.
Through emails, hackers send malicious emails containing malicious URL’s. Once
a person clicks the URL, his personal information gets shared with the hackers.

 

Another way to
send malicious messages is by inserting an exciting link on the websites that
people are searching. Once someone has searched for ‘Cure for coronavirus
disease’, a malicious window gets opened; and if the person clicks that window
he will lose his personal information, in fact, he might even lose his entire
computer database.

Why we must
be extra vigilant and ‘C’: Careful while searching about coronavirus.

 

Hackers are
writing city-specific malware to trap curious citizens. As governments across
the world are trying to minimise the risk of coronavirus, steps are being taken
to limit gatherings of people by cancelling public events, closing malls,
halls, schools, etc. Hackers have been using city-specific messages which
contain information about these government orders and asking users to click on
a link which takes them to an outside page.

 

In this example,
an email intimating the closure of schools, colleges and cinema halls in Mumbai
is used to lure the user and draw him into clicking on a suspicious link. Once
you click on any one of the outside links, it will prompt the system to open a
new outside web-page which might contain harmful malware.

 

How to be
safe in such a situation.

 

1.     Don’t click on Links: Avoid the habit of
clicking on links shared via social media, instant messaging applications, or
any other source;

2.     
Don’t open unfamiliar emails: Do not open
emails if you don’t trust the sender. Don’t click on links in emails with
coronavirus in the subject line under any circumstances;

3.    Reporting fake emails:  Report such mails to your email service
provider or to your organisational security team;

4.     
Updates on government websites: Rely only on
known sources for healthcare updates (these include the official websites and
social media channels of government health departments, union or state
governments, news publications of repute and your local healthcare
professionals);

5.     
Important thought: In today’s environment,
if someone cares for you and wants to reach out to you with some emergency
communication, they will call you or text you.

They will not
share any URLs;

6.   Updating of software: Do update all your software,
Operating Systems and mobile applications. Don’t skip updates;

7.     
HTTPS: Check the URL of websites very
vigilantly every time. A single typo could lead you to an infected website.
Refer only https websites and not ‘http’ websites.

 

These are a few suggestions which we must implement in our day-to-day
life as well.

 

BE AWARE! BE ATTENTIVE!! AND BE SAFE!!!

SELF-QUARANTINE YOUR MIND WHILST ‘WORKING FROM HOME’

Uncertain times call for decisive
actions, and decisions need to be taken at a much quicker pace than one would
do in the normal course. Both data points and market news point to a
catastrophe with the coronavirus (COVID-19) outbreak; there are public health
challenges confronting the leaderships of several countries and nearly all
businesses at large. As leaders of professional service firms, how we respond to
the challenges will largely drive our respective firms’ growth and positioning
in the market and ensure that our teams and the communities around us remain
safe and healthy. As part of a functioning society, the question to ask is:
have we done our bit as a responsible firm and as a responsible professional?

 

Increasingly, either by safety
concerns or by regulatory enforcement, most firms have already grounded their
teams to a partial or a complete work from home (WFH) mode, or are in the
process of doing so. By definition, WFH means that one needs to be working from
one’s confines and not be ‘surrounded’ by people. This also means that teams
will need to be effective in their pursuits whilst working from home.
Can we therefore practice quarantine in its truest form, i.e., meditation,
which is nothing but quarantine of the mind, and to think better? Aligning
one’s mindset to WFH needs practice and some good refreshing ideas.

 

TECHNOLOGY

Here are some thoughts on increasing
effectiveness during these WFH times.

Imagine a situation where you are
not allowed to access your office servers or data files for a prolonged period of time.

(i) How
will you conduct your professional engagements?

(ii) How will you discharge your tax and regulatory compliance obligations?

(iii) How will you ensure data protection and exchange of client
information without running the risk of privacy breach, or confidentiality
invasions?

 

Using cloud technology has
never been more needed than in today’s times.

Experts have long argued for
cloud-based systems to address efficiencies that help in remote working and
active collaboration. Hosting your data on the cloud and having virtual
desktops seems to be the right way to think. A lot of products are available in
the market for cloud servers, right from IBM to Alibaba Cloud and a host of
local service providers.

 

Collaboration and conferencing tools
such as Zoom, Google Meet, Skype and Microsoft Teams and many others allow
teams sitting remotely to interact with each other on a real-time basis,
without having the need to meet physically.

 

Technology
is all-pervasive and, during such times when we have no choice, the adversities
bring out solutions that help firms to adapt and align their practices to be
benchmarked to global standards. It may need a change in mindset and a
commitment to unlearn and relearn, but in the end it is all worth the while.
Imagine, if everything you can do in your physical office is now available in
the comfort of your homes and your teams don’t have to commute or travel for
getting their work done, the additional productivity would mean that so much
more work can be accomplished.

 

Traditional VPN-based models may
also be effective with static IPs. There could be challenges of too many people
trying to access the network at the same time and resultant delays and output.
For this, Microsoft Office 365 itself provides a host of applications.

 

ROBUST PROCESSES

Of course, you may explore any
technology that works for the firm. Being smart about it and investing the
right mind space and resources in technology usage will yield good dividends
for the practice in times to come, much beyond the WFH period.

When a firm is adopting WFH, one of
the key elements to a successful strategy is to ensure that it has robust
processes in place for exchange of information, planning for an engagement,
conduct of fieldwork, review of work performed by the team members and final
delivery of an engagement. Processes should include the following:

(a) Planning
for remote working, rules and to-do’s: HR teams should send out early
notifications of what teams should do whilst a WFH is in place;

(b) The
fieldwork stage of engagements during WFH would mean that you are not monitored
at every step, nor can you expect to reach out for assistance ‘on call’. You
will have to brace for individual efforts much more than what you are normally
accustomed to in a team environment. This calls for processes for increasing
individual performance such as:

(1) Planning
the day for specific and achievable goals and targets whilst having to WFH;

(2) Prioritisation
of what comes first and focusing on the task at hand;

(3) Organising
conference calls with the team lead / manager to ensure that you have a
sign-off on the work you are performing;

(4) Challenging
your abilities to work individually by extensive reading and applying your
knowledge to a given client solution;

(5) Writing
down areas of the work product that need a review during the collaborative
phase of the day;

(6) Scheduling
those reviews such that the time spent is optimised without impairing the
manager’s schedule for his / her own tasks of the day.

 

DATA PRIVACY AND CONFIDENTIALITY

Quite often, firms have got into
trouble for breach of data, data leakages, confidentiality breaches and similar
violations, mostly inadvertently and something that is discovered much later in
the day. Clients have strict clauses and firms have an obligation to protect
client data as much as the firm’s own data.

 

How do you do it? The first
step is to sensitise team members to your data privacy and your confidentiality
policies. These would have pre-existed the current catastrophe in most firms.
For firms where these policies were not well articulated, now is the time to do
it.

 

The next step is to ensure that
these policies are implemented. Get the best minds in the firm to work on
these. Give them the tools they need to achieve 100% compliance to standards
such as GDPR. Encourage them to benchmark best practices from the market. Get
outside technical help as and when necessary.

 

Clients don’t like any of their
stuff to be discussed or leaked outside. They will sue for breaches. They will
fire your firm if it is found guilty of violation. You may end up losing an
account if motives are ascribed. This has happened in a public company in India
in 2019. There are many past instances of data breaches.

 

And finally, ensure that these
actions are monitored and a monthly review is undertaken to make course
corrections when needed. There are current standards in place and there will be
stricter norms prescribed; the firms need to take this very seriously.

 

TEAM ALIGNMENT

Getting
your teams ready and with a mindset to work from home is all about alignment.
Just like when you are forced to sit at home to prepare for an event or to run
an errand, when professionals have to sit at home and think about delivery of
work, there could be an initial mental block. That’s where the mindset to be
effective has to be upper-most. There will be challenges and this is when the
firm’s leaders, HR teams and technology champions all have to collaborate and
communicate constantly, to reassure the teams to be in alignment at all times.
A help-desk should be established to mentor and guide the team members with
answers to their questions. When team members know who to turn to for help,
half the crisis is solved.

 

It is the firm’s leadership’s job to
set the tone on alignment during WFH. It is the manager’s job to monitor
execution. It is the team member’s job to ensure that he gives his all to be in
alignment for achieving effective results.

 

REFLECT ON PAST LEARNINGS

Reflect on past learnings, on what
lies ahead and channelize available time into research.

(A)   What lies ahead:

(i) Firms
will need to reorient their processes;

(ii) Setting
billing goals, with billable hours for advisory engagements;

(iii) Setting goals on completing specific audit areas for the day, along
with conducting audit steps / audit procedures as needed;

(iv) Tax teams will need to think about aspects of their engagements that
will need discussions and use online databases to good effect;

(v) Firms
will need to communicate with clients to expect disruptions in delivery and to
convey the firm’s preparedness;

(vi) How will the firm want to appear before its clients?

(vii) How can you increase your effectiveness in such a situation?


(B)   Past learnings:

We
have all had our fair share of experiences with managing crises, managing
turbulent times, managing stressful clients, facing challenging times and so
on. Can we put that to good effect when we are designing our WFH days?

(a)
What does the market want?

(b)
What does the client expect?

(c)
Is the firm equipped to service the
client?

(d)
What needs to change?

(e)
What will I do to make a difference?

(f) What will my partners need to do to
achieve the results we seek?

 

(C)   Research:

Can we self-quarantine our mind
whilst at home and focus on some interesting ideas, such as completing projects
that were long conceived but could not be finished:

 (I) That
new product or new service offering?

(II) Video podcasts of strategic insights for clients?

(III) Evolving latest thinking and converting it into frameworks?

(IV) That thought leadership article?

(V) That
white paper on latest developments in your area of expertise (Vivad se
Vishwas, GST interpretations, MLI, etc.)?

 

But above all we must remember at all times to
stay safe, to stay healthy and to stay effective.

LIMITATION ON FILING A PROBATE PETITION

INTRODUCTION

A probate means a copy of a Will
certified by the seal of a Court. A probate of a Will establishes the
authenticity and finality of that Will and validates all the acts of the
executors. It conclusively proves the validity of the Will; after a probate has
been granted, no claim can be raised about the genuineness or otherwise of the
Will.

 

One of the important questions
that often arises in relation to a probate is till when can a probate petition
be lodged? Is there a maximum time limit after the death of the testator within
which the executors must lodge the petition before the Courts? The Bombay High
Court had an occasion to consider this question in the case of Suresh
Manilal Mehta vs. Varsha Bhadresh Joshi, 2017 (1) AIR Bom R 487. Let us
examine this issue.

 

NECESSITY
FOR A PROBATE


The Indian Succession Act,
1925 deals with the law relating to Wills. According to this Act, no
right as an executor or a legatee can be established in any Court unless a
Court has granted a probate of the Will under which the right is claimed. This
provision applies to all Christians. In the case of any Hindu, Buddhist, Sikh
or Jain, it applies to:

(a) any Will made within the local limits of the ordinary original civil
jurisdiction of the High Courts of Madras or of Bombay, or within the
territories which were subject to the Lieutenant-Governor of Bengal;

(b) to all such Wills made outside those territories and limits so
far as it relates to immovable property situated within those territories or
limits.

 

Thus, for Hindus, Sikhs, Jains
and Buddhists, who are / whose immovable properties are situate outside the
territories of West Bengal or the Presidency Towns of Madras and Bombay, a
probate is not required. Similarly, where a Will is made outside Mumbai (say,
in Ahmedabad) and it makes no disposition of any immovable property in Mumbai
or other designated town, then such a Will would not require a probate.


An executor of such a Will may
need to do so only on the occurrence of a certain event, for instance, on a
suit being filed challenging that Will. However, a Will made in Mumbai or
pertaining to property in Mumbai needs to be compulsorily probated,
irrespective of whether or not there is an actual need for it.

 

DOES
THE LAW OF LIMITATION APPLY?

Coming back to the issue at hand,
the question which arises is whether the filing of a probate petition is barred
by any law of limitation, i.e., is there an outer time limit for filing the
petition? In this respect, one may consider the provisions of the Limitation
Act, 1963 which provides for periods of limitations for various suits.
Article 137 of the schedule to this Act states that in respect of any other
application for which no specific period of limitation is provided elsewhere in
that Act, the period of limitation is three years from when the right to apply
accrues. Further, Rule 382 of the Bombay High Court (Original Side) Rules
provides that in any case where an application for probate is made for the
first time after the lapse of three years from the death of the deceased, the
reason for the delay shall be explained in the petition. If the explanation is
unsatisfactory, the Prothonotary and Senior Master may require such further
proof of the alleged cause of delay as he may deem fit.

 

In Vasudev Daulatram
Sadarangani vs. Sajni Prem Lalwani, AIR 1983 Bom 268, the Court dealt
with the issue of whether Article 137 was applicable to applications for
probate, letters of administration or succession certificate. The Court held
that there was no warrant for the assumption that this right to apply accrued
on the date of death of the deceased. It held that the right to apply
may therefore accrue not necessarily within three years from the date of the
deceased’s death but when it becomes necessary to apply, which may be any time
after the death of the deceased, be it after several years. However,
reasons for delay must be satisfactorily explained to the Court. Further, such
an application was for the Court’s permission to perform a legal duty created
by a Will or for recognition as a testamentary trustee and was a continuous
right which could be exercised any time after the death of the deceased, as
long as the right to do so survived.

 

This view of the High Court was
approved by the Supreme Court in Kunvarjeet Singh Khandpur vs. Kirandeep
Kaur & Ors (2008) 8 SCC 463. However, the Supreme Court also held
that the application for grant of a probate or letters of administration was
covered by Article 137 of the Limitation Act. In Krishna Kumar Sharma vs.
Rajesh Kumar Sharma (2009) 11 SCC 537 the Supreme Court once again reiterated
this view and also held that the right to apply for a probate was a continuous
right.

 

WHAT
IS THE MAXIMUM TIME LIMIT?

In Suresh Manilal Mehta
(Supra) a daughter opposed her father’s probate petition. Here, the
probate petition was filed 33 years after the testator died. She argued that
such a long delay in seeking the probate was itself a sufficiently suspicious
circumstance to warrant the dismissal of the suit, especially if there was no
explanation for the delay. The explanation for this delay was that under the
husband’s Will, a majority of his estate devolved upon his wife and some
portion on his son. Further, his daughter was to take in the residuary estate
only if both her parents and her brother were no more and if her brother died
before turning 21 years of age. Since that was not the case the daughter did
not get the residuary estate. When the mother got the father’s estate under his
Will, no dispute was raised. However, when she died and her Will was sought to
be probated, her daughter argued that first the father’s Will must be probated
since the mother derived her entire estate from the father. Thus, the act of
probating the father’s Will was a good 33 years after his death.

 

The High Court held that the view
that Article 137 would have no application at all in any case to any
application for probate was incorrect. However, neither of the aforesaid two
Supreme Court decisions had held that the date of death of the deceased would
invariably provide the starting point of limitation. On the contrary, both the
decisions confirmed that the right to apply for a probate was a continuing
right so long as the right to do so survived.

 

Giving the analogy of two Wills,
one made in Mumbai and the other outside Mumbai, the High Court explained that
it could not be that the three-year limitation from the testator’s death would
apply to one of those two Wills, the one made in Mumbai, and not to the other
Will, i.e., the one made outside Mumbai. The date of death of the deceased
could not, therefore, be the starting point for the limitation in two otherwise
identical situations separated only by geographies, or else there would be
different starting points of limitation!

 

Accordingly, the Court held that
the only consistent view was that the right to apply for a probate was a
continuing right and the application must be made within three years of
the time when the right to apply accrued. An executor named in the Will could
apply for probate at any time so long as the right to do so survived.

 

CONCLUSION

This
is an extremely essential judgment which would help ease the process of
obtaining probates. There are numerous cases where probates have not been
obtained and this has led to the properties / assets getting stuck. In all such
cases it should be verified whether a probate petition could now be launched,
even if it is many years after the testator’s death.

IS IT FAIR TO PUNISH TAXPAYERS FOR A FAULTY GSTN?

BACKGROUND

When the GST (Goods and Services
Tax) law was introduced in India in 2017, sufficient time was not given to
taxpayers, professionals, technical teams and the country as a whole to
understand it. Adapting to something new takes its own time to understand and
implement at the ground level; GST has been no exception to this thumb rule.
Every new reform will require an initial learning experience and will also face
some resistance; clearly, the government could have managed its implementation
better had it given sufficient time to build the GSTN portal.

 

Earlier, taxpayers were so
disappointed with VAT compliances and multiple State taxes that they adopted a
welcoming approach to GST and were willing to embrace it wholeheartedly. The
government had spoken so much about it and boosted it so much that there was a
hope in the taxpayers that the new law would be easy to understand and
implement and that the return-filing process would be smooth. However, the
frequent changes in the GST law has led to delays in technical implementation
at the GSTN portal which has made it cumbersome to comply with and resulted in
the wasting of thousands of person-hours of both taxpayers and professionals.

 

In this article, we have
highlighted some of the technical problems faced by taxpayers in compliance due
to bugs and errors in the GSTN portal; although it has been about 31 months
since its introduction, the GSTN portal has not been functioning very well.

 

ISSUES
AT HAND

Taxpayers cannot be expected to
have enough technical knowledge of the GSTN portal and the concept behind it.
Still, since it has now become a law, or kanoon, both taxpayers and professionals
are making valiant attempts to carry on business and adhere to the compliances
in accordance with the law.

 

Registering on the GSTN portal is
a lengthy and time-consuming process. It is a very stringent procedure and
requires too many details and specific formats for uploading documents; so is
the case with various other forms and returns. The businessman is being forced
to spend more hours fulfilling compliances, accumulating various data points,
most of which could have been avoided, rather than focusing on his business and
growth prospects. This is followed by a continuous process of filing
back-to-back returns either monthly or quarterly, as applicable, instead of a
single return having all the details. Moreover, there are no revision / amendment
facilities for the returns filed.

 

Limitless updates and
notifications have now become the norm 
and there is no clarity; instead, things are becoming more complicated
and cumbersome, thanks to the Advance Ruling Authority. The constant updates,
notifications, etc. have become a nightmare and any single unintentional missed
update of notification results in penalty and interest. Frequent changes and
revisions in the GST rates have led to uncertainty for both businessmen and
government. Further, the new Input Tax Credit (ITC) rule limiting ITC from 20%
to 10%, and managing all the calculations has become difficult for SMEs and
also for large corporates. Besides, there is a severe lack of natural
justice as the burden to prove the purchase details is placed on the
purchasers instead of punishing the defaulting sellers. The increase of
government tax revenue by curbing the working capital has thereby created
unfair business practices and pressure of paying tax on honest taxpayers; and this
might have even led to an increase in the black economy because many small
businesses have started to do business in cash, not to avoid GST but to avoid
compliance because of the torturous procedures of GST.

 

The GSTN portal is faulty and
weak and no repair has been done thanks to which both taxpayers and
professionals are facing problems. There is a lack of clarity and knowledge
with the technical support team. The helpline numbers have turned out to be
helpless. There is so much pressure on the GSTN portal that it is always down
or under maintenance. In spite of the faulty system, it is the taxpayer who has
to bear the burden of paying late fees even if payment is done within
the due date but there were system issues while filing the returns. The faulty
and delayed release of forms and utilities without proper testing has added
further to the existing problems. There are many bugs and tech issues in
various forms and returns, creating hurdles in filing the returns within the
due date. Extensions given by the government can be a temporary solution;
however, it will not help unless the system is upgraded to optimum capacity to
handle taxpayers’ logins. Despite all these facts, government continues to
levy penalty and interest for late filing of returns, in spite of knowing
that very often the GSTN portal is out of service.

 

Separate due dates for filing of
returns and payment of tax should be taken into consideration. Further, extreme
importance is given to set-off of tax instead of considering the date of
deposit of tax as the date of payment. Very few resources are available to deal
with the plethora of problems. Solutions to problems are offered quite late and
are not effective enough to deal with those problems. Moreover, the opinions
of ground-level experts are neglected and more trust is placed on the
bureaucracy.

 

THE QUESTION IS – IS IT FAIR?

Is it fair for the taxpayers to
shift their focus from business to adhering to innumerable compliances? The new
ITC rule which has added to the unfairness and its working has worsened things
even further. Is it right for purchasers to be burdened and punished for
defaulting sellers? Let’s understand this with an illustration.

 

Mr. A has a business selling
goods and pays GST on the same. He purchases goods from Mr. B and these goods
are eligible for claiming of ITC. But Mr. B defaults in making GST payments to
the government and filing his returns, which results in non-reflection of the
transaction on Mr. A’s  GSTR2A. Mr. A has
honestly paid his share of tax to the government but is unable to claim his
rightful share due to the default by Mr. B. Is this fair to Mr. A?

 

Similarly, with the new ITC rule
it has become practically impossible to do the workings and track the entries
of those that are reflecting in GSTR2A on a month-on-month basis. If a dealer
is filing monthly returns of GSTR3B and quarterly returns of GTSR1, the entire
working capital is curbed and the taxpayer is at times paying taxes from his
savings instead of his business because entries are not reflecting in GSTR2A.

Is it fair for professionals to
have so many continuous updates and notifications with so much ambiguity?

 

PROBLEMS (AND SOLUTIONS) WITH THE GSTN
PORTAL

(i) Rectification and revision of all GST returns to be made available,
say once a quarter;

(ii) Increasing the capacity of the portal from the existing 1.5 lakh
to 50 lakhs (in line with the Income Tax Portal) to handle the login for one
crore taxpayers;

(iii) Ensure effective functioning of the helpdesk and helpline numbers
and also provide training to the assigned staff, thus providing immediate and
effective solutions to grievances;

(iv) Immediate solutions of glitches and drawbacks on the GSTN portal
within ten days;

(v) Waiver of late fees, especially when the fees are levied due to
the faults and failures of the GSTN system;

(vi) Refund of late fees paid earlier by those whose deadlines and due
dates were later extended;

(vii) Simple procedures and format of filing GST returns; 50% of data
sought in various tables of annual returns forms are unnecessary and can be
avoided for smoother filing;

(viii) Separate due dates for payment of tax and filing of returns so that
downloading system reports like GSTR2A and reconciliation become easier;

(ix) Scrap the GSTR3B form and take the summary of sales and purchase
from both purchasers’ and sellers’ quarterly returns instead of bill-wise
summary;

(x) Provide a solution to the illogical sections of 16(4) and 36(4)
of the IGST;

(xi) Date of tax deposit to be considered as the payment date;

(xii) System testing and checking prior to the release of any new form
or process;

(xiii) Waive late fees until the GST portal turns smooth and efficient;

(xiv) Single return to be introduced consisting of all the details of receipts
and supply;

(xv) Amendments and notifications without ambiguity;

(xvi) ITC rules to be amended in an effective manner, thus making it fair
to practice business for taxpayers and shifting the burden on to defaulting
sellers;

(xvii) Furnish and publish telephone and email ids that are working and
reachable of officers concerned on the website;

(xviii) Self-adjustments of balances in cash ledger and electronic credit
ledger across multiple GSTNs of a single legal entity;

(xix) GSTR3B filing for earlier period without late fees;

(xx) E-Act – there are so many changes, there should be a mandatory
updated legal position, Act, Rules, Notifications all incorporated at one
place. We do have such daily updated laws under the Companies Act, 2013;

(xxi) Bringing out amendments only once a month (with reasonable
exceptions) like a master circular rather than uncontrolled rolling out of
changes.

 

CONCLUSION

Even today, GSTN portal is not
glitch-free; it would still be a bumpy ride for taxpayers and professionals who
are dealing with it; Infosys Chairman Nandan Nilekani has promised to solve all
technical issues by July, 2020. However, by that time the new forms are
expected to be live (by October, 2020) with new challenges.

 

The demand
from taxpayers and professionals is very simple and can be met if there is
willingness on the part of the government to act fast rather than acting only
when the problems are highlighted by professionals and taxpayers.

 

The
government would do well to work upon making the frameworks and the GSTN portal
more user-friendly; the present situation and scope of GST leads to varied
interpretations, thereby resulting in possible litigations in the GST regime in
the near future. With the new forms deadline deferred by the government, we
hope the forms are made live with proper testing and feedback from all
stakeholders.

 

IS IT FAIR?

The
question remains, is it fair to punish taxpayers for a faulty GSTN?

SEBI’S RECENT ORDER ON INSIDER TRADING – INTERESTING ISSUES

SEBI recently passed an interim
order in an alleged case of insider trading and ordered impounding of profits
running into several crores of rupees, along with interest on it. This order
was apart from other adverse directions in the form of restrictions and also
such further other action that may be initiated later in the form of penalty,
etc. While the order by itself has several points which are analysed here,
there are certain other issues arising out of this order, as also a settlement
order in a related matter of the company, which also need a look.

 

Insider trading is something that
every securities regulator across the world seeks to prevent and strictly
punish and, as an offence, stands second perhaps only to blatant market
manipulation. Insider trading is a breach of trust by insiders with
shareholders and the public generally and by itself also leads to loss of faith
in stock markets. When persons are placed in positions of power and access to
sensitive information, they are duty-bound not to profit illegitimately from
it. If, for example, a Chief Financial Officer learns something from sensitive
information relating to accounts / finance made available to him due to his
position of power and trust, he is duty-bound not to exploit it for his
personal profit. For instance, if he comes to know that his company has made
substantial profits, he is expected not to buy shares based on this information
that is not yet public and also not to share such information.

 

The
offence of insider trading – whether dealing on the basis of such unpublished
sensitive information or sharing such information – is so difficult to prove,
that the law has been drafted very widely and presumptively. Many aspects are
presumed in law even if some of these presumptions can be rebutted by persons
accused of insider trading. The tools of punishment for insider trading
available with SEBI are varied and far-reaching. The profits made can be
disgorged, penalty up to three times the profits made, or Rs. 25 crores,
whichever is higher, can be levied, the guilty persons can be debarred from
capital markets and so on.

Let us examine and analyse a recent
order which is a good test study of how the legal concepts are applied in an
actual case (Order No. WTM/GM/IVD/55/2019-20 in the matter of PC Jeweller
Limited, dated 17th December, 2019).

 

BASIC FACTS

SEBI has made certain allegations of
findings relating to this listed company, PC Jeweller Limited (‘PC Jeweller /
Company’). These allegations of findings are given below as the basic facts and
then we will see how SEBI established the guilt of insider trading, how the
alleged illegitimate profits from insider trading have been calculated and what
initial directions have been issued.

 

To
broadly summarise, the company had proposed a substantial buyback of its shares
and obtained approval of its board of directors. The announcement resulted in a
sharp rise in its share price. Later, however, when the company approached the
lead banker / lender for approval, it was rejected. The rejection was
reconfirmed when the lender was approached a second time. Consequently, the
company had no choice but to withdraw the buyback decision. In the meanwhile,
during this period certain insiders not only sold shares in the company at the
then ruling high price but even squared off certain buy futures and also
entered into fresh sell futures. Each of these resulted in the insider
allegedly avoiding significant loss and even profited. The buy / long future
was for purchase of shares and if squared off at the ruling high price, it
saved the insider from suffering loss that would have arisen when the share
price fell after the announcement of withdrawal of the buyback decision.
Similarly, the put option was for sale of shares at the ruling high price and
when squared off when the price fell, profits were made.

 

Several issues arose. Whether the
company should have initiated the buyback proposal without duly disclosing that
it was subject to approval of lenders? Whether this was a case of insider
trading and, if yes, what action should be taken?

 

The following are some specific
facts as per findings in this interim order (note that the interim order is issued
without giving parties a hearing, which is given after the order and
which may result in modification of facts / directions):

 

(i) There
were two directors who were brothers and promoters. There was another brother
who was ex-Chairman. There were certain relatives of such persons who were the
sons and wives of such sons. There was also a private limited company (QDPL) in
which a family member held 50% shares. One of the brothers passed away by the
time this order was passed;

(ii) The company initiated the buyback proposal on 25th April,
2018 after internal discussions followed by discussions with auditors and
merchant bankers. Thereafter, it convened a Board meeting on 10th
May, 2018 when the Board approved the buyback;

(iii) The buyback proposed was at a significant price and of a
significant amount. It was for 1.21 crore shares at a price up to Rs. 350 (the
ruling market price of shares just before the Board meeting was about Rs. 216).
The total buyback consideration would have been approximately Rs. 424 crores;

(iv) The company also had in the meantime initiated approval of
shareholders for the buyback through postal ballot. However, it appears that
the outcome of the voting of the ballot was not announced, although it appears
that more than 99% of votes were in favour of the buyback;

(v) However,
on 7th July, 2018, the lead banker rejected the request to allow the
buyback of shares. A request to reconsider was also rejected. Consequently, the
company convened a Board meeting on 13th July, 2018 to withdraw the
buyback proposal and duly announced the decision;

(vi) Certain relatives of the promoter-directors and QDPL (the
private company in which a relative held 50% shares) entered into certain
transactions during the time after the announcement of the buyback
proposal but before the announcement regarding the withdrawal of the
buyback. Fifteen lakh shares were sold. A long position in futures of 2.25 lakh
shares was squared off by a similar put future. A fresh short position of three
lakh shares was also entered into.

 

FINDINGS BY SEBI

SEBI made the following findings in
its interim order: The relations and transactions between the
promoter-directors and the relatives / QDPL who traded in the shares / futures
were laid down in detail. These relatives / QDPL were thus held to be insiders
/ beneficiaries of inside information. The timing of the transactions was
specified as being during the time after the buyback was announced and
information about the rejection by the lead banker, but before the time
when the announcement of withdrawal of buyback was published.

 

SEBI worked out the notional gains /
losses avoided by such transactions by taking the price when such transactions
were undertaken and the price quoted in the markets after the announcement of
withdrawal of buyback was made. This was calculated at about Rs. 7.10 crores.
To this, interest @ 12% per annum was added till the date of order which
amounted to Rs. 1.21 crores. The total came to Rs. 8.31 crores.

 

ORDERS BY SEBI

SEBI held that the
promoter-directors were insiders and they communicated the price-sensitive
information to persons connected to them who traded in the shares / futures.
Thus, there were two sets of alleged violations. One was by the
promoter-directors who were alleged to have shared the price-sensitive
information to persons connected to them. The second was by such connected
persons who dealt in the shares / futures based on such information and avoided
a large amount of losses.

 

SEBI directed the persons who traded
in the shares / futures to deposit the notional gains along with interest in an
escrow account pending final orders. Till that time, no transactions were
allowed in their bank, demat and other accounts and they were not allowed to
dispose of any of their other assets, except for complying with such directions
and till such deposit was made.

 

Further, they were asked to show
cause why such notional gains should not be formally disgorged, along with
interest, and why they should not be restrained from accessing securities
markets / dealing in securities for an appropriate period. The
promoter-director was also asked to show cause why he should also not be
restrained similarly from accessing securities markets / dealing in securities.

 

SETTLEMENT ORDER

Interestingly, a settlement order
was passed a few weeks before the interim order. Vide this, the company agreed
to pay Rs. 19,12,500 as settlement charges for certain alleged defaults in
disclosures. These mainly related to not informing in time about the objections
of the lenders to the buyback offer which was stated to be material information. SEBI had initiated
proceedings to levy a penalty. However, the company came forward for a
settlement and paid the agreed amount.

 

OBSERVATIONS

There
are several interesting issues here. Some are lessons for companies and persons
associated with such companies generally. The other is about concerns over such
interim orders and findings and their implications.

 

It
is critical that companies and managements should consider carefully the
implications of major decisions and disclose to public meticulously all
relevant information in that regard. In this case, the issue was not so much
that the buyback had to be cancelled because of lack of approval from the lead
lender, but that such condition was not disclosed beforehand. It may be that
often such approvals ordinarily do come in due course. But in this particular
case, it mattered significantly, so much so that the buyback had to be called
off and the share price seems to have crashed because of this.

 

Promoters
/ insiders need to be generally very careful in dealing in shares. There are
many safeguards provided in law. For example, prior approval of the Compliance
Officer ensures a check on whether any price-sensitive information remains
undisclosed. However, even in such cases, the promoters / management may have
as much, if not more, knowledge of what critical issues may arise.

 

There
are also concerns about such an interim order and some very general
observations can be made for academic analysis. In this case, it appears that
the promoters held more than 60% shares and even after the sale, the holding
was 57.59%. It is not as if a very significant portion of the shares was sold.
One does not know whether there was a particular reason for such sale other
than what SEBI has alleged for the sale of the shares. Interim orders, it is
well settled, have to be made sparingly. The SEBI order states that if an
interim order is not passed, it would ‘result in irreparable injury to the
interests of the securities markets and the investors’. From the facts stated
in the order itself, the promoter holding is very significant even after such
sale. It is not clear how then such an order would have prevented such
‘irreparable injury’. An interim order of such a nature is stigmatic and
restrictions placed can affect day-to-day business. One wonders whether first
issuing a show-cause notice giving all alleged facts as presented and giving
due opportunity to the parties would have been a better course.

 

Be that as it may, such orders continue to
provide and reinforce lessons for companies, promoters and insiders generally
for exercising due care.

OVERVIEW OF AMENDMENTS TO THE ARBITRATION AND CONCILIATION ACT, 1996: ONE STEP FORWARD AND TWO STEPS BACK

INTRODUCTION

In recent years, the volume and intensity of cross-border
investment, trade and commerce have become the key indicators for defining the
developmental growth index of a sovereign state. The Government of India has
implemented a myriad legislations and policies to attract investments and make
it easier to do business in India.

 

A key impediment of doing business in India has been the
difficulty of enforcing contracts and the time taken by courts and tribunals to
give determinations. An effective and efficient dispute resolution mechanism is
critical for instilling confidence in investors and to achieve the goals of a
growing economy.

 

Against this backdrop, the Government of India (GoI) after a
period of almost 20 years, in the year 2015 made much-needed amendments to the
Arbitration and Conciliation Act, 1996 (the 1996 Act) to ensure that
arbitrations are quicker and smoother. The amendments were indeed
path-breaking, since some of the amended provisions went well beyond what the
law in even arbitration-friendly countries provided for. These included
disclosures of impartiality (adopting the International Bar Association’s
Guidelines on Conflicts of Interest in International Arbitration, in the Act
itself) and providing for strict timelines within which an arbitration is to be
completed.

 

However, the GoI and the stakeholders in the arbitration
process felt that various provisions required clarifications or amendments. The
GoI, which has been closely watching the situation, was eager to provide
necessary support to the legislative framework for arbitrations in India.

 

A high-level committee under the chairmanship of Justice B.N.
Srikrishna, former judge of the Supreme Court of India, was constituted by the
Central Government to submit a report on how to achieve the goal of making
India an arbitration hub, to explore the lacunae in the effective
implementation of the 1996 Act and the Arbitration and Conciliation
(Amendment), 2015 (2015 Amendment) and also to provide a robust scheme of
legislation aligned with the letter and spirit of the UNCITRAL Model Law and
the Convention on the Recognition and Enforcement of Foreign Arbitral Awards
(the New York Convention).

 

Based partly on the report of the high-level committee, the
Arbitration and Conciliation (Amendment) 2019 Bill (the Bill) was framed and
placed before both the Houses of Parliament for approval. Both Houses swiftly
approved the Bill and the Arbitration and Conciliation (Amendment Act) 2019
(2019 Amendment) was passed. The 2019 Amendment received Presidential assent on
9th August, 2019 and by a Gazette Notification dated 30th
August, 2019 bearing No. S.O. 3154(E) (Gazette Notification), certain
provisions, namely, section 1, section 4-9 (both inclusive), sections 11-13
(both inclusive) and sections 15 of the 2019 Amendment were brought into force.
Some of the other provisions are yet to be notified. The speed at which such
amendments were passed and came to be implemented makes GoI’s intention to
support arbitrations clear. But has the GoI been successful? Some of the
amendments have given rise to mystifying questions which will be explored in
this article.

 

KEY
AMENDMENTS UNDER THE 2019 AMENDMENT

 

Definition of arbitral institution

Section 1(ca) inserted by the 2019 Amendment provides for the
definition of ‘arbitral institution’ to mean ‘arbitral
institutions designated by the Supreme Court / High Court under the Act’.
This would mean that the established arbitral institutions such as the
International Court of Arbitration (ICC), the Singapore International
Arbitration Centre (SIAC), the London Court of International Arbitration
(LCIA), etc., would have to necessarily be designated to fall within the scope
of the definition of arbitral institution under the amended 1996 Act. This
section has been notified under the Gazette Notification. However, it is
unclear how arbitral institutions of the world will be designated and what
criteria will be required to be met to be recognised under the 1996 Act.

 

Arbitral appointments u/s 11

Sub-section 3A, inserted by the 2019 Amendment, empowers the
Supreme Court and High Court to designate arbitral institutions graded by the
Arbitration Council of India (ACI) u/s 43-I to make arbitral appointments. It
further provides that in cases where the High Court concerned does not have any
graded arbitral institutions within its jurisdiction, the Chief Justice of such
High Court is empowered to maintain a panel of arbitrators to discharge the
functions within the meaning of ‘arbitral institution’ under the amended 1996
Act. The arbitrators shall be entitled to fees as prescribed under the Fourth
Schedule of the amended 1996 Act.

 

The 2019 Amendment provides an explanation to sub-section 14
of section 11 that the rates as per the Fourth Schedule shall not be applicable
in cases of international commercial arbitration and in arbitrations (other
than international commercial arbitration) where parties have agreed for
determination of fees as per the rules of the arbitral institution. It may be
inferred from this that parties can agree to determination of fees by an
arbitral institution which is designated by the Supreme Court / High Court.
However, what happens in cases where an arbitral institution is not designated
with the Supreme Court / High Court remains unanswered.

 

The amendment also states that such panel of arbitrators as
maintained by the High Court is subject to review by the Chief Justice of the
High Court concerned. Although it may seem that the intention behind the
amendment to section 11 is to popularise institutional arbitration in India,
however, the intervention and excessive supervision may hamper party autonomy.
These provisions have not been notified as yet. There are several
representations pending with the GoI to revisit these provisions.

 

TIMELINES

The 2015 Amendment introduced a timeline of 12 months from
the date an arbitrator entered reference to complete the arbitration. This was
extendable by six months by consent of the parties. Further extensions could be
granted only by the courts.

 

The 2019 Amendment now provides that an arbitral tribunal has
to render an award within 12 months from the date of completion of pleadings
u/s 23(4) in cases of domestic arbitrations. Section 23(4) has been introduced,
providing a timeline for filing of the pleadings as six months from the date of
the arbitrator/s receiving notice of appointment. It may be noted that this
provision does not take into account the timelines for filing counterclaims and
defence thereto, rejoinders and sur-rejoinders. This provision has been
notified under the Gazette Notification. There could be challenges in some
cases, especially since there are times when parties seek additional time to
permit settlement talks, even once an arbitrator is appointed. The 12-month
timeline does not apply to international commercial arbitration. It is not
clear why international commercial arbitrations have been excluded from such
timelines and such distinction between domestic and international arbitrations
seems artificial. It is unlikely that foreign parties choosing arbitration in
India would appreciate this, since they would also desire that the arbitration
is concluded within the timeframe.

 

The Delhi High Court in its recent judgment in the matter of Shapoorji
Pallonji & Co. Pvt. Ltd. vs. Jindal India Thermal Power Limited1
 has clarified that the new
timelines set out in the 2019 Amendment would be applicable not only to
arbitration proceedings which have commenced after the 2019 Amendment, but also
to arbitration proceedings which are pending as on the date of enactment of the
2019 Amendment. This will add to additional uncertainty, since there may be
pending arbitrations in which pleadings have not been filed within six months.

 

Amendment to section 34

The amendment to section 34 provides that the challenge to an
arbitral award could be established only on the basis of the record of the
Arbitral Tribunal.

 

The amendment was a welcome step to ensure speedy disposal of
challenges by losing parties, wherein the parties seek to produce new /
additional documents and lead evidence before the courts at the stage of
challenge to an award, thus fundamentally trying to re-open the arbitral
dispute itself. However, in September, 2019 the Supreme Court in Canara
Nidhi Limited vs. M. Shashikala2  clarified the legal position that a challenge
u/s 34 ‘will not ordinarily require anything beyond the record that was
before the arbitrator and that cross-examination of persons swearing into the
affidavits should not be allowed unless absolutely necessary.’ It will be
interesting to see how this judgment is used further as it provides for an open
field for the practitioners to adduce additional evidences, by proving that
their case falls within the exceptional circumstances contemplated under the Canara
judgment.

 

CONFIDENTIALITY

The issue of confidentiality pertaining to arbitral
proceedings has been debated extensively in international arbitrations. The
1996 Act did provide for confidentiality to be maintained in cases of
conciliation, but not in arbitration. In international arbitrations, the
parties have the option to apply the confidentiality provisions under the
International Bar Association (IBA) Guidelines and Rules; however, the IBA
Rules and Guidelines can only act as a soft law. The insertion of section 42A
provides the disclosure of the arbitral award to be made only where it is
necessary for implementing or enforcing the award. It is a welcome move to
provide statutory backing to the concept of confidentiality in arbitral
proceedings and ensuring that the stand taken by the Indian legislation is akin
to the international best practices. However, the interplay between the ACI’s
power to keep a depository of arbitral awards and confidentiality provisions is
something to be seen in future.

 

Protection afforded to an arbitrator for action taken in
good faith

Under the newly-inserted section 42B of the 2019 Amendment,
immunity is now provided to the arbitrators against liabilities for acts
performed in their capacity as arbitrators, so long as they are in good faith.
This section should act as an incentive for more people to act as arbitrators.

 

Arbitration Council of India

The 2019 Amendment sought to insert an altogether new Part
‘1A’ to the 1996 Act for the establishment and incorporation of an independent
body corporate, namely, the Arbitration Council of India (ACI) for the purposes
of grading of arbitral institutions as per the qualifications and norms
contained in the Eighth Schedule (as inserted vide the 2019 Amendment) which
includes criteria relating to the infrastructure, quality and calibre of
arbitrators, performance and compliance of time limits for disposal of domestic
or international commercial arbitrations, etc., formulating policies and training
modules to adept professionals in the field of arbitration and ADR mechanisms.

 

Section 43C(1) provides that the ACI shall be composed of a
retired Supreme Court or High Court judge, appointed by the Central Government
in consultation with the Chief Justice of India, as its Chairperson; an eminent
arbitration practitioner nominated as the Central Government Member; an eminent
academician having research and teaching experience in the field of
arbitration, appointed by the Central Government in consultation with the
Chairperson, as the Chairperson-Member; Secretary to the Central Government in
the Department of Legal Affairs, Ministry of Law and Justice and Secretary to
the Central Government in the Department of Expenditure, Ministry of Finance,
both as ex-officio members; one representative of a recognised body of
commerce and industry, chosen on rotational basis by the Central Government, as
a part-time member; and Chief Executive Officer-Member-Secretary,
ex-officio.

 

The Ministry of Law and Justice has, in its press release
dated 12th February, 2020, enlisted the draft rules prepared to set
in motion the proposal of the ACI and has invited comments from various
stakeholders on the following:

 

(1)   The
Arbitration Council of India (the Salary, Allowances and other Terms and
Conditions of Chairperson and Members) Rules, 2020;

(2)   The
Arbitration Council of India (the Travelling and other Allowances payable to
Part-time Member) Rules, 2020;

(3)   The
Arbitration Council of India (the Qualifications, Appointment and other Terms
and Conditions of the service of the Chief Executive Officer) Rules, 2020;

(4)  The
Arbitration Council of India (the Number of Officers and Employees of the
Secretariat of the Council and the Qualifications, Appointment and other Terms
and Conditions of the officers and employees of the Council) Rules, 2020.

 

This provision has received vastly
differing views from the arbitration fraternity. On the one hand, it is said to
enhance the use of institutional arbitration over ad hoc, as well as an
attempt to ensure that there is some quality control over institutions and
arbitrators. On the other hand, stakeholders have taken the view that being
accredited by government officials amounts to regulation and excessive control
of arbitrators. This is all the more significant, given that the government is
one of the largest litigants in India. The provisions relating to the ACI have
not been notified yet.

 

The Eighth Schedule

One of the biggest benefits for
parties opting for arbitration rather than a court process to dispute
resolution is the right to nominate an arbitrator of their choice. This gives
flexibility in the process and often parties can nominate domain experts to
determine a particular matter, rather than someone who may be a qualified
lawyer or a retired judge but who may not be as well versed in the subject
matter of the dispute. The 2019 Amendment has introduced an Eighth Schedule
setting out the eligibility requirements for the accreditation and
qualification of an individual as an arbitrator. These provisions have not been
notified as yet.

 

RESTRICTING FOREIGN LAWYERS?

While such accreditation and
qualification of individuals acting as arbitrators may, at first glance, seem
attractive as a measure for quality control, some of the eligibility criteria
are highly restrictive and will infringe on a party’s right to appoint an
arbitrator of its choice, keeping in mind the nature of the dispute.

 

Some qualifications under the Eighth
Schedule require an arbitrator to, inter alia, have knowledge of the
laws in India such as the Constitution of India and the labour laws. Such
knowledge may not have any connection with a dispute at hand, such as, say,
whilst determining a matter relating to a contractual dispute governed entirely
by foreign law.

 

The Eighth Schedule also speaks of
appointment of advocates having ten or more years’ experience and being
registered under the Advocates Act in India. This throws open the question
whether this would potentially restrict foreign lawyers from acting as
arbitrators in India. This may prove to be an issue in a contract in disputes
having smaller value. A lawyer of ten or more years’ experience may charge an
amount that is a substantial portion or even more than the amount in dispute.
Besides, the ban on foreign qualified lawyers acting as arbitrators would be
contrary to the ethos of international arbitration and could discourage foreign
parties from seating their arbitrations in India since they would be prevented
from appointing an arbitrator of their choice. This may be more significant if the arbitration itself is
governed by foreign law (although seated in India).

 

Of the changes and standards
introduced under the 2019 Amendment, the Eighth Schedule by far contains the
most restrictive provisions which might take a toll on the promotion of
arbitrations in India. In the interest of promoting India as a hub for
arbitration, it is hoped that the government will reconsider this amendment
and, inter alia, allow foreign lawyers to act as arbitrators.

Insertion of section 87

When
the 2015 Amendment came into force, there was a huge debate as to whether the
amendments would apply retrospectively or prospectively. This was ultimately
settled by the Supreme Court in Board of Control for Cricket in India vs.
Kochi Cricket Private Limited and Ors3. Interestingly, the
GoI had filed an affidavit in the matter stating that its intention was to have
the 2015 Amendment apply only to arbitrations invoked after the 2015 Amendment
came into force. However, in the judgment, despite the position of the GoI stated
on affidavit, on an interpretation of a plain reading of the language used in
the 2015 Amendment it was ultimately held, inter alia, that the 2015
Amendment applied to applications which were pending in various courts
challenging an award in an arbitral proceeding which commenced before the
enactment of the 2015 Amendment. The judgment also went on to analyse and hold
exactly which section of the amendment would apply to ongoing arbitrations and
proceedings arising therefrom and which amendments would apply to arbitrations
invoked after the 2015 Amendment came into force.

 

The 2019 Amendment attempted to undo
the position held in the above judgment. The 2019 Amendment provides that,
unless otherwise agreed by parties, it shall not apply to:

(a)   the
arbitral proceedings commenced prior to the 2015 Amendment;

(b) the
Court proceedings arising out of or in relation to such arbitral proceedings
irrespective of whether such court proceedings have commenced prior to or after
the commencement of the 2015 Amendment.

 

MAKING INDIA AN ARBITRATION HUB?

It was further clarified that the
2015 Amendment shall only apply to arbitral proceedings that have commenced on
or after the introduction of the 2015 Amendment and to court proceedings
arising out of or in relation to such arbitral proceedings.

 

However, in the matter of Hindustan
Construction Company Limited & Anr vs. Union of India4
the Supreme Court has now held that section 87 of the 2019 Amendment is
manifestly arbitrary and unconstitutional. This judgment goes on to clarify
that the 2015 Amendment, in its original form, shall be applicable as held in
the Board of Control for Cricket in India matter.

Observing the latest arbitration
trends in India, there is not an iota of doubt that the GoI is leaving no stone
unturned to try to make India an arbitration hub. However, the continuous
change in the position of the arbitration law has left many questions
unanswered. Some well-intentioned amendments also have underlying issues that
need to be revisited.

It
is also noteworthy that the Constitutional validity of the 2019 Amendments is
under challenge before the Supreme Court in Writ Petition (Civil) No. 76 of 2020
filed under Article 32 of the Constitution. The main challenge is to the
provisions relating to the qualification required to be an arbitrator and the
mandatory requirement for the Arbitral Institutions to register themselves
before the High Courts and the Supreme Court of India. This petition is subjudice
before the Supreme Court. It would be interesting to follow the developments in this matter as they might
lead to defining the arbitration regime in India.

 

The 2019 Amendment, however well intentioned,
clearly has some challenges. We will have to wait and see whether these issues
are addressed by the GoI or interpreted by the Supreme Court so that there is
clarity on them.


__________________________________________

1   OMP (Misc) (Comm) 512/2019

2   2019 SCC OnLine SC 1244

3   (2018) 6 SCC 287

4   Writ Petition (Civil) No. 1074 of 2019

Business expenditure – Obsolescence allowance – Sections 36 and 145A of ITA, 1961 – Assessee following particular accounting policy from year to year consistent with provisions of section 145A – Concurrent finding of fact by appellate authorities that stock had been rendered obsolete – Loss allowable

1. CIT vs. Gigabyte
Technology (India) Ltd.

[2020] 421 ITR 21 (Bom.)

Date of order: 7th
January, 2020

 

Business expenditure –
Obsolescence allowance – Sections 36 and 145A of ITA, 1961 – Assessee following
particular accounting policy from year to year consistent with provisions of
section 145A – Concurrent finding of fact by appellate authorities that stock
had been rendered obsolete – Loss allowable

 

In its return, the assessee
claimed losses towards stock obsolescence in respect of laptops and
motherboards. The A.O. held that the laptops and the motherboards which had a
long shelf life could not be considered to have become obsolete and disallowed
the losses in his order passed u/s 143(3) of the Income-tax Act, 1961.

 

The Commissioner (Appeals)
allowed the appeal filed by the assessee. The Tribunal held that the obsolete
stock which was not disposed of or sold was allowable as expenditure and
dismissed the appeal filed by the Department.

 

On appeal by the Revenue, the
Bombay High Court upheld the decision of the Tribunal and held as under:

 

‘i)    There were concurrent findings of fact recorded by the
Commissioner (Appeals) as well as the Tribunal that the laptops and
motherboards had been rendered obsolete. There were findings of fact in respect
of the assessee consistently following a particular accounting policy from year
to year, which was consistent with the provisions of section 145A.

 

ii)    The Tribunal was right in holding that the obsolete stock which
was not disposed of or sold was allowable as expenditure.’

REMUNERATION BY A FIRM TO PARTNERS: SECTION 194J ATTRACTED?

From the remuneration payable by a
firm to its partners in pursuance of section 40(b) of the Income-tax Act, 1961
(‘the Act’), the firm does not deduct any tax at source (hereinafter also
referred to as ‘TDS’) under any provision of the Act. This position has been
undisputedly settled and accepted by the Income-tax Department for over 25
years since the new scheme of taxation of firms and partners was brought on the
statute book by the Finance Act, 1992 from the assessment year 1993-94.

But in a recent case I came across an
overzealous officer of the Income-tax Department adopting the stand that a firm
is liable to effect TDS u/s 194J of the Act @ 10% from the remuneration payable
to its partners as, in their view, the services rendered by the partners to the
firm are in the nature of ‘managerial services’ which fall within the scope of
the term ‘technical services’ employed in section 194J. Apart from a huge demand
of tax u/s 201(1), a substantial amount of interest u/s 201(1A) is also being
charged. This is playing havoc with the taxpayers, especially when the partners
have already paid tax on their remuneration in their respective individual
returns and the credit for such tax paid allowable under the first proviso
to sub-section (1) of section 201 is being denied on procedural technicalities.

Therefore, before proceeding further,
it is fervently pleaded that to alleviate the hardships faced by the taxpayers
and to avoid unnecessary litigation, the Central Board of Direct Taxes (‘CBDT’)
needs to urgently issue a circular clarifying the position on this subject, to
be followed (if necessary) by an appropriate legislative amendment in section
194J expressly excluding such remuneration from the purview of section 194J.

 

CLEAR LEGISLATIVE INTENT

Principally, it is submitted that the
remuneration payable by a firm to its partners cannot be subjected to TDS u/s
194J. In this regard the following propositions are submitted:

(1)  Firstly,
the legislative intent has always been clear beyond doubt that under the new
scheme of taxation of firms and partners, interest and remuneration payable by
a firm to its partners are not liable to TDS since by nature, character and
quality any such payment by a firm to its partners is nothing but a share in
the profits of the firm, though called interest or remuneration and though
deductible u/s 40(b). This legislative intent is manifestly evident from the
following:

 

ACCEPTED FOR OVER 25 YEARS

(a)  When
the new scheme of taxation of firms and partners was introduced by the Finance
Act, 1992 with effect from A.Y. 1993-94, section 194DD1 was also
proposed to be inserted in the Act which provided for TDS2 both from
interest and remuneration payable by a firm to its partners. But section 194DD
was dropped during the process of the Finance Bill, 1992 becoming an Act,
because the legislature was conscious that, conceptually, under the new scheme
of taxation of firms and partners, both interest and remuneration payable by a
firm to its partners are only a mode of transferring profits from the firm to
the partners for tax. This is fortified from the statutory provision that the
remuneration (as well as interest) received by a partner from the firm is treated
as business income in the individual hands of the partner u/s 28(v)3
of the Act4;

(b)  Explanation
2 below section 15 unambiguously provides that any salary, bonus, commission or
remuneration, by whatever name called, due to, or received by, a partner from
the firm shall not be regarded as ‘salary’. Consequently, provisions of section
192 relating to TDS from salaries are not attracted. This is statutory
recognition of the principle that there cannot be an employer-employee
relationship between a firm and its partners and as such no tax is required to
be deducted from such remuneration u/s 192;

(c)  Section
194A(3)(iv), likewise, expressly provides that no tax is to be deducted at
source from the interest payable by a firm to its partners;

(d) As
a matter of fact, any firm deducting tax at source under any provision of the
Act, including section 194J, from the remuneration payable to its partners is
unheard of in India and this position has been undisputedly, ungrudgingly and
eminently accepted by the Income-tax Department for over 25 years since the new
scheme of taxation of firms and partners came on the statute book;

(e)  Section 194J was introduced in the Act by the
Finance Act, 1995 with effect from 1st July, 1995 for TDS from fees
for professional services5  and fees for technical services6.
Later, by the Finance Act, 2012 a new category was added by inserting clause
(ba) in sub-section (1) of section 194J with effect from 1st July,
2012 which mandates TDS from ‘any remuneration or fees or commission, by
whatever name called, other than those on which tax is deductible u/s 192, to a
director of a company’. Thus, whenever the legislature intended that tax should
be deducted u/s 194J from the remuneration payable, it has expressly provided
for it in so many words as is the case with clause (ba) above applicable to
remuneration payable by a company to its directors. But no such specific clause
is inserted with regard to the remuneration payable by a firm to its partners;
while inserting clause (ba), the Memorandum explaining the provisions in the
Finance Bill, 2012 ([2012] 342 ITR [St] 234, 241) visibly
acknowledges that there is no specific provision for deduction of tax on the
remuneration paid to a director which is not in the nature of salary.
Furthermore, it is also judicially held7  that prior to insertion of the above referred
clause (ba) with effect from 1st July, 2012, no tax was deductible
u/s 194J from the commission / remuneration payable by a company to its
directors. It follows, therefore, that in the absence of any such specific
clause in section 194J postulating TDS from the remuneration payable by a firm
to its partners, the legislative intent is loud and clear – that no tax is
deductible u/s 194J by a firm from such remuneration.

 

A FIRM HAS NO LEGAL EXISTENCE

(2)  A
firm and its partners are treated as separate assessable entities for the
limited purpose of assessment under the Act, but, in law, as is settled
judicially for ages, a firm has no legal existence of its own, separate and
distinct from the partners constituting it, and the firm name is only a
compendious mode of describing the partners constituting the partnership. As
such, a person cannot render services to himself and there cannot be a contract
of service between a firm and its partners. Therefore, a firm cannot be
expected or made liable to deduct tax at source u/s 194J from such remuneration.


In CIT vs. R.M. Chidambaram
Pillai [1977] 106 ITR 292 (SC) the Apex Court observed that a firm is
not a legal person even though it has some attributes of a personality; and
that in income-tax law a firm is a unit of assessment by special provisions,
but not a full person.

The Supreme Court then unequivocally
held that since a contract of employment requires two distinct persons, viz.,
the employer and the employee, there cannot be a contract of service, in
strict law, between a firm and its partners8.

 

SHARE OF PROFITS OF THE FIRM

(3)  A
partner works for the firm since he is duty-bound to do so under the deed of
partnership as well as in terms of the provisions of the Indian Partnership
Act, 19329  and therefore
there is no relationship of service provider or consultant and client between
the partners and the firm.

(4)  Under
the Indian Partnership Act, 1932 since there is a relationship of ‘mutual
agency’ among the partners, there cannot be a relationship between a firm and
its partners which could give rise to a liability to deduct tax at source u/s
194J.

(5)  Conceptually,
whatever may be the amount received by a partner from the firm, whether called
salary or remuneration, it is not expenditure of the firm (though allowed as
such u/s 40[b]), nor in the nature of compensation for services in the hands of
the partner, but it is in the nature of a share of profits from the firm as is
settled judicially, including by the Supreme Court. In CIT vs. R.M.
Chidambaram Pillai (Supra) it was categorically held that payment of
salary to a partner represents a special share of the profits of the
firm and salary paid to a partner retains the same character of the
income of
the firm.

(6)  Even
under the statutory provisions embodied in section 28(v) of the Act, both
interest and remuneration received by a partner from the firm are expressly
assessed as business income in the hands of the partner and as such interest
and remuneration both are statutorily recognised as in the nature of a share of
profits from the firm10.

 

RULE OF CONSISTENCY

(7)  Since
generally the remuneration payable to the partners is a percentage of the
profits of the firm determined at the end of the year, which keeps on varying with
the amount of profits and is not reckoned with with reference to the quantity
and quality of services rendered by the partners to the firm, the same is a
mode of transferring a share of the profits of the firm to the partners and not
a compensation for the services rendered by the partners to the firm, and hence
the question of invoking section 194J does not arise.

(8)  Inasmuch
as the position that no tax is required to be deducted by a firm from the
remuneration payable to its partners is undisputedly and consistently accepted
by the Income-tax Department for over a quarter of a century now, even the rule
of consistency11 obligates
that this position should not be disturbed by the Income-tax Department at this
stage.

(9) It
can also be contended that by nature the services rendered, if any, by a
partner to the firm do not fall within the connotation of either ‘professional
services’ or ‘technical services’ as defined and understood for the purposes of
section 194J.

(10) No tax is levied under the laws
relating to Goods and Services Tax (‘GST’) on the remuneration received by a
partner from the firm. Thus, the remuneration received by a partner from the
firm is not treated as consideration for the supply of services to the firm but
as a share of profits even under the GST laws.

One arm of the Union Government (the
Income-tax Department) cannot adopt a stand conflicting with the view accepted
by another arm of the same Union Government (GST Department). In Moouat
vs. Betts Motors Ltd. 1958 (3) All E R 402 (CA) it was held that two
departments of the government cannot, in law, adopt contrary or inconsistent
stands, or raise inconsistent contentions, or act at cross purposes. Lord
Denning in this case succinctly summed up the principle in his inimitable
style: ‘The right hand of the government cannot pretend to be unaware of what
the left hand is doing.’ To the same effect was the Supreme Court decision in M.G.
Abrol, Addl. Collector of Customs vs. M/s Shantilal Chhotelal & Co. AIR
1966 SC 197, holding, to the effect, that the customs authorities12
cannot, in law, take a stand or adopt a view which is contrary to that taken by
the licensing authority under the Export (Control) Order, 195413.
This principle of law has been consistently applied for income-tax purposes as
well in a variety of contexts under the Act14.

In view of the foregoing discussion,
it is submitted that the remuneration payable by a firm to its partners cannot
suffer TDS u/s 194J of the Act.  

__________________________________________________________________

1   Clause 74 of the Finance Bill, 1992: [1992]
194 ITR (St) 68-69

2   At the average rate of income-tax computed on the basis of the
rates in force for the financial year concerned

3   Read with section 2(24)(ve)

4      See
also CBDT Circular No. 636 dated 31st August, 1992: [1992] 198
ITR (St) 1, 42-43

5   Clause (a) of sub-section (1) of section 194J

6   Clause (b) of sub-section (1) of section 194J

7      See, among others, Dy. CIT vs. ITC
Ltd. [2015] 154 ITD 136 (Kol.) and Dy. CIT vs. Kirloskar Oil
Engines Ltd. [2016] 158 ITD 309 (Pune). See also Bharat Forge
Ltd. vs. Addl. CIT [2013] 144 ITD 455 (Pune) (pre-2012 period) (sitting
fees to directors not ‘fees for professional services’ u/s 194J)

8   While reaching this conclusion, the Supreme
Court referred to, among others, Dulichand Laxminarayan vs. CIT [1956] 29
ITR 535 (SC); CIT vs. Ramniklal Kothari [1969] 74 ITR 57 (SC); and
Addanki Narayanappa vs. Bhaskara Krishnappa AIR 1966 SC 1300

9      See sub-sections (a) and (b) of section 12
along with sub-section (a) of section 13 of the Indian Partnership Act, 1932

10  See also CBDT Circular No. 636 dated 31st
August, 1992: [1992] 198 ITR (St) 1, 42-43

11     The rule of consistency is settled by
countless judicial precedents. See, for example, Radhasoami Satsang vs.
CIT [1992] 193 ITR 321 (SC); Berger Paints India Ltd. vs. CIT [2004] 266 ITR 99
(SC); Bharat Sanchar Nigam Ltd. vs. UOI [2006] 282 ITR 273 (SC); CIT vs. Neo
Poly Pack (P) Ltd. [2000] 245 ITR 492 (Del.); CIT vs. Leader Valves Ltd. [2007]
295 ITR 273 (P & H); CIT vs. Darius Pandole [2011] 330 ITR 485 (Bom.);
and Pr. CIT vs. Quest Investment Advisors Pvt. Ltd. [2018] 409 ITR 545
(Bom.)

12  Under the Sea Customs Act, 1878

13  Issued under the Import and Export (Control)
Act, 1947

14  See, for instance, Mobile
Communication (India) P. Ltd. vs. Dy. CIT [2010] 33 DTR (Del) (Trib) 398, 416

VIRUS AND US

There are
decades where nothing happens; and there are weeks where decades happen – Lenin

When I
called people in Italy, UK, Australia and America, they had three words to say:
‘It’s not good’. The news has been about infections, deaths and recoveries. An
invisible sub-microscopic agent stops the mighty and haughty China and America
and halts the unstoppable global industrial machine. The evolved and progressed
homo sapiens finds himself under house arrest.

The
pollution in Mumbai in the first seven days (since the lockdown) is down by 40%
(AQI PM 2.5 levels from 118 to 70). Clear skies, fresh air, zero noise. As I
write this, I can hear the Tibetan chimes playing in the breeze outside my
balcony. A Dutch client wrote that nature has put humans on notice. Earth,
which was on ventilator, seems to be breathing again, taking a break from human
disregard, entitlement and greed. On the other side there is pain and loss – of
lives and livelihoods, of wealth and income, and displacement and disarray.

The wise
must have had a thought as to why this is happening to us. The word virus
phonetically sounds like why us. What is all this telling us
individually and collectively? What is happening? Here are some immediate
reflections:

One focus: The distorted and fragmented humanity – in thought and action – was
never so cohesive in focusing on a single agenda. If one took the ‘point of
focus’ out and just became aware of the ‘focus’ itself, it is astounding.
Imagine working with such focus together on an issue like climate change that
affects every single person. (About 12.4 lakh people die in India and 16 lakhs in
China each year due to pollution). But can we? The past has shown that we are
just as likely to carry on as before. Someone wrote that perhaps the virus will
save as many or more lives of people dying from pollution and road accidents as
it takes away.

Leveller: Royalty to movie stars, all fell prey to the virus. The virus doesn’t
differentiate between rich and poor, known and unknown. Humanity as a whole
never seemed so vulnerable, overpowered and scuffling to keep its mortality
away. Each one, despite every manmade division, feels equally susceptible.

Decision,
action and speed: Economic leverage seemed less critical,
whereas action and speed are the real levers! Those who acted faster fought
better, those who were casual are trapped. The decisions India took wisely put
life over economy, survival over everything else. The PM pleaded with gentle
persuasiveness, with folded hands, to stay indoors. The administration brought
out extensions in compliance deadlines with speed and sensibility. Food, cash
and waivers for the marginalised came out with care and clarity. The central
banker was emphatic and reassuring and put money in the hands of the banks to
lend. Governance, the health care system and social capital are at their
ultimate acid test.

Illusions: Albert Einstein said that Reality is merely an illusion, albeit
a very persistent one. Many illusions we loved and lived with are busted.
Someone wrote: Coronavirus has proved that most corporate jobs are just
exchanges of emails, texts and calls and nothing else. Everything – from
‘values’ and ‘ways’ – will be subjected to deep inquiry. Many narratives could
stand on their heads. The hypothetical is now the reality. Washing hands, which
was difficult to enforce even in hospitals, is more important than shaking
hands. Social distancing is more important than bridging distances.
Mathematically put, namaskar > hugs, and social capital >
capital market valuations. Eighteen million people have viewed the TED talk by
Bill Gates on a pathogen attack, in October 2019 John Hopkins Centre for Health
Security gamed a germ war, America ranked at the top in Global Health Security
Index and today it has highest infections. Context changes everything,
including ‘reality’!

The next few
months, the end game and aftermath will be long and difficult. It won’t be a
balance that we can write off with a journal entry.

I will leave
you to complete the reflective thoughts of Anand Mahindra in your own words:
‘After the pandemic, we will …….’

Meanwhile, may you remain free from affliction

Raman Jokhakar

Editor

TRUTH AND TAX PRACTICE

What is the connection between
truth and tax practice? There are two answers to this question.

Truth is a matter of philosophy.
Its right place is in temples and books. It has no place in tax practice. (1.1)

Truth is applicable to every
human being. Taxpayers, tax practitioners and tax officers are all human
beings. They should also understand and practice truth. (1.2)

Does this mean that there are
two answers to one question? Hence truth depends upon one’s belief?

No. There is only one answer.
But people have different beliefs. And it is no use entering into arguments
with people holding contrary beliefs. People who have similar beliefs and want
to understand the deeper meanings of philosophical concepts, can discuss and
learn together.

Query: Is there any
difference between ‘Truth in Substance’ and ‘Truth in Form’?

Answer: The question
itself is baseless The form must always
represent substance. If form does not represent substance, that form has to be
discarded like a dead body without an Atma.

The entire litigation about ‘Form vs. Substance’ has been possible
because certain people believe in the answer 1.1 and not in the answer 1.2 as
mentioned above. If all the taxpayers, tax consultants and tax officers
practised answer 1.2, then 95% of tax litigation would not take place. There
may be genuine differences of opinion between two honest individuals. For them,
the courts would act as arbiters to decide which opinion is correct. This may
form 5% of litigation today.

The
entire debate about ‘BEPS’, anti-avoidance provisions and digital taxation
would not be necessary. SAAR, GAAR and harsh penalty provisions would be
unnecessary. Just imagine – how many intelligent brains are being wasted today
on obviously useless issues!
(The issues are useless from the point of view of society as a whole.)

Issue: Such a belief is Utopian.
It exists only in the minds of dreamers. People will act greedily. They will
avoid and evade taxes. Only the fear of harsh punishment keeps them
disciplined. Society will always need laws and regulations with harsh
punishment provisions.

Responses: Greed is as
prevalent as gravity. People will act greedily. Greed applies to taxpayers,
tax advisers, tax officers and law-makers – politicians, equally. Law
makers’ and regulators’ greed, corruption and ego get boosted with harsh
laws. We have experienced that society cannot throw out the corrupt politicians
even in elections. Harsh laws and punishment have, in reality, failed. Society
becoming spiritual is the only solution. A spiritual person will not abuse law,
will not avoid / evade taxes; nor will he take bribes. Today, a majority of the
global society is not spiritual. The BEPS project is proof. As the late Shri
Nani Palkhiwala said: Society will choose the right solution only after it
experiences failure of all available wrong solutions.

A comment from Maharshi Ved Vyas
in the Mahabharata on ‘Substance vs. Form’: Bhishma Pitamaha did not protect
Draupadi from her extreme humiliation at the time of her Vastra Haran.
He even said, ‘Dharma’s secret is complex Then Draupadi told the Sabha:

                                             

Where there are no wise old
men, it is not a conference. Those who do not support Dharma are not wise old
men. That which is not based on Truth is not Dharma. That which is obtained by
twisted interpretations is not Truth.

When to tell the truth and when
to maintain silence? This shloka provides the answer:

Speak pleasant truth. Do not tell a lie. Do not
tell an unpleasant truth. Never tell untruth even if it is pleasant. This is
Sanatan / Eternal dharma. However, this restriction does not apply to
‘Activists’. They have to tell unpleasant truths to the authorities and others.
Activists are doing a different kind of Karmayog.

TRANSITION TO CASH FLOW-BASED FUNDING

HISTORY

The Indian
banking industry is centuries old. A peep into its recent past is replete with
milestone events of change. Notable among them, starting with social control
over banks, have been nationalisation of commercial banks; identification of
priority sector for lending; an annual credit plan; diversification of
institutions and setting up of the Exim Bank to focus on export financing;
regional rural banks to introduce the hybrid of commercial bank strength with
local government participation; the creation of local area banks; micro-finance
companies; and so on. Clearly, banks have been an important tool to facilitate
the development of the Indian economy for decades. Foreign direct investment
norms in the banking sector were relaxed and the cap raised to 74%. The
financial needs of the rapidly-growing economy were catered to by government
banks, private banks and foreign banks, with a major share taken by government
banks. The Reserve Bank of India (RBI) issued guidelines for banks and ensured
compliance of BASEL-I norms in a phased manner between 1991 and 1999.

 

The growing economy needed more
finance and advanced banking. The ever-increasing need for strengthening of the
banking sector was further underlined as Lehman Brothers collapsed in the
Sub Prime Crisis (it filed for bankruptcy in 2008 – the largest in US
history). Around that time, commercial banks in India were in the process of
implementing BASEL-II norms which were completed by March, 2009. With the
advent of Information Technology, the retail industry boom and modernisation of
communication and data transfer, there have been rapid changes in the way
people and corporates do banking. The most recent development in the banking
business was in 2016 when RBI approved ten entities to set up small finance
banks.

 

Reserve Bank of India is the
regulatory body of Indian banking. With the adoption of BASEL norms, the
functioning of Indian banks is more standardised and in line with international
practices.

 

PRESENT SCENARIO

There have been various business strategies
in corporate lending followed by bankers. Banks with large balance sheets have
shown an appetite for taking large exposures and have been also daring to play
long term. On the other hand, Non-Banking Financial Corporations (NBFCs) have
exercised quick entry and timely exit compromising on collateral covers but
snatching from banks the opportunity of making good profit margins. Whatever
the form of these loans, all of these are asset-backed financing models.

 

By and large, all public sector
banks in India are disbursing loans (long–term, short-term loans, working
capital loans / cash credits) on the basis of assets as security. For term
loans, the primary security are assets like property, plant, equipment (fixed
assets) owned by the company. For short-term loans and working capital loans,
normally stock and debtors (current assets) are the primary security. The
liquidation value of an asset is the primary focus and projected cash flows are
the secondary focus. Cash flows are part of project proposals; however, such
inflows are not linked directly to loan eligibility or repayment / servicing
frequency and mode. This involves a lot of documentation and mortgage of the
asset in the name of the banker till the loan remains outstanding.

 

Post-disbursal, borrowers submit
periodic performance reports and provisional financials to the bankers as per
agreed terms. This information is not real-time information and in many cases
there are delays in submission of these documents. Banks lack the advanced
analytical tools and bandwidth to assess these reports regularly on a real-time
basis. Non-performance of an asset, i.e., borrower account, gets noticed quite
late when risk exposure is already very high. Increase in non-performing assets
is worrisome not only for the banker but for the economy at large as public
funds are at stake.

 

One may find that the practice of
asset-based lending has not helped us in timely identification of likely
non-performing credit and immediate reconstruction to put them back on track. A
question therefore arises whether it is time to go for alternate methods of
credit appraisal and adopt international best practices in banking in general
and lending in particular.

 

PROPOSED CHANGE

Assets don’t help companies to
repay loans. Often, the disposal of assets, primarily immovable property, poses
great difficulty in selling. It’s their cash flow that makes a difference. The
need for mitigation of risk is inherent to the banking business – new
technologies, policies and strategies are adopted from time to time for this.
Under the new mechanism, banks would be able to prioritise their fund
deployment programme. The public sector major, State Bank of India (SBI), has
announced that it will shift to the cash flow-based lending model beginning April,
2020. Other PSUs will not lag behind in following suit; some banks are already
doing it for a portion of their products.

 

Banks in India have traditionally
lent to companies against their assets. Cash flow-based lending is widely
considered to be a more efficient and safe way of mitigating risk as it reduces
discretion on the part of the lender. The new framework for loan sanctions will
apply to large companies as well as small enterprises.

 

THE MECHANISM

Cash flow-based lending (CFL)
envisages a shift in the bank’s appraisal system from traditional balance
sheet-based funding to a more objective appraisal system of leveraging the cash
flows of the unit. In CFL, loan requirement is based on actual revenue
generation and capacity to repay. Further, the repayment schedule is based on
the timing of the entity’s cash inflows. Company’s cash conversion cycle is
calculated. Based on cash conversion cycle, the ability of the borrower to pay
back the loan is calculated. With better negotiated terms with vendors / creditors,
the cash conversion cycle will shrink; and with increase in credit period to
the customer, the cash conversion cycle will be longer. While 25% of the
working capital gap (the difference between assessed gross working capital
assets minus gross working capital liabilities) is met by the company, banks
fund the remainder. Most of the working capital finance is in the form of cash
credit, a system where companies freely draw (and service interest) within a
certain limit or drawing power fixed by the lender. Drawing power is arrived at
on the basis of inventory volume minus margin therein. Cash flow lending, then,
is essentially lending to repeated asset conversion cycles and payback is
dependent on the firm’s ability to generate (and retain in the business)
sufficient cash over a number of years of profitable operations to make
required interest and principal payments on the loan. The loan amount as well
as mode of repayment is adjusted with cash inflows based on the cash conversion
cycle. Documented cash flows and the credit rating of the borrower will play an
important role.

 

A system of determining monthly /
quarterly utilisation limits for credit drawings can be fixed. Actual drawings
should be confined to determine limits. Deviations are not allowed and, when
allowed, they are always with approval from higher levels. The quarterly
monitoring system should ensure no diversion of bank credit for purposes other
than the sanctioned purpose.

 

NATURE
OF CHANGE IN BASIS OF LENDING

India’s government-owned banks
are likely to change the way they lend. Since the 1970s, public sector banks
have given out most working capital loans and short-term loans required for the
day-to-day operations of a business. Public sector banks have a more than 55%
share of the loan market. These loans were disbursed on the basis of the net
current assets of corporate borrowers. This is considered as a flawed system
that is believed to have resulted in over-funding to some and under-funding to
others. A system which does not focus on entity cash inflows as the primary
basis of loan availment and mode of repayment, often results in delayed
repayments, thus adversely affecting the NPA ratio. The outdated practice may
soon change with the country’s largest lender State Bank of India proposing a
transition from an ‘asset-based lending’ model to ‘cash flow-based lending’, a
mechanism that, among other things, may reduce diversion of funds by borrowers
and enable banks to assess the ability of borrowers to service loans on time.
The shift will require borrowing entities to share their cash flow statements
more frequently with banks.

 

NATURE OF LOAN PORTFOLIOS

Except for
some seasonal industries such as sugar, public sector banks arrive at a
company’s working capital requirements by considering the difference between
the borrower’s current assets (receivables, raw material stock, finished goods)
and current liabilities (payables like loan interest, taxes, payment to vendors
and workers). While 25% of the working capital gap (the difference between
assessed gross working capital assets minus gross working capital liabilities)
is met by the company, banks fund the remainder, although in many cases they
end up funding more. Most of the working capital finance is in the form of cash
credit, a system where companies freely draw (and service interest) within a
certain limit or drawing power fixed by the lender. Such asset-based lending
ignores the manipulation of the actual value of the assets pledged.

In a country like India a major
portion of the short-term loan portfolios of PSU banks consists of Cash Credit
(CC) accounts. As mentioned above, these loans are disbursed on the basis of
current assets as primary security. These assets themselves are not cash but
there is always conversion time in which these assets will generate cash. On a
broader basis, there would be the cash conversion cycle of every company. These
types of loans are most suited for cash flow-based funding. This is further
suited for MSMEs (Medium, Small and Micro Enterprises). Cash flow-based lending
envisages a shift in the banks’ credit appraisal mechanism and monitoring
system from the traditional balance sheet-based funding to a more objective
appraisal system. In CFL, loan requirement is based on actual revenue
generation and capacity to repay. Furthermore, the repayment schedule is based
on the timing of the MSME’s cash inflows. The advantages of CFL are that the
loan amount and repayment are based on the MSME’s actual cash generation,
reduction in credit risk, reduced monitoring costs for banks, reduction in
turnaround time and ability to serve entities that don’t have adequate
collaterals.

 

CHANGE IN ASSESSMENT OF BORROWER
BUSINESS

The primary focus in assessment
of business will no longer be the asset base of the balance sheet. The primary
focus will be cash inflows and the cash conversion cycle. Assets will be only
secondary support. Proven past cash flow generation data and credit ratings
will play an important role. Various databases and information available on the
cloud platform will be considered for data analysis. TransUnion CIBIL data will
by and large be considered a reliable source. Nowadays this data is available
at one’s fingertips, thanks to linking of the data base of PAN, Udyog Aadhaar,
Credit Cards. This data is more reliable and available independently for
verification.

 

IMPACT

Banking disbursement is expected
to rise. As asset backing is no more a primary criterion, companies not having
a large fixed capital base or real estate but having past record of operations
and margins can now avail cash flow-based loans. Various Startups which are in
the category of service sector will be benefited as these cash flow-based
funding loans will be available to these units, thereby increasing the size of
the disbursement portfolios of banks and financial institutions.

 

IMPACT – On NPA and bank balance
sheet

As mentioned earlier, due to lack
of expertise and bandwidth to assess various financial data real time, the
monitoring was not very effective. Since there was no direct linking of the
timing of cash inflows, the cash conversion cycle and repayment mode and
frequency, there used to be delays and at times diversion of funds, too. With
the shift to cash flow-based funding, these drawbacks will no more result in
NPAs growing without any control as drawings can be stopped when cash flows are
affected. The framework is already available for analysis of data. Databanks
are ready with authenticated data linked to the borrower and access to such
information is available to bankers. Loan amount and repayment frequency when
tied up with cash inflow working and timing, loan disbursal will be more
scientific and will cover the cyclical nature of business. All these will
facilitate timely servicing of loans, thereby improving overall NPA ratio.

 

IMPACT – On borrowing cost

Since the primary security is
future cash flows based on past records and credit ratings, there is no
tangible security in many cases. The cost of borrowing will tend to be higher
than asset-backed lending. With favourable performance and consistency in
repayment, this cost will also tend to ease out for standard portfolios.

 

IMPACT – On sectors

Service-oriented businesses with
minimum fixed or tangible capital with proven business model Startups – which
do not have any past record but are in a tie-up with payment gateways for
capturing sales inflows which can be reliably assessed for funding.

 

Financial Technology Companies
which provide various financial solutions to traders and service providers for
capturing the data real time and for producing various complex reports needed
for assessment will be benefited and the impact will be positive.

 

INTERNATIONAL PRACTICE

Cash flow-based financing may be
a recent development in India; however, all over the world this is a settled
method of financing, specially to small and medium enterprises, or to
organisations which do not have collateral but have a strong margin business
model, or organisations which do not have past track records and hence
appraisal risks are high; in such cases also, cash flow-based funding is in
vogue.

 

Key Features:

Lending to finance an entity’s
permanent (long-term) needs, seasonal needs;

Usually medium-term, with loan
terms of up to seven or eight years in most cases;

Covenants in the loan agreement
are often included as a ‘trigger’ to signal to the lender a deteriorating
situation so that corrective action may be taken.

 

While there are pronounced
advantages in CFL over asset-based lending, the emphasis is on the process of
the lending method. This presupposes a dedicated and purpose-oriented
policy-making personnel equally supported by an alert team of front-end staff.

 

CONCLUSION

From the foregoing paragraphs one
may conclude that the rapid growth of the Indian economy needs to be
continuously supported by an efficient system of banking dedicated to lend with
care and identify the potential risk much in advance; and also to mitigate the
risk by suitably hedging with a cash flow-based lending in place of asset-based
lending with all its limitations.

 

In
the short run, or even in the long run, cash is the only factor that repays a
loan; the cash conversion cycle is the only correct method to decide the mode
and frequency of repayments. Collateral is the buffer in case cash is not
generated to repay a loan. Cash flow control is the need of the times. In order
to be in line with government policies and also to reap the benefits of a
win-win situation for bankers and small and medium enterprises, cash flow-based
loans appear more appropriate as the supporting infrastructure framework is
already ready.

PANEL DISCUSSION ON UTILITY OF FINANCIAL STATEMENTS AND RELEVANCE OF AUDIT AT THE 10TH Ind AS RSC

A panel discussion on the ‘Utility
of Financial Statements and Relevance of Audit’ was the highlight of the 10th
Ind AS Residential Study Course (RSC) held at the Alila Diwa
Hyatt in Goa from 5th to 8th March, 2020.

 

The panellists represented
various stakeholder groups related to financial statements: Mr Raj Mullick,
Senior Executive Vice-President at Reliance Industries Ltd. from the preparers’
side; Mr. Nilesh Vikamsey, Past President of the ICAI representing the auditor
fraternity; Mr. Jigar Shah, CEO, Kimeng Securities India Pvt. Ltd. and
also an analyst; and Mr. Prashant Jain, Chief Investment Officer of HDFC
AMC (a fund manager). The discussion was moderated by Mr. Sandeep Shah,
CA. This report on the panel discussion is for the readers of the BCAJ
who would benefit immensely considering the present situation relating to audit
of financial statements.

 

INITIAL
REMARKS

Preparers’ Perspective:

Mr. Raj Mullick began by
indicating that the utility of the financial statements lay at two extreme
ends; whilst they provide a lot of value to certain classes of users such as
analysts, government authorities and bankers, they are often relegated to the
dustbin by certain other users, including some shareholders. However, generally
financial statements are relevant to various stakeholders like shareholders,
government authorities, bankers, analysts, suppliers and customers, each of
whom looks at specific aspects as per their requirements and serve as an
important communication tool on various matters like vision, mission and
strategy of the entity, its leadership, dividend policy and CSR activities,
amongst others.

 

He highlighted that there are
several challenges which could hamper their utility, including the sheer size
of the content, the use of several technical jargons like MAT, Deferred Tax,
OCI, ESOP, etc. Some of these challenges could be overcome by disclosure of
sufficient qualitative and quantitative information covering impact analysis of
future events and other explanatory and proactive disclosures so as to meet the
varying needs of lenders, analysts and also credit rating agencies.

 

On the role of the finance team
in making the financial statements more relevant and reliable, he highlighted
various steps which could be taken as under:

(a) Working closely with the CEO;

(b) Establishing appropriate accounting policies;

(c) Reflecting the nature of the business in the financial statements;
and

(d) Disclosing critical estimates and judgements.

 

Finally, Mr. Mullick
stated that the role of the auditors is of paramount importance since they
provide an assurance on the completeness of the financial statements and their
compliance with the generally-accepted accounting principles. He also
emphasised that by performing systematic, in-depth reviews of corporate
controls, the auditors help ensure that a company avoids coming under
regulatory scrutiny. He cautioned that going forward, for auditors to be
relevant they need to go much beyond numbers and be more tech-savvy and exhibit
a better understanding of the business.

 

Auditors’ Perspective:

Mr. Nilesh Vikamsey began by
stating that for (this) audience the relevance of the financial statements and
the utility of audit is a no-brainer in spite of some recent
‘accidents’. He indicated that financial statements are relevant to the
following sets of users:

(i) Shareholders, managements, potential investors and promoters;

(ii) Lenders, analysts, rating companies and potential lenders;

(iii) Government and tax authorities;

(iv) Regulators like SEBI, MCA
and RBI.

 

He lamented
the fact that in the past even when the auditors had qualified the financial
statements of a particular company on several counts, including on ‘going
concern’ issues, large funding was provided to it mainly on the security of its
brand, which raised a doubt as to whether the intended users took the financial
statements seriously.

According to him, the financial
statements reflect on matters involving governance, risks, estimates,
contingencies, etc. which may not always be a focus point of the various users,
and hence their relevance and utility could get diluted. Besides, the credit
and market risk disclosures need improvement from the current boiler plate /
template-ised disclosures.

 

Another area where there was
enough ammunition provided by the financial statements was the red flags (which
may not be always acted upon by the users), on issues such as:

(1)   Rising debt-equity ratio;

(2)   Capitalising revenue expenditure;

(3)   Rising fixed assets without corresponding increase in production
and / or sales;

(4)   Large ‘other expenses’ in the P&L account;

(5)   Rising accounts receivable and inventory compared with sales;

(6)   Higher or lower ‘other income’ as compared to ‘revenue from operations’.

 

Mr. Vikamsey also
touched upon disclosure initiatives at the international level to address
issues around which accounting policies need to be disclosed, defining
materiality, better organised entity-specific disclosures on performance,
working capital management, etc., improving the structure and content of
financial statements with new sub-totals (EIBDTA) and notes on management
performance measures.

 

He pointed out that in spite of
the recent aberrations due partly to the greed of some members and which needed
to be tempered, the role of auditors will always remain relevant. However, they
would need to embrace greater digitisation which would result in sampling
getting replaced with AI and routine operations like reconciliation being
automated. Going forward, the auditors would need to adopt a middle path
between scepticism and investigation. Various reporting initiatives like
KAMS, ICFR CARO, LFAR, etc. provide useful insights to analysts, investors and
regulators. Moreover, independent directors need to see greater value in the
audit process and need to don the auditor’s hat to keep pushing the management.

 

Analysts’ Perspective:

Mr. Jigar Shah stressed
that the utility and relevance of the financial statements can be improved by
building ‘additional, relevant, non-conventional’ disclosures,
especially around predicting future events, diversity and ESG (Environment,
Social and Corporate Governance) which would be a win-win situation for all
stakeholders. Earnings may not always necessarily represent the bottom line and
may not have a correlation to the market capitalisation of the entity due to
various reasons like contingent liabilities, whistle-blower complaints, etc.

 

On the question of asset
impairment, he observed that it is generally done only in times of an extreme
business cycle, or when the business is about to be sold. He emphasised a more
regular and vigorous assessment of asset impairment due to various
technological changes like 5G, IOT and other matters like climate change and
sustainability which could have an impact on industries like automobiles
(emission norms, electric vehicles), cement (penalties for flouting pollution
norms), real estate (climate change and global warming resulting in destruction
of real estate in coastal cities due to floods), general insurance (impact of
climate change on underwriting models) and IT (impact due to water crisis in
cities like Bangalore and Chennai).

 

Another area where he felt that
more granular disclosures were needed was with regard to intangibles in certain
specific industries like pharma, banks / finance companies, consumer goods
companies and so on on matters like expenses on brands, digital initiatives,
customer acquisition, technology development (because as per the current
accounting standards, any expenses on self-generated intangibles need to be
expenses off and may not always be completely disclosed).

 

On audit quality and its
relevance, Mr. Jigar Shah felt that the same is largely maintained and
it would not be proper to paint everyone with the same brush. The role of audit
is also likely to increase in the coming days due to various additional
reporting requirements under CARO. He also felt that auditors should not resign
immediately but must report.

 

Fund Managers’ / Investors’
Perspective:

Mr. Prashant Jain started by
stating that as an investor there are two mistakes which need to be guarded
against: the first is to avoid investments in entities whose value is likely to
fall, and the other is to miss investing in entities whose value is likely to
rise. Whilst the financial statements generally provide clues to the first
situation if one reads the notes and other information in detail and identifies
any aggressive accounting policies and other red flags, the same may not be
true in the case of the latter. In his view the balance sheet and the cash
flows are more important and relevant from their long-term value perspective
than the Profit and Loss statement which is more temporary in nature. He
recalled that one of his earliest learnings from a senior fund manager was that
the bottom line is sanity, the top line is vanity but cash
is reality!

 

It would be wrong to link
failures entirely to the financial statements, except in situations like severe
ALM mismatches or aggressive accounting policies since they could arise due to
various other reasons like government policies, competitor actions, failed
acquisitions and incorrect capital allocation, amongst others.

 

Mr. Jain felt that
there could be better quality disclosures on certain matters such as:

(A) Impact on the financial statements due to non-routine matters like
significant changes in oil prices, foreign exchange volatility in case an
entity has operations in several geographies;

(B) The reasons for recording huge amounts as goodwill in tune with the
underlying performance of the group companies;

(C) The impact on the financial statements due to long-term leases where
there is a lower profitability in the initial years, and in situations where
the entity keeps on entering into new leases continuously.

 

PANEL DISCUSSION

After the above observations,
moderator Sandeep Shah put forth various questions arising out of them
and on certain other matters, resulting in a healthy discussion amongst the
panellists. A summary of the views of the panellists on various matters is
provided here:

 

(i) Whether rigorous examination by auditors
is undertaken: The primary responsibility for the preparation of the
financial statements is that of the management and the auditors generally
conduct a rigorous examination thereof. However, the quality of disclosures
could improve and greater scepticism on their part is warranted in view of the
recent failures;


(ii) Whether audit is a commodity: There
were differing views on this. The views in support thereof arose primarily from
the growth expectations and undercutting of fees due to rotation, especially
amongst the larger firms. However, firms are now evaluating their risk
profiling of clients and increasingly resorting to resignations within the
regulatory framework. On the other hand, since in certain cases the auditors
grow with the companies, there is no commoditisation and it is up to the entity
whether it wants to do so;


(iii) Competitiveness of audit fees: On the
question whether the fees paid to the auditors are reasonable vis-a-vis
the complexity involved, it was felt that there was scope for improvement since
the lower fees are partly due to the lower rate of growth in the compensation
levels of the white-collar employees in the past 20 years compared to the
blue-collar employees, such as drivers;


(iv) Audit quality and related disclosures: The
quality of the audit firms is primarily driven by the partners and the staff
both in terms of their brand value and technical competence. However, adequate
disclosures are not made in respect of the credibility of the team members
except for the name of the signing partner. It was felt that a rating of the
audit firms is the need of the hour. The AQI proposed in the MCA consultation
paper could also be a step in that direction, though the ICAI has not made much
progress in the matter. Many small firms are quite meticulous in undertaking
their assignments. In sum, it was noted that in many cases, at the time of
acquisition the acquirer insists on firms of a certain standing to ensure quality;


(v) Role of auditors in evaluation of business and industry impact: It is not
the responsibility of the auditors to evaluate the future impact on the
entity’s business since they are not industry experts, except that they may
only highlight the risks. It was suggested that the management may, as part of
the annual report, give specific disclosures about the possible pricing and
financial implications due to the impact of technology changes on their
business in the foreseeable future;


(vi) Role of technology and digitisation on the audit function: This will
result in a revised set of skills on the part of the auditors around data
inputs / querying which would be very dynamic in nature;


(vii) Relevance and utility of the MD&A: There
were mixed reactions on its utility. Whilst, on the one hand, it serves as a
useful communication tool especially for the larger companies, on the other it
always tends to be optimistic and a report card of the present without
providing a meaningful analysis of the future plans of the business.
Accordingly, it was felt that it does not merit more than a passing interest;


(viii) Relevance of investor presentations: Since
they generally tend to be more detailed than the MD&A, they are more
relevant to the analysts due to their interactive nature which helps them in
updating their valuation models. However, the forward-looking statements made
therein are quite often not substantive and tend to be optimistic and biased;
hence they should be read in conjunction with the detailed notes in the
financial statements, because the devil lies in the details;


(ix) Transition to Ind AS – whether beneficial: Whilst
there is no doubt that Ind AS provides better quality of disclosures, it was
felt that the earlier format of the balance sheet was more reader-friendly
since it provides the sum total of the various line items at a glance as
against the ‘Current’ and ‘Non-Current’ classification of all line items under
Ind AS, which could be summarised. Further, the concept of ‘Mark to Market’ presents
challenges in analysing the financial position and results in a meaningful
manner;


(x) Earnings management: The greatest challenge therein
lies in managing the expectation mismatch. In certain situations, it could be
used as a legitimate tool by the management by cutting certain discretionary
costs like advertising or delaying capital expenditure; in other situations, it
may not be justified, especially if it is achieved through aggressive and
questionable accounting policies. It was, however, agreed that over a period of
time the same would be mitigated through a natural process of reconciliation
and tie-up with the market forces coupled with greater regulatory scrutiny;


(xi) Sufficiency of the current financial statements framework to all
industries: Whilst it was largely felt that the current financial statements
framework is sufficient for most industries, in certain industries such as
media, real estate, airlines, multiplexes, pharma, etc., it may not always
provide meaningful and relevant information like the extent of land parcels
(real estate), products, USFDA inspections (pharma), impact of long-term leases
(airlines, multiplexes) and IPR (media);


(xii) Usefulness of joint audit: It does provide value and add to
the quality of the audit, especially in the case of larger entities; the
experience has been generally good in countries which have mandated it.
However, care needs to be exercised that whilst allocating the work no
significant areas are left out. For the smaller companies it may result in
increased cost;


(xiii) Incentives for auditors: The main incentive and
motivating factor for an auditor is being a member of the ICAI. However,
considering his role as a solution provider, one of the motivating factors
would be that his recommendations are accepted. There can be no greater feather
in the cap than when the financial statements certified by him get an award
from the ICAI for the best-presented accounts.

 

CONCLUSION

There
was unanimity that the discussion provided a 360-degree view of various matters
from the perspectives of a preparer, auditor, investor and analyst. However,
concerns remain on overregulation and the existence of a trust
deficit which would in the coming days play a greater role in determining
the efficacy of the financial statements and the role of the auditors.

DISCONTINUED OPERATIONS

BACKGROUND

Ind AS 105 Non-current
assets held for sale and discontinued operations requires discontinued
operations to be presented separately in the profit and loss account, so that
the users of financial statements can separate the profits or losses from
continuing and discontinued operations. Such a segregated presentation helps
users of financial statements to determine the maintainable profits or losses
that arise from continuing operations.

 

Ind AS 105 (paragraph 32) defines
a discontinued operation as a component of an entity that either has been
disposed of, or is classified as held for sale, and

(a)   represents a separate major line of business or geographical area
of operations,

(b)  is part of a single co-ordinated plan to dispose of a separate
major line of business or geographical area of operations, or

(c)   is a subsidiary acquired exclusively with a view to resale.

 

Paragraph 33 of Ind AS 105
requires an entity to disclose:

(a)   a single amount in the statement of profit and loss comprising the
total of:

(i)    the post-tax profit or loss of discontinued operations; and

(ii)   the post-tax gain or loss recognised on the measurement to fair
value less costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation.

(b)   an analysis of the single amount in (a) into:

(i)    the revenue, expenses and pre-tax profit or loss of discontinued
operations;

(ii)   the related income tax expense;

(iii) the gain or loss recognised on the measurement to fair value less
costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation; and

(iv) the related income tax expense.

A common question that is
generally raised is with respect to a parent transferring an operation to a
subsidiary and whether in the parent’s separate financial statements the
disposal of the operation will be presented as a discontinuing operation. In
the consolidated financial statements, since the business remains within the
group, there is no discontinued operation which is required to be presented separately. Consider the detailed fact pattern below:

 

FACT PATTERN

A Ltd. (‘the Company’ or ‘the
parent’) enters into an arrangement whereby it will transfer an operation that
qualifies as an operation (as defined earlier) under Ind AS 105 to a
newly-set-up company (NewCo). The transfer is a slump sale and is set out in a
Business Transfer Agreement (BTA). NewCo is a wholly-owned subsidiary of the
company when it is set up.

 

The transfer is done with a
pre-requisite that an investor will concurrently invest in NewCo. to the extent
of 30%. The company has not lost control due to the said infusion, because it
still holds majority (70%) ownership. The investor will have significant
influence over NewCo.

 

There is no impairment on the
assets transferred.

 

Should the transferred operation
be classified as discontinued operations in the Separate Financial Statements
of A Ltd.?

 

ANALYSIS

There is no guidance with respect
to this specific issue either under Ind AS 105 or other Ind AS’s. In the stated
fact pattern, there are two possible views for the classification of the
transferred operation.

 

View 1: The
transferred operation is a discontinued operation in the parent’s separate
financial statements

In the fact pattern, an investor
will be investing to the extent of 30% shareholding in NewCo. There will be no
loss of control for the parent, because the parent still owns a majority stake
in NewCo. Nonetheless, running the operations by the company on its own as
against transferring it to a subsidiary, in which a potential investor has
significant influence, are two different things. Essentially, in the separate
financial statements of the parent the business is getting converted into an
investment in a subsidiary in which an independent investor will play a
significant role.

 

Earlier, the parent was running
the operations. After the transfer, the parent will have to manage the
investment in the subsidiary. The relevant decisions at the separate financial
statement level will be whether to retain the investment or dispose of the
investment, whether the investment should be further diluted, the proposal with
respect to dividends, etc. The parent and the subsidiary are two separate
entities with independent boards and subjected to a regulatory framework. This
suggests that the appropriate classification of the transferred operation
should be discontinued operation.

 

Accordingly, the transferred
operations should be classified as a discontinued operation.


View 2: The
transferred operation is not a discontinued operation in the parent’s separate
financial statements

The transfer
of operations to NewCo is simply a change in the geography of the operations,
because the operations continue to remain with the group. The transferred
operations are still controlled by A Ltd. In substance, A Ltd. continues to
control the operations though there will be significant influence exercised by
the independent investor in NewCo. There is a very thin line between managing
the investment in a subsidiary vs. running the operations represented by that
investment. Consequently, the transferred operations are not discontinued
operations in the separate financial statements of the parent.

 

The author believes that both the above views are
acceptable. However, View 1 may be preferred keeping in mind the concept
of ‘substance over form’. View 1 also represents faithfully the fact
that the profit and loss in the separate financial statements will not include
the results of the operation going forward. A segregated presentation will help
users of financial statements to determine the maintainable profits or losses
that arise from continuing operations in the separate financial statements. 

COVID-19 AND THE RESHAPING OF THE GLOBAL GEOPOLITICAL ORDER

Geopolitics has been historically
shaped by multiple events in history. Wars, conflicts and occasionally
haphazard events have changed how nations have achieved and lost power on the
international stage. The international system after the Cold War ended has been
characteristically driven by the United States-led global order. The Western
institutions, collectively known as the Bretton Woods system, have been major
institutions shaping the global financial order. In the dying stages of the
Cold War, China’s rise was seldom seen as that of the next big global power fit
enough to challenge the US presence in Asia. The post-Cold War era also saw the
formation and development of the European Union. The diffusion of power and
geopolitics from central power to multiple regional power centres led to the
formation of the multipolar regional order.

 

Frictions between countries were
commonplace in Asia; an ascendant China was not only challenged by US presence
in the region, but also by the rise of India throughout the 2000s. However,
since the mid-2000’s, the rise of China and the debate on the uneasy decline of
US power in Asia has displayed itself in multiple events and forums across the
region, often with countries such as India and groupings like ASEAN having to
pay the price for choosing sides. The recent episode involving a trade war
between the US and China over supremacy in the technological space exposed the
limits of the structure and tipping points between both the countries in the
region. Eventually, the end of this war was followed by COVID-19, a ‘Black
Swan’ event which has had a huge impact on the global economy and geopolitics.

 

‘Black Swan’ events are an extremely
negative event or occurrence that is impossibly difficult to predict. In other
words, such events are both unexpected and unpredictable. As the world deals
with the COVID-19 pandemic which has seen 15,361 deaths till 23rd
March, 2020, reports have indicated faults at multiple levels in controlling
the issue at the right time. While China’s suppression of the information has
surfaced in recent understanding, the drop in its consumption levels has
severely impacted the global economy. Businesses have been clearly hit. Major
among them have been aviation and tourism. The drop in travel and bans on
flights have impacted the two industries, leading to a complete shutdown of
some sectors within these areas. Major global airlines have cut anywhere
between 80 to 90% of their capacity on the backs of travel bans and the lack of
passengers as a result thereof. Some economies reliant on tourism have been
badly hit.

 

Nevertheless, crisis times call for
astute diplomacy and capitalisation of the issues at hand. Several issues could
be noticed on how states handled the crisis and their response, and how global
markets and the uncertainty were taken advantage of by a few countries. While
China reached the peak of the crisis, global markets had started to respond by
closing down to the outside world systemically. Crashing markets and impacted
supply chains followed by reduced demands were indicative of the coming crisis.
One of the key impacts of the slowing economy was felt in the oil markets. The
reduced demand from China and the rest of the world has led to tumbling prices.
The OPEC, which coordinates and sets global oil prices, fell out with Russia.
This fallout between Russia and Saudi Arabia has sent oil prices crashing,
leading to historical lows, possibly benefiting bigger global consumers.

 

Japan, which had been continually
struggling to keep its economy afloat, reported one of the slowest growth rates
in many years due to domestic policies. Just staying above the line going into
recession, due to the slowdown caused by the virus, Japan may very well be
heading into an economic crisis. Recent discussions also highlight that Japan
would most likely be postponing the Summer Olympics which could have provided a
great boost to its economy.

 

Similarly, some other countries have
not failed to showcase their power through diplomacy. India, which has till now
done some of the most extensive relief operations in all affected regions by
bringing back stranded citizens, has also extended its hand to the South Asian
region which has fallen apart after the failure of the South Asian Association
for Regional Co-operation (SAARC); the joint effort call was heeded by all
(except Pakistan). Similarly, India also lifted the ban on the export of all
kinds of personal protection equipment, including masks, and cleared some
consignments of medical gear placed by China, a move seen as a goodwill
gesture; such diplomatic signalling is seen positively as an extending reach in
times of crisis. India’s ability to get back its citizens from Wuhan is also a
demonstration of this extended positive reach.

 

In the global sense, as the crisis’s
epicentre moves to Europe where the death toll has now overtaken that of China,
and the United States’ healthcare system has showcased its total unpreparedness
to tackle this epidemic, China’s reviving supply lines will surely find a
future market to sell its goods. India, with its developed pharmaceutical
sector, should capitalise on this situation. However, the US lobbies which are
averse to generic substitutes have always scuttled any ideas for the lucrative
markets. China’s companies, including its retail giant Alibaba, have already
started to send across protective medical supplies to all South Asian countries
(excluding India) as well as some countries in Africa. The inability to rely on
existing Western donor systems which have been increasingly challenged by China
since the last decade, may turn out to be a silver lining for China.

 

The
future of the global order remains uncertain; the COVID-19 crisis has struck at
a time when leaderships have been challenged domestically all over the world.
While the United States is in election season, China’s vulnerability to a
crisis has put a question mark on the strengthening of the power base of
President Xi Jinping within China and that of its ruling Communist Party.
However, India’s handling of the situation has helped quell some negativity for
now about the ongoing domestic issues in the country. Nevertheless, once the
dust settles, the gravest impact would be felt in Europe. As the region was
already battling a refugee crisis, deaths relating to Coronavirus would add a
burden on the regional economies. The inability to rebuild from the economic
impact would invariably shift the burden on the emerging powers within the
grouping, forcing an already delicate line in the grouping; the region’s
economic engine Germany has already recorded no growth in the coming year. The
negative growth rate and the developing internal political crisis within the
country do not hold a positive outlook.

 

In the second half of 2020, the geopolitical
shifts will be visible through geo-economics outlays. China, which was first in
and is now first out, will continue to rebuild from the economic shocks. It is
bound to benefit most from the post-crisis scenario as the virus spread will
keep it from exhausting its options in supplying the growing needs during the
crisis and its aftermath. India’s chances to plug into this geopolitical
reordering will be crucial. The uncertain political and economic reach of the West
could well make it use a resilient India to assert itself to balance China in
Asia; nevertheless, India will have to once again resort to its delicate
balancing game between the US and China, at the same time being careful not to
tip the scales too much to still be able to plug itself into a reviving Asian
economy.

HOUSEKEEPING FOR BHUDEVI

Nandurbar is one of Maharashtra’s
smaller districts by area (5,955 sq. km.) and its forest cover, according to
the India State of Forest Report, 2019, is just over 20% of its area; which
means that about 1,196 sq. km. of Nandurbar is forest. Far away from Nandurbar
is the district of Kokrajhar in Assam, which has about 1,166 sq. km. of forest
covering a smaller total area (3,296 sq. km.).

 

For all those who prefer seeing the
wood for the trees, the more forest a district has, the happier it must be.
There are a host of reasons why this is so and many of these reasons have to do
with the idea of ‘environment’, both as the presence of and manifestation of
what in English is called ‘nature’, and also as the provision of many of the
basic materials that are central to our lives.

 

Our Indic conception transcends
‘environment’ entirely, for our tradition regards the earth as Bhudevi,
whose consort Vishnu incarnates from age to age to rid her of the
accumulation of demonic forces. He does this out of love for the earth and its
inhabitants.

 

As guardians and practitioners of
this tradition, those who live close to and within the forest tracts of
Nandurbar and Kokrajhar would be the ideal persons to inform us about the worth
and value of the forest to their lives. To even the partially observant
traveller, India’s tribal and rural societies – wondrously variegated though
their individual cultures may be – take much of their identity from the forest
and from nature.

 

The forest supplies them with
firewood and timber for construction, it is home to the animal and bird prey
they seek for their cooking pots; the forest contains the medicinal plants and
herbs that indigenous and local medicinal traditions depend upon; fruits are
plentiful, cattle are watchfully allowed into the forest to seek the remedies
they are preternaturally aware of; and the forest is home to the wild relatives
of the grasses we call cereals and to the great majority of our vegetables.

 

If we compare this list of what the
forest supplies its residents with with another list, that of what contemporary
industrial society supplies its residents with, then there is no contest about
which list is the longer one. However, the most elementary materials on both
lists are none too different from each other. What is different is that the
non-forest list supplies each and every one of its items for a fee.

 

That fee embodies several important
concepts. There is extraction or collection of the primary material (wood, for
example, in the form of whole, uncut logs), movement of the primary material to
a place where some initial transformation to it can take place (such as a saw
mill), movement of the transformed material to a consumption centre (such as a
town or city), further transformation (sections for door and window frames, for
furniture, shaping into ordinary household goods, shaping into crafts items and
curios), final purchase and use in a wholesale or retail transaction.

 

These concepts communicate with us
in today’s world not as the transformation of a material, not as a reminder of
the origin of a material, but through a number we call the cost that is
connected to either the extraction of a material, the transformation of a
material, or the marketing of a transformed material to its final consumers.

 

These costs, whether considered once
depending upon where, in this chain of transformation, you stand, or whether
considered two or three times by those tasked with analysing an industry based
on a primary material, satisfy the current frameworks we employ to describe how
value is understood, multiplied and given economic substance. But they are
utterly unable to convey other kinds of valuing, especially the kind that the
tribal societies of Nandurbar and Kokrajhar use when they regard primary
material from their forests.

 

What are these other kinds of value?
From the point of view of the holders of knowledge about the primary material
in all its aspects, values associated with the forest in their living vicinity
are cultural, social, spiritual and pertain to health and well-being. Their
knowledge relates not to the market worth of a cubic metre of wood and how much
price value can be added to that block of wood by transforming it into a
contemporarily styled cabinet, or an objet d’art. Their knowledge
relates to the numerous physical conditions that need to be maintained and
balanced so that trees in the forest, just as much as the forest’s flora and
non-human residents, continue to be nourished.

 

The manner in which our system of
national accounts is framed, there is no scope whatsoever for knowledge of this
kind to be recognised, let alone to be valued even if imperfectly. Yet it is
becoming clearer with every passing year that such a valuation is needed. The
clarity comes because several biophysical and geophysical changes are becoming
more intense.

 

There is the diminishing of
biodiversity, which means fewer species than before. There is the expansion of
the human settlement footprint, which encroaches on nature’s territory, and in
doing so alters natural rhythms (such as when a wetland is filled in to become
a city suburb). There are the effects of climate change and variation, which
affect crop cycles as much as coastal towns or snowfields.

 

The science that monitors these
changes has led to some sophisticated models being created which, in turn, lead
to estimates of risk (and the corollary, prescriptions for the mitigation of
risk) and therefore estimates of the costs of not acting to reduce risk. This
is where cost sets that can apply to the bewildering complexity of our natural
world make their appearance. A domain dedicated to this nascent art has been
named, too: it’s environmental-economic accounting.

 

India’s official statisticians have considered
how to ‘cost’ (or ‘price’) nature since the mid-1990s, when experimental
accounts which included ‘nature’s value’ were drawn up for a few states. The
activity has languished at that level since. Had they looked at our wisdom,
they may well have found inspiration, for the Shiva Purana explained to
us that during Kaliyuga, our present age, one of the many signs of
growing chaos is that the merchant class ‘have abandoned holy rites such as
digging wells and tanks, and planting trees and parks’ (II.1.24).

 

Now, however, India’s obligations to
the large number of multilateral treaties and agreements which have to do with
environment and biodiversity broadly, as well as the effects of climate change,
and moreover to the United Nations Sustainable Development Goals, are running
into the inherent limitations of the system of national accounts that, so far,
excludes nature and knowledge systems associated with nature.

 

The accounting fraternity in our
country possesses experience and wisdom aplenty, for they know the daily pulse
of a huge and astonishingly variegated economic web. As our companies and
industries learn to lighten the environmental footprint of all their
activities, their need to adopt methods to measure, cost, assess and plan for
the environmental consequences of those activities will only increase.

 

Yet
it is not for us to adopt, in the name of standardisation, an ‘international’
method that values nature. Rather, what is called for is an Indic
conceptualisation of nature which suits our civilisational economic trajectory
and which is rooted in our scriptures. ‘Heaven is my father; my mother is this
vast earth, my close kin,’ says the Rig Veda (1.164.33).

 

By taking up such a challenge –
conceiving and imparting a new accounting literacy that sensitively interprets
the wisdom of our rishis and sants to temper the demands of our
era – the accounting fraternity will contribute considerably to renewing our
homage to Bhudeví.

 

(The author, Rahul Goswami, lives in Goa and is
the Unesco-Asia expert on intangible cultural heritage) 

Sections 144C(1), 143(3) – For the period prior to 1st April, 2020 in case of an eligible assessee, draft assessment order u/s 143(3) r.w.s. 144C(1) is not required to be passed in cases in which no variation in returned income or loss is proposed Mere issuance of draft assessment order, when it was legally not required to be issued, cannot end up enhancing the time limit for completing the assessment u/s 143(3)

2.       [2020]
115 taxmann.com 78 (Mum.)

IPF India Property Cyprus (No. 1) Ltd. vs. DCIT

ITA No. 6077/Mum/2018

A.Y.: 2014-15

Date of order: 25th February, 2020

 

Sections 144C(1), 143(3) – For the period prior to 1st April,
2020 in case of an eligible assessee, draft assessment order u/s 143(3) r.w.s.
144C(1) is not required to be passed in cases in which no variation in returned
income or loss is proposed

 

Mere issuance of draft assessment order, when it was legally
not required to be issued, cannot end up enhancing the time limit for
completing the assessment u/s 143(3)

 

FACTS

The A.O., for A.Y. 2014-15, passed a draft assessment order
u/s 143(3) r.w.s. 144C(1) even when no variation was proposed therein to the
income or loss returned by the assessee.

 

The assessee challenged the correctness of the DRP’s order
dated 26th July, 2018 in the matter of assessment u/s 144(C)(1)
r.w.s. 143(3) of the Act. It contended that the A.O. had erred in passing a
draft assessment order u/s 143(3) r.w.s. 144C(1) of the Act, even when no
variation has been proposed therein to the income or loss returned by the
assessee and in passing the final assessment order u/s 143(3) of the Act, after
the due date provided u/s 153 of the Act, thus making the final assessment
order illegal, bad in law and non-est.

 

HELD

The Tribunal observed that the short question for
adjudication is whether or not the A.O. was justified in passing a draft
assessment order on the facts of the case, and whether the fact that the A.O.
chose to issue the draft assessment order even though he was not required to do
so, would result in affecting the normal time limit within which the normal
assessment order u/s 143(3) is to be issued. It also observed that there are no
variations in the returned income and the assessee income.

 

The controversy is thus confined to the question as to what
will be the rate on which income returned by the assessee is to be taxed. While
the assessee has claimed taxation @ 10% under article 11(2) of the India-Cyprus
DTAA, the A.O. has declined the said treaty protection on the ground that the
assessee was not beneficial owner of the said interest and, accordingly,
brought the income to tax @ 40% thereof. The Tribunal observed that there is,
quite clearly, no variation in the quantum of income.

 

The Tribunal observed that the assessee before it is a
non-resident company incorporated, and fiscally domiciled, in Cyprus.
Accordingly, in terms of section 144C(15)(b)(ii), the assessee is an eligible
assessee but then there is no change in the figure of income returned by the
assessee vis-a-vis the income assessed by the A.O. It held that there
is, therefore, no question of a draft assessment order being issued in this
case. It noted that the Finance Bill, 2020 proposes to make the issuance of
draft assessment orders in the case of eligible assessees mandatory even when
there is no variation in the income or loss returned by the assessee, but then
this amendment seeks to amend the law with effect from 1st April,
2020. Since the amendment is being introduced with effect from that date, the
Tribunal held that it is beyond any doubt that so far as the period prior to 1st
April, 2020 is concerned, in the cases in which no variations in the returned
income or loss were proposed, the draft assessment orders were not required to
be issued. The Tribunal upheld the plea of the assessee on this point.

 

The Tribunal noted that if no draft assessment order was to
be issued in this case, the assessment would have been time-barred on 31st
December, 2017 but the present assessment order was passed on 17th
August, 2018. It held that since no draft assessment order could have been
issued in this case, as the provisions of section 144C(1) could not have been
invoked, the time limit for completion of assessment was available only up to
31st December, 2017. The mere issuance of a draft assessment order,
when it was legally not required to be issued, cannot end up enhancing the time
limit for completing the assessment u/s 143(3). The Tribunal held the
assessment order to be time-barred.

 

The Tribunal allowed these grounds of appeal filed by the
assessee.

Sections 23, 24(b) – Where assessee is receiving rent from his own son and daughter who are financially independent, property is both a self-occupied and a let-out property – Consequently, interest claim cannot be allowed in full and shall have to be suitably proportioned, restricting the interest claim relatable to the self-occupied part thereof to Rs. 1.50 lakhs

1.       [2020]
115 taxmann.com 179 (Mum.)

Md. Hussain Habib Pathan vs. ACIT

ITA No. 4058/Mum/2013

A.Y.: 2009-10

Date of order: 5th March, 2020

 

Sections 23, 24(b) – Where assessee is receiving rent from
his own son and daughter who are financially independent, property is both a
self-occupied and a let-out property – Consequently, interest claim cannot be
allowed in full and shall have to be suitably proportioned, restricting the
interest claim relatable to the self-occupied part thereof to Rs. 1.50 lakhs

 

The children of the assessee were financially independent;
so instead of just transferring some money to their father, they wanted it to
be regarded (by mutual agreement) as rent – They believed that thus he would
receive funds in the shape of rent and that would also help meet their father’s
(the assessee’s) interest burden and help him with some tax savings – It was to
be regarded as a genuine arrangement in order to minimise assessee’s tax
liability

 

FACTS

The assessee claimed a loss of Rs. 15,32,120 qua his
residential house property in Mumbai. He claimed that he had incurred interest
on borrowed capital of Rs. 21,62,120 which was adjusted against rental income
of Rs. 9,00,000; this (rent), on a field inquiry, was found by the A.O. to be
from the assessee’s major son and major daughter residing in the said property
along with other family members of the assessee.

 

The A.O. was of the view that nobody would charge rent (for
residence) from his own son and daughter, particularly considering that both
are unmarried and living together with their family at its self-owned abode.
The arrangement was therefore regarded as merely a tax-reducing device adopted
by the assessee and liable to be ignored. Treating the house property as a
self-occupied property, the A.O. restricted the claim of interest u/s 24(b) to
Rs. 1,50,000.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) who
confirmed the action.

 

Aggrieved, the assessee preferred an appeal to the Tribunal
where he contended that there is nothing to show that the arrangement, which is
duly supported by written agreements furnished in the assessment proceedings,
is fake or make-believe. Rental income cannot be overlooked or disregarded
merely because it arises from close family members. However, on a query from
the Bench, the counsel for the assessee was not able to state the status, i.e.,
self-occupied or rented, of the said premises for the earlier or subsequent
years, though he submitted that this is the first year of the claim of loss. He
was also unable to tell the Bench about the area let out, i.e., out of the
total area available, inasmuch as other family members, including the assessee,
were also residing in the same premises.

 

The Revenue’s case, on the other hand, was of no cognisance
being accorded to an arrangement which is against human probabilities and
clearly a device to avoid tax.

 

HELD

The Tribunal observed that the arrangement is highly unusual,
particularly considering that the rent is in respect of a self-owned property
(i.e., for which no rent is being paid), which constituted the family’s
residence, and with the assessee’s son and daughter both being unmarried.
However, the Bench felt that that may not be conclusive in the matter. Being a
private arrangement not involving any third party, not informing the
co-operative housing society was also found to be of not much consequence. It also
observed that the Revenue has rested on merely doubting the genuineness of the
arrangement without probing the facts further. What was the total area, as well
as its composition / profile? How many family members, besides the assessee
(the owner) and the two ‘tenants’, were resided thereat? Has the area let out
been specified, allowing private space (a separate bedroom each) to the son and
the daughter who would in any case be also provided access to or use of the
common area – specified or not so in the agreement/s, viz. kitchen, balcony,
living area, bathrooms, etc.? How had the rent been received, in cash or
through a bank and, further, how had it been sourced, whether from the assessee
(or any other family member), or from the capital / income of the ‘tenants’?
Why was there no attempt even to inquire whether the arrangement was a
subsisting / continuing one, or confined to a year or two, strongly suggestive
in the latter case of a solely tax-motivated exercise?

 

The Tribunal held that it could, however, well be that the
assessee’s major son and daughter are financially independent (or substantially
so), with independent incomes, sharing the interest burden of their common
residence with their father. As such, instead of transferring funds to him have
decided by mutual agreement to give the amounts as rent as that would, apart
from meeting the interest burden to that extent, also allow tax saving to the
assessee-father. A genuine arrangement cannot be disregarded just because it
results in or operates to minimise the assessee’s tax liability. The Tribunal
found itself in agreement with the assessee’s claim inasmuch as there was
nothing on record to further the Revenue’s case of the arrangement not being a
genuine one, but just that it was an unusual one.

 

However, on quantum the Tribunal found the stand of the
assessee infirm. It held that the house property, that is, the family residence
of the Pathan family, was both a self-occupied and a let-out property in view
of the rent agreements. It observed that the interest claimed (Rs. 21.62 lakhs)
is qua the entire property, which therefore cannot be allowed in full
against the rental income, which is qua only a part of the house
property. The assessee’s interest claim therefore cannot be allowed in full and
shall have to be suitably proportioned, restricting the interest claim
relatable to the self-occupied part thereof to Rs. 1.50 lakhs as allowed. The
assessee shall provide a reasonable basis for such allocation as well as the
working of the area let out. It observed that it may well be that in view of
the joint residence, no area (portion) is specified in the rent agreements. The
number of family members living jointly; their living requirements – which may
not be uniform; fair rental value of the property; etc. are some of the
parameters which could be considered for the purpose. The Tribunal directed the
A.O. to adjudicate thereon per a speaking order, giving definite reasons for
being in disagreement, whether in whole or in part, with the assessee’s claim
within a reasonable time.

 

The Tribunal allowed this ground of appeal filed by the
assessee.

VVF Ltd. vs. DCIT-39; [ITA. No. 9030/Mum/2010; Date of order: 31st August, 2016; A.Y.: 2007-08; Bench: F; Mum. ITAT] Section 37 – Business expenditure – Salary paid to director – The expenditure may be incurred voluntarily and without any necessity – So long as it is incurred for the purposes of business, the same is allowable as deduction

The Pr. CIT-3 vs. VVF Ltd.
[Income tax Appeal No. 1671 of 2017]

Date of order: 4th
March, 2020

(Bombay High Court)

 

VVF Ltd. vs. DCIT-39; [ITA. No.
9030/Mum/2010; Date of order: 31st August, 2016; A.Y.: 2007-08;
Bench: F; Mum. ITAT]

 

Section 37 – Business expenditure
– Salary paid to director – The expenditure may be incurred voluntarily and
without any necessity – So long as it is incurred for the purposes of business,
the same is allowable as deduction

 

A search and seizure action u/s
132(1) of the Act was carried out by the Department in the case of the assessee
and its group associates, including its directors, on 3rd January,
2008. In A.Y. 2002-03, the A.O. made an addition of Rs. 13,00,000 which
represented the salary paid to Shri Faraz G. Joshi, its Director.

 

The A.O. disallowed the salary
paid to Shri Joshi primarily relying on a statement recorded during the course
of the search u/s 132(4) of the Act. The A.O. noted that in the course of the
search it was gathered that Shri Joshi was not attending office on a day-to-day
basis and no specific duties were assigned to him except some consultation.

 

The assessee had pointed out
before the A.O. that Shri Joshi was a whole-time Director and was performing
his duties as Director of the assessee-company and was being paid remuneration
in accordance with the limits prescribed under the Companies Act, 1956.

 

The A.O. disagreed with the
assessee and concluded that the payment made to Shri Joshi in the form of
salary was an expenditure not expended wholly and exclusively for the purposes
of business and, therefore, disallowed the same u/s 37(1) of the Act.

 

The CIT(A) also sustained the
action of the A.O. by noting that Shri Joshi had specifically admitted in the
statement recorded at the time of the search that he was not attending office
for the last six years and no specific duties were assigned to him.

 

The Tribunal held that the
assessee has appropriately explained the statement rendered by Shri Joshi. His
answer has to be understood in the context of the question raised. In this
context, attention has been drawn to the relevant portion of the statement,
which reads as under:

 

‘Q.9: What is the nature of
business conducted by the company, i.e., M/s VVF Ltd.?

A.9:  The company deals in Oleo-Chemicals. We also
work on contract basis for Jhonson & Jhonson (sic)
& Racket – Colman (sic). (Johnson & Johnson; Reckitt-Coleman.)

Q.10: Who looks after the day to
day activity of that company and what are the duties assigned to you?

A.10: I am not aware about the
person who looks after the day to day business activity. Since last 6 years I
am not attending the office nor any duty is assigned to me except
consultation.’

 

It has been explained that the
answer by Shri Joshi was in response to the question put to him which was as to
whether he was involved in the day-to-day management of the company. It was in
this context that the answer was given. However, it is sought to be pointed out
that the said Director was rendering consultation and advisory services which,
in fact, is the role of a Director. Therefore, it has to be understood that
services were indeed being rendered by the said Director to the assessee
company. The Tribunal observed that the overemphasis by the Revenue on the
wordings of the reply of Shri Joshi has led to a wrong conclusion.

 

Further, Shri
Joshi was one of the two main Directors of the assessee company and that
historically such salary payments had been allowed as a deduction. In fact,
there is no negation to the plea of the assessee that for A.Ys. 2009-10 to
2012-13, such salary payments stood allowed and such assessments have been
completed even after the search carried out on 3rd January, 2008. It
is judicially well settled that it is for the assessee to decide whether any
expenditure should be incurred in the course of carrying on of its business. It
is also a well-settled proposition that expenditure may be incurred voluntarily
and without any necessity and so long as it is incurred for the purposes of
business, the same is allowable as deduction even though the assessee may not
be in a position to show compelling necessity of incurring such expenditure. In
support of the aforesaid proposition, reliance can be placed on the judgment of
the Hon’ble Supreme Court in the case of Sasoon J. David & Co. P.
Ltd., 118 ITR 261 (SC).

 

Being aggrieved, the Revenue
filed an appeal to the High Court. The Court held that in response to the
specific query the answer given by Shri Joshi was quite reasonable and no
adverse inference could be drawn therefrom. Besides, the Tribunal also found that
in all the assessments made up to the date of the search, the salary payment to
Shri Joshi was allowed. Even post-search, from A.Y. 2009-10 onwards where
assessments have been made u/s 143(3) of the Act, salary paid to Shri Joshi was
not disallowed.

 

The Supreme Court in the case of Sassoon
J. David & Co. Pvt. Ltd. vs. CIT (Supra), examined the expression
‘wholly and exclusively’ appearing in section 10(2)(xv) of the Income tax Act,
1922 which corresponds to section 37 of the Act. Sub-section (1) of section 37
says that any expenditure not being expenditure of the nature described in
sections 30 to 36 and not being in the nature of capital expenditure or
personal expenses of the assessee, laid out or expended wholly and exclusively
for the purposes of the business or profession, shall be allowed in computing
the income chargeable under the head ‘Profits and gains of business or
profession’.

 

It was observed that the expression ‘wholly
and exclusively’ appearing in the said section does not mean ‘necessarily’.
Ordinarily, it is for the assessee to decide whether any expenditure should be
incurred in the course of his business. Such expenditure may be incurred
voluntarily and without any necessity. If it is incurred for promoting the
business and to earn profits, the assessee can claim deduction u/s 10(2)(xv)
even though there was no compelling need for incurring such expenditure. The
fact that somebody other than the assessee is also benefited by the expenditure
should not come in the way of an expenditure being allowed by way of deduction
u/s 10(2)(xv) of the Act. In the light of the above, the Revenue appeal was
dismissed.

 


M/s Sunshine Import and Export Pvt. Ltd. vs. DCIT; [ITA No. 4347/Mum/2015; Date of order: 9th September, 2016; Bench: B; A.Y.: 2008-09 to 2010-11; Mum. ITAT] Section 133A – Survey – Statement of directors of company recorded u/s 133A – No incriminating evidence and material – No evidentiary value – Any admission made in course of such statement cannot be made basis of addition

The Pr. CIT-4 vs. M/s Sunshine Import and Export Pvt. Ltd. [Income
tax Appeal Nos. 937, 1121 & 1135 of 2017]

Date of order: 4th March, 2020

(Bombay High Court)

 

M/s Sunshine Import and Export
Pvt. Ltd. vs. DCIT; [ITA No. 4347/Mum/2015; Date of order: 9th September,
2016; Bench: B; A.Y.: 2008-09 to 2010-11; Mum. ITAT]

 

Section 133A – Survey – Statement
of directors of company recorded u/s 133A – No incriminating evidence and
material – No evidentiary value – Any admission made in course of such
statement cannot be made basis of addition

 

The assessee is engaged in the
business of manufacturing and trading in precious and semi-precious stones and
jewellery. It has two Directors, Shri Paras Jain and Shri Saurabh Garg. A
survey u/s 133A of the Act was carried out in respect of the assessee. During
the post-survey proceedings, the statement of one of the Directors, Shri
Saurabh Garg, was recorded. He was reported to have stated that the assessee
company provided only bill entries and there was no actual transaction of
purchase and sale. Subsequently, the statement of the other Director, Shri
Paras Jain, was also recorded. From the latter statement, the A.O. came to the
conclusion that he was a person of no means and drew the inference that the
assessee was engaged in the activity of issuing accommodation bills for the
sale and purchase of diamonds, apart from acting as a dummy for importers.
Holding the transactions as not reliable, the A.O. rejected the books of
accounts of the assessee company. He assessed 2% as the rate of commission of
the assessee on account of import purchases, i.e., for acting as a dummy. That
apart, commission @ 0.75% on sales bills was also assessed.

 

The CIT(A) confirmed the action
of the A.O., whereupon the assessee filed an appeal to the Tribunal.

 

The Tribunal held that the
assessee is mainly engaged in the import of diamonds and their sale in local
markets to exporters. The import of diamonds is done through customs
authorities and banking channels in India. The import of diamonds undergoes the
appraisal process by appraisers appointed by the custom authorities. The officers
appointed by the Government of India verify physically each and every parcel of
diamonds in order to ascertain the quality, quantity, rate, value and place of
origin against the declaration made by the importers. Further, all the
transactions of purchase, sales, import are made through account payee cheques
and not a single payment is made to any party by way of cash. All the purchase
and sales transactions are carried out with reputed parties in the diamond
trade and all the payments received from debtors are through account payee
cheques; similarly, all payments to creditors are through account payee
cheques.

 

As such, the A.O. cannot
allegedly consider the import of goods as providing accommodation bills in the
market when physical delivery of goods was confirmed by the other arm of
government, i.e., the custom authorities. From the record it is noted that the
sales were made to reputed exporters who are assessed to tax and their
identities are known to the Income Tax Department. The customers are registered
under state VAT laws. The company has received payments against sales proceeds
by account payee cheques. The company has also purchased from local parties to
whom payment was made by account payee cheques. To discharge the onus of
proving the transactions as genuine and to substantiate that all purchases and
sales made are genuine, the assessee has submitted various documents and
submissions; copies of bank statement for the relevant year; ledger copies of
various purchases from parties for A.Y. 2008-09 and 2009-10; photo copies of
purchase invoices of parties for A.Y. 2008-09 and 2009-10; the relevant copies
of the daily stock register; confirmation from various sale parties; details of
interest received from various parties; details of unsecured loans along with
confirmation; and so on. These documents prove that the assessee is not engaged
in issuing accommodation bills and acting as a dummy for importing diamonds.
Thus, the contention of the A.O. that the bills issued by the assessee are all
accommodation bills is wrong. Just on the basis of one recorded statement he
cannot reach the conclusion that the assessee has issued accommodation bills
and reject the books of accounts of the assessee.

 

Being aggrieved by the order of
the ITAT, the Revenue filed an appeal to the High Court. The Court held that in
arriving at such a finding, the Tribunal had noted that the survey party did
not find any incriminating evidence and material that could establish the stand
taken by the A.O. There was no disputing the fact that no incriminating
evidence was found on the day of the survey. It was also noted that merely on
the basis of the statement of one of the directors, Shri Saurabh Garg, and
that, too, recorded after 20 to 25 days of the survey, could not be sufficient
for bringing into assessment and making any addition to the income without
further supporting or corroborative evidence. The statement recorded u/s 133A
of the Act not being recorded on oath, cannot have any evidentiary value and no
addition can be made on the basis of such a statement.

 

In CIT
vs. S. Khader Khan Son 300 ITR 157, the Madras High Court had concluded
that a statement recorded u/s 133A of the Act has no evidentiary value and that
materials or information found in the course of survey proceedings could not be
a basis for making any addition; besides, materials collected and statements
obtained u/s 133A would not automatically bind the assessee. This was affirmed
by the Supreme Court by dismissing the civil appeal of the Revenue in CIT
vs. S. Khader Khan Son (Supra). In view of the above, the Revenue
appeal fails and is accordingly dismissed.

Settlement of cases – Section 245D of ITA, 1961 – Proceedings for settlement are not adjudicatory proceedings – Assessee disputing liability but offering to pay additional tax – No non-disclosure of full and true facts – Order of Settlement Commission accepting offer of assessee is valid

8. Principal CIT vs.
Shreyansh Corporation

[2020] 421 ITR 153 (Guj.)

Date of order: 7th
October, 2019

A.Y.: 2004-05

 

Settlement of cases – Section
245D of ITA, 1961 – Proceedings for settlement are not adjudicatory proceedings
– Assessee disputing liability but offering to pay additional tax – No
non-disclosure of full and true facts – Order of Settlement Commission accepting
offer of assessee is valid

On an application for settlement
after considering the issues put forth by the Principal Commissioner in the
report u/r 9 of the Income-tax Rules, 1962 and the rejoinders of the assessees
and the documents submitted along with the statement of facts and the
submissions of the respective parties, the Settlement Commission noted that
insofar as the addition to partner’s capital was concerned, the assessees had
submitted affidavits made by M and the two assessees and it was further stated
that if at any stage these affidavits were found to be false, it may be treated
as a misrepresentation of facts u/s 245D(6) of the Act and the consequences as
u/s 245D(7) of the Act may follow in the case of the two assessees. The
Settlement Commission further noted that the assessees had offered additional
income for bringing quietus to certain issues in the spirit of a
settlement.

 

Taking into account all the facts
and discussions on record, the Settlement Commission was of the view that the additional
income offered during the section 245D(4) proceedings by the applicant’s letter
dated 8th June, 2018 over the additional income disclosed in the
settlement applications could be accepted with reference to the income
disclosed in the settlement applications. It further noted that the
Commissioner and the A.O. also did not make any further submissions. The
Settlement Commission accordingly settled the cases of the assessees on the
terms and conditions set out in the order.

 

The Principal Commissioner filed
writ petitions and challenged the order of the Settlement Commission. The
Gujarat High Court dismissed the petitions and held as under:

 

‘i)    The proceedings before the Settlement Commission are in the
nature of settlement between the parties and are not strictly speaking
adjudicatory proceedings. On a perusal of the order passed by the Settlement
Commission it was abundantly clear that the assessees had not accepted the
liability of 5% of trading expenses but in the spirit of settlement offered to
pay the amount computed by the A.O. with a view to bring quietus to the
matter and buy peace of mind. The offer to pay such amounts in addition to the
amounts disclosed in the applications u/s 245C of the Act could not be said to
be disclosure of any further amounts under that section as they had been
offered only to bring about a settlement.

 

ii)    The fact that the assessees had offered to pay such amounts, the
liability whereto they had not accepted, could not be termed as non-disclosure
of full and true facts in the applications u/s 245C of the Act.


iii)  Under the circumstances, considering
the amounts so offered by way of settlement, which were quite meagre
considering the overall disclosure made, there was no infirmity in the order
passed by the Settlement Commission warranting interference in exercise of
powers under article 226 of the Constitution of India’.

Revision – Section 264 of ITA, 1961 – Application for revision – Powers of Commissioner – Powers u/s 264 are very wide – Mistake in computation of income and revised return barred by limitation – Commissioner finding that mistake was inadvertent and claim for deduction bona fide – Order rejecting application for revision is not valid Income-tax – General principles – Effect of Article 265 of the Constitution of India – No tax collection except by authority of law

7. Sharp Tools vs. Principal
CIT

[2020] 421 ITR 90 (Mad.)

Date of order: 23rd
October, 2019

A.Y.: 2013-14

 

Revision – Section 264 of ITA,
1961 – Application for revision – Powers of Commissioner – Powers u/s 264 are
very wide – Mistake in computation of income and revised return barred by
limitation – Commissioner finding that mistake was inadvertent and claim for
deduction bona fide – Order rejecting application for revision is not
valid

 

Income-tax – General principles –
Effect of Article 265 of the Constitution of India – No tax collection except
by authority of law

 

The assessee
filed its return of income for the A.Y. 2013-14. It then received an intimation
u/s 143(1) of the Income-tax Act, 1961 accepting the returned income.
Thereafter, the assessee realised that a mistake had inadvertently crept in
while filling up the quantum in column 14(i) of the return. Therefore, on 9th
January, 2016, the assessee filed a revised return rectifying the mistake. The
return was not processed by the Central Processing Centre, since it was
considered as a revised return filed beyond the specified time u/s 139(5) of
the Act. The assessee made an application to the A.O. for rectification u/s
154. The A.O. rejected the plea,  stating
that the claim was belated. Thereafter, the assessee filed a revision petition
u/s 264. Though the Principal Commissioner found that the mistake was inadvertent
and that the claim was bona fide, he rejected the revision petition.

 

The assessee filed a writ
petition against the order. The Madras High Court allowed the writ petition and
held
as under:

‘i)    A careful perusal of section 264 of the Income-tax Act, 1961
would show that it empowers the Principal Commissioner or the Commissioner to
exercise the revisional jurisdiction over “any order” other than the
order to which section 263 applies. Such power is wider and confers on such
authority the responsibility to set things right wherever he finds that an
injustice has been done to the assessee. Before passing any order u/s 264 of
the Act, it is open to the authority to make such inquiry or cause such inquiry
to be made. However, such order should not be prejudicial to the assessee.

 

ii)    Article 265 of the Constitution of India specifically states that
no tax shall be levied or collected except by authority of law. Therefore, both
the levy and collection must be with the authority of law, and if any levy or
collection is later found to be wrong or without authority of law, certainly
such levy or collection cannot withstand the scrutiny of the Constitutional
provision and would be in violation of article 265 of the Constitution of
India.

 

iii)   A mere typographical error committed by the
assessee could not cost it payment of excess tax as collected by the Revenue.
The denial of repayment of such excess collection would amount to great
injustice to the assessee. Even though the statute prescribes a time limit for
getting the relief before the A.O. by way of filing a revised return, there was
no embargo on the Commissioner to exercise his power and grant the relief u/s
264. The order rejecting the application for revision was not valid.

 

iv)    Accordingly, this writ petition is
allowed and the impugned order is set aside. Consequently, the matter is
remitted back to the respondent for considering the claim of the petitioner and
to pass appropriate orders in the light of the observations and findings
rendered supra. The respondent shall, accordingly, pass such fresh order
within a period of six weeks from the date of receipt of a copy of this order.’

Recovery of tax – Company in liquidation – Recovery from director – Section 179 of ITA, 1961 – Where A.O. issued a notice u/s 179 against assessee director of a company seeking to recover tax dues of the company, since such notice was totally silent regarding fact that tax dues could not be recovered from company and, further, there was no whisper of any steps being taken against company for recovery of outstanding amount, impugned notice u/s 179 against director was to be set aside

6. Ashita Nilesh Patel vs.
ACIT

[2020] 115 taxmann.com 37
(Guj.)

Date of order: 20th
January, 2020

A.Ys.: 2011-12 to 2014-15

 

Recovery of tax – Company in
liquidation – Recovery from director – Section 179 of ITA, 1961 – Where A.O.
issued a notice u/s 179 against assessee director of a company seeking to
recover tax dues of the company, since such notice was totally silent regarding
fact that tax dues could not be recovered from company and, further, there was
no whisper of any steps being taken against company for recovery of outstanding
amount, impugned notice u/s 179 against director was to be set aside

 

The assessee was a director in
the company TPPL which failed to make payment of outstanding tax demand of
certain amount. The A.O. observed that it was noticed from the records of the
company that there were no recoverable assets in the name of the assessee
company. In such circumstances, proceedings u/s 179 of the Income-tax Act, 1961
were initiated by way of issuing of notice to the assessee treating her as
jointly and severally liable for payment of such tax.

 

The assessee filed a writ
petition challenging the notice. The Gujarat High Court allowed the writ
petition and held as under:

 

‘i)    Section 179(1) provides for the joint and several liability of
the directors of a private company, wherein the tax dues from such company in
respect of any income of any previous year cannot be recovered. The first
requirement, therefore, to attract such liability of the director of a private
limited company is that the tax cannot be recovered from the company itself.
Such requirement is held to be a pre-requisite and necessary condition to be
fulfilled before action u/s 179 can be taken. In the context of section 179
before recovery in respect of the dues from a private company can be initiated
against the directors, to make them jointly and severally liable for such dues,
it is necessary for the Revenue to establish that such recovery cannot be made
against the company and then alone can it reach to the directors who were
responsible for the conduct of the business during the previous year in
relation to which liability exists.

 

ii)    There is no escape from the fact that the perusal of the notice
u/s 179 reveals that the same is totally silent as regards the satisfaction of
the condition precedent for taking action u/s 179, viz., that the tax dues
cannot be recovered from the company. In the show cause notice, there is no
whisper of any steps having been taken against the company for recovery of the
outstanding amount. Even in the impugned order, no such details or information
has been stated.

 

iii)   In the circumstances referred to above, the question is whether
such an order could be said to be sustainable in law. The answer has to be in
the negative. At the same time, in the peculiar facts and circumstances of the
case and, more particularly, when it has been indicated by way of an additional
affidavit-in-reply as regards the steps taken against the company for the
recovery of the dues, one chance is to be given to the Department to undertake
a fresh exercise so far as section 179 is concerned. If the show cause notice
is silent including the impugned order, the void left behind in the two
documents cannot be filled by way of an affidavit-in-reply. Ultimately, it is
the subjective satisfaction of the authority concerned that is important and it
should be reflected from the order itself based on some cogent materials.

 

iv)   The impugned notice as well as the
order is hereby quashed and set aside. It shall be open for the respondent to
issue fresh show cause notice for the purpose of proceeding against the writ
applicant u/s 179.’

Income – Business income – Section 41 of ITA, 1961 – Remission or cessation of trading liability – Condition precedent for application of section 41 – Assessee must have obtained benefit in respect of liability – Mere change of name in books of accounts not sufficient – Interest liability of State Government undertaking on government loans converted by order of State Government into equity share capital – No cessation of liability – Section 41 not applicable

5. CIT vs. Metropolitan
Transport Corporation (Chennai) Ltd.

[2020] 421 ITR 307 (Mad.)

Date of order: 9th
July, 2019

A.Y.: 2001-02

 

Income – Business income –
Section 41 of ITA, 1961 – Remission or cessation of trading liability –
Condition precedent for application of section 41 – Assessee must have obtained
benefit in respect of liability – Mere change of name in books of accounts not
sufficient – Interest liability of State Government undertaking on government
loans converted by order of State Government into equity share capital – No
cessation of liability – Section 41 not applicable

 

The assessee was a wholly-owned
Tamil Nadu Government undertaking, operating transport services. The assessee
had taken over the assets and liabilities of the transport services, which were
previously run by the Tamil Nadu State Government. The State Government treated
a part of the net worth of the undertaking as its share capital and the balance
as loan, on which the assessee claimed and was allowed interest payable year
after year as deduction u/s 37 of the Income-tax Act, 1961. The Government of
Tamil Nadu took a decision and issued G.O. (Ms). No. 18, dated 7th
March, 2001 converting the interest outstanding of Rs. 8,264.17 lakhs payable
by the assessee company on 31st October, 2000 into equity shares.
The A.O. held that the sum of Rs. 8,264.17 lakhs was assessable u/s 41(1) of
the Act.

 

The Tribunal held that the amount
was not assessable u/s 41.

On appeal by the Revenue, the
Madras High Court upheld the decision of the Tribunal and held as under:

 

‘i)    It is a prerequisite condition before having recourse to section
41 of the Income-tax Act, 1961 that the assessee must have either obtained the
amount in respect of the loss, expenditure or trading liability incurred
earlier by it, or it should have received any benefit in respect of such
trading liability by way of remission or cessation thereof. The objective is to
tax the amount or benefit received by the assessee, thereby making him pay back
the benefit availed of earlier by him by way of claiming loss, expenditure or
liability in respect of that amount. Remission is a positive conduct on the
part of the creditor. Mere change of nomenclature in the books of accounts
without anything more brings no benefit to the assessee and its liability to
pay to the creditor does not get extinguished. The treatment given in
accounting entries does not give rise to a taxable event. To invoke section 41
of the Act, the initial burden is on the Revenue to establish cessation or
remission of liability.

 

ii)    When there was no writing off of liabilities and only the
sub-head under which the liability was shown in the account books of the
assessee was changed, there could be no cessation of liability. When the
assessee company was liable to pay and it continued to remain liable even after
change of entries in the books of accounts, no benefit would accrue to the
assessee company merely on account of change of nomenclature, and consequently
the question of treating it as profit and gain would not arise.

 

iii)   For all the above reasons, the appeal
filed by the Revenue is dismissed and the substantial question of law is
answered against the Revenue.’

Income – Accounting – Section 145 of ITA, 1961 – Rejection of accounts and estimate of income – Discretion of A.O. must be exercised in a judicious manner

4. Rameshchandra Rangildas
Mehta vs. ITO

[2020] 421 ITR 109 (Guj.)

Date of order: 15th July,
2019

A.Y.: 2011-12

 

Income – Accounting – Section 145
of ITA, 1961 – Rejection of accounts and estimate of income – Discretion of
A.O. must be exercised in a judicious manner

 

For the A. Y. 2011-12 the
appellant had filed his return of income on 15th September, 2011
declaring total income at Rs. 5,34,342. The case was selected for scrutiny and notice
u/s 143(2) of the Income-tax Act, 1961 was issued dated 31st July,
2012. The appellant filed his revised return of income on 30th
March, 2012, declaring a total income of Rs. 7,44,070 and claimed refund of Rs.
23,26,700. According to the appellant, he derived income from civil contracts
(labour job works). The appellant showed gross business receipts of Rs.
12,00,02,100 and a net profit of Rs. 5,37,942. The refund of Rs. 23,26,700 out
of the prepaid taxes contained tax deducted by M/s PACL Limited against the
payment for labour. The appellant showed labour receipts for income account of
Rs. 12,00,02,100.

 

The A.O., relying on the
statement of the appellant recorded u/s 131 of the Act and the information
received subsequent to the search in the case of M/s PACL India Limited, came
to the conclusion that the dealings of the appellant with M/s PACL India
Limited were accommodation entries. The A.O. issued show cause notice dated 14th
March, 2014 calling upon the appellant to show cause as to why the labour
receipt income of Rs. 12,00,02,100 should not be treated as income from other
sources u/s 56 of the Act. The appellant, vide his reply dated 21st
March, 2014, explained that he had only received commission of Rs. 0.30 on Rs.
100, i.e., Rs. 3,60,000 on Rs. 12,00,02,100 which had already been included in
the net profit and reflected in the profit and loss account. The A.O. rejected
the books of accounts u/s 145(3) of the Act and estimated the income at 10% of
the gross receipts; he made an addition of Rs. 1,20,00,210 as income from other
sources u/s 56 of the Act.

 

The appellant submitted before
the Commissioner of Income-tax (Appeals) that the estimation of net profit at
10% was on the higher side and he had received commission at 0.45% only. He
also pointed out that the returned income included the profit of Rs. 4,13,742
from the labour contract receipts and set-off should have been granted against
the addition of commission income by the A.O. The Commissioner (Appeals)
estimated the commission at Rs. 24,00,042, i.e., 2% on the basis that the same
is 6.7% of the tax benefit derived by PACL India Limited, i.e., 30%, and the
same was a reasonable estimate. The Commissioner (Appeals) took the view that
the set-off of only the net income from the fictitious contract receipts could
be granted. Further, he reduced the interest income and retail sales from the
net profit to grant the set-off. The set-off granted by the Commissioner
(Appeals) came to only Rs. 1,46,942 [Rs. 5,37,942 (net profit) – Rs. 1,20,000
(interest income) – Rs. 2,71,000 (retail sales)]. Thus, the Commissioner
(Appeals) partly confirmed the addition to the extent of Rs. 22,53,100.

 

Being dissatisfied with the order
passed by the Commissioner (Appeals), the Department preferred an appeal before
the Income-tax Appellate Tribunal. The appellant preferred cross-objection. The
Appellate Tribunal confirmed the order of the Commissioner (Appeals).

 

Dissatisfied with the order
passed by the Appellate Tribunal, the appellant filed an appeal before the High
Court and proposed the following substantial question of law:

 

‘Whether in the facts and
circumstances of the case, the Income-tax Appellate Tribunal was right in law
in confirming addition of Rs. 22,53,100 on account of alleged commission income
at 2% without there being any evidence or material on record for making such
estimate?’

 

The Gujarat High Court allowed
the appeal and held as under:

 

‘i)    Section 145 of the Income-tax Act, 1961 gives power to the A.O.
to reject the assessee’s accounts. Although sub-section (3) of section 145
gives him the discretion to make an assessment in the manner provided in
section 144, yet this discretion cannot be exercised arbitrarily. The question
to determine in every such case is whether there is any material for the basis
adopted by the A.O. or the Tribunal, as the case may be, for computing the
income of the assessee. The material which is irrelevant or which amounts to
mere guesswork or conjecture is no material.

 

ii)    The A.O. thought it fit to estimate 10% commission for providing
accommodation entries to the tune of Rs. 12,00,02,100. The Commissioner
(Appeals) took the view that the estimation of commission at 10% by the A.O. is
one-third of the benefit, which could be termed as excessive and not a
reasonable estimate. The Commissioner (Appeals), without there being anything on
record, thought it fit to take the view that the estimate by the assessee at 3%
translated to 1% of the benefit derived, which could be termed too low, and in
such circumstances, estimated it at 2%, which would translate to about 6.7% of
the benefit alleged to have been derived by P. This was nothing but pure
guesswork without there being any material or basis for arriving at the same.
The Tribunal was not right in law in confirming the addition.

 

iii)   Ordinarily, we would not have entertained the appeal of the
present nature having regard to the fact that the income has been assessed
based on estimation. However, the way the authorities have proceeded with the
guesswork, it cannot be approved.

 

iv)   In view of the above, this tax appeal
succeeds and is hereby allowed. The question of law is answered in favour of
the assessee and against the Revenue. The impugned order passed by the
Income-tax Appellate Tribunal is hereby quashed and set aside.’

Charitable purpose (objects of general public utility) – Section 2(15) r.w.s. 12A of ITA, 1961 – Where assessee association was engaged in primary aim and objective to organise and arrange all licensed third party administrators (TPAs) to be members of trust for mutual betterment of TPA business, merely because certain benefits accrued to TPA members and certain objects of trust were for advancement of business of TPA, it would not ipso facto render trust to be non-charitable

3. CIT (Exemption) vs.
Association of Third Party Administrators

[2020] 114 taxmann.com 534
(Delhi)

Date of order: 20th
January, 2020

 

Charitable purpose (objects of
general public utility) – Section 2(15) r.w.s. 12A of ITA, 1961 – Where
assessee association was engaged in primary aim and objective to organise and
arrange all licensed third party administrators (TPAs) to be members of trust
for mutual betterment of TPA business, merely because certain benefits accrued
to TPA members and certain objects of trust were for advancement of business of
TPA, it would not ipso facto render trust to be non-charitable

 

On 12th December, 2005
the assessee association of third party administrators (ATPA) filed an
application seeking registration u/s 12A of the Income-tax Act, 1961. The said
application was rejected by the Director (Exemption) holding that certain
objects of the trust were not charitable and trustees had discretion in
applying the trust’s income to any of the objects. The Director (Exemption)
held that the assessee ATPA was aiming at industry status for third party
administrator (TPA) business and was working for mutual benefit of its members.

 

The Tribunal allowed the appeal
in favour of the assessee and directed the Commissioner (Exemption) to provide
registration to the assessee u/s 12AA of the Act.

 

On appeal by the Revenue, the
Delhi High Court upheld the decision of the Tribunal and held as under:

 

‘i)    At the initial stage of registration, it is
to be examined whether the proposed activities of the assessee can be
considered charitable within the meaning of section 2(15). On an application
for registration of a trust or institution made under section 12AA, the
Principal Commissioner or Commissioner shall call for such documents or
information from the trust or institution as he thinks necessary in order to
satisfy himself about the genuineness of the activities of the trust or
institution; and the compliance of such requirements of any other law for the
time being in force by the trust or institution, as are material for the
purpose of achieving its objects, and he may also make such inquiries as he may
deem necessary in this behalf. Once he is satisfied about the objects of the
trust or institution and the genuineness of its activities, he shall pass an
order under the said provision. On this aspect the tax authorities have looked
into the aims and objects of the trust.

 

ii)    The primary or dominant object of the trust satisfies the
conditions laid down u/s 2(15). Even if some ancillary or incidental objects
are not charitable in nature, the institution would still be considered as a
charitable organisation. Merely because some facilities were beyond its main
object, that by itself would not deprive the institution of the benefits of a
charitable organisation. If the primary purpose of advancement of objects is
for general public utility, the institution would remain charitable, even if
there are incidental non-charitable objects for achieving the said purpose.

 

iii)   Merely because the objects of the trust are for the advancement of
the business of TPA, it would not ipso facto render the trust to be
non-charitable. The objects of the trust are not exclusively for the promotion
of the interests of the TPA members. The objects were to provide benefit to the
general public in the field of insurance and health facilities. In the course
of carrying out the main activities of the trust, the benefits accruing to the
TPA members cannot, by itself, deny the institution the benefit of being a
charitable organisation.

 

iv)     For
the foregoing reasons, there is no substantial question of law arising.
Accordingly, the appeal is dismissed.’

Business expenditure – Disallowance of expenditure relating to exempted income – Section 14A of ITA, 1961 – Disallowance cannot exceed exempt income earned – Tribunal restricting disallowance to extent offered by assessee – Proper

2. Principal CIT vs. HSBC Invest Direct (India) Ltd.

[2020] 421 ITR 125 (Bom.)

Date of order: 4th
February, 2019

A.Y.: 2009-10

 

Business
expenditure – Disallowance of expenditure relating to exempted income – Section
14A of ITA, 1961 – Disallowance cannot exceed exempt income earned – Tribunal
restricting disallowance to extent offered by assessee – Proper

 

The assessee
is a limited company. In the return of income filed for the A.Y. 2009-10, the
question of making disallowance to the expenditure claimed by the assessee in
terms of section 14A of the Income-tax Act, 1961 read with Rule 8D of the
Income-tax Rules, 1962 came up for consideration. During the assessment in the
appellate proceedings, the assessee offered restricted disallowance of Rs. 1.30
crores. The Department contended firstly that the statutory auditors in the
report had made a disallowance of Rs. 2.53 crores u/s 14A of the Income-tax
Act, 1961, and secondly that in view of the assessee’s income which was exempt,
the disallowance had to be made under Rule 8D of the Income-tax Rules, 1962.
The Tribunal accepted the assessee’s voluntary offer of disallowance of
expenditure.

 

The Revenue filed an appeal
against the judgment of the Income-tax Appellate Tribunal, raising the
following question for consideration:

 

‘(i) Whether the order of the
Tribunal is perverse in law as it ignored the disallowance computed by the
auditors of the assessee which was in accordance with section 14A of the
Income-tax Act, 1961 read with Rule 8D of the Income-tax Rules, 1962?’

 

The Bombay High Court upheld the
decision of the Tribunal and held as under:

‘i) The disallowance of expenditure incurred to earn the exempt
income could not exceed the exempt income earned. The ratio of the decisions in
the cases of Cheminvest Ltd. vs. CIT [2015] 378 ITR 33 (Delhi) and
CIT vs. Holcim India (P) Ltd. (I.T.A. No. 486 of 2014 decided on 5th
September, 2014) would include a facet where the assessee’s exempt
income was not nil, but had earned exempt income which was more than the
expenditure incurred by the assessee in order to earn such income.

 

ii) The order of the Tribunal which
restricted the disallowance of the expenditure to the extent voluntarily
offered by the assessee was not erroneous.’

RETURNS UNDER GST – A NEW LOOK !!

INTRODUCTION


1.  When GST was introduced in July,
2017, a lot of noise was created around the proposed elaborate return filing
systems which provided for online uploading of invoices issued by the supplier
systems, monthly reconciliation of transaction between registered persons,
amendment of transaction in case of mis-matches and subsequently filing of the
final return on a monthly basis to be followed by an annual return at the end
of the financial year and audit for suppliers where the aggregate turnover
exceeded the prescribed limit of Rs. 2 crore.

2.  However, the system remained in
papers only as implementation was hit with multiple issues, ranging from
non-functional government portal, lack of preparedness amongst all the
stakeholders, confusion relating to the law, and so on. Therefore, dropping the
above proposed structure, the elaborate return filing mechanism was kept on
hold and compliance was restricted to filing of GSTR 1, i.e., details of
outward supplies on either monthly or quarterly basis depending upon prescribed
turnover and GSTR 3B, a summary statement of outward supplies made during the
period and input tax credit availed on inward supplies on a monthly basis.

3.  However, the makeshift
arrangement did not serve the purpose of Government to allow credits based on
transaction level matching, identifying defaulting taxpayers at an earlier
stage, etc. Therefore, a new return filing mechanism has been proposed to
re-introduce the concept of uploading of all details relating to outward and
inward supplies and matching of transactions. In this article, we shall deal
with the proposed return forms and various intricate issues revolving around
the same. The entire discussion is based on the proposed return formats made
available on the public platform. The proposed return filing mechanism is
expected to be made applicable w.e.f July, 2019. The enabling provisions w.r.t
the same are contained in section 43A of the CGST Act, 2017.

 

BROAD FRAMEWORK

4.  The proposed framework
bifurcates tax payers into two categories, based on their aggregate turnover
as:

–Tax payers having annualised aggregate turnover during FY 2017-18
not exceeding Rs. 5 crore. Such tax payers have been given an option to
file returns quarterly or monthly. Further, there are three different options
of returns which can be filed by such tax payers, which are Sahaj, Sugam and
Normal returns. However, if opting for quarterly returns, the tax payers would
be required to make payment of taxes on monthly basis only, which would be
considered while filing of quarterly returns. Further, in case of fresh
registration, the turnover of the previous financial year shall be considered
as zero and therefore such taxpayers shall have an option of filing the returns
either monthly or quarterly.

–Tax payers having annualised aggregate turnover during FY 2017-18
exceeding Rs. 5 crore. Such tax payers have to compulsorily file returns on
monthly basis.

5.  The following chart explains
the proposed scheme:

 

6.  The option of whether return
has to be filed monthly or quarterly has to be selected at the start of the
financial year. It is important to note that once a periodicity is selected,
the same can be changed only during the start of next financial year. It is
also important to note that in case there is a change in status during the next
Financial Year, it will be the responsibility of the tax payer to opt for the
change. In case no option is selected, the option selected in the previous year
shall continue to be applied for the next Financial Year as well.

7.  Once a tax payer opts to file
quarterly returns, the next step that he needs to take is decide the type of
return that he has to file. For such tax payers there are three different
options of return filing available based on the type of transactions carried
out. For instance, Sahaj scheme is feasible for such tax payers who exclusively
provide service to unregistered persons while Sugam is suitable for those class
of tax payers who are providing service to both, registered as well as
unregistered persons but do not make other supplies, such as exempt, non-GST,
zero rated, etc. For the balance tax payers, i.e., who have all kinds of
transactions, the normal option has to be chosen.

8.  In case Sahaj option has been
selected, the tax payer can switch to Sugam but not vice-versa. Similarly, in
case a tax payer selects the normal scheme, he can switch to Sahaj / Sugam
scheme. However, the switch can be done only once, at the start of the
financial year. Further, option for switching from Sugam to Sahaj is not
available, except at the start of the financial year.

 

FLOW OF EVENTS


9.  The flow of events preceding
the filing of the above returns, be it Sahaj / Sugam / Normal return is

-Filing of ANX – 1 – this contains details of outward supplies made
during the tax period and details of inward supplies liable to RCM.

-Filing of ANX – 2 – based on details auto-populated from the suppliers
ANX – 1, the recipient shall file details of inward supplies are following the
steps discussed in the subsequent paras.

-Filing of RET – 1/2/3 – basis the details furnished in ANX – 1 and ANX
– 2, the tax payer will be required to file his applicable return and discharge
the applicable taxes, interest, fees, etc.,

-Interestingly, the formats are silent w.r.t the due dates for filing
the Annexures. Only in the context of ANX – 2, it has been stated that the same
shall be deemed to be filed after the return for the relevant period (month /
quarter) has been filed.

10. While the return in case of
Sahaj and Sugam has to be filed quarterly, the tax payer will have to make
payment on monthly basis in PMT-08 on provisional basis, after disclosing the
liability as well as the ITC availed provisionally, which will be available for
offset while filing the quarterly return. However, in all other cases,
compliances will have to be done on a monthly basis.

11. In this article, we shall
discuss in detail the various intricate aspects revolving around the filing of
ANX – 1 , ANX – 2 and RET – 1 along with the amendments through ANX – 1A and
RET – 1A.

 

ANX – 1 – details of outward supplies and inward
supplies liable to RCM

12. The new mechanism provides the
tax payer an option to upload ANX – 1 during the course of tax period itself
and not after the end of tax period. Further, the details will also be updated
on real time basis and would be made available to the recipient in his ANX – 2
by way of auto-population.

13. It is imperative to note that
the information to be provided in ANX – 1 is segregated into two parts, one
relating to outward supplies and second relating to inward supplies liable to
RCM. However, on going through the proposed formats, one can note that the
details relating to inward supplies required to be reported not only covers
transactions where tax is payable on RCM, but also all other cases where tax is
applicable but not charged by vendors. For instance, import of goods from
outside India / SEZ / SEZ developer and documents on which credit has been
claimed but not disclosed by the supplier in his RET – 1 for more than two tax
periods, if the tax payer files return monthly and one tax period if the tax
payer files return quarterly.

14. The following table lists down
the key information relating to a transaction that would be required to be
reported in ANX – 1:

 

GSTIN / UIN

–      The requirement to file this information
is available in the current scheme as well.

Place of Supply
(Name of State/ UT)

Document Details

–      Type

–      No.

–      Date

–      Value

 

–      Under the
current scheme of things, each document type had to be reported separately.
For instance, under the current regime, invoices and credit notes were
reported in separate tables. This is sought to be changed with all document
types, have to be reported under the same head.

HSN Code

–      While the
current formats prescribed the  need to
disclose the HSN code of goods / SAC of service being supplied to be
disclosed in the GSTR 1, the said functionality was never enabled on the
portal. The same is sought to be reintroduced.

–      Under the
proposed scheme, the reporting is mandated as under:

 

 

–      Interestingly, the need to report HSN
wise summary, containing quantitative details has been done away with.

 

Tax rate (%)

This is standard
information which is required to be disclosed even under the existing scheme.

Taxable value

Tax amount
(I/C/S/Cess)

–      Under the proposed scheme, the tax
amount will be auto calculated and not editable, except by way of issue of
debit notes / credit notes. Cess will have to be inputted manually.

Shipping Bill/ Bill
of Export details (No. & Date)

–      If at the time of filing ANX – 1, these
details are not available, an option to update the same at a later date will
also be provided.

 

15. Once the above set of details
w.r.t each transaction has been collated, the tax payers will need to
segregate, depending on its’ nature, each transaction into:

 

Segregation into
the basket of

Comments

3A. Supplies made to consumers and unregistered persons
(Net of debit notes/ credit notes)

3A is common across all the three return schemes while
3B is common for Sugam and the normal scheme.

–      HSN wise
details need not be reported for 3A, though required for 3B.

–      It is
however important to note that disclosure relating to outward supplies liable
for tax under reverse charge need not be reported here.

3B. Supplies made to registered persons (Other than
those attracting reverse charge mechanism) – including edit / amendment

3C. Exports with payment of tax

–      The
information sought in this section is similar to what is being required to be
provided in the current scheme as well.

–      However, it
is provided that in case of export of goods, details of shipping bill / bill
of export may be provided at a later date also. 

3D. Exports w/o
payment of tax

3E. Supplies to SEZ units/ developers with payment of
tax – including edit / amendment

–      The
information sought in this section is similar to what is being required to be
provided in the current scheme as well.

–      However,
one important aspect that needs to be noted in the context of 3E is that the
supplier will have an option to select whether he / the SEZ Unit / Developer
would claim refund on such supplies or not? The SEZ Developer / unit will be
entitled to avail such credits and claim consequential claim refund of such
tax only if the supplier is not claiming refunds.

–      Similarly,
even in the context of 3G, it has been provided that supplier shall declare
who will claim the refund, the supplier or recipient. If supplier is claiming
refund, the recipient shall not be entitled to avail the corresponding
credits.

3F. Supplies to SEZ units/ developers without payment
of tax – including edit / amendment

3G. Deemed exports
– including edit / amendment

3H. Inward supplies attracting reverse charge

–      The notes
to the return provides that the details of inward supplies attracting RCM
need to be provided GSTIN wise and not invoice wise. In case of unregistered
suppliers, it has been provided that the PAN wise details may be disclosed.

–      Furthermore,
it has been also clarified that the details of advances / debit notes /
credit notes relating to such inward supplies have also to be included in the
summary referred. Interestingly, the notes further provide that in case of
advance payment, the tax credit needs to be reversed in the Return form and
the same has to be claimed only after the said service has been received.

3I. Import of Services (Net of DN/ CN and advances
paid, if any)

3J. Import of goods

–      The note
provides that the details of tax paid on import of goods from outside India /
SEZ Units / developers shall be reported here.

–      It further
clarifies that this information shall be required to be provided till the
data starts flowing from the ICEGATE (Customs) portal.

 

3K. Import of goods from SEZ units/developers on a Bill
of Entry

3L. Missing documents on which credit has been claimed
in T-2 / T-1 (for quarter) tax period and supplier has not reported the same
till the filing of the return for current tax period

–      This refers
to cases where credit was claimed though not appearing in ANX – 2 but even
after the expiry of two months/1 quarter from the availment of credit, the
same has not been uploaded by the supplier, thus triggering a reversal u/s.
42 (5) of CGST Act, 2017.

 

16. The above classification at
various junctures mentions “including edit / amendment”. The background to the
same is that the proposed scheme is also expected to work on a concept of
matching of transactions. It has been provided that once a transaction has been
uploaded on the portal, the facility to edit/amend the same shall depend on the
status of the transaction, i.e., whether it has been accepted or not? If not
accepted, the same can be amended upto 10th of the following month.
However, if accepted, the same can be amended upto 10th of the
following month, provided the same has been reset/unlocked by the recipient.
However, this restriction of editing/amending a transaction will not apply to
cases where the same pertains to a transaction of supply to a person not filing
returns in RET – 1/2/3, for example supplies made to composition dealers, ISD
or UIN holders and so on). Further, a facility of shifting the documents is
also proposed to be provided for transactions rejected by recipients on account
of wrong tagging. For instance, transaction wrongly tagged as SEZ supply on
payment of tax while the same relates to SEZ supply without payment of tax.

17. In addition to the above, all
tax payers who make supplies through e-commerce operators shall also be
required to disclose the details of turnover made through E-commerce operator
in table 4. However, it is important to note that the details to be disclosed
in table 4 should already be disclosed in table 3 and this is merely for
statistical purpose and would not have any impact on the output liability of
the tax payer.

 

TRANSITION FROM EXISTING SYSTEM


18. One important question that
arises is how to deal with cases where invoices were issued prior to the
introduction of the proposed scheme. For such cases, there can be three
probable scenarios, as tabulated below:

 

Scenario

Probable actions

Not reported, either in R1/ 3B

Upload the document in ANX – 1 and discharge tax along
with interest in RET – 1

Reported in 3B, but not reported in R1

Document should be uploaded, but in case of invoice,
since the tax liability would already have been discharged, the same would
have to be disclosed at 3C (5) of RET – 1 as reduction in liability.

However, while dealing with CNs, since the reduction
has already been claimed in the earlier scheme, reporting of CN would require
increase in liability to be reported at 3A (8) of RET – 1.

Reported in R1, but not reported in 3B

This would refer to cases where the tax effect of an
invoice/CN has not be considered while filing 3B. For such cases, w.r.t
invoices, the tax amount should be disclosed at 3A (8) in RET – 1 to increase
the liability and in case of credit notes, the tax amount should be disclosed
at 3C (5) to reduce the liability.

 

ANX – 2 ANNEXURE OF INWARD SUPPLIES AND MATCHING CONCEPT


19. This annexure primarily deals
with the concept of matching of transactions wherein the transactions reported
by suppliers would be auto-populated on real time basis in this annexure and
the recipient is required to mark each such transaction as either accepted,
rejected or pending.

20. The act of accepting a document
would mean that the recipient has accepted the transaction in all aspects. Acceptance
of a transaction would make it not eligible for edit / amendment by supplier,
unless unlocked.

21. Upon acceptance, if the
supplier has disclosed the transaction in ANX – 1 by 10th of the
next month, credit of the same can be claimed by the recipient in the month to
which the transaction pertains. However, for transactions disclosed after 10th
of the next month, credit would get deferred. Let us understand this with an
example. A supplier has issued an invoice on 15th July, 2019 and
disclosed the same in ANX – 1 on 5th August, 2019, the recipient can
claim credit of this invoice while filing the return for the month of July,
2019 itself. However, in case the supplier reports this transaction only on 15th
August, 2019, then the credit will have to be claimed in the next month.

22. The need to reject a
transaction shall arise, as per the instructions to filing ANX – 2, when
recipient does not agree with details disclosed such as the HSN Code, tax rate,
value etc., which cannot be corrected through a credit/debit note or the GSTIN
of the recipient itself is erroneous and therefore the transaction appears to a
person who is not concerned with the same. The notice of rejection of a
transaction would be sent to the supplier only after filing of return by the
recipient and the same would enable the supplier to edit / amend the
transactions in ANX – 1.

23. The third action, i.e., mark
the transaction as pending means that the recipient is either unsure of the
transaction appearing in ANX – 2 or he is yet to receive the invoice for such
transaction or the corresponding supplies would not have been received by them.
Such transactions which are marked as pending would be rolled over to the ANX –
2 for the next period. However, the same would not be available to the
supplier for editing / amendment unless the recipient rejects them.

24. However, if any transaction is
not marked as accepted/ rejected / pending and the return in RET – 1 / 2 / 3 is
filed, the same shall be deemed to be accepted and corresponding ITC shall be
made available for such recipient. Therefore, it would be very important for
the recipient to ensure that all transactions are marked as either accepted,
rejected or pending as failure to do so might result in claim of credit in case
of transactions which were ultimately meant to be rejected or dealt with
ineligible credits.

25. In addition to the above, there
can be instances wherein a recipient has received invoice from a supplier and
accounted the same in his books of accounts. However, such invoice is not
reported by the supplier in his ANX – 1 or has been reported wrongly (say
classified as B2C or tagged to wrong GSTIN and so on). For such transactions,
the recipient of supply shall be required to self-claim credit for such
transactions in the return form. However, such recipient shall be required to
disclose transactions of self – claim of credit in ANX – 1 if the supplier has
failed to report the transaction in his ANX – 1, in the following manner:

-If the supplier failed to report supplies after lapse of two tax
periods in case of monthly return and one tax period in case of quarterly
return being filed by the recipient.

-The details of such transactions
wherein the suppliers have still not filed their returns, but credit has been
claimed by therecipient shall be made available to the recipient through ANX –
2.



RET – 1 – MONTHLY OR QUARTERLY RETURNS UNDER THE NORMAL SCHEME


26. This is the return which each
tax payer is required to file w.r.t his outward and inward supplies. As of now,
the formats suggest that substantial information would be auto-populated from
disclosures made in ANX – 1 and actions taken on various transactions appearing
in ANX – 2 of the tax payer.

27. However, there would be certain
information which would be required to be filled by the tax payer. The same in
the context of outward supplies would be:

 

3.A.8. Liabilities relating to period prior to the
introduction of current return filing system and any other liability to be
paid

Refer discussion at para 19

3.C.3. Advances received (net of refund vouchers and
including adjustments on account of wrong reporting of advances earlier)

In the current scheme, this information needs to be
furnished in GSTR 1 along with POS wise, rate wise summary.

3.C.4. Advances adjusted

3.C.5. Reduction in output tax liability on account of
transition from composition levy to normal levy, if any or any other
reduction in liability

Refer discussion at para 19

3.D. (1-5) Details of supplies having no liability
[Exempt and nil rated supplies, non-GST supplies (including no
supply/Schedule III supplies), outward supplies attracting reverse charge and
supply of goods by a SEZ unit/ developer to DTA on a bill of entry]

This clause proposes to cover transactions of outward
supplies on which no GST is applicable, such as exempt supplies, non-GST
supplies and so on.

 

28. Similarly in the context of
inward supplies and input tax credit, the tax payer would require to input
following details which would increase the claim of input tax credit:

 

4.A.4. Eligible credit (after 1st July,
2017) not availed prior to the introduction of this return but admissible as
per Law (transition to new return system)

This clause will cover disclosure of  credit claim relating to invoices issued
under the GST Regime but prior to the introduction of the new scheme of
returns filing.

4.A.10. Provisional input tax credit on documents not
uploaded by the supplier (net of ineligible credit)

This clause will cover self – claimed credits where
transactions are not appearing in ANX – 2 but claimed by the tax payer on the
strength of the documents available on record.

4.A.11. Upward adjustments to input tax credits due to
receipt of credit notes and all other adjustments and reclaims

In case of credit notes reported by a supplier in ANX –
1 and accepted by the recipient in his ANX – 2, there will be automatic
reversal of input tax credit. However, there can be cases where the recipient
would not have claimed credit in the original invoice itself, thus resulting
in double reversal of credit for the recipient. For such cases, the amount of
tax associated with each credit notes will have to be added back to the ITC
claim of the recipient.



Any other adjustments shall also be reported here.

 

29. Further following details which
would decrease the claim of input tax credit will also have to be manually
added to the return by the tax payer:

 

4.B.2. Supplies not eligible for credit (including ISD
credit)

[out of net credit available in table 4A above]

This would cover cases relating to claim of input tax
credit which are covered by section 17 (5) or other cases wherein the claim
of credit is not eligible.

4.B.3. Reversal of credit in respect of supplies on
which provisional credit has already been claimed in the previous tax periods
but documents have been uploaded by the supplier in the current tax period

This clause covers credits which were self-claimed in
the earlier period, and the corresponding transaction has been uploaded by
the supplier and accepted by the tax payer during the current tax period and
therefore in order to avoid double claim, to the extent credit was claimed
provisionally to be reversed.

4.B.4. Reversal of input tax credit as per law (Rule
37, 39, 42 and 43)

This would include adjustments on account of the
specific provisions in the Act

4.B.5. Other reversals, including downward adjustments
to input tax credits on account of transition from composition to normal
levy, if any

This would include all other reversals to input tax
credit on account of reasons, other than the above.

30.In addition to the above, as statistical
information, the tax payer would need to identify the amount of credit which
pertains to capital goods and input services out of ITC available net of
reversals determined in the return. The logic behind this segregation is to
determine the amount of ITC in case the tax payer claims refund of accumulated
ITC on account of zero rated supplies/inverted rate structure. However, this
would pose a substantial challenge since various adjustments to the ITC
reported in the return, such as relating to Rule 43 are at aggregate level and
cannot be identified easily at transaction level and therefore the submission
of information to this extent might pose difficulty.

31. The next field that is relevant relates to
calculation of interest and late fee details at table 6. The liability on
account of interest and late fee due to late filing of returns would be
auto-computed by the system. Interestingly, this would also cover following:

liability on
account of late reporting of tax invoices, for instance, invoice of July
reported in August.

liability on
account of rejection of accepted documents.

32. In addition to the above, the tax payer will be
also required to self-calculate interest liability on account of following:

reversal of input
tax credit on account of various reasons, such as Rule 37, 42, 43, etc., as
well as interest

interest liability on account of delayed reporting of transactions
attracting reverse charge. The time of supply in case of reverse charge
transactions is attracted within 60 days from the date of invoice or date of
payment to the vendor, whichever is earlier. However, in case of supply of
services by Associated Enterprises located outside India, the time of supply is
triggered on the date when the entry is made in the books of accounts or the
date of payment, whichever is earlier. In all such cases where the time of
supply is determined late, the same would result in a liability to pay interest
which would have to be reported here.

•    Any other interest liability

33. Once the above action is taken, the tax payer
will have to discharge the liability, either by utilising the balance lying in
electronic cash ledger or electronic credit ledger as per the applicable
provisions and file the return.

 

ANX – 1A – AMENDMENTS TO ANX – 1

34. Under the proposed scheme, it is provided that
a tax payer can amend the details furnished in ANX – 1 and RET – 1 by amending
the return filed for the tax period in which the transaction was reported.
However, such amendment can be done only for transactions wherein GSTIN level
details were not submitted. In other words, B2B, SEZ and Deemed export
transactions cannot be amended. The same will have to be processed through the
“edit/amendment” route only as discussed above.

35. For other cases wherein amendment is required,
the amendment will have to be given effect for the period to which the
transaction pertains. For instance, a sales invoice was reported in July, 2019
as local sale. In September, 2019, it came to the tax payers’ attention that
the transaction was wrongly reported as local sale though it was an interstate
sale as per invoice. Accordingly, for such transaction, the tax payer will be
required to file ANX – 1A of July, 2019 and then proceed to file RET – 1A to
amend the RET – 1 of that period.

36. The above concept will be applicable in case of
amendment of transaction reported late in ANX – 1 also. For instance, an
invoice dated July, 2019 has been reported in ANX – 1 of September, 2019 and
liability discharged while filing the return for September, 2019. However, if
for such transaction any amendment is required to be done, the same will have
to be done in the month of July, 2019 as the transaction pertains to that
month, though disclosed in September, 2019.

37. An amendment can be done in ANX – 1A only w.r.t
transactions which have been reported in ANX – 1. For instance in the above
example, if an invoice dated July, 2019 was not reported in ANX – 1 of July,
2019, the same cannot be then reported in July, 2019 through ANX – 1A. Such
transactions can be reported only through ANX – 1.

38. The ANX – 1A shall be deemed to be filed only
after the RET – 1A has been filed.

 

RET – 1A – AMENDMENT TO RET – 1

39. Based on the details amended in ANX – 1A,
amendment to details already disclosed in RET – 1 on account of the ANX – 1A
will have to be done. For instance, in ANX – 1A, the liability under reverse
charge has been increased. The impact of this amendment will be auto-populated
in RET – 1A and the tax payer will have to make disclosures w.r.t the said
amendment as to whether any supplies are not eligible for credits and so on.
Only the impact of amendments will be considered in RET – 1A and not all the
transactions reported in the original return.

40. Basis the amendments disclosed in the RET – 1A,
the net tax payable/refundable will be determined. In case a liability is
determined, the same will have to be paid before the filing of RET – 1A.
However, in case the amendment results in excess payment, or negative liability
as referred in the instructions, the same will be made available to the
taxpayer in the next RET – 1 to be filed after filing of RET – 1A. 

 

CONCLUSION:

41. The proposed scheme of returns, undoubtedly
appear more in the nature of old wine in new bottle, with the scope of details
to be disclosed remaining more or less the same. However, there are certain
substantial changes, such as option to amend the returns itself.

42.  In
addition to the above, it will also be important for tax payers to shore up
their IT systems to facilitate the above process through automation rather than
manual intervention to avoid possibility of errors.

IMPORTANCE OF VOLUNTEERING IN STUDENT LIFE

“The way to find
yourself is to lose yourself in the service of others” – Mahatma Gandhi.

 

It is rightly
concluded by the great national leader and human being, Mahatma Gandhi in the
above quote that you need to serve others in order to know your true purpose in
life and what better stage than student life.

 

WHAT DO YOU MEAN BY VOLUNTEERING?

Volunteering simply
means undertaking a task or providing service to an organisation or a cause
without being paid for the same. It is an act of altruistic behaviour i.e., not
having a selfish motive behind doing anything. Thus, it is rightly said that
volunteers are paid in six figures i.e. S-M-I-L-E-S.

 

WHY SHOULD STUDENTS VOLUNTEER?

The early you start
a habit the better it is. A human being while he is studying can quickly adapt
changes and make such change a part of his life. Student life enables a person
to explore among the choices which he can make along with its academic curriculum.

 

Following are the
benefits of volunteering in a student’s life which make the act of volunteering
important:

 

1. Effective
utilisation of time and time management skills

Nowadays, it is a
common scenario to find students of all ages especially the teenagers glue
their eyes to electronic devices like mobiles, tablets and laptops. Though
technology is an integral part of the human beings alive today but more often
it is found to be misutilised or excessively utilised by the younger
generation.

 

Volunteering for a
particular cause or an event will help a student to effectively utilise the
available time.

 

Also, it is
observed that those students’ who volunteer develop better time management
skills because they learn to balance all tasks in the given time.

 

2. Inculcating civic behaviour

Students who
volunteer for social causes tend to develop a sense of civic behaviour. A
recent example is that of Swachh Bharat Mission which saw many students
actively participating in cleanliness drive which has created awareness among
all.

 

Causes like
protecting the environment, saving wildlife, segregation of waste, saving
water, among others have immensely helped in creating a sense of responsibility
towards the society and mankind.

 

3. Develops a habit
of team work

“Alone we can do
little but together we can do so much” – Hellen Keller.


Volunteering is
done in groups or teams and students are assigned tasks they are supposed to
perform in a team. A student learns how to be a team player. He learns to adapt
with people of different culture and background and thus be effective in
adjusting with anyone in the future while working in a team.

 

4. Improve leadership skills

Students who volunteer often find themselves capable of taking any task
on their own. The confidence gained during volunteering helps them to possess
good leadership skills which will be beneficial in every aspect of life in the
future.

 

5. Promotes healthy well-being

Students remain
active when they take up any other activity voluntarily and it is normally seen
that such students are very active, energetic and have a positive outlook
towards life. They are enthusiastic as they always look forward to do something
more than normal. It is observed that students who volunteer gain peace of mind
through the activities they perform for others.

 

6. Students become more responsible –
socially

Be the change
you wish to see in the world. – Mahatma Gandhi

 

In todays’ era,
change is inevitable and it is the only thing which is constant. Students wish
to make a difference in the society and volunteering or standing up for
something gives them a platform to put forward their point of views and help in
bringing about the change by first, starting themselves and then creating
awareness among their peers social responsibility is that of the society and
what better way than learning in a students’ life.

 

7. Helps in improving CV

After completing
your academic career, a student builds his professional career based on his
knowledge. But it is those extra-curricular activities which give him an extra
edge among his peers. Employers generally find it impressive when they find
that a person has volunteered in his student life because it helps to make them
conclude that he/she is a person with a vision, a purpose and he can do so much
more than what is generally expected out of employees.

 

8. Provides an opportunity to learn a new
skill

Based on my personal experience, I had the opportunity to be part of
the club which promoted Gujarati and Marathi language wherein several
activities were conducted weekly. As a student volunteer, I not only gained
knowledge on these languages but also a sense of belonging to the people
belonging to the respective caste.



Many organisations, University Clubs and Associations take up
activities which are either not for profit or are for a particular event which
involves lot of work from organising, co-ordinating, working with technology,
innovation and so much more. These activities help students to learn a new
skill for example, calligraphy or may be learning a new language or painting,
sketching, public speaking among others.



9. Makes way for future goals

If a student has
volunteered for something then it is quite possible that he can take the
learnings further by making a career in the same. Many students who volunteer
for a single task or may be try hands at different things often are able to
judge their capabilities and interests which helps them to make a career
choice.

 

10. Gives a sense of satisfaction and its
fun

The miracle is
not knowing how the work is done but by being happy in doing it. – Mother
Teresa

 

It is always a
joyous feeling to do something for others and it is quite evident when you see
smiles on the faces of other people or you are able to do something for a
cause. It is always happy feeling to do something for others.

 

First give and only
then you can get.  

 

Note – Kanika has been an active and regular
participant in Tarang 2K15, Tarang 2K16, Tarang 2K17 and Tarang 2K18 events and
has consistently won prizes in Essay and debate competitions. In Tarang 2K18,
she bagged the 1st prize in Essay Competition for this Essay. In a
fitting tribute to her contribution, this award winning Essay is printed in
this BCAJ issue.

 

 

FDI IN E-COMMERCE

Background

 

Retail sector in
India is considered to be a sensitive sector especially due to factors, such as
(i) the employment it generates; (ii) unorganised clusters of traders iii)
inability to compete with large players iv) concentration of vote bank.
Accordingly, Government over the years has traded consciously and opened up FDI
in retail sector in truncated manner.

 

The Department of
Industrial Policy and Promotion (DIPP) of the Ministry of Commerce and
Industry, Government of India has issued Press Note No 2 (2018 Series) on 26th
December, 2018 (PN 2 of 2018). PN 2 of 2018 amends paragraph 5.2.15.2
(e-commerce activities) of the current ‘Consolidated FDI Policy’ of the DIPP
effective from 28th August, 2017 (FDI Policy), effective from 1st
February, 2019. Paragraph 5.2.15.2 (e-commerce activities) incorporates the
provisions of Press Note No 3 (2016 Series) dated 29th March, 2016
(PN 3 of 2016), pursuant to which foreign direct investment (FDI) up to 100%
was allowed under the automatic route in entities engaged in the marketplace
model of e-commerce, subject to compliance with certain conditions. However,
FDI in entities engaged in the inventory-based model of e-commerce was
expressly prohibited, and this continues to be the case as on date. A
marketplace-based model of e-commerce is a model of providing an information
technology platform by an e-commerce entity on a digital and electronic network
to act as a facilitator between buyer and seller. An inventory-based model of
e-commerce, on the other hand, is a model where inventory of goods and services
is owned by an e-commerce entity and is sold to the consumers directly.

 

It has been a bone
of contention of trade association that FDI component is creating an uneven
playing field to the disadvantage of millions of small business enterprises. It
is alleged that the e-retailers are engaged in predatory pricing policy and
subsidizing the prices with a view to oust brick and mortar shops from retail
trade.

 

While the
conditions contained in PN 3 of 2016 were introduced to bring some comfort to
brick and mortar retailers (small traders) and to ostensibly create a level
playing field for such retailers with their e-commerce counterparts, it was
felt in some quarters that the wording of PN 3 of 2016 was not stringent enough
and that the intended goal of such PN 3 of 2016 was not being achieved.
Complains were made to regulator that certain marketplace platforms were
violating policy by influencing the price of products and indirectly engaging
in inventory-based model. In order to ensure that rules are not circumvented
DIPP came up with PN 2 of 2018[1].

 

Some of the
important changes made by PN 2 of 2018 are highlighted in this article.

 

Scope and
applicability

PN 2 of 2018
proposes to amend para 5.2.15.2 dealing with e-commerce activities.
Accordingly, PN 2 of 2018 has no impact on following:

 

  •     Wholesale cash and carry
    trading;
  •     Single brand retail trading
    operating through brick and mortar stores;
  •     Multi brand retail trading;
  •     Indian entity with no FDI
    engaged in online e-commerce business;
  •     Indian entity with FDI
    engaged in manufacturing selling products in India through e-commerce.

 

Restrictions of PN
2 of 2018 are applicable to Indian e-commerce company having FDI. It does not
apply to home grown retail majors like Vijay Sales, Big Bazaar, Reliance Retail
etc. Thus, PN 2 of 2018 may assure level playing field against foreign capital but
does little to prevent small traders from predatory pricing and market
penetration policy adopted by Indian conglomerates.

 

PN 2 of 2018 is
applicable from 1st February, 2019. There is no express
grandfathering of existing structures. Moreover, since amendments seek to
clarify legislative intent, it is advisable that e-commerce companies comply
with new regulations. Some of the stringent conditions will require e-commerce
companies to rejig their business model.

 

 

Ownership and control over inventory

 

Policy

E-commerce entity
providing a marketplace will not exercise ownership or control over the
inventory i.e. goods purported to be sold. Such an ownership or control over
the inventory will render the business into inventory based model. Inventory of
a vendor will be deemed to be controlled by e-commerce marketplace entity if
more than 25% of purchases of such vendor are from the marketplace entity or
its group companies.

 

Comments

  •     Existing regulation i.e. PN
    3 of 2016 provides that e-commerce entity providing a market place will not
    exercise ownership over the inventory i.e. goods purported to be sold. Such an
    ownership over inventory will render the business into inventory-based model.
  •     PN 2 of 2018 imposes an
    additional condition and deems inventory of vendor to be controlled by
    e-commerce marketplace entity if more than 25% of purchases of such vendor are
    from market place entity or its group companies.
  •     Said condition seems to
    plug in loophole in existing regulatory framework. Under existing regulatory
    framework e-commerce entity can undertake B2B trading. Marketplace Entities
    used one or more of their group entities to sell goods to sellers on a B2B
    basis with such sellers in turn listing the goods on the Marketplace Entity’s
    platforms for sale to retail customers.
  •     Going forward, e-commerce
    entity will have to develop mechanism to track purchases of vendor listed on
    its portal. If 25% limit is breached by vendor it will tantamount to violation
    of FDI conditions for e-commerce entity. This is likely to be cumbersome
    compliance as vendors may be reluctant to share their financial details.
  •     Regulation is not clear on
    period for computing ‘25%’ threshold limit. Arguably, 25% of purchases should
    be calculated for each financial year and reference to 25% should be in value
    terms based on financial statement of vendor. Further, 25% of overall threshold
    can be computed only after closure of financial year. This poses challenge on
    e-commerce companies to test compliance before closure of financial year. Further,
    regulation is not clear in case of computation of 25% threshold in case of
    vendor engaged in trading of multiple goods. It is not clear whether 25%
    threshold should be computed for that segment of goods traded on e-commerce
    website or purchase on overall basis needs to be seen.
  •     Regulation stresses on
    purchase aspect of vendor from e-commerce companies or its group companies and
    has nothing to do with the aspect of vendor selling goods on market platform of
    e-commerce companies. Accordingly, on plain reading – say Vendor A purchasing
    goods in bulk[2]
    from group companies of Flipkart and selling on Amazon and offline in large
    quantities and on Flipkart in small quantities, will render Flipkart to
    violation of FDI norms.
  •     Restriction may put
    limitation on Indian vendors who are not 
    recipient of FDI to look out for alternatives sources to procure goods.
    Thus, PN 2 of 2018 indirectly regulates procurement pattern of non FDI
    companies trading on e-commerce platform.
  •     Sellers may require to
    broad base their procurement function and approach directly distributors or
    manufacturer of products. This is likely to impact margins and supply chain
    efficiency.
  •     Interestingly, PN 2 of 2018
    permits e-commerce companies to provide support services in respect of
    warehousing, logistics, order fulfilment, call centre, payment collection and
    other services. Accordingly, it may be open for e-commerce company or group
    company to provide indenting services to sellers and facilitate them to
    purchase goods from distributor or manufacturers. Said services can be validly
    provided as long as it is provided in fair and non-discriminatory manner.
  •     Regulation 2 of FEMA 20(R)
    defines group company as follows:

“Group Company
means two or more enterprises which, directly or indirectly, are in a position
to

(a)  Exercise 26 percent, or more of voting rights
in other enterprise;  or

(b) Appoint more than 50 percent, of members of
board of directors in the other enterprise.”

  •     Definition of Group Company
    is based on 26% shareholder threshold and power to appoint more than 50%
    members of Board. This definition is in contradiction to definition of control
    under Ind AS 110[3].
    Ind AS definition of control is expansive and requires Company to give
    consideration to shareholders agreement and right flowing to investor to
    determine control. As against that, definition of group company in FEMA 20(R)
    is more legalistic. Further, analyst believes that stringent condition is
    likely to pave way to franchisee models[4].

 

Restriction on group company sellers to
participate on e-commerce platform

 

Policy

An entity having
equity participation by e-commerce marketplace entity or its group companies,
or having control on its inventory by e-commerce marketplace entity or its
group companies, will not be permitted to sell its products on the platform run
by such marketplace entity.

 

Comments

  •     Existing regulation i.e. PN
    3 of 2016 provides that e-commerce entity will not permit more than 25% of the
    sales value on financial year basis affected through its marketplace from one
    vendor or group company.
  •     PN 2 of 2018 prohibits i)
    entity having equity participation by e-commerce marketplace entity or its
    group companies or ii) vendor on which e-commerce marketplace entity or its
    group companies has control over inventory.
  •     On comparison of existing
    and new regulation following are notable changes:

•    Ban on entity in which e-commerce
marketplace entity or its group companies has equity participation to sell on
e-commerce platform.

•    Ban on entity on which e-commerce
marketplace entity or its group companies has control over inventory to sell on
e-commerce platform.

•    Other vendors (other than mentioned above)
can sell on e-commerce platform even if its sales amount to more than 25% of
sales value.

  •     PN 2 of 2018 has used
    ambiguous term ‘equity participation’. Extant FDI Policy defines ‘capital
    instrument’ as referring to equity shares, CCPS, CCDs and warrants. It is
    therefore unclear whether the term “equity participation” refers solely to
    equity investments or whether it includes investments using other instruments
    (such as CCPS, CCDs or warrants) as well and its impact on conversion. Further
    no threshold for equity participation is prescribed. Accordingly, holding of 1%
    by specified entities will debar investee entity from trading in e-commerce platform.
  •     At times investing in
    companies providing support services are driven by business and commercial
    consideration. Since services are so interlinked, it may be a commercial
    necessity to hold stake in service company to ensure quality of service and safeguard
    reputation of e-commerce companies. Revised policy seems to give a total go-by
    to business consideration and looks involvement of service company (with equity
    participation of e-commerce company) as a sole driver.

•    Many e-commerce entities operating in India
have made (or entities controlled by them have made) investments in entities
(First Level JV Entity) that are owned and controlled by an Indian resident.
The First Level JV Entities establish further subsidiaries (Second Level JV
Entity). In light of the current guidelines on downstream investments, these
Second Level JV Entities or group entities are not subjected to similar
obligations as applicable to foreign direct investment in First Level JV
Entity. Use of term ‘equity participation’ raises issue whether restriction
will apply to First Level JV entity or even Second Level JV Entity. In contrast
to other clauses in PN 2 of 2018, this clause does not use the words equity
participation ‘directly or indirectly’.

•    Policy is likely to put a break on Amazon
from selling products from subsidiaries like Cloudtail and Appario, Flipkart
from selling products through its investee company WS Retail unless e-commerce
major restructures their business model. 

 

No exclusivity

 

Policy

E-commerce
marketplace entity will not mandate any seller to sell any product exclusively
on its platform only.

 

Comments

  •     Condition seems to be one
    way in terms of requiring e-commerce entity to sell product exclusively on its
    platform. Condition does not restrict seller to approach e-commerce company to
    sell its product exclusively on its platform.
  •     This condition will put
    check on practices of selling mobile phones and white goods on exclusive basis.
    Accordingly, it will no longer be open for Flipkart to have exclusive partnership
    of selling smartphones like Xiaomi and Oppo. Exclusive sale was perceived to be
    concentration of power in hands of few and detrimental to the interest of small
    traders.
  •     Said condition puts
    practice of selling private label products say Amazon kindle, Amazon Echo, MarQ
    range of electronic goods in doubt. Private label products are in-house brands
    of e-commerce company. Reason for promoting private label products is to earn
    high margin and seek repetitive customers as private label products are exclusively
    sold by e-commerce companies.  E-commerce
    entities seek to sell private label products at discounted price vis-à-vis
    compete and try to lure customers.
  •     On plain reading, there is
    no bar on sellers to sell products exclusively on e-commerce platform. DIPP in
    its press release has clarified that present policy does not impose any
    restriction on the nature of products which can be sold on the marketplace.

 

Level playing field

 

Policy

E-commerce entities
providing marketplace will not directly or indirectly influence the sale price
of goods or services and shall maintain level playing field. Services should be
provided by e-commerce marketplace entity or other entities in which e-commerce
marketplace entity has direct or indirect equity participation or common
control, to vendors on the platform at arm’s length and in a fair and
non-discriminatory manner. Such services will include but are not limited to
fulfilment, logistics, warehousing, advertisement/marketing, payments,
financing etc. Cash back provided by group companies of marketplace entity to
buyers shall be fair and non-discriminatory. For the purposes of this clause,
provision of services to any vendor on such terms which are not made available
to other vendors in similar circumstances will be deemed unfair and
discriminatory.

 

Comments

  •     PN 3 of 2016 merely
    stipulates that e-commerce entities providing marketplace will not directly or
    indirectly influence the sale price of goods or services and shall maintain
    level playing field. PN 2 of 2018 imposes additional conditions on e-commerce
    companies and its investee company to provide services to vendors on platform
    at arm’s length on fair and non-discriminatory manner. Policy deems that
    provision of services to any vendor on such terms which are not made available
    to other vendors in similar circumstances will be deemed unfair and
    discriminatory.
  •     Policy seems to plug
    practices of predatory pricing policy and subsidising the prices. Going forward
    it will be difficult to provide cash back, fast delivery, etc., to select set
    of sellers. All the service providers will have to open up such services for
    all the sellers on its platform.
  •     Use of terms ‘arm’s
    length’, ‘fair and non-discriminatory’ and ‘similar circumstance’ are
    subjective and is likely to give rise to further frictions. It is equally true
    in a market place; all sellers can’t be treated similarly. It is natural for
    business to give preferential treatment to set of customers who are top
    customers. Person selling miniscule quantity cannot be compared with customer
    selling substantial quantity. Use of the word ‘similar circumstances’ should be
    construed in right perspective.
  •     Policy requires cash back
    to be provided to buyers and services to be provided to sellers to be fair and
    non-discriminatory. Policy does not seem to restrict buyer/seller to be
    provided better services if they are paying a premium/price to avail
    preferential service. Accordingly, services like prime membership are unlikely
    to be affected by new regulation.

 

Report to RBI

 

Policy

E-commerce
marketplace entity will be required to furnish a certificate along with a
report of statutory auditor to Reserve Bank of India, confirming compliance of
above guidelines, by 30th of September of every year for the
preceding financial year.

 

Comments

  •     Regulation places
    additional obligation on statutory auditor to certify compliance with new
    guidelines. This will be an onerous task given subjectivity involved in
    guidelines.

 

Concluding Remarks

Revised regulation
seeks to provide level playing field to small traders and protect them from
foreign capital. Changes come at a time when 
investments in e-commerce are at record high. Acquisition of controlling
stake by Walmart in Flipkart at whopping USD 16 billion raised bar of
e-commerce industry in India. Research firm Crisil has estimated that nearly
35-40% of e-retail industry sales, amounting to Rs 35,000-40,000 crore, could
be impacted due to the tightened policy. It is further estimated that Brick and
Mortar business will gain 150-200 bps topline boost. Media5 has
reported that new regulations are draconian and a bigger retrograde move than
even Vodafone tax issues. It will not only impact e-commerce sector but also
FDI inflow in other sectors because regulations can change overnight. One
believes that DIPP will come out with clarification and allay all fears.

STAMP DUTY ON CHAIN OF DOCUMENTS

Introduction


Go to register a document
for a flat/office and chances are that the Sub-registrar of Assurances would
point out that the antecedent title documents have not been stamped properly
and hence, the current instrument cannot be registered. The Authority would first
ask that stamp duty with penalty be paid on all the earlier chain of documents
and only then would the current instrument get stamped and registered. This
creates several hurdles for property buyers and they are unnecessarily
penalised for past lapses in the property documents. One wonders till what
extent can the current buyer be asked to go to pay stamp duty on the past
documents?

 

In this respect, the Bombay
High Court has given a path breaking decision which would ease the property
buying process.

 

The Case


The decision was rendered
in  the case of Lajawanti G.
Godhwani vs. Shyam R. Godhwani and Vijay Jindal, Suit No. 3394/2008,
decision rendered on 13th December, 2018.This case
pertained to a flat purchased in an auction conducted by the Court Receiver.
The last time the flat was sold was in 1979 and that document was stamped only
with a duty of Rs. 10. The old agreement was not even registered. When the
purchaser went to register the instrument of transfer, the Sub-registrar of
Assurances demanded stamp duty on the entire chain of title documents since the
same was not paid. The duty alone on the old agreement at the Stamp Duty
Reckoner Rates amounted to Rs. 2 crore. As the purchaser had bought the flat
through a Court Receiver’s auction, he approached the High Court to get
directives that the seller should bear the previous stamp duty and penalty.
While one of the original owners agreed, the other former co-owners refused.
Accordingly, the High Court was hearing their dispute.

 

Basics of Stamp Law


Before understanding what
the Court held, it would be useful to appreciate certain basics of stamp duty.
Stamp duty is both a subject of the Central and the State Government. Under the
Constitution of India, the power to levy stamp duty is divided between the
Union and the State. The Parliament has the power to levy stamp duty on the
instruments specified in Article 246 read with Schedule VII, List I, Entry 91
and the State Legislature has the power to levy stamp duty on instruments
falling under Article 246 read with Schedule VII, List II, Entry 63. Often a
question arises, which Act applies – the Indian Stamp Act, 1899 or the
Maharashtra Stamp Act, 1958. For most of the instruments, the State Act would
apply. However, for the nine instruments provided in the Union List of the
Constitution of India, the rates are mentioned in the Schedule to the Indian
Stamp Act, 1899.

 

In Hindustan Steel
Ltd. vs. Dalip Construction Company, 1969 SCR (3) 796, the Supreme
Court held that the Stamp Act is a fiscal measure enacted to secure revenue for
the State on certain classes of instruments. 

 

Stamp Duty is leviable on
an instrument (and not a transaction) mentioned in Schedule I to the Maharashtra
Stamp Act, 1958 at rates mentioned in that Schedule – LIC vs. Dinannath
Mahade Tembhekar AIR 1976 Bom 395. An Instrument is defined under the
Maharashtra Stamp Act to include every document by which any right or liability
is created, transferred, limited, extended, extinguished or recorded.  However, it does not include a bill of
exchange, cheque, promissory note, bill of lading, letter of credit, policy of
insurance, transfer of share, debenture, proxy and receipt. This is because
these nine instruments are within the purview of the Indian Stamp Act, 1899.
All instruments chargeable with duty and executed in Maharashtra should be
stamped before or at the time of execution or immediately thereafter or on the
next working day following the date of execution. 

 

One of the biggest myths
surrounding stamp duty is that it is levied on a transaction. It is only levied
on an instrument and that too provided the Schedule mentions rates for it. If
there is no instrument then there is no duty is the golden rule one must always
keep in mind. An English decision in the case of  The Commissioner of Inland Revenue vs.
G. Anous & Co. (1891) Vol. XXIII Queen’s Bench Division 579 has
held that held that the thing, which is made liable to stamp duty is the
“instrument”. It is the “instrument” whereby
any property upon the sale thereof is legally or equitably transferred and the
taxation is confined only to the instrument whereby the property is
transferred. If a contract of purchase or sale or a conveyance by way of purchase
and sale, can be, or is, carried out without an instrument, the case would not
fall within the section and no tax can be imposed. Taxation is confined to the
instrument by which the property is transferred legally and equitably
transferred. This decision was cited by the Supreme Court in the case of Hindustan
Lever Ltd vs. State of Maharashtra, (2004) 9 SCC 438.

 

On 9th December,
1985, the Maharashtra Stamp Act was amended which mandated that stamp duty had
to be paid at the rates prescribed in the Ready Reckoner published every year.
Following this, the Stamp Office started demanding stamp duty even on resale
agreements of old properties for which a nominal duty had been paid on the
agreements when they were originally executed. Consequently, the issue arose as
to whether the amendments made in 1985 were applicable even to documents which
were registered earlier than 1985. Two Single Judge decisions of the Bombay
High Court, Padma Nair vs. The Deputy Collector, Valuation, AIR 1994 Bom
160 / ITC Limited and Anr. vs The State and a Division Bench decision in the
case of Nirmala Manherlal Shah vs State, 2005 (5) BomCR 206 are
relevant in this respect. The Courts in these cases were considering whether
stamp duty was payable on the agreement to sell entered into before 9th
December, 1985. The Courts took a view that only in respect of those Agreements
to Sell entered into with effect from 9th December, 1985 and not
earlier were to be stamped in terms of the definition ‘conveyance’ read with
Explanation under article of Schedule I. Inspite of these verdicts the Stamp
Office demands stamp duty on old agreements that had been executed prior to
1985.

 

Bombay High Court’s verdict


The verdict in the instant
case was delivered by J. Gautam Patel. The Court held that as regards the
question of stamp duty on antecedent documents there was no clear or well
considered response from the Stamp Office. Neither the Officer from the Stamp
Office nor the Assistant Government Pleader was able to show the Court as to
under what provision of the Stamp Act, old documents prior to the amendments to
the Stamp Act could be legitimately or lawfully said to be “unstamped” or even
insufficiently stamped if, according to the law as it stood at that historical point
in time, the document itself was not liable to stamp in the first place. The
Counsel for the Government agreed that any such assessment would have to be on
the basis of the Stamp Act as it stood at that time of the older transactions
and not at the current rates.

 

The High Court held that
the entire approach of seeking duty on past agreements seemed prima facie
entirely incorrect. The Court considered a very simple example to substantiate
its stand—a flat in a cooperative housing society was held by A, who was the
original allottee of the flat. In 1970, he sold the flat to B. It is not shown
that the 1970 sale attracted stamp duty. B held the flat until 2018, when he
sold it to C. Now when C submitted his transfer instrument of 2018  (from B to C) for adjudication, was it even
open to the Stamp Authorities to contend that the parent 1970 transfer from A
to B was bad or invalid or inoperative for want of stamp since, had it been
done today, it would have attracted stamp, notwithstanding that it did not attract
duty at the date of that transfer in 1970? The Court did not think so and held
that the Authority should remember that what was submitted to it was the
current instrument of 2018, not the instrument of 1970; the latter was only an
accompaniment to trace a history of the title of the property, not to
effectuate a transfer. Stamp duty was attracted by the instrument, not the
underlying transaction, and not by any historical narrative in the instrument.
If the Authority’s view of levying duty on past instruments was to be accepted,
then it had no answer to the inevitable consequences, for its view necessarily
meant that no title ever passed to B, and A would have to be held to continue
to be the owner of the flat, which was clearly absurd and was nobody’s case. It
was also unclear just how far back the Authority could travel by applying the
current taxing regime on old concluded transactions. Moreover, when such
transactions were in every sense complete and not being effectuated currently.

 

Accordingly, the Court concluded that there
was no question of either the auction purchaser or anyone else being liable to
pay stamp duty on the older documents, copies of which were tendered along with
the auction purchaser’s instrument of transfer. The Bombay High Court also laid
down very vital principle—since the auction purchaser’s instrument of transfer
had been stamped, no question could arise of reopening an issue of sufficiency
of stamps on the antecedent documents. That claim was deemed to have been given
up by the Authority by its act of accepting the stamp duty paid on the auction
purchaser’s transfer instrument.

 

CONCLUSION

Registration offices should no longer demand
payment of stamp duty on antecedent documents of title at current rates before
accepting registration of the current instrument of transfer. This decision
have very rightly held that a purchaser only seeks to register and pay duty on
the current instrument of transfer and he cannot be held responsible for
non-payment of past owners. One hopes that the offices of the Registrar would
take this decision in the right spirit and act accordingly. A circular from the
Stamp Office toeing the line of this decision would really help smoothen the
property buying process and may ultimately even act as an impetus to the house
buying process.  

PENALTY PROVISIONS UNDER SECURITIES LAWS – SUPREME COURT DECIDES

Securities Laws empower
SEBI to levy penalty in fairly large amounts, often even for technical
violations. The maximum amount can extend in some cases to upto Rs. 25 crores
or even more. It is fairly common to see penalties in lakhs or tens of lakhs
and more even for violations such as late filing of returns and making of
certain disclosures, etc.

 

The legal provisions have
seen frequent changes and even suffer from poor drafting. Even court decisions
have seen twists and turns by changes in interpretation by SEBI. SEBI
interpreted an earlier decision of Supreme Court in Shri Ram Mutual Fund
((2006) 5 SCC 361 (SC)) that the court held that penalty was mandatory in
case of violations and no mens rea had to be proved. It was arguable
that the Court did not make penalty mandatory. However, SEBI took a view that
it had no choice but to levy penalty. This had also to be seen in context of
the fact that there were provisions which provided for fairly large minimum
penalties.

 

Finally,
there were two fundamental interpretation issues of certain provisions. One
related to section 15J in the Securities and Exchange Board of India Act, 1992
provided that three factors to be taken into account by the Adjudicating
Officer (“the AO”) while levying penalty. The second question was whether these
three factors were merely illustrative, in which case other factors
could also be taken into account? Or whether they were exhaustive, meaning
that no other factors could be taken into account.

 

A related issue was whether
the AO has any discretion not to levy penalty or levy a lower penalty
than the one prescribed. These questions arose out of seemingly anomalous or
contradictory provision because some sections provided for a minimum and
mandatory penalty while another provision required the AO to consider certain
factors while deciding levy of penalty.

 

Fortunately, all of these
issues have been considered by the Supreme Court in a recent decision in Adjudicating
Officer, SEBI vs. Bhavesh Pabari ((2019) 103 taxmann.com 8 (SC)).

 

Background


The decision with several
separate cases in appeal though all of them had a common theme of penalty. The
Court thus first discussed in detail the legal background in the form of
earlier cases of the Supreme Court and also the provisions of the Act including
the various changes therein over the period.

 

The Court then arrived to
certain conclusions as to how the law should be interpreted and applied with
regard to certain matters and questions. These interpretation were then applied
to the facts of individual cases while deciding the violation.

 

It will be thus necessary
to summarise what the Court decided for each issue before it.

 

Whether
penalty is to be mandatorily levied or is there any discretion/exception
possible?

This has been a fundamental
question and the general stand taken by SEBI was that its hands were tied by
the decision of the Supreme Court in Shriram. Thus, SEBI held that once there
was a violation levy of penalty was mandatory and mens rea has no
relevance. Author submits that the Court in Shriram’s case did not held that
levy of penalty was mandatory. However, the Court in the present case has
reviewed the provisions dealing with penalty and some other issues.

 

It was seen that there were
several provisions dealing with levy of penalty – for example section 15A(a) to
15-HA) each section provided for penalty for the specific violation dealt with
in the section. Curiously, from 2002 to 2014, provisions relating to penalty
made a strange reading. Some provisions provided for a minimum penalty of Rs. 1
crore u/s. 15-A. The questions were : whether minimum penalty was to be
mandatorily levied? Did the Adjudicating Officer have the power to levy a lower
penalty or even waive the penalty? For instance section 15J provided for three
specific factors to be considered whilst levying penalty. The issue was : if
levy of a minimum penalty was mandatory, then would section 15J not become
redundant?

 

The Court pointed this
anomalous consequence and held that such a view usually cannot be taken. It
observed, “…if the penalty provisions are to be understood as not admitting of
any exception or discretion and the penalty as prescribed in Section 15-A to
Section 15-HA of the SEBI Act is to be mandatorily imposed in case of default/failure,
Section 15-J of the SEBI Act would stand obliterated and eclipsed… Sections
15-A(a) to 15-HA have to be read along with Section 15-J in a manner to avoid
any inconsistency or repugnancy. We must avoid conflict and head-on-clash and
construe the said provisions harmoniously. Provision of one section cannot be
used to nullify and obtrude another unless it is impossible to reconcile the
two provisions.”.

 

The court then pointed out
that the law had been amended in 2014 and it was clarified that discretion was
available to the Adjudicating Officer to consider the specified factors before
levying a penalty. The Court held that this clarification put beyond doubt that
discretion was always available with the Adjudicating Officer to consider
various factors and was not bound by the provisions providing for minimum and
mandatory penalty.

 

The Court observed, “The
explanation to Section 15- J of the SEBI Act added by Act No.7 of 2017, quoted
above, has clarified and vested in the Adjudicating Officer a discretion
under Section 15-J on the quantum of penalty to be imposed while adjudicating
defaults under Sections 15-A to 15-HA. Explanation to Section 15-J was
introduced/added in 2017 for the removal of doubts created as a result of
pronouncement in M/s. Roofit Industries Ltd. case ([2016] 12 SCC 125).”
(emphasis supplied). Hence the court reaffirmed that the earlier decision in
Roofit’s case was erroneous.

 

How should
a provision specifying a minimum penalty be interpreted?

There were several
provisions in the Act that provide, even today, for a minimum penalty of Rs. 1
lakh. The Court pointed out that some of these can be even for technical
defaults involving small amounts. The Court highlighted its earlier decision in
Siddharth Chaturvedi & Ors.( [2016] 12 SCC 119), which had held,
“…that Section 15-A(a) could apply even to technical defaults of small amounts
and, therefore, prescription of minimum mandatory penalty of Rs.1 lakh per day
subject to maximum of Rs.1 crore, would make the Section completely
disproportionate and arbitrary so as to invade and violate fundamental rights.”

 

The Court also pointed out
that the law was later amended to provide for a lower minimum penalty. In
short, the court concluded that discretion was available with the AO even with
regard to levy of a minimum penalty taking into account relevant facts of the
case.

 

Whether
the factors specified in section 15J were illustrative or exhaustive?

Section
15J is the general provision that applies to the various specific penalty provisions.
It states that while levying penalty, the AO shall consider three factors. One
was the amount of disproportionate gain or unfair advantage made. The second
was whether loss was caused to investors. The third was whether the default was
repetitive.

 

The
issue was: whether the above three were the only factors to be
considered by an AO or whether the other relevant factors AO could consider. It
was pointed out that section 15-I did provide that the AO shall levy “such
penalty as he thinks fit in accordance with the provisions of any of those
sections.”.

 

The
Court pointed out that there were several penalty provisions where none of the
three factors specified in section 15J would be relevant. Hence, taking a view
that these three factors are the only relevant factors would lead to an
anomalous result.

 

The
Court thus concluded the AO ought to consider not just the three factors
specified in section 15J but such other factors that are relevant. It observed,
“Therefore, to understand the conditions stipulated in clauses (a), (b) and (c)
of Section 15-J to be exhaustive and admitting of no exception or vesting any
discretion in the Adjudicating Officer would be virtually to admit/concede that
in adjudications involving penalties under Sections 15-A, 15-B and 15-C,
Section 15-J will have no application. Such a result could not have been
intended by the legislature. We, therefore, hold and take the view that
conditions stipulated in clauses (a), (b) and (c) of Section 15-J are not
exhaustive and in the given facts of a case, there can be circumstances
beyond those enumerated by clauses (a), (b) and (c) of Section 15-J which
can be taken note of by the Adjudicating Officer while determining the quantum
of penalty.”

 

Application
in individual cases

The Court then applied the
aforesaid conclusions in the various individual cases before it in appeal to
decide whether the penalty levied was in accordance with law and the
conclusions reached by the Court.

 

Can
penalty be levied separately for transactions in a party’s own name and also in
the name of a firm in which he is sole proprietor?

While dealing with individual cases, the
Court was presented with an interesting question. In a particular case, it was
observed that a party carried out transactions in violation of law in two names
– one (Bhavesh Pabari) was in his own name and the other through a firm name
(Shree Radhe) where he was sole proprietor. SEBI levied penalty of Rs. 20 lakhs
each for both the names. The appellant argued only one penalty should have been
levied since the party was the same. The Court rejected this argument on the
facts of the case. It observed, “This contention superficially seems
attractive, but on an in-depth reflection should be rejected as Bhavesh Pabari
had indulged in trading in its personal name and also in the name of his firm
M/s. Shree Radhe.”.



Can the
Supreme Court consider the reasonableness of penalty levied?

This was yet another issue
worth discussing. Can a party pray to the Supreme Court for reconsidering the
amount of penalty levied and argue that it was excessive or disproportionate?
This is particularly relevant since appeals against such orders can be to the
Securities Appellate Tribunal and thereafter straight to the Supreme Court. The
Court rejected this contention, and made the following pertinent observation,
“This court, in the exercise of its jurisdiction under Section 15-Z of the SEBI
Act, cannot go into the proportionality and quantum of the penalty imposed,
unless the same is distinctly disproportionate to the nature of the violation
which makes it offensive, tyrannous or intolerable. Penalty by it’s very
nature of the is penal. We can interfere only where the quantum is wholly
arbitrary and harsh which no reasonable man would award.”

Hence, except in exceptional
case the court, would generally not go into the reasonableness of the penalty.

 

Conclusion

The
decision of the Supreme
Court is very relevant and will need to be considered by SEBI and even
SAT
while considering cases of penalty. Parties would be free to present all
relevant facts of the case and emphasise all relevant factors with
respect to
the alleged violations in penalty proceedings. The AO will have to
judicially consider the facts and is no longer bound to levy ?minimum
penalty’.  

 

 

 

DUPLICATE PART OF C FORM, WHETHER VALID

Introduction


Under CST
Act, the vendor can sell the goods against C form to the buyer. The vendor is
depending upon buyer for getting the C form. As per Rules, there are three
identical parts in C form. The buyer retains counterpart with him. The two
parts marked as original and duplicate are given to vendor. The vendor is
required to produce the above two parts before his assessing authority for getting
the claim of sale against C form allowed.

 

India Agencies case


There the
controversy is about which part to be produced before the assessing authority.
The party, India Agencies, produced duplicate parts of C forms in its
assessment and they were disallowed on the ground that original parts are
required to be produced. The matter went to the Hon. Supreme Court which is
reported in case of India Agencies (139 STC 329)(SC). In this case,
Kerala (CST) Rules provided for production of original parts and on
non-production the claim was disallowed which was contested before the Hon.
Supreme Court. In above judgment the Hon. Supreme Court has rejected the claim
observing, amongst others, as under:- 

 

“25. The
learned Senior Counsel for the appellant submitted that there is no suggestion
anywhere that there is anything wrong with the genuineness of the transaction
or any doubts as to the possession by the purchasing dealer on a certificate
enabling the sellers to obtain the concessional rate of tax under section 8 of
the Act.

 

Under such
circumstances, the authorities should not have taken the strict view in
rejecting the claim of the concessional rate of tax. At first sight, the
argument of the learned counsel for the appellant appears to be genuine and
acceptable but considering the mandatory nature of the provisions of the Act
and Rules, this Court is called upon to decide the questions involved in this
case. The provisions being mandatory they should have been complied with. The
appellant made no attempt to comply with rule 12(3) till after his claim was
rejected by the assessing authority. Having made no attempt to comply with the
mandatory provisions, he disentitled himself from getting the concessional
rate. Even otherwise, in our view, it is a pure question of law as to the
proper interpretation of the provisions of section 8 of the Central Sales Tax
Act and the provisions of rule 12 of the Central Sales Tax (Registration and
Turnover) Rules, 1957 and rule 6(b)(ii) of the Central Sales Tax (Karnataka) Rules,
1957. In view of the decision of this Court in the case of Kedarnath Jute
Manufacturing Co.* [1965] 3 SCR 626 and of the decision in Delhi Automobiles
(P) Ltd.† (1997) 10 SCC 486, it is clear that these provisions have to be
strictly construed and that unless there is strict compliance with the
provisions of the statute, the assessee was not entitled to the concessional
rate of tax.”

 

Based on
above judgment there are a number of Tribunal judgments in Maharashtra where
the claims are disallowed for non-production of original parts.

 

Recent judgment of the Hon. Madras High
Court in case The State of Tamil Nadu vs. TVL India Rosin Industries [Tax Case
(Revision) No.66 of 2017 dt.13.12.2017]

The Hon.
Madras High Court had an occasion to deal with similar issue. The facts in this
case are that the original parts were misplaced and in appeal, the claim was
allowed based on duplicate parts. The Tribunal confirmed the order of the first
appellate authority. Therefore, the State Government has filed revision before
the Hon. Madras High Court. Following questions were referred for the opinion
of the High Court.

 

“9. Being
aggrieved by the dismissal of the appeal in S.T.A.No.86 of 2011, dated 25/10/2013,
on the file of the Tamil Nadu Sales Tax Appellate Tribunal (Additional Bench),
Chennai, instant Tax Case Revision Petition is filed, on the following
substantial questions of law:-

 

1. Whether
on the facts and in the circumstances of the case, the Tribunal was right in
law in holding that duplicate Form F is sufficient for availing concessional
rate of tax?

2. Whether
on the facts and in the circumstances of the case, the Tribunal was right in
law in holding that though the decision reported in 83 STC 116 is related to C
Form, F Form also comes under CST Act?

3. Whether
on the facts and in the circumstances of the case, the Tribunal was right in
not considering the Rule 10 (2) of the CST Rule which prescribed, under which
circumstances duplicate forms can be accepted?

4. Whether
on the facts and in the circumstances of the case, the Tribunal was right in
not considering Rule 12 (2) and 12 (3) of the CST Rule which deals with the
procedure to be followed for obtaining duplicate forms in lieu of the original
declaration forms lost?

5. Whether
the Tribunal was right in ignoring the fact that the dealer while replying to
the pre-revision notice issued by the Assessing Officer, promised to file the
original form and requested extension of time for filing the same?” 

The Hon.
Madras High Court referred to the arguments of the State Government i.e.
revisionist and also referred to various provisions applicable on above subject
under CST Act and Local Act.

In
particular arguments on behalf of State Government are noted as under:-

“17.
Though Ms. Narmadha Sampath, learned Special Government Pleader contended that
one of the conditions required to be satisfied by the purchasing dealer is that
the Forms should have been lost and that the purchasing dealer, ought to have
submitted an indemnity bond, in Form G to the notified authority, from whom the
said Form was obtained, for such sum and only in the event of satisfying the
above said requirement, the Assessing Authority can decide, as to whether such
duplicate/certificate, can be accepted or not, and further submitted that in
the case on hand, when purchasing dealer had failed to discharge the statutory
obligation, refusal to accept the duplicate forms, cannot be said to be
erroneous, we are not inclined to accept the said contention, for the simple
reason that the Assistant Commissioner (CT) Harbour 2, Assessment Circle, has
not passed orders, with the above said reasons.”

 

The Hon.
Madras High Court further observed as under while rejecting the revision filed
by the State Government.

“20.
Having regard to the Forms (Original, duplicate or counter foil) and placing
reliance on the decision rendered in Manganese Ore (India) Ltd Vs. Commissioner
of Sales, Tax, Madhya Pradesh, reported in {1991 (83) STC 116}, the Appellate
Deputy Commissioner (CT)-I, has passed the orders, stating that, there is
nothing wrong in filing duplicate forms, for availing concessional rate. The
Tamil Nadu Sales Tax Appellate Tribunal (Additional Bench), Chennai, has
referred to the Rules and accordingly, concurred with the views of the
appellate Authority.

21. Though
before the appellate Authority, contention has been made that submission of
original portion of Form, is mandatory for claiming concessional rate and that
there is every possibility of misuse of original Form, in some other
transaction, the said contention has been rejected. Form C (Rule 12 (1), is
issued by the State authority of the State. It also contains and name of the
person signing the declaration. Genuineness of the duplicate forms issued by
the authority of the other state to the purchaser-dealer is not disputed.
Revenue has not disputed that there was a inter-state sale and that a
certificate has been issued by the competent authority. Both the appellate
Deputy Commissioner (CT), Chennai, as well as the Tribunal had the opportunity
of perusing the duplicate forms. Assessee has relied on Manganese Ore Ltd’s
case and revenue has not placed any contra decision. On the facts and
circumstances of the instant case, the said judgment has persuasive value and
rightly applied.”

 

Thus, the
Hon. Madras High Court has taken a view, which will certainly give relief to
the litigants. It is nightmare to get the original of duplicate C forms from
the buyers. Under such circumstances, in genuine cases, the claim should remain
allowable against duplicate part of C form.

Although,
in this case the judgment of the Hon. Supreme Court in case of India Agencies
is not referred. But still the above judgment of the Hon. Madras High Court
based on provisions of CST Act will be helpful to the litigants. 

 

Conclusion

The above judgment is really very useful and it is a judgment
contemplating good relief in case of loss of original parts of C forms. Since
it is judgment under CST Act, it should remain applicable in all States unless
there is contrary judgment of any jurisdictional High Court. It should also
remain applicable in Maharashtra. A line of clarification and confirmation
about acceptance of above judgment by the concerned authority of Maharashtra
State will be much useful to avoid unnecessary litigations.  

 

Article 12 and Article 14 of DTAA – Consultants providing technical consultancy services in the capacity of an advisor and who also bears the risk in relation to such services, would be treated as an independent person – services rendered by them would qualify as Independent Personal Services.

1.      
TS-43-ITAT-2019 (AHD) DCIT vs.
Hydrosult Inc. A.Y.: 2011-12 Date of Order: 31st
January, 2019

 

Article 12 and Article 14 of DTAA –
Consultants providing technical consultancy services in the capacity of an
advisor and who also bears the risk in relation to such services, would be
treated as an independent person – services rendered by them would qualify as
Independent Personal Services.

 

FACTS

Taxpayer, a foreign Company incorporated in
Canada, was engaged in the business of providing technical consultancy services
for development of irrigation and water resources in India. During the year
under consideration, Taxpayer was awarded a contract for providing consultancy
services in relation to irrigation development project. In relation to the said
project, Taxpayer made payments to certain non-resident individuals as fees for
consultancy services. Taxpayer did not withhold tax from the payments on the
ground that such payments were not chargeable to tax in India for the following
reasons:

 

a. Payments made to professionals were in the
nature of independent personal services (IPS).

b. Aggregate period of presence of such
professionals in India did not exceed the threshold provided in the treaty.

c. Professionals did not have a fixed base in
India.

 

The Assessing Officer (AO), however
contended that the professionals were not independent per se as their
scope of work and activities were regulated by contractual obligations or other
forms of employment. Hence, payments made to them would not qualify as IPS
under the treaty. AO held that the services were rendered by the professionals
specialising in their respective domains. Accordingly, such services were in
the nature of technical/consultancy services covered under the Fees for
Technical Services (FTS) article of the treaty and therefore, subject to
withholding of tax in India.

 

Aggrieved, the Taxpayer appealed before
Commissioner of Income Tax (Appeal) [CIT(A)]. CIT(A) examined the terms of
agreement between Taxpayer and the non resident consultants and held that such
services qualified as IPS and, in absence of a fixed base as also stay in India
being within the prescribed threshold of 90 / 183 days of the respective DTAA,
such income was not taxable in India.

 

Aggrieved, the AO appealed before the
Tribunal.

 

HELD

  • Perusal of the specimen
    agreement entered into between the Taxpayer and one of the non-resident
    consultants indicated the following:

•    The non-resident consultant was engaged in
the capacity of an ‘advisor’.

•    The responsibility or the risk for the
results to a greater degree belonged to the professional.

•    The obligations arising from the contract
could not have been assigned to some other persons unlike in the case of an
employer.  Thus, the contract did not
lack independence of work/services to be rendered.

 

  •   Above factors indicate that
    the services rendered by the consultants was of independent in nature, which
    qualified it as IPS under the treaty. Payment for such services was not taxable
    in India in absence of fixed base in India and the physical presence of
    professionals in India not exceeding the threshold of 90 / 183 days that was
    specified in the respective DTAA. 

 

(PS: However, it is not clear from the
ruling if the recipient would have been taxable in India, if he had rendered
services in the capacity of an employee.)

 

Section 271(1)(c), 271AAA – In a case where penalty is leviable u/s. 271AAA, penalty initiated and levied u/s. 271(1)(c) is unsustainable in law.

3.  ACIT
vs. Nitin M. Shah  (Mumbai) Members: G. S. Pannu, VP and Sandeep Gosain,
JM ITA No.: 2863/Mum./2017 A.Y.: 2012-13 Dated: 1st November, 2018 Counsel for revenue / assessee: B. S. Bist /
Dr. P. Daniel

 

Section 271(1)(c), 271AAA –  In
a case where penalty is leviable u/s. 271AAA, penalty initiated and levied u/s.
271(1)(c) is unsustainable in law.

 

FACTS

The assessee was a director and key person
of one company N. A search and seizure operation was carried out on the
assessee and his group concerns. During the course of assessment proceedings,
the Assessing Officer (AO) made addition of Rs. 5,81,07,680 and assessed his
income at Rs. 12,06,72,926. Subsequently, the AO initiated penalty proceedings
u/s. 271(1)(c) of the Act in respect of the additions made during the course of
assessment. Aggrieved the assessee preferred an appeal to CIT(A) who confirmed
the addition of Rs. 2,67,68,882. As regards, the balance additions for which
relief was allowed by the CIT(A), the department filed appeal before the
Tribunal. The Tribunal upheld the order of the CIT(A) and thereafter, the AO
initiated the action for levy of penalty.

 

Aggrieved, the assessee preferred an appeal
before the CIT(A). The CIT(A) allowed the appeal of the assessee.

 

Aggrieved, revenue preferred an appeal to
the Tribunal on the ground that explanation furnished by the assessee was not bonafide
and incriminating material was found and seized in search and that the assessee
had defrauded the revenue by not offering true and correct income in the return
of income filed by the assessee. The assessee was therefore liable for penalty
as per Explanation to section 271(1)(c) of the Act.

 

HELD

The Tribunal observed that the CIT(A) held
that assessee’s case for levy of penalty fell u/s. 271AAA of the Act and not
u/s. 271(1)(c) of the Act. Further, sub-clause (3) to sub-section (1) of
section 271 of the Act clearly prohibited imposition of penalty in respect of
undisclosed income referred to in sub-section (1) of section 271 of the Act.
Since the AO had initiated penalty u/s. 271(1)(c) of the Act, the same was
unsustainable in law and therefore was directed to be deleted. The Tribunal
concurred with the view of the CIT(A) and held that penalty initiated and
levied by the AO u/s. 271(1)(c) of the Act was unsustainable in the eyes of law
and was thus rightly held to be deleted by the CIT(A).

 

The Tribunal dismissed the appeal filed by
the revenue.    

Section 54F – Claim u/s. 54 is admissible in respect of flats allotted by the builder to the assessee under the terms of the Development Agreement as the same constitute consideration retained by the Developer and utilised for construction of flats on behalf of the assessee.

2.  Shilpa
Ajay Varde vs. Pr. CIT (Mumbai) Members: Joginder Singh, VP and Ramit Kochar, AM  ITA No.: 2627/Mum./2018 A.Y.: 2013-14. Dated: 14th November, 2018 Counsel for assessee / revenue: M.
Subramanian / L. K. S. Dehiya

 

Section 54F – Claim u/s. 54 is admissible in respect of flats allotted by the
builder to the assessee under the terms of the Development Agreement as the
same constitute consideration retained by the Developer and utilised for
construction of flats on behalf of the assessee.

 

FACTS

The assesse, an individual, in his return of
income declared Capital Gains at Rs. 15,982 after claiming deduction u/s. 54F
and 54EC of the Act. The Assessing Officer (AO) completed the assessment
accepting the returned income. Subsequently, the Pr. CIT issued notice u/s. 263
of the Act and held that the order passed by the AO u/s. 143(3) of the Act was
erroneous as the same was prejudicial to the interest of the revenue. The Pr.
CIT observed that during the year under consideration, the assessee along with her
relatives entered into development agreement for the development of property
owned by the assessee with her relatives. As per the terms of agreement with
the developer, consideration for the said transfer of development rights was a
sum of Rs. 40 lakhs and four residential flats and six car parking spaces. The
assessee computed the gains by adopting Rs. 1,32,62,500 to be full value of
consideration. This sum of Rs.1,32,62,500 comprised of Rs. 40,00,000 being the
monetary consideration and Rs. 92,62,500 being the value of residential flats
which the assessee was entitled to receive from the developer. From the full
value of consideration the assessee reduced indexed cost of acquisition and the
value of two new residential houses which were to be received by the assessee
u/s. 54F of the Act.

 

The Pr. CIT, however, held that the assessee
could not be allowed to claim exemption u/s. 54F of the Act in respect of the
said two residential flats as the said flats were yet to be constructed by the
developer and were future properties and hence the assessee was not entitled to
claim exemption u/s. 54F of the Act. 
Further, he also observed that the assessee claimed deduction of Rs.
71,50,000 u/s. 54EC of the Act which was restricted to Rs. 50,00,000 as per the
amended provisions of the Act and therefore directed the AO to revise the order
passed u/s. 143(3) of the Act.

 

Against the said order passed by the Pr.CIT,
the assessee preferred an appeal to the Tribunal challenging the Pr. CIT’s
action of directing the AO to revise the order passed u/s. 143(3) of the Act.

 

On appeal, the Tribunal held as follows:

 

HELD

The Tribunal observed that the assessee,
during the course of assessment, disclosed complete details of transaction with
the developer and furnished all the details of computation of long term capital
gains and exemption claimed u/s. 54F and 54EC of the Act.  The Tribunal also observed that the AO had,
after due application of mind and considering all the details and documents on
record allowed the assessee’s claim for exemption u/s. 54F and 54EC of the Act
and it would not be correct to say that the AO did not make any inquiry or did
not make proper inquiry before allowing the claim of the assessee. The Tribunal
thus held the action of Pr. CIT of initiating section 263 of the Act to be
bad-in-law.

 

On merits, the Tribunal observed that flats
were specifically allotted by the developer in favour of the assessee under the
development agreement and effectively it could be said that the share of
consideration in lieu of property for development given by the assessee to the
developer to the extent of four residential flats will be retained by the
builder and invested by the developer by utilising its own funds for
constructing the flats on behalf of the assessee. Effectively, therefore
consideration under development agreement which the assessee was otherwise
entitled to receive was withheld by the developer for constructing the flats on
behalf of the assessee which satisfied the requirement of making investment in
construction of new residential flat as provided u/s. 54F of the Act. The
Tribunal also observed that CBDT in circulars had held that allotment of flat under
self-financing scheme is held to be construction for the purposes of capital
gains. Thus the Tribunal allowed the assessee’s claim for exemption u/s. 54F of
the Act. As regards assessee’s claim for exemption u/s. 54EC of the Act of Rs.
71,50,000, following the decision of the Madras High Court in CIT vs.
Jaichander [2015] 370 ITR 579 (Madras) and co-ordinate bench of the
Tribunal in Tulika Devi Dayal vs. JCIT [2018] 89 taxmann.com 442 (Mum.)
held that the exemption claimed u/s. 54EC of the Act was in accordance with the
provisions of the Act.

 

The Tribunal allowed the appeal filed by the
assessee.

Section 54 – Purchase of residential property is said to have been substantially effected on the date of possession. Accordingly, where assessee had received possession of a residential house one year before the date of transfer of residential house, though the agreement to purchase was entered into much prior thereto, the assessee was held to be eligible to claim deduction u/s. 54.

1. Ranjana R. Deshmukh vs. ITO (Mumbai) Members : Shamim Yahya,  AM and Ravish Sood, JM ITA No.: 697/Mum./2017 A.Y.: 2013-14 Dated: 9th November, 2018. Counsel for assessee / revenue: Moti B.
Totlani / Chaitanya Anjaria

 

Section 54
–  Purchase of residential property is
said to have been substantially effected on the date of possession.  Accordingly, where assessee had received
possession of a residential house one year before the date of transfer of
residential house, though the agreement to purchase was entered into much prior
thereto, the assessee was held to be eligible to claim deduction u/s. 54.

 

FACTS

The assessee,
an individual, sold immovable property on 28th March, 2013 and
claimed exemption u/s. 54 on the resultant gains. During the course of
assessment, the Assessing Officer (AO) observed that the property in respect of
which exemption was claimed by the assessee was purchased on 29th
January, 2009 by entering into an agreement to purchase. The AO therefore
concluded that since the residential property purchased by the assessee was
beyond the stipulated period of one year before the transfer of property under consideration
and hence the assessee was not entitled to claim exemption u/s. 54 of the Act.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who upheld the action of the AO.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal observed that possession of the
residential property purchased by the asssessee was handed over to the assessee
18th May, 2012 which was within the prescribed period of one year
prior to the date of transfer of property under consideration and therefore the
assessee was entitled to claim exemption u/s. 54 of the Act. The Tribunal held
that purchase of residential property is said to have been substantially
effected on the date of possession and for this view it relied on the decision
of the Bombay High Court in the case of CIT vs. Beena K. Jain [1994] 75
Taxman 145 (Bom.) wherein it was held that purchase was completed by
payment of full consideration and handing over of possession of the flat.

The Tribunal allowed the appeal of the
assessee.

Section 154 – What is permissible is merely rectification of an obvious and patent mistake apparent from record and not wholesale review of an earlier order.

4. 
[2019] 103 taxmann.com 154
(Mum.) Maccaferri
Environmental Solutions (P.) Ltd. vs. ITO ITA No.:
7105/Mum./2014 A.Y.: 2010-11 Dated: 12th
December, 2018

 

Section 154 – What is permissible is merely
rectification of an obvious and patent mistake apparent from record and not
wholesale review of an earlier order.

 

FACTS


The assessee, a private limited company,
filed its return of income declaring total income at NIL after setting off
brought forward losses under the normal provisions of the Act. Further, since
the book profit determined by the assessee was a negative figure, there was no
liability to pay MAT on book profits u/s. 115JB of the Act and the same was
accordingly declared and disclosed in the return of income filed by the
assessee. The case was selected for scrutiny and assessment was completed u/s.
143(3) of the Act determining the total income at NIL. Subsequently, the
Assessing Officer (AO) issued notice u/s. 154 of the Act so as to rectify the
mistake of accepting the book profits as such and thereby determined the book
profits at Rs. 6,95,57,438.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who upheld the action of the AO.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal,

 

HELD


The Tribunal made a reference to the well
settled position that the power u/s. 154 to rectify a mistake apparent from
record did not involve a wholesale review of the earlier order and rather, what
was permissible was only to rectify an obvious and patent mistake. The Tribunal
further noted that even debatable points of law would not fall in the meaning
of the expression “mistake apparent” for the purposes of section 154
of the Act. The Tribunal observed that the adjustments made by the AO disagreeing
with the determination of book profits by the assessee u/s. 115JB of the Act
involved a debatable issue which was outside the purview of section 154 of the
Act. The Tribunal held that action of the AO in invoking section 154 was unjust
in law as well as on facts. The appeal filed by the assessee was allowed.

Section 54F – Deposit of the amount of capital gains in a separate savings bank account and utilisation thereof for the purposes specified u/s. 54F is said to be substantial compliance with the requirements of section 54F.

3.      
[2019] 102 taxmann.com 50
(Jaipur) Goverdhan Singh
Shekhawat vs. ITO ITA No.:
517/JP/2013 A.Y.: 2009-10  Dated: 11th
January, 2019

 

Section 54F – Deposit of the amount of
capital gains in a separate savings bank account and utilisation thereof for
the purposes specified u/s. 54F is said to be substantial compliance with the
requirements of section 54F.

 

FACTS


The assessee, an individual, received
certain compensation on compulsory acquisition of land. The assessee offered
the said receipts as long-term capital gains and claimed exemption u/s. 54F of
the Act by depositing the amount of capital gains in a separate savings bank
account. The assessee contended that the amount of gains was deposited under
Capital Gains Accounts Scheme 1988. The Assessing Officer (AO) observed that
the account in which amount was deposited by the assessee was not a Capital
Gains Scheme Account and therefore denied exemption u/s. 54F of
the Act.

 

Aggrieved the assessee preferred an appeal
to the CIT(A) who confirmed the order of the AO.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal noted that the undisputed facts
viz. that despite having an existing account in another bank, the assessee
opened a new bank account and deposited not only the amount of consideration
but also the TDS refund received by it in this respect. Subsequently, the
assessee utilised the said amount for the construction of house. Thus, the
Tribunal noted that since the assessee had not utilised the amount for the
purposes stated u/s. 54F, he had duly deposited the entire compensation in the
bank account at the time of filing of return of income and claimed exemption
u/s. 54F of the Act. The Tribunal held that the assessee was entitled to claim
exemption as the assessee had substantially complied with the provisions of
sub-section (4) of section 54F.

 

The Tribunal held that the idea of opening
capital gains account under the scheme is to delineate the funds from other
funds regularly maintained by the assessee and to ensure that benefit availed
by an assessee by depositing the amount in the said account is ultimately
utilised for the purposes for which the exemption has been claimed i.e, for
purchase or construction of a residential house.

 

The Tribunal further observed that though
savings bank account was not technically a capital gains account, however the
essence and spirit of opening and maintaining a separate capital gains account
was achieved and demonstrated by the assessee. The Tribunal thus held that
merely because the saving bank account is technically not a capital gains
account, it cannot be said that there is violation of the provisions of s/s.
(4) of the Act in terms of not opening a capital gains account scheme.

 

The Tribunal allowed the appeal filed by the
assessee.

Section 22, 24(4) and 56 – Income earned by assessee from letting out space on terrace for installation of mobile tower/antenna was taxable as ‘income from house property’ and, therefore, deduction u/s. 24(a) was available in respect of it.

2.      
(2019) 197 TTJ (Mumbai) 966 Kohinoor
Industrial Premises Co-operative Society Ltd. vs. ITO ITA No.:
670/Mum/2018 A. Y.: 2013-14 Dated: 5th
October, 2018

           

Section 22, 24(4) and 56 – Income earned by
assessee from letting out space on terrace for installation of mobile
tower/antenna was taxable as ‘income from house property’ and, therefore,
deduction u/s. 24(a) was available in respect of it.

 

FACTS

 The assessee, a co-operative society, had
derived income from letting out some space on terrace for installation of
mobile towers/antenna which was offered “as income from house
property”. Further, against such income the assessee had claimed deduction
u/s. 24(a). The Assessing Officer observed that, the terrace could not be
termed as house property as it was the common amenity for members. Further, the
Assessing Officer observed that the assessee could not be considered to be
owner of the premises since as per the tax audit report, conveyance was still
not executed in favour of the society. He also observed that the annual letting
value of the terrace was not ascertainable. Accordingly, he concluded that the
income received by the assessee from the mobile companies towards installation
of mobile towers/antenna was to be treated as “income from other
sources”.

 

Aggrieved by the assessment order, the
assessee preferred an appeal to the CIT(A). The CIT(A) confirmed the order of
the Assessing officer on grounds that the income received by the assessee was
in the nature of compensation received for providing facilities and services to
cellular operators on the terrace of the building.

 

HELD

The Tribunal
held that the terrace of the building could not be considered as distinct and
separate but certainly was a part of the house property. Therefore, letting-out
space on the terrace of the house property for installation and operation of
mobile tower/antenna certainly amounted to letting-out a part of the house
property itself. That being the case, the observation of the Assessing Officer
that the terrace could not be considered as house property was unacceptable. As
regards the observation of the CIT(A) that the rental income received by the
assessee was in the nature of compensation for providing services and facility
to cellular operators, it was relevant to observe, the department had failed to
bring on record any material to demonstrate that in addition to letting-out
space on the terrace for installation and operation of antenna, the assessee
had provided any other service or facilities to the cellular operators. Thus,
from the material on record, it was evident that the income received by the
assessee from the cellular operators/mobile companies was on account of letting
out space on the terrace for installation and operation of antennas and nothing
else. Therefore, the rental income received by the assessee from such
letting-out had to be treated as income from house property.

 

 

Section 68 – Bank account of an assessee cannot be held to be ‘books’ of the assessee maintained for any previous year, and therefore, no addition u/s. 68 can be made in respect of a deposit in the bank account.

1.      
[2019] 198 TTJ (Asr) 114 Satish Kumar vs. ITO ITA No.: 105/Asr/2017 A.Y.: 2008-09 Dated: 15th January, 2019

                                               

Section 68 – Bank account of an assessee
cannot be held to be ‘books’ of the assessee maintained for any previous year,
and therefore, no addition u/s. 68 can be made in respect of a deposit in the
bank account.

 

FACTS


The assessee had filed his return of income
for A.Y. 2008-09. In the course of the assessment proceedings the Assessing
Officer observed that the assessee had during the previous year made a cash
deposits of Rs.11,47,660 in his saving bank account. In the absence of any
explanation on the part of the assessee as regards the ‘nature’ and ‘source’ of
the aforesaid cash deposit in the aforesaid bank account, the Assessing Officer
made an addition of the peak amount of cash deposit of Rs.11,47,660 u/s. 68 of
the Act.

 

Aggrieved by the assessment order, the
assessee preferred an appeal to the CIT(A). The CIT(A) upheld the addition made
by the Assessing Officer and dismissed the appeal.

 

HELD


The Tribunal held that an addition u/s. 68
could only be made where any sum was found credited in the books of an assessee
maintained for any previous year, and the assessee either offered no
explanation about the nature and source as regards the same, or the explanation
offered by him in the opinion of the assessing officer was not found to be
satisfactory. A credit in the ‘bank account’ of an assessee could not be
construed as a credit in the ‘books of the assessee’, for the very reason that
the bank account could not be held to be the ‘books’ of the assessee. Though it
remained as a matter of fact that the ‘bank account’ of an assessee was the
account of the assessee with the bank, or in other words the account of the
assessee in the books of the bank, but the same in no way could be held to be
the ‘books’ of the assessee. Therefore, an addition made in respect of a cash
deposit in the ‘bank account’ of an assessee, in the absence of the same found
credited in the ‘books of the assessee’ maintained for the previous year, could
not be brought to tax by invoking the provisions of section 68.

TOP BOOKS ON PROFESSIONAL SERVICES MANAGEMENT: THE QUINTESSENTIAL McKINSEY WAY

INTRODUCTION


In the December, 2018 issue of the Journal, Nitin Shingala wrote an
article that highlighted the need to read a number of books on management of
professional services firms and also curated a list of must-read books on the
subject. He summarised key lessons from The Trusted Advisor by David
H. Maister, Charles H. Green and Robert M. Galford.

 

This article seeks
to summarise and highlight key learnings from another classic — The McKinsey
Way by Ethan M Rasiel.

 

THE McKINSEY WAY


The McKinsey Way is
one of the most recommended, read and referred books on consulting as it
delivers crisp insights into the working of one of the most successful
consulting firms in the world. The book is teeming with amusing anecdotes which
make it quite different from the usual dry management literature on similar
subjects. The book provides an honest account of how one can be a successful
consultant and how can consulting firms grow themselves in the footsteps of
McKinsey & Co.

 

Ethan M. Rasiel was
a consultant in McKinsey & Co.’s New York office. His clients included
major companies in the finance, telecommunications, computing and consumer
goods sectors. Prior to joining McKinsey, Rasiel, who earned an MBA from the Wharton School at the University of Pennsylvania,
was an equity fund manager at Mercury Asset Management in London, as well as an
investment banker.

 

THEME


McKinsey & Co,
(“the firm”) is arguably the most celebrated consulting firm in the world.
Since its founding in 1923, it has now grown to 65+ offices in 130+ countries
and employs 4,500+ top minds. The book provides the reader a keyhole view of
how the firm thinks about business problems and the process through which it
solves them. The book also provides insight into how the firm markets its
services without “selling”. The final section of the book helps the reader
reflect on how to survive at McKinsey and how is life after working with the
firm.

 

The most important
learnings from each of these parts in the book are highlighted in this article.

 

PART ONE: THE McKINSEY WAY OF THINKING ABOUT BUSINESS PROBLEMS

When team members
meet for the first time to discuss their client’s problem, they know that their
solution will be:

  •    Fact-based
  •    Rigidly structured
  •    Hypothesis-driven

 

Fact-based

The firm loves facts for two key reasons. First, facts compensate for
lack of knowledge since most McKinsey-ites are generalists rather than industry
specialists. They bridge this industry knowledge gap through extensive
research. Second, facts bridge the credibility gap. The CEO of a Fortune 50
company will not give much credence to what some newly-minted, 27-year-old MBA
has to say.

 

Rigidly structured

Further, the
section explains a sine qua non for problem-solving at McKinsey –
“MECE”.

 

MECE stands for
mutually exclusive collectively exhaustive. Every list that the firm comes up
with in the process – problems with client, possible solutions or probable
outcomes – needs to be MECE. This ensures that while all possible items are
covered, none of them overlaps any other to add just redundant pointers to a
list.

 

Hypotheses-driven

The initial
hypotheses (IH) is an important pillar to McKinsey problem-solving which
involves 3 steps:

  •    Defining the IH
  •    Generating the IH
  •    Testing the IH

 

Defining the IH

The essence of the
IH is “Figure out the solution to the problem before you start”. While it may
sound counter-intuitive, IH is not the answer – it is just a theory which needs
to be proved or disproved. If IH is proved to be correct, it will become the
first slide of the presentation to be delivered a few months later. If proved
wrong, however, the process will give enough information to move on towards the
right answer.

 

Generating the
IH

The hypothesis is
then broken down into key drivers. Next, making an actionable recommendation
regarding each driver. For the next step, each top line recommendation is
broken down to the level of issues. If a given recommendation is correct, what
issue does it raise?

 

Testing the IH

Finally, the
hypothesis is tested to check whether anything is being missed out or any
issues are being ignored or all drivers of the problem have been considered?

 

Don’t reinvent the wheel and don’t boil the
ocean


McKinsey, like many
other firms, has developed a number of problem-solving methods. These
techniques are immensely powerful and allow the consultants to quickly fit in
raw data into frameworks and quickly begin to work towards the solution.
Further, the firm has a database of cases they have solved in what they call PD.net.
Here, the consultants can often tap into solutions to similar problems and
sometimes save days of effort. Further, sometimes it’s good to take a break
from the problem and resume later rather than sitting at a place and trying to
“boil the ocean”.

 

80/20 and other rules


80/20 is a rule
that has wide applicability and is one of the greatest truths of management.
80% of sales come from 20% of customers, 80% of the wealth is owned by 20%
people and 20% of a secretary’s job will take 80% of her time. The 80/20 rule
can provide the much-needed jumpstart in solving a problem as one can focus on
the few items that create maximum impact on the business and work on them
rather than going through a sea of data which has little impact.

 

The elevator test


Know your solution
(or your product or business) so thoroughly that you can explain it clearly and
precisely to your client (or customer or investor) in 30 seconds. If you can do
that, then you understand what you’re doing well enough to sell your solution.
You never know how long you might have with the CEO or a top investor to tell
him about your idea and keep them interested enough that they will come back to
know more.

 

Pluck the low hanging fruit


Clients can get
impatient during longer assignments. In such cases, rather than waiting to
present all findings and solutions in that final presentation, it is better to
present easy initial victories to the client. They boost team and client morale
and give the firm added credibility by showing anybody who may be watching that
you are on the ball and mean business. This rule is really about satisfying the
client in a long-term relationship.

 

Just say “I don’t know”


As professionals,
we think we are expected to solve challenges and answer queries at the drop of
a hat. I observe many professionals falling prey to this delusion and often
offering shallow or incorrect advice just to save face. A much better approach
is to just accept that you do not know something and that you will get back on
it. This helps build trust in the long term as people see you as somebody who
will not comment without adequate facts and credence.

 

PART TWO: THE McKINSEY WAY OF WORKING TO SOLVE BUSINESS PROBLEMS

How to sell without selling?

McKinsey is one
firm that does not advertise itself or have a sales team to constantly call and
reach out to prospects to grow their practice. However, it has still been one
of the most successful consulting firms in history. So how does the firm sell
without selling? The secret is that McKinsey constantly produces high quality
reports and newsletters which make their way onto the desks of CXOs. So, when
they have a business problem, who do they think of? You guessed it right! This
is how McKinsey markets itself but without selling.

 

Conducting interviews

Interviewing the
employees and management of the client is one of the most important tasks of
the firm’s engagements. They ensure that they use the best of their client’s
knowledge to assimilate processes and provide the most apt solutions. The
author advises that interviews should begin on a broad note and graduate to
specific questions as it progresses. This helps the interviewee to be more
relaxed in the process. Further, the interview should be a two-way process for
sharing information so that it makes the most of the time of all parties to the
interview. The author has also given advise on how to conduct difficult
interviews where the interviewee refuses to participate and has recommended
escalation of the issue to managers as a final resort.

 

Brainstorming

The firm is known
to think and provide solutions as a team. The whole team may sometimes spend a
whole day together in a room brainstorming on the solution. They also ensure
that the discussion points are being noted by someone in the room or by use of
digital whiteboards. The firm’s strength lies in its teams and how its best
brains work together.

 

“My experience at
the firm (and that of the many McKinsey alumni I interviewed for this book)
taught me that IHs produced by teams is much stronger than that produced by
individuals. Why? Most of us are poor critics of our own thinking.”

 

PART THREE : THE McKINSEY WAY OF SELLING SOLUTIONS

Making presentations

Client
presentations are where the firm presents its solution. They also print their
study and solution in ‘blue books’ which are handed over to each person in the
board room as they take them through the presentation. The author recommends
the client should be kept abreast of developments and findings in the study so
that the final presentation does not come as a surprise but rather, the client
has already begun to buy into the solution by the time the final presentation
takes place.

 

Rigorous implementation

A strategy is only
as good as how it is implemented. The author has suggested that the person in
charge of implementing the strategy at the client level should be thorough,
precise and with the propensity to get things done by people. This will ensure
that the strategy gets implemented in a timely and effective manner. Rigorous
implementation ensures that the strategy is able to see the light of day.

 

PART FOUR: SURVIVING AT McKINSEY

Finding a mentor

The author has
suggested that every person in the firm should have a mentor who can provide
necessary guidance and feedback to help them grow in their career. The mentor
could be the manager in the team or some other person who has considerable
experience at the firm. The mentor helps them see a different perspective, find
their place in the firm and grow in the required direction.

 

Recruiting at McKinsey

McKinsey invests
considerable time, attention and resources to hire nothing but the best brains
across top schools around the globe. They also recruit people from varied
backgrounds and disciplines to add diversity to their teams. The author has
also given various examples of how the firm goes to different lengths (like
taking them to the best fine dines in town) so that who they recruit are
nothing short of the best.

 

PART FIVE : LIFE AFTER McKINSEY

“As one former
McKinsey-ite told me, leaving McKinsey is never a question of whether — it’s a
question of when. We used to say that the half-life of a class of new
associates is about two years — by the end of that time, half will have left
the firm. That was true in my time there and still is today. There is life
after McKinsey, however. In fact, there may be more life, since you are
unlikely to work the same hours at the same intensity in any other job. There
is no doubt, however, that the vast majority of former McKinsey-ites land on
their feet.

 

A quick scan
through the McKinsey Alumni Directory, which now contains some 5,000 names,
reveals any number of CEOs, CFOs, senior managers, professors, and
politicians.”

 

The drill that
consultants go through at the firm and their interactions with the best minds
of the world in absolutely unforgiving scenarios helps McKinsey-ites flourish
long after they have moved on from the firm.

 

CONCLUSION


The book is a rare,
honest and striking account of what consultants and firms can learn from “The
McKinsey Way” to grow their careers and practice. The anecdotes dotted across the
book keep the readers’ attention alive and also quickly endorse the opinions
presented by the author. The book runs across multiple vertical facets like
practice-building, presentations, marketing, client management, psychology and
productivity while still not coming across as generic. These directly
applicable tools and advices hit the nail on the head rather than beating
around the bush.  

 

TWO SETS OF STARS LIGHT UP THE 50TH BIRTHDAY CELEBRATIONS OF BCAJ

There were two sets of stars at the launch of the Golden Jubilee issue of the Bombay Chartered Accountant Journal (BCAJ) – on the one hand were five young music students at the Symphony Orchestra of India, NCPA, and on the other hand were stalwarts who had consistently contributed to the Journal for decades.

The glittering event was held on Wednesday, 6th March, 2019 in the C.K. Nayudu Hall of the Cricket Club of India and attracted a full house of office-bearers, eminent chartered accountants, committed contributors and unabashed admirers of the BCAJ. When the special commemorative issue was formally released, there was prolonged applause, bursting of balloons and a shower of confetti.

BCAJ Editor Raman Jokhakar, who was the master of ceremonies, started by welcoming the guests and introducing the young musicians at the ‘Birthday Celebrations of the BCA Journal’. First off, Gauri Khanna played Air Pergolesi and Dance Jenkenson on the cello. She was followed by Pranaya Jain on the flute rendering Rondo Mozart. Leah Divecha on the violin and Tivona Murphy D’Souza (D-Bass) rendered the popular Bollywood number “Senorita”. And Sangeeta Jokhakar ended the performance with a Bollywood medley and a cavatina by J. Raff on the violin. The budding, young musicians (some of whom will become the stars of tomorrow) and their teachers were felicitated with bouquets and mementoes.
Next, Raman invited the chief guest, Sunil Nair, Mumbai Resident Editor of the Times of India and BCAS President Sunil Gabhawalla to the dais. He stressed that the purpose of the celebration was to honour and acknowledge those who had contributed to the BCAJ for long and enabled it to reach the fabulous figure of fifty. He also quoted Steve Jobs who had said, “One way to remember who you are is to remember who your heroes are.”

Thereafter, the President spoke about the service provided by the Journal and acknowledged the scores of dedicated people who had nurtured it for years. He then introduced the chief guest.

Sunil Nair, who spoke on the “Future of the Print Media”, gave a brief and informative talk. He spoke about similarities in the roles of auditors and the press. He stressed the need for independence of media and also spoke about the future trends in media by embellishing his points with statistics.

He was astounded by the fact that the BCAJ had been published without a break for fifty long years and depended totally on subscriptions. Another unique achievement was that it was being brought out by chartered accountants who stole time from their professions to publish it on a voluntary basis. Warming up, he was candid enough to admit that although The Times of India was the biggest English language newspaper in the world, of late it had slid to the third position overall in terms of copies sold in India. The first two positions were now held by Hindi news dailies and the Times was no longer the highest-selling daily in the land. The silver lining, according to him, was that overall the circulation of newspapers in India was on the upswing – whereas in the rest of the world it was seeing a pronounced fall.

In other words, he stressed, the printed word still carried weight, and although television, the internet and other electronic forms of dissemination of news were becoming popular all over the world, they had still to make any huge impact in India. This was probably because of the late “blooming” of the Indian economy. Nair’s talk was well received and he was presented with a memento by Vice-President Manish Sampat.
Raman then spoke about the early days when editing DID NOT involve backspace, select, delete, cut, copy, paste. He stated that instead of a big bang special issue, the Editorial Board had decided to carry Golden Pages throughout the year which contained Interviews, Views and Counterviews and Special Articles (32 in number) amongst other regular features.

Just before the release of the last issue of Volume 50, past Editors Ashok Dhere, Gautam Nayak, Sanjeev Pandit and Anil J. Sathe along with Editorial Board members Kishor Karia and Anup Shah were invited to be part of the team to release the special issue. The twelfth issue of Volume 50 was then released by them.

The next segment consisted of honouring the Editors and the authors, writers and columnists of existing features. Raman started off with the words of Khalil Gibran: “You give little when you give of your possessions. It is when you give of yourself that you truly give.” What Gibran meant was giving of one’s time, because one’s time was one’s life. He also spoke about the past eight Editors and acknowledged the presence of the family members of the Late B.V. Dalal, the Late Ajay Thakkar and the Late Narayan Varma who served as Publisher for a long time. He also regretted the absence of K.C. Narang who was indisposed on that day.

Four past Editors, Ashok Dhere, Gautam Nayak, Sanjeev Pandit and Anil Sathe, were felicitated by the chief guest with a special memento designed for the event for their diligent, meticulous, persistent and focused contribution to the BCAJ. The words on the mementoes read: “In appreciation of your long and outstanding contribution to the BCA Journal…”

There was special applause when President Sunil took the mike in between and requested the chief guest (himself a resident Editor) to present a trophy to the BCAJ Editor, Raman.

In a touching gesture, Raman did not overlook those of his predecessors who were no longer with us. Thus, bouquets were presented to Mrs. Dalal, Mrs. Thakkar and Mrs. Varma, spouses of late Editors and Publisher.

Moving on, Raman spoke about a set of Japanese people called TAKUMI, which stood for artisans. This word could be written in many different ways in Kanji characters and each one of them gave different meanings – adroit, eminent, clear and so on. It is said that the intensity of the Takumis’ work borders on obsession – they are precise, absorbed and meticulous. These people are real experts. One of their characteristics is – Ganbaru – or to persevere, to stay firm by doing one’s best, with obsessive attention to detail. All of this is considered to be a unique talent in Japan.

The twenty five feature writers of the BCAJ, he stated, are perhaps best described by these two words: They are “Takumis” or artisans whose hands dance and flow in concert, designing and creating a new form each month.

Each of the features was introduced with a brief history, how it was curated and who were the people who wrote them. Each of the feature writers was then presented with a trophy as a mark of appreciation and regard for their consistency, quality and length of voluntary service to the Journal. It was notable that some feature writers had been contributing for more than 30 years on a monthly basis.

In an interesting twist, the trophies were not presented by the chief guest or by the Editor. Rather, the past Editors and President were called upon to make the presentations. Editor Raman, who compered the event, included not only facts and anecdotes during the presentations, but also sprinkled a fair dose of humour on the proceedings. He requested Gautam Nayak to present the trophy to the other Nayak — Mayur. Similarly, one Anil (Sathe) was asked to present a trophy to another Anil (Doshi). A round of applause greeted Anup Shah when Raman pointed out that when he had started off as a contributor, he was called CA. Anup Shah, but after nearly two hundred columns he had now become Dr. Anup Shah.

The presentation included a specially-designed trophy to all the regular contributors who had been writing for more than five years for the features concerned. Each trophy contained a sketch of the feature writer himself, along with a citation mentioning the feature. More than 40 trophies were ready for distribution.

Raman also recognised those involved in bringing out the Journal : V.K. Sharma, the Knowledge Manager, and Ms. Navina Vishwanathan, the Assistant Knowledge Manager, Anmol Purohit and the BCAS team. The printers, M/s Spenta Multimedia, were also present and each of the team members was acknowledged with a round of applause.

And then it was time to cut the ceremonial cake. It was a huge cake, to put it mildly, and it required the efforts of Raman, Sunil and some of the past Editors to cut it. The icing on top of the cake was designed to look like the cover of the issue that was released on the occasion.

Apart from the Editors, office-bearers and authors, the C.K. Nayudu Hall also saw the presence of some of the chartered accountants whose absorbing life stories featured in the article “Kaleidoscopic View” in the Golden Jubilee issue. Among them were Motichand Gupta, now Senior Manager for Taxation with Ion-Exchange (India) Ltd.; Ms. Nandini Shankar, CA, violinist and music teacher; Kisan Daule, who established his own practice after serving Transworld Shipping for 20 years (he retired as Senior GM); and Brij Mohan Chaturvedi, who is the third generation in a family having five generations in the CA world (he was accompanied by his granddaughter Tina, who is the fifth-generation CA in the Chaturvedi family).

A sumptuous repast was laid out for the guests who partook of it with great delight. As the eventful night came to an end, the hosts and the guests headed home carrying pleasant memories of an evening well spent.

KEY AUDIT MATTERS IN THE AUDITOR’S REPORT

It is always dissatisfaction with the status quo that drives
change, and the quantum of change is often proportionate to the magnitude of
dissatisfaction. So it was with the auditor’s report that auditors the world
over had been issuing with consistency. When the powerful investor-lender
lobby, who are the prime stakeholders in corporate enterprises, and therefore
the most crucial users of auditor’s reports, said that “the auditor’s opinion
on the financial statements is valued, but that the report could be more
informative”, they were making a polite understatement. In reality, they were
pretty upset about the fact that auditors were not telling them very much about
the most important matters they dealt with during the audit, how they responded
to them, and how they had concluded on them in forming their opinion. They were
unhappy that the entire process of audit was rather opaque and mysterious and
sought greater transparency. Their dissatisfaction got exacerbated each time
one more large corporation went under and they lost money. 

 

Standard setters across the world were under acute pressure from this
powerful lobby, supported by regulators, to change the situation. That was the
genesis of the effort to revise reporting standards by the two leading standard
setters in the world: the IAASB1 and the PCAOB. In the meanwhile, an
initiative for change was taken independently by the UK as early as in 2012-13
followed closely by the Netherlands, both countries bringing out revised
reporting standards by 2014. When the IAASB announced 2016 as the effective date
for its revised ISAs, there were several countries that early-adopted them,
including Germany, Switzerland, Hong Kong, South Africa, New Zealand and
Poland. In fact, Zimbabwe conducted a “dry run” of the revised reporting
standards a full year ahead of the IAASB effective date. The PCAOB in the US
started its effort even earlier, in 2008. The new proposed standard was exposed
for outreach of various stakeholders several times, comments were invited and
examined, roundtables were held and finally, in 2016, a reproposed standard was
announced with staggered effective dates2. India framed its revised
reporting standards, based almost wholly on ISAs, with 2017 as the effective
date. But that date was later revised to accounting periods beginning 1st
April, 2018.

___________________________________________________

 

1   IAASB or
International Auditing & Assurance Standards Board is a constituent of the
International Federation of Accountants. The PCAOB or Public Companies
Accounting Oversight Board is the audit oversight body created under the
Securities & Exchange Commission of the United States.

 

 

The auditor’s report of a large enterprise is the “finished product”
signed and delivered after months of sustained efforts put in by a large number
of audit professionals and partners in planning and performing an audit. It
addresses the final outcome of that process for users of financial statements.
Yet, over the years, the auditor’s report largely became so standardised (or
“boilerplate”) that there was no significant difference to be seen between the
auditor’s report of one enterprise as compared to that of another, particularly
where the opinion was “clean”, even though the two entities’ businesses and
economic situations would be completely different. Users of audited financial
statements wanted to see more distinctiveness in the auditor’s report so that
each such report told its own story and had its own character. To achieve this,
the standard setters introduced the concept of disclosing Key Audit Matters
(KAMs) in the auditor’s report.

 

INTENDED
BENEFITS

Communicating KAMs3  in
the auditor’s report does not change the auditor’s responsibilities in any way.
Nor does it change the responsibilities of either the management or those
charged with governance (TCWG). Rather, it is intended to highlight matters of
the most significance in the audit that was performed “through the eyes of the
auditor”. KAMs may also be perceived by users to enhance audit quality, and
improve the confidence that they have in the audit and the related financial
statements. The communication of KAMs could help to alleviate the information
asymmetry that exists between company managements and investors, which could
result in more efficient capital allocation and could even lower the average
cost of capital.

 

Throughout the standard-setting
process, both by IAASB and by PCAOB, the multitude of stakeholders who
responded, ranging from investors, lenders, regulators, oversight authorities,
national standard setters, preparers of financial statements and accounting
firms have expressed their support to the introduction of KAMs in auditors’
reports of listed entities and felt that it would protect the interests of
investors and further the public interest in the preparation of informative,
accurate and independent auditors’ reports. 

 

2   For large
accelerated filers FYs ending on or after 30/6/2019; Others – 15/12/2020

3         Under
the related PCAOB Standard, KAMs are called Critical Audit Matters (CAMs). An
effort has been made to give key comparative positions under the
related PCAOB standard in the footnotes, for the general appreciation of the
reader.

 

It is believed that having KAMs in the auditor’s report will:

  •    Increase transparency
  •     Focus users of the financial statements on
    areas of financial statements that are subject to significant risks,
    consequence and judgement
  •    Provide users with a basis to further engage
    with managements and TCWG
  •     Enhance communications between the auditor
    and TCWG on the most significant matters in the audit
  •     Increase the attention given by both,
    managements and auditors, to disclosures in the financial statements,
    particularly for the most significant matters
  •     Renew the auditor’s focus on matters to be
    communicated, indirectly resulting in an increase in professional scepticism
    and improvement in audit quality. 

 

CHANGES MADE IN
STANDARDS


Apart from the introduction of the concept of communicating KAMs
contained in a new Standard, SA 701 Communicating Key Audit Matters in the
Independent Auditor’s Report, some other changes have also been made,
mainly in SA 260(R) Communication with Those Charged With Governance; SA
570(R) Going Concern; SA 700(R) Forming an Opinion and Reporting on
Financial Statements; SA 705(R) Modifications to the Opinion in the
Independent Auditor’s Report; SA 706(R) Emphasis of Matter Paragraphs
and Other Matter Paragraphs in the Independent Auditor’s Report; and SA
720(R) The Auditor’s Responsibilities Related to Other Information.
Besides this, consequential amendments have also been made to SAs 210, 220,
230, 510, 540, 600 and 710.

 

WHAT IS A KEY
AUDIT MATTER?


KAM is defined in the Standard as: Those matters that, in the
auditor’s professional judgement, were of most significance in the audit of the
financial statements of the current period. Key audit matters are selected from
matters communicated with those charged with governance.4

_______________________________________

4   A
CAM under the PCAOB Standard, on the other hand, is any matter arising from the
audit of the FS that was communicated or required to be communicated to the
audit committee and that (1) relates to accounts or disclosures that are
material to the FS, and (2) involved especially challenging, subjective, or complex
auditor judgement. CAMs are not a substitute for the auditor’s departure from
an unqualified opinion.

 

Perhaps the most challenging part of disclosing KAMs is how to determine
the matters that constitute KAMs. The Standard has struck a delicate balance
between prescription and auditor judgement over here. The definition itself
clearly states that the matters to be disclosed should be those that “in the
auditor’s professional judgement” were of the most significance. It then
requires that such matters should be selected by the auditor “from matters
communicated with TCWG”. Apart from this, it also underlines three areas that
are the most likely sources of matters that would be discussed with TCWG, among
others.

 

Several auditing standards specify matters that the auditor should take
up with TCWG, in addition to SA 260(R) Communication with Those Charged with
Governance, and 265 Communicating Deficiencies in Internal Control to Those
Charged with Governance. From these, the auditor first picks out matters
“that required significant auditor attention.” Then he applies his professional
judgement to further filter down matters and selects those that were “of the
most significance” in the audit of the current period as KAMs.

 

The auditor would
therefore be well advised to be armed with a ready-referencer checklist of
matters that the various standards prescribe for communication with TCWG to
first ensure that he complies with that requirement. It may be noted that there
is a subtle difference between SA 260 and SA 265 that is to be found in their
respective titles. Whereas SA 260 requires the auditor to communicate “with”
TCWG, SA 265 requires him to communicate “to” TCWG. To put it colloquially, SA
260 is two-way traffic (a discussion) but SA 265 is largely one-way traffic.
The definition of KAM talks about matters that were communicated “with” TCWG.
Significant deficiencies in internal control that are communicated to TCWG may
not always fall within the concept of KAM, although the auditor might have had
to modify his audit approach due to them, increasing his audit effort.

 

MATTERS TO BE
CONSIDERED BY THE AUDITOR IN DETERMINING KAMS5

The auditor is required to explicitly consider:

  •     Areas of higher assessed risks of material
    misstatement, or significant risks.
  •     Significant auditor judgements relating to
    areas of significant management judgement, including accounting estimates
    having high estimation uncertainty.
  •     The effect of significant events or
    transactions that occurred during the year. 

______________________________________________

5   For
determining CAMs under the PCAOB Standard, the following points are provided:
(a) the auditor’s assessment of the risks of misstatement, including
significant risks; (b) the degree of auditor judgement related to areas in the
FS that involve the application of significant judgement or estimation by
management, including estimates with significant measurement uncertainty; (c)
the nature and timing of significant unusual transactions and the extent of audit
effort and judgement related to these transactions; (d) the degree of auditor
subjectivity in applying audit procedures to address the matter or in
evaluating the results of those procedures; (e) the nature and extent of audit
effort required to address the matter, including the extent of specialised
skill or knowledge needed or the nature of consultations outside the engagement
team regarding the matter; and (f) the nature of audit evidence obtained
regarding the matter.

 

 

This requirement articulates the thought process the auditor should go
through to consider these drivers of “areas of significant auditor attention”
while noting that KAMs are always selected from matters communicated to TCWG.
It should not, however, be assumed that KAMs could only result from a
consideration of these three specific indicators, nor that all the three
indicators must exist to determine KAMs. Furthermore, the standard requires the
auditor to filter down to “matters of most significance” from out of the “areas of significant auditor
attention”. 

 

If one examines the three indicators mentioned above, one would see that
these are matters of most concern to the users of the audited financial
statements because any of them could turn out to be the cause of material
infirmity in the balance sheet of an entity or a source of management fraud.
Identification of matters drawn from them as KAM would enlighten users about
their nature, magnitude and how the auditor dealt with them. It would also
enable users, such as investors or analysts, to directly question the
management and TCWG about those matters. 

 

The importance given in the Standard to matters discussed with TCWG has
a double purpose: (a) investors and lenders want to have insights into matters
taken up in interactions between the auditor and TCWG, including those that
were keeping the auditor up at nights, consistent with the audit committee’s
role representing the interest of shareholders; and (b) to stimulate discussion
between the auditor and TCWG that, it was perceived, was not happening as much
as it should. Obviously, matters that comprise communications with TCWG would
be matters that are material to the audit of the financial statements, and
selecting the ones that are of the most significance out of these would limit
KAMs to only crucial issues that were hitherto not getting disclosed in the
auditor’s report, and which investors and lenders wanted to focus on in
understanding the financial statements of companies they had put their money
into.

 

Significant
risks


To determine a risk as significant the auditor considers:

(a)    Whether it is a fraud risk;

(b)    Whether the risk relates to
major changes in developments that impact the entity or its business;

(c)    Whether the risk arises from
complexity of transactions;

(d)    Whether there are
significant related party transactions;

(e)    Whether measurements of
amounts included in the financial statements involve a high level of
subjectivity or measurement uncertainty; and

(f)     Whether the risk involves
significant events or transactions that are outside the normal course of
business of the entity, or appear to be unusual in nature.

 

Significant
judgements


The second point of consideration is significant auditor judgements
relating to areas of significant management judgement, including accounting
estimates having high estimation uncertainty. Accounting estimates involving
the outcome of litigation, fair value estimates for derivative financial
instruments that are not publicly traded, and fair value accounting estimates
for which a highly specialised entity-developed model is used, or for which
there are assumptions or inputs that cannot be observed in the marketplace,
generally involve a high level of estimation uncertainty. However, estimation
uncertainty may exist even where the valuation method and data are well
defined. Estimates involving judgements are generally made in the following
areas and often involve making assumptions about matters that are uncertain at
the time of estimation:

(a)    Allowance for doubtful
accounts;

(b)    Inventory obsolescence;

(c)    Warranty obligations;

(d)    Depreciation method used or
useful life of assets;

(e)    Provision against carrying
amounts of investments;

(f)     Outcome of long-term
contracts;

(g)    Financial obligations or
costs arising from litigation;

(h)    Complex financial
instruments that are not traded in an open market;

(i)     Share-based payments;

(j)     Property or equipment held
for disposal;

(k)    Goodwill, intangible assets
or liabilities acquired in a business combination;

(l)     Transactions involving non-monetary
exchange.

 

Estimates involving
judgements are likely to be susceptible to intentional or unintentional
management bias. This susceptibility increases with subjectivity and is often
difficult to detect at the individual account balance level. Intentional
management bias often foreshadows fraud.

 

Significant
events and transactions

The auditor would
need to exercise professional judgement to determine if a significant event or
transaction that he encounters in an audit poses a risk of material misstatement
or not, since such events or transactions could be of many assorted types. Some
such events are listed below:

(a)    Operations in economically unstable regions,
volatile markets, or those subject to complex regulation;

(b)    Cash flow crunch, non-availability of funds,
liquidity and going concern issues, or loss of customers;

(c)    Changes in the industry where the entity
operates, or in the supply chain;

(d)    Forays into new products, services, lines of
business, or new locations;

(e)    Failed products, service
lines, ventures, business segments or entities;

(f)     Complex alliances, joint
ventures, or significant transactions with related parties;

(g)    Use of off-balance sheet
finance, special purpose entities, and other complex financial arrangements;

(h)    Distress related to
personnel like non-availability of required skills, high attrition, frequent
changes in key executives;

(i)     Unremediated internal
control weaknesses;

(j)     Inconsistencies between
entity’s IT and business strategies, changes in IT environment, installation of
new IT systems and controls having a bearing on revenue recognition or
financial reporting;  

(k)    Inquiries into the entity’s
business by regulators or government bodies;

(l)     Past misstatements, history
of errors, or significant period-end journal entries;

(m)   Significant non-routine or
non-systematic transactions, including inter-company transactions, and large
revenue transactions at or near period-end;

(n)    Transactions recorded based
on management intent, e.g. debt financing, intended sale of assets,
classification of marketable securities;

(o)    Application of new
accounting pronouncements;

(p)    Pending litigation and
contingent liabilities.

 

Matters to be
communicated with TCWG

SA 260, Communication with Those Charged With Governance,
includes many matters that should be communicated by the auditor. For the
purposes of KAMs reporting, however, all of those (e.g. the auditor’s
responsibility in relation to the audit; auditor independence) may not be
relevant. What would be relevant are communications of the significant risks
identified by the auditor and his significant findings.

 

Significant
risks


Communication with TCWG of significant risks (including fraud risks)
identified by the auditor helps them understand those matters, why they require
special audit consideration, and helps them in fulfilling their oversight
responsibility better. However, care should be taken when discussing the
planned scope and timing of the audit procedures so as to not compromise the
effectiveness of the audit, especially when some or all of TCWG are also part
of management. Such communication may include:

(a)   How the auditor plans to
address the risks;

(b)   The auditor’s approach to
internal control;

(c)   The application of the
concept of materiality;

(d)   The nature and extent of
specialised skills or knowledge needed to perform the audit, including the use
of auditor’s experts;

(e)   The auditor’s preliminary
views about matters that are likely to be KAMs;

(f)    Interaction and working
together with the entity’s internal audit function.

 

On his part, the auditor also benefits from a discussion with TCWG by
understanding:

(a)   The appropriate persons
within TCWG with whom to communicate;

(b)   The allocation of
responsibility between management and TCWG;

(c)   The entity’s objectives,
strategies and the related business risks;

(d)   Matters that TCWG consider
warrant particular auditor attention and areas where they request him to
perform increased audit procedures;

(e)   Significant communication
with regulators;

(f)    Other matters that TCWG
consider may influence the audit;

(g)   The attitudes, awareness and
actions of TCWG concerning (i) the importance of internal control and how they
oversee the effectiveness of internal control, and (ii) the detection and
possibility of fraud;

(h)   The actions of TCWG in
response to changes taking place in the accounting, IT, legal, economic and
regulatory environment;

(i)    Responses of TCWG to
previous communication with the auditor.

 

Significant
findings


These include:

(a)    The auditor’s views about
qualitative aspects of the entity’s accounting practices such as the
appropriateness of accounting policies, determination of accounting estimates,
and adequacy of financial statement disclosures;

(b)    Significant difficulties
encountered by the auditor during the audit;

(c)    Significant matters arising
during the audit that were or are being discussed with management;

(d)    Written representations that
the auditor desires;

(e)    The form and content of the
auditor’s report (now also including matters that the auditor expects to
include as KAMs);

(f)     Other significant matters
arising during the audit that the auditor feels are relevant to TCWG.

 

Other matters:

Beyond SA 260, there are several other standards that specifically
require the auditor’s communication with TCWG that have a bearing on KAMs
reporting:

(a)    SA 240, pertaining to the
auditor’s responsibilities relating to fraud;

(b)    SA 250, pertaining to
consideration of laws and regulations;

(c)    SA 265, pertaining to
communicating internal control deficiencies;

(d)    SA 450, pertaining to
evaluation of misstatements;

(e)    SA 505, pertaining to
external confirmations;

(f)     SA 510, pertaining to
initial audit engagements;

(g)    SA 550, pertaining to
related parties;

(h)    SA 560, pertaining to subsequent
events; and

(i)     SA 570, pertaining to going
concern.

 

ORIGINAL
INFORMATION AND SENSITIVE MATTERS


During the
formation of the Standard, concerns were voiced that the auditor might provide
“original information” when reporting KAMs. Original information is any
information about the entity that has not otherwise been made publicly
available by the entity. The Standard has addressed this in paragraphs A35-A38
by emphasising that the auditor should take care not to provide any original
information in KAMs, but if it becomes necessary to do so, he should encourage
management to include new or additional disclosures in the financial statements
or elsewhere in the annual report so that it no longer remains original
information.

 

Similar apprehension was voiced with regard to the auditor disclosing
“sensitive matters” when reporting KAMs. Sensitive matters could be possible
illegal acts or possible fraud, significant deficiencies in internal control,
breaches of independence, complex tax strategies or disputes, problems with
management or TCWG, quality of risk management structures, regulatory
investigations, a contingent liability that did not meet the requirements for
disclosure, other litigation or commercial disputes, evaluation of identified
or uncorrected misstatements, etc. The Standard has addressed this in paragraph
14(b), with more detailed application guidance in paragraphs A53-A56, by
stating that in extremely rare circumstances, where the entity has not publicly
disclosed information about it, the auditor may determine that a matter should
not be communicated in the auditor’s report because the adverse consequences of
doing so would reasonably be expected to outweigh the public interest benefits
of such communication.

 

COMMUNICATING
KAMS


To introduce KAMs to the user, and to dispel the danger that
communication of KAMs might be misunderstood by some users to be a separate
opinion by the auditor on those specific matters, the Standard makes the
following introductory statements6:

 

  •     Key audit matters are those matters that,
    in the auditor’s professional judgement, were of most significance in the audit
    of the financial statements of the current period; and
  •      These matters were addressed in the context
    of the audit of the financial statements as a whole, and in forming the
    auditor’s opinion thereon, and the auditor does not provide a separate opinion
    on these matters.

 

Each KAM should then describe (i) why the matter was considered to be
one of most significance in the audit, and was therefore determined to be a
KAM, and (ii) how the matter was addressed in the audit. It would be advisable
for the auditor to include in the description of a KAM a reference to a Note to
the Financial Statements where management has described the matter in detail
from its point of view7. And, if there is no such disclosure, he
should encourage management to include it. Doing so will also take care of the
danger of the auditor unwittingly providing any original information.  

_________________________________________

6   The introductory statement
in case of CAMs under the PCAOB Standard is: The critical audit matters
communicated below are matters arising from the current period audit of the FS
that were communicated or required to be communicated to the audit committee
and that: (1) relate to accounts or disclosures that are material to the
financial statements and (2) involved our especially challenging, subjective,
or complex judgements. The communication of critical audit matters does not
alter in any way our opinion on the financial statements, taken as a whole, and
we are not, by communicating the critical audit matters below, providing
separate opinions on the critical audit matters or on the accounts or
disclosures to which they relate.

7   The
following needs to be done to communicate CAMs under the PCAOB Standard: (a)
identify the CAM; (b) describe the principal considerations that led the
auditor to determine that the matter is a CAM; (c) describe how the CAM was
addressed in the audit [in doing so, describe: (i) the auditor’s response or
approach that was most relevant to the matter; (ii)  a brief overview of the audit procedures
performed; (iii) an indication of the outcome of the audit procedures; and (iv)
key observations with respect to the matter, or some combination of these
elements]; (d) refer to the relevant financial statement accounts or
disclosures that relate to the CAM.

 

To dispel any misunderstanding that may arise in the minds of users as
to the import of disclosing KAMs by the auditor, and to clearly make users
understand the significance of a KAM in the context of the audit, and the
relationship between KAMs and other elements of the report, it is necessary for
the auditor to use language that:

  •       Does not imply that the matter was not appropriately
    resolved by the auditor in forming his opinion;

  •       Relates the matter directly to the
    specific circumstances of the entity, while avoiding generic or standardised
    language;
  •       Takes into account how the matter is
    addressed in the related disclosures in the financial statements, if any; and
  •       Does not contain or imply discrete
    opinions on separate elements of the financial statements.

 

The Standard intends that description of a KAM should be relatively
clear, concise, understandable, entity-specific and should not be viewed as
competing with the management’s disclosures or providing original information
about the entity. Also, that there should be a balance between the requirement
to explain why the auditor considered each matter to be of the most significance
in the audit and the flexibility allowed in describing its effect on the audit.
The Standard has left the nature and extent of the auditor’s response and
conclusion on the matter to his judgement by using the words “how the matter
was addressed in the audit”. Nevertheless, the Standard provides guidance that
the auditor may describe:

  •       Aspects of the auditor’s response or
    approach that were most relevant to the matter or specific to the assessed risk
    of material misstatement;
  •       A brief overview of procedures performed;
  •       An indication of the outcome of the
    auditor’s procedures; or
  •       Key observations with respect to the
    matter;

– or some combination of these elements.

 

While matters that give rise to a modified opinion that are reported
under SA 705(R) or going concern matters that are reported under SA 570(R) are,
by definition, KAMs, as they are already prominently mentioned elsewhere in the
auditor’s report, they are not required to be again described in detail under
the KAMs section. Only a reference may be made in the KAMs section to the
related Basis for Qualified/ Adverse Opinion, or the Material Uncertainty
Related to Going Concern sections of the auditor’s report.

 

Where the auditor determines, based on facts and circumstances of the entity
and the audit, that there is no KAM to be disclosed, he shall nevertheless
include a statement under the KAMs section that there is no KAM to communicate.
It is an expectation in the Standard that in every audit of a listed entity
there would be at least one matter that qualifies as KAM, and therefore the
auditor should be very circumspect in asserting that there is no KAM to report.
However, there could be situations where the auditor determines that a KAM,
though there, is not to be communicated (i) because law or regulation prohibits
such communication, (ii) that the matter belongs to the category of extremely
rare circumstances where the consequences of communication outweigh the public
interest benefits of communication, or (iii) that the only matters to be
communicated as KAMs are disclosed elsewhere in the report in the basis for
modified opinion or going concern sections.

 

SA 705.29, Considerations When the Auditor Disclaims an Opinion on
the Financial Statements states that when the auditor disclaims an opinion
on the financial statements, the auditor’s report shall not include a KAMs
section.

 

The auditor is required to communicate with TCWG (i) the matters that he
has determined to be KAMs, or (ii) that he has determined that there are no KAMs.

 

APPLICABILITY


The Standard is mandatorily applicable to listed entities8.
Yet, the Standard allows for voluntary application by the auditor to audits of
financial statements of other entities also. SA 700(R).A35-A38 deals with two
situations where KAMs may be communicated: (i) where law or regulations
requires such communication, and (ii) where the auditor decides to communicate
KAMs for unlisted entities, particularly in case of unlisted public interest
entities (PIEs). PIEs are large entities that have a large number and a wide
range of stakeholders, for example, banks, insurance companies, employee
benefit funds, charitable institutions, etc.

 

Even where law or regulation is silent, voluntary communication of KAMs
in the auditor’s report by auditors of PIEs is to be encouraged, given the fact
that most of them are very large in size, have many stakeholders, and deal with
huge amounts of public money and may often also have large government
shareholding.

 

The ICAI Implementation Guide to SA 701
pointedly mentions that: “The auditor’s report is a deliverable by the auditors
and hence the decision to communicate key audit matters is to be taken by
auditors only.” In cases of unlisted entities where the auditor would like to
keep his option open for communicating KAMs, ISA 210.A249 (2018
Handbook) Agreeing the Terms of Audit Engagements, states that the
engagement letter may make reference to “the requirement for the auditor to
communicate key audit matters in the auditor’s report in accordance with ISA
701.” This is also reiterated in SA 700.A37.  

 

 

8   PCAOB Standards apply only to listed
entities and hence there is no ambiguity w.r.t. CAMs communication.

 

 

DOCUMENTATION


While the overarching requirements of SA 230, Documentation, of
documenting significant professional judgements made in reaching conclusions on
significant matters arising during the audit appropriately address the
documentation of significant judgements made in determining KAMs, SA 701
nevertheless includes specific documentation requirements in respect of the
following:

  •       Matters that required significant auditor
    attention and the rationale for the auditor’s determination as to whether or
    not each of these matters is a KAM;
  •       Where applicable, the rationale for the
    auditor’s determination that there are no key audit matters to communicate in
    the auditor’s report or that the only key audit matters to communicate are
    those matters addressed by paragraph 1510 ;
  •       Where applicable, the rationale for the
    auditor’s determination not to communicate in the auditor’s report a matter
    determined to be a key audit matter.

 

This is so that a more specific documentation requirement 11 would
address the concerns of regulators and audit oversight authorities (like NFRA)
for their ability to appropriately inspect or enforce compliance with the
Standard.  

 

ILLUSTRATIVE KAMs

A)      Introductory paragraph

  •       Key Audit Matters

Key audit matters are those matters
that, in our professional judgement, were of most significance in our audit of
the financial statements of the current period. These matters were addressed in
the context of our audit of the financial statements as a whole, and in forming
our opinion thereon, and we do not provide a separate opinion on these matters.

 

 

9   The related Indian Standard
on Auditing, SA 210, has not been correspondingly revised by ICAI as of the
date of this article.

10  Matters given in the basis
for modified opinion or the going concern sections of the auditor’s report

11       The
corresponding documentation requirement for CAMs under the PCAOB Standard is:
For each matter arising from the audit of the financial statements that: (a)
was communicated or required to be communicated to the audit committee, and (b)
relates to accounts or disclosures that are material to the financial
statements; the auditor must document whether or not the matter was determined
to be a critical audit matter (i.e., involved especially challenging,
subjective, or complex auditor judgement) and the basis for such determination.
[Note: Consistent with the requirements of AS 1215, Audit Documentation, the
audit documentation should be in sufficient detail to enable an experienced
auditor, having no previous connection with the engagement, to understand the
determinations made to comply with the provisions of this Standard.]

 

B)      Why the matter was considered to be one of
most significance in the audit and therefore determined to be a KAM?

 

  •       Goodwill

Under Indian Accounting Standards (Ind AS), the Group is required to
annually test the amount of goodwill for impairment. This annual impairment
test was significant to our audit because the balance of XX as of March 31,
20X1 is material to the financial statements. In addition, management’s
assessment process is complex and highly judgemental and is based on
assumptions, specifically [describe certain assumptions], which are
affected by expected future market or economic conditions, particularly those
in [name of country or geographic area].

 

  •       Valuation of Financial Instruments

The Company’s investments in structured financial instruments represent
[x %] of the total amount of its financial instruments. Due to their
unique structure and terms, the valuations of these instruments are based on
entity-developed internal models and not on quoted prices in active markets.
Therefore, there is significant measurement uncertainty involved in this
valuation. As a result, the valuation of these instruments was significant to
our audit.

 

  •       Effects of New Accounting Standards

As of April 1, 20XX, Ind ASs 110 (Consolidated Financial Statements),
111 (Joint Arrangements) and 112 (Disclosure of Interests in Other Entities)
became effective. Ind AS 110 requires the Group to assess for all entities
whether it has: power over the investee, exposure or rights to variable returns
from its involvement with the investee, and the ability to use its power over
the investee to affect the amount of the investor’s returns. The complex
structure, servicing and ownership of each vessel requires the Group to assess
and interpret the substance of a significant number of contractual agreements.

 

  •       Valuation of Defined Benefit Pension
    Assets and Liabilities

The Group has recognised a pension surplus of [monetary value] as
of March 31, 20X1. The assumptions that underpin the valuation of the defined
benefit pension assets and liabilities are important, and also subjective
judgements as the surplus/deficit balance is volatile and affects the Group’s
distributable reserves. Management has obtained advice from actuarial
specialists in order to calculate this surplus, and uncertainty arises as a
result of estimates made based on the Group’s expectations about long-term
trends and market conditions. As a result, the actual surplus or deficit
realised by the Group may be significantly different to that recognised on the
balance sheet since small changes to the assumptions used in the calculation
materially affect the valuation.

 

  •       Revenue Recognition

The amount of revenue and profit recognised in the year on the sale of [name
of product] and aftermarket services is dependent on the appropriate
assessment of whether or not each long-term aftermarket contract for services
is linked to or separate from the contract for sale of [name of product].
As the commercial arrangements can be complex, significant judgement is applied
in selecting the accounting basis in each case. In our view, revenue
recognition is significant to our audit as the Group might inappropriately
account for sales of [name of product] and long-term service agreements
as a single arrangement for accounting purposes and this would usually lead to
revenue and profit being recognised too early because the margin in the
long-term service agreement is usually higher than the margin in the [name
of product] sale agreement.

 

  •       Going Concern Assessment

As disclosed in Note 2, the Group is subject to a number of regulatory
capital requirements, which are a key determinant of the Group’s ability to
continue as a going concern. We identified that the most significant assumption
in assessing the Group’s and [significant component’s] ability to
continue as a going concern was the expected future profitability of the [significant
component], as the key determinant of the forecasted capital position. The
calculations supporting the assessment require management to make highly
subjective judgements. The calculations are based on estimates of future
performance, and are fundamental to assessing the suitability of the basis
adopted for the preparation of the financial statements. We have therefore
spent significant audit effort, including the time of senior members of our
audit team, in assessing the appropriateness of this assumption.

 

C)      How the matter was addressed in the audit?

  •       Goodwill

Our audit procedures included, among others, using a valuation expert to
assist us in evaluating the assumptions and methodologies used by the Group, in
particular those relating to the forecasted revenue growth and profit margins
for [name of business line]. We also focused on the adequacy of the
Group’s disclosures about those assumptions to which the outcome of the
impairment test is most sensitive, that is, those that have the most
significant effect on the determination of the recoverable amount of goodwill.

 

  •       Revenue Recognition

Our audit procedures to address the risk of material misstatement
relating to revenue recognition, which was considered to be a significant risk,
included:

•    Testing of controls, assisted
by our own IT specialists, including, among others, those over input of
individual advertising campaigns’ terms and pricing; comparison of those terms
and pricing data against the related overarching contracts with advertising
agencies; and linkage to viewer data; and

•    Detailed analysis of revenue
and the timing of its recognition based on expectations derived from our
industry knowledge and external market data, following up variances from our
expectations.

 

  •       Disposal of a Component

We have involved our valuation, financial instruments and tax
specialists in addressing this matter and focused our work on:

•       Assessing the
appropriateness of the fair values assigned to each element of the
consideration received by referring to third-party data as applicable;

•       Evaluating management’s
assessment of embedded derivatives within the sale and purchase agreement; and

•       Critically assessing the
fair value of [name of component] and the related allocation of the
purchase price to the assets and liabilities acquired by evaluating the key
assumptions used.

 

We also evaluated the presentation and disclosure of the transactions
within the consolidated financial statements.

 

  •       Restructuring Provision and
    Organisational Changes

In our audit we addressed the appropriateness and timely recognition of
costs and provisions in accordance with Ind AS 37 – Provisions, Contingent
Liabilities and Contingent Assets. These recognition criteria are detailed and
depend upon local communication and country-specific labour circumstances.
Recognition criteria can be an agreement with the unions, a personal
notification or a settlement agreement. The component audit teams have
performed detailed audit procedures on the recognition and measurement of the
restructuring provisions related to their respective components. The Group
audit team has identified the completeness and accuracy of the restructuring
provisions as a significant risk in the audit, has reviewed the procedures
performed by the component audit teams and discussed with the component teams
the recognition criteria. The restructuring provisions at the head office were
audited by the Group audit team. We found the criteria and assumptions used by
management in the determination of the restructuring provisions recognised in
the financial statements to be appropriate.

 

Decision framework to guide the auditor in
exercising his professional judgement





  •       Restructuring Provision and Disposition
    of a Mine

Our audit procedures included, among others: examining the
correspondence between the Group and the [name of government] and
discussing with management the status of negotiations; examining announcements
made by management to assess whether these currently commit the Group to
redundancy costs; analysing internal and third-party studies on the social
impact of closure and the related costs; recalculating the provision for
closure and rehabilitation costs for the mine in the context of the accelerated
closure plans; and reassessing long-term supply agreements for the existence of
any onerous contracts in the context of the Group’s revised requirements of the
accelerated closure plans. We assessed the potential risk of management bias
and the adequacy of the Group’s disclosures.

 

We found the assumptions and resulting estimates to be balanced and that
the Group’s disclosures appropriately describe the significant degree of
inherent imprecision in the estimates and the potential impact on future
periods of revisions to these estimates. We found no errors in calculations.

 

D)      How the auditor may refer to the related
disclosures in the description of a KAM?

 

  •       Valuation of Financial Instruments

The Company’s disclosures about its structured financial instruments are
included in Note 5.

 

  •       Goodwill

The Company’s disclosures about goodwill are included in Note 3, which
specifically explains that small changes in the key assumptions used could give
rise to an impairment of the goodwill balance in the future.  

 

BAN ON UNREGULATED DEPOSIT SCHEMES

1.  BACKGROUND


The Lok Sabha
passed the “Banning of Unregulated Deposit Schemes Bill, 2019” on 13th
February, 2019. As the said Bill could not be passed by Rajya Sabha before the
Parliament was dissolved, the Hon’ble President has issued an Ordinance called
“The Banning of Unregulated Deposit Schemes Ordinance, 2019”, on 21st
February, 2019. This has come into force on 21st February, 2019. The
main objective of the Ordinance is to provide for a comprehensive mechanism to
ban unregulated deposit schemes and to protect the interest of depositors. The
Ordinance contains a substantive banning clause which bans deposit takers from
promoting, operating, issuing advertisements or accepting deposits in any
unregulated deposit scheme. It creates three different types of offences, viz.,
Running Unregulated Deposit Schemes, Fraudulent default in Regulated Deposit Schemes
and Wrongful inducement in relation to Unregulated Deposit Schemes. There are
adequate provisions for disgorgement or repayment of deposits in cases where
such schemes have managed to raise deposits illegally. The Ordinance provides
for attachment of properties/assets of the deposit taker by the Competent
Authority and subsequent realisation of assets for repayment to the depositors.
However, there are some controversial provisions in the Ordinance which have
created some practical issues. In this article an attempt is made to discuss
some of the important provisions of this Ordinance.

 

2. UNREGULATED
DEPOSIT SCHEMES

(i)     Section 2(17) of the
Ordinance states that an “Unregulated
Deposit Scheme” shall mean a Scheme or an arrangement under which deposits are
accepted or solicited by any deposit taker by way of business. However, this
term does not include a deposit taken under the Regulated Deposit Scheme as
stated in the First Schedule to the Ordinance.


(ii)    Section 3 of the Ordinance
bans any Unregulated Deposit Schemes effective from 21st February,
2019. In other words, no deposit taker can directly or indirectly promote or
issue any advertisement soliciting participation or enrolment in such a scheme.
Further, the deposit taker cannot accept any deposits in pursuance of an
Unregulated Deposit Scheme.


(iii)    Section 5 of the Ordinance
provides that no person shall knowingly make any statement, promise or forecast
which is false, deceptive or misleading in material facts or deliberately
conceal any material facts to induce another person to invest in, or become a
member or participant of, any Unregulated Deposit Scheme.


(iv)   Further, section 6 of the
Ordinance states that a Prize Chit or Money Circulation Scheme which is banned
under the provisions of the Prize Chits and Money Circulation Scheme (Banning)
Act, 1978, shall be deemed to be an Unregulated Deposit Scheme under this
Ordinance.

 

3. REGULATED DEPOSIT SCHEMES


(i)     The Ordinance does not apply to Regulated
Deposit Schemes as mentioned in the First Schedule to the Ordinance as under:  


S.No

Schemes Prescribed by

Regulated Deposit Schemes

(a)

Securities and  Exchange
Board of India

Collective Investment Scheme

Alternative Investment Funds

Funds managed by Portfolio Managers

Share-Based Employee Benefits

Any other scheme registered under SEBI

Amounts received by Mutual Funds

(b)

Reserve Bank of India

Deposits accepted by NBFC

Any other scheme registered / regulated with RBI.

Amounts received by 
Business Correspondents and Facilitators

Amounts received by Authorised Payment System.

(c)

Insurance Regulatory and Development Authority

Contract of Insurance

(d)

State Government or Union Territory Government

Scheme by Co-operative Society

Chit Business under Chit Funds Act, 1982.

Scheme regulated by enactment relating to money lending

Any scheme of prize chit or money circulation scheme

(e)

National Housing Bank

Scheme for accepting deposits under NHB Act, 1987

(f)

Pension Fund Regulatory and Development Authority

Scheme under PFRDA

(g)

Employees P. F. Organisation

Scheme under EPFMP Act, 1952

(h)

Central Registrar, Multi-State Corporative Society

Scheme for accepting deposits from voting members

(i)

Ministry of Corporate Affairs

Deposits under Chapter V of Companies Act, 2013

Nidhi or Mutual Benefit Society u/s. 406 of Companies Act, 2013.

(j)

Any Regulatory Body

Deposits accepted under any scheme registered with a regulatory
body

(k)

Central Government

Any other scheme as notified by the Government under this
Ordinance

 

(ii)    Section 4 of the Ordinance
provides that while accepting deposits pursuant to a “Regulated Deposit Scheme”
no deposit taker shall commit any fraudulent default in the repayment or return
of the deposit on maturity or in rendering any specified services promised
against such deposit.


(iii)    From the above provisions
for Unregulated Deposit Schemes it is evident that the terms (a) Deposit and
(b) Deposit Taker are important. It may be noted that merely because a person
is covered by the term “Deposit Taker”, or loan or advance is covered by the
term “Deposit”, it does not mean that such deposit taken by a deposit taker is
prohibited by the Ordinance. These two terms defined in the Ordinance are
explained in the following paragraphs.

 

4.     DEFINITION OF “DEPOSIT”


The term “Deposit” is defined in section 2(4) of the Ordinance as under:

 

(i)     Deposit

Deposit means an amount of money received by way of an advance or loan
or in any other form by any Deposit Taker with a promise to return the money
after a specified period or otherwise, either in cash or kind or in the form of
a specified service. This may be with or without any benefit in the form of
interest, bonus, and profit, or in any other form.

(ii)    Exclusions

However, the following transactions are excluded from the definition of deposit.

(a)    Loan from a Scheduled Bank,
Co-operative Bank or any other banking company as defined in the Banking
Regulation Act, 1949.

(b)    Loan or financial assistance
received from a notified Public Financial Institution, Regional Financial
Institution or insurance companies.

(c)    Amount received from a State
or Central Government or from any other source if it is guaranteed by the
government or from a Statutory Authority.

(d)    Amounts received from any
foreign government, foreign bank, multilateral financial institution, foreign
government-owned development financial institutions, foreign export
collaborators, foreign corporate bodies, foreign citizens, foreign authorities
or persons resident outside India (subject to provisions of FEMA, 1999), etc.

(e)    Amounts received as credit
by a buyer from a seller on the sale of any movable or immovable property.

(f) Amounts received by a recognised asset reconstruction company.

(g)    Any deposit made u/s. 34 or
an amount accepted by a political party u/s. 29B of the Representation of
People Act, 1951.

(h)    Any periodic payment made by
the members of the self-help groups recognised by the State Government.

(i)     Any amount collected for
such purpose as is authorised by the State Government.

(j)     An amount received in the
course of or for the purpose of business and bearing a genuine connection to
such business. This includes the following receipts:

(i)     Payment or advance for
supply or hire of goods or services.

(ii)    Advance received in
connection with consideration of an immovable property.

(iii)    Security or dealership
deposit for contract for supply of goods or services.

(iv)   Advance received under
long-term projects for supply of capital goods.

 

The above receipts are subject to the following conditions:

  •    If the above amounts become refundable,
    such amount shall be deemed to be deposits on the expiry of 15 days, if not
    refunded within 15 days.
  •     If the above amount becomes refundable due
    to the Deposit Taker not obtaining necessary permission or approval under the
    law to deal in goods or properties or services for which the money is taken, it
    will be treated as a ‘Deposit’

(k)    Amount received as
contribution towards the capital by partner of any partnership firm or LLP.        

(l)     Amounts received by an
Individual by way of loan from relatives or amounts received by a firm by way
of loan from relatives of any of its partners.

 

For the above purpose the term “relative” is defined to mean any one who
is related to another if they are members of an HUF, or is husband, wife,
father, mother, son, son’s wife, daughter, daughter’s husband, brother, or
sister of the individual.

 

It may be noted that this is a very restricted definition as brother’s
wife, sister’s husband, nephew, niece, mother-in-law, father-in-law or near
relatives of spouse are not considered as relatives.  Therefore, any loan or advance received from
such persons will be treated as a deposit.

 

5.     DEPOSIT TAKER

Section 2(5) of the Ordinance states that a “Deposit Taker” means (i) An
Individual or a Group of Individuals, (ii) A proprietorship Concern, (iii) A
Partnership Firm, (iv) An LLP, (v) A company, (vi) AOP, (vii) A Trust – Private
Trust or Public Trust, (viii) Co-operative Society or a Multi – State
Co-operative Society, (ix) Any other arrangement of whatsoever nature. However,
this term does not include (a) A Corporation incorporated under an Act of Parliament
or a State Legislature or (b) a Banking Company, SBI, a subsidiary bank, a
regional rural bank, a co-operative bank, or a multi- state co-operative bank.

 

6.     IMPACT OF THE ORDINANCE ON CERTAIN DEPOSITS

Some practical issues arise from the above provisions of the
Ordinance.  As stated above, if any loan,
advance or deposit is taken by a person who falls in the list of Regulated
Deposit Schemes the provisions of the Ordinance will not apply.  Further, merely because a loan, advance or
deposit falls within the definition of ‘Deposit’ given in the Ordinance it does
not mean that it is to be considered as a deposit under the Unregulated Deposit
Scheme.  What is prohibited under the
Ordinance is a loan, advance or deposit taken under the “Unregulated Deposit Scheme”
as defined in section 2(17) of the Ordinance. 
In other words, if the deposit taker is not operating any scheme under
which deposits are accepted by way of business, such deposit will not be
considered as a deposit under Unregulated Deposit Scheme.  Accepting deposit by way of business would
mean that the business of the deposit taker is to accept deposits and give the
money as loans to others (i.e. Money-Lending or Finance business). 

 

In the light of the above, some of the practical issues are discussed
below:

 

(i)     If an Individual takes a
loan of Rs. 50 lakh from his friends for construction of his house, such loan
is not prohibited by the Ordinance although such loan is considered as a
deposit u/s. 2(4) of the Ordinance.  This
is because under the definition of the term “Unregulated Deposit Scheme” only
such deposit which the deposit taker takes by way of business is
prohibited.  In other words, if the
deposit taker is taking loans, advances or deposits for his money-lending or
finance business and such business is not covered by the definition of
Regulated Deposit Schemes, it will be considered as a deposit under the
Unregulated Deposit Scheme.

(ii)    If an Individual, Firm or
LLP takes any loan, advance or deposit of Rs. 1 crore from any person (including
a partner of the firm or LLP or a non-relative of such partner) as working
capital for the manufacturing or trading business, it is not prohibited by the
Ordinance.  The reasoning is the same as
stated in (i) above as the person taking such loan, advance or deposit is not
taking the same for the business of taking deposits.  Further, the deposit taker cannot be
considered as having advertised or solicited for taking loans, advances or
deposits.  Such receipt is in the course
of, or for the purpose of, business and bearing a genuine connection to such
business and therefore will not be considered as a ‘Deposit’ u/s. 2(4) of the
Ordinance.

(iii)    If an LLP engaged in
construction of residential flats takes an advance from the prospective
customers against promise to allot residential flats after construction, the
said advance cannot be considered as a deposit taken under the Unregulated
Deposit Scheme. This is because the advance is not taken for the purpose of
business of taking deposits as stated in (i) above.

(iv)   If an individual carrying on
business of money-lending has taken loans, advances or deposits from relatives
he will not be considered as  having
contravened the provisions of the Ordinance since such  loans, advances or deposits do not come within
the definition of ‘Deposit’ u/s. 2(4) of the Ordinance. The same will be the
position if such loans, advances or deposits are taken from relatives of a
partner of a partnership firm.  However,
if such loans, advances or deposits are taken from relatives of any partner of
an LLP carrying on money-lending business, which is not falling within the
definition of Regulated Deposit Scheme, the LLP will be considered as violating
the provisions of the Ordinance.  This is
because deposits from a relative of a partner of an LLP is not excluded from
the definition of a deposit under the Ordinance.

(v)    Amounts received by way of
contributions towards the capital by partners of any partnership firm or an LLP
are not considered as ‘Deposit’ u/s. 2(4) of the Ordinance.  A partnership deed of any partnership firm or
LLP specifies the initial contribution to be made by partners towards
capital.  Further, the deed also provides
that further contribution of money shall be made by the partners in such manner
as may be mutually agreed upon by the partners. 
Therefore, it is possible to take the view that any further funds
brought in by the partners in the partnership firm or LLP will be considered as
contribution towards capital by partners. 
Further, even if the amount received from a partner is considered as a
‘Deposit’ u/s. 2(4) of the Ordinance, it will not be considered as a deposit
under Unregulated Deposit Scheme if the partnership firm or LLP is not carrying
on money-lending or finance business.

(vi)   If a company is accepting
deposits from public and is complying with Chapter V  (Acceptance of Deposits by Companies) of the
Companies Act, 2013, such deposits will not be considered as deposits under
Unregulated Deposit Scheme.

(vii)   If an LLP engaged in manufacturing business takes
a loan of Rs. 2 crore from a partnership firm carrying on Money-Lending
Business, the provisions of the Ordinance will not apply.  This is for the  reason that the  term ‘Deposit’ in section 2(4) of the
Ordinance does not include any amount received in the course of or  for the purpose of business of LLP and having
a genuine connection to the business.

(viii)  If a subsidiary company
takes a loan from its holding company it will not be contravening the
provisions of the Ordinance. This is because u/s. 2(4) of the Ordinance
‘Deposit’ taken by a company is given the same meaning as assigned to it in the
Companies Act, 2013. Section 2(31) of the Companies Act read with Rule 2(1) (c)
(vi) of the Companies (Acceptance of Deposits) Rules, 2014 provides that “Any
amount received by a company from any other company is  not to be considered as a deposit.

(ix)   If a buyer of goods receives
credit of 45 days from the seller, the same will not be considered as an
Unregulated Deposit and the Ordinance will not apply to such credit.  This is because such credit is not considered
as a Deposit u/s. 2(4) of the Ordinance.

(x)    Section 3 of the Ordinance
bans the Unregulated Deposit Schemes w.e.f 21st
February, 2019. It also prohibits, w.e.f. 21st
February, 2019, any deposit taker from,
directly or indirectly, promoting, operating, issuing any advertisement or
accepting deposits in pursuance of an Unregulated Deposit Scheme.  This will mean that a Deposit Taker cannot
take any fresh deposit under such scheme on or after 21st
February, 2019.  However, it is not clear from this section as
to what is the position of the deposits already taken before 21st
February, 2019 under any Unregulated Deposit
Scheme.  This issue — whether the Deposit
Taker has to refund such outstanding deposits to the depositor and, if so,
within what period? — requires clarification from the government.

 

7.     COMPETENT AUTHORITY


(i)     The provisions of the
Ordinance are to be administered by the State Governments and the Union
Territories (Appropriate Governments). Section 7 of the Ordinance authorises
the Appropriate Governments to appoint one or more officers (not below the rank
of Secretary to that government) as a Competent Authority.


(ii)    Where a Competent Authority
has reason to believe, on the basis of the information and particulars as
prescribed by the Rules, that any Deposit Taker is soliciting deposits in
contravention of the provisions of the Ordinance, he may provisionally attach
the deposits held by the Deposit Taker. 
He may also attach the money or other property acquired by the Deposit
Taker or any other person on his behalf. 
The procedure for such attachment will be as prescribed by the Rules.  


(iii)    For the above purpose the
Competent Authority is vested with the powers of the Civil Court under the Code
of Civil Procedure, 1908. While conducting the investigation or inquiry he can
exercise this power for (a)  discovery
and inspection, (b) enforcing attendance of any person, (c) compelling the production
of records, (d) receiving evidence on affidavits, (e) issuing commission for
examination of witnesses and documents, 
and (f) any other matter which may be prescribed  by the Rules.


(iv)   Except for the offences u/s.
4 (fraudulent default under Regulated Deposit Schemes) and intimation to be
given about accepting deposits u/s. 10, all other offences under the Ordinance
shall be cognisable and not-bailable. In other words, for these offences any
police officer can book a case on receipt of an FIR without waiting for a
magistrate’s order. The police officer has, then, to inform the Competent
Authority. On receipt of such information, the Competent Authority shall refer
the matter to CBI if the offence relates to a deposit scheme involving
depositors or properties located in more than one State or Union Territory or
outside India and the amount involved is of such magnitude as to significantly
affect public interest.  


(v)    The proceedings before the
Competent Authority shall be deemed to be judicial proceedings u/s. 193 and 288
of the Indian Penal Code.  In other
words, the Competent Authority will have to conduct the proceedings as per the
Rules to be prescribed and on the basis of principles of natural justice.


(vi)   U/s. 9(1) the Central
Government is required to designate the Authority to maintain and operate an
online database for information on Deposit Takers operating in India.  This Authority may require any Regulator
(SEBI, RBI, IRDA, State Government, Union Territory, etc.,) or the Competent Authority
to share such information about Deposit Takers as may be prescribed.  Similarly, section 11 of the Ordinance
provides that all other authorities such as Income tax  authorities, banks, regulators or any investigating
agency has to share information about any offence by a Deposit Taker with the
Competent Authority, CBI, police, etc.


(vii)   Section 10 of the Ordinance
provides that every Deposit Taker who commences or carries on its business as
such on or after 21st February, 2019 shall intimate the Authority appointed by the
Central Government u/s. 9(1) of the Ordinance about its business in the
prescribed form.  It may be noted that
this form is required to be filed by any Deposit Taker who accepts or solicits
deposits as defined u/s. 2(4) of the Ordinance. Further, this form is to be
filed by a company which accepts deposits under Chapter V of the Companies Act,
2013. In other words, the form is required to be filed even if the deposits
taken by the Deposit Taker are under unregulated Deposit Scheme or not.


(viii)  It may be noted that the requirement of
furnishing information u/s. 10 of the Ordinance is going to be onerous as it
applies to almost all persons who are carrying on any business of manufacturing
goods, trading in goods, money lending, financing, rendering of services, etc.
The definition of ‘Deposit’ in 2(4) of the Ordinance includes any loan or
advance. Therefore, any person engaged in business or profession receiving
loan, advance or deposit, as stated in Para 3 and 4 above, will have to furnish
the information in the prescribed form to the Authority appointed u/s. 9(1) of
the Ordinance. Even a company accepting fixed deposits as specified under
Chapter V of the Companies Act, 2013 has to comply with this requirement. It is
not clear as to whether this information is to be given only once or every year
on an ongoing basis. We will have to await the relevant rule to be prescribed
or any clarification from the government.

       

8.     DESIGNATED COURTS

(i)     Section 8 of the Ordinance
provides that the appropriate government shall constitute one or more courts
which will be called “Designated Courts” to deal with the cases relating to
contravention of the provisions of the Ordinance.  No other court shall have jurisdiction in respect
of matters relating to the provisions of the Ordinance.


(ii)    The Competent Authority,
within a period of 30 days (which may be extended to 60 days for the reasons to
be recorded in writing) from the date of provisional attachment of the
property, as stated in Para 7(ii) above, has to file an application to the
Designated Court for confirmation of the attachment and for permission to sell
the property so attached by public auction or by private sale.


(iii)    On receipt of such
application the Designated Court has to issue notice to the Deposit Taker, the
person whose property has been attached and other concerned persons to show
cause within 30 days as to why the attachment should not be confirmed and  these properties should not be sold.


(iv)   The Designated Court, after
adopting the established procedure, has to pass an order confirming the
attachment or such other order as it deems fit. 
The Designated Court can also pass an order that either entire or part
of the attached property may be sold by the Competent Authority by public
auction or by private sale.


(v)    The Designated Court can
pass an order or issue directions, as may be necessary, for equitable
distribution amongst the depositors of money attached or realised from the sale
of attached properties.


(vi)   When the default relates to
one or more Unregulated Deposit Schemes which are investigated by CBI, the
Supreme Court can direct that the case be transferred from one designated court
to another designated court.


(vii)   Section 15 of the Ordinance
provides that the Designated Court shall endeavour to complete the above
proceedings within a period of 180 days from the date of receipt of the
application from the Competent Authority.


(viii)  Any aggrieved person who is
not satisfied with the order of the Designated Court can file an appeal before
the High Court against the said order within 60 days of such order. The High
Court may entertain any appeal  filed after the above period if sufficient cause for the delay is explained.

 

9.     PUNISHMENT
FOR OFFENCES


Sections 21 to 27 of the Ordinance
provide for punishment for contravention of the provisions of the Ordinance as
under:

SNo.

Nature of Offence

Fine

Imprisonment

Minimum

Maximum

Minimum

Maximum

 

 

(Rs. in lakh)

(No. of Years)

(No. of Years)

(i)

Soliciting
for Unregulated Deposits Scheme (Section 3) (This will include advertisement)

2

10

1

5

(ii)

Accepting
deposit under Unregulated Deposits Scheme (Section 3)

3

10

2

7

(iii)

Deposit
Taker fraudently defaults in repayment of such deposit or in rendering any
specified service (Section 3)

5

200% of deposit collected

3

10

(iv)

Failure
to furnish information u/s. 10

0

5

—

—–

(v)

Contravention
of section 4

5

25 crore or 300%, of profits made whichever is
higher

0

7

(vi)

Contravention
of section 5

0

10

1

5

(vii)

Second
or subsequent offence

10

50 (crore)

5

10

(viii)

In
case of offences by persons other than individual,  every individual in charge of the affairs
of the Deposit Taker shall be deemed to be guilty of the offence and  punished as above

—–

—–

—–

—–

 

 

10.   TO SUM UP

(i)       The
present Ordinance banning Unregulated Deposits Scheme has been issued after
detailed consideration at various levels. The Standing Committee on Finance
(SCF) presented its report on the subject of “Efficacy of Regulation of
Collective Investment Schemes, Chit Funds, etc.” in the Lok Sabha.  The SCF had issued this report after
consultations with various ministry officials and other stakeholders.


(ii)    The Central Government had
appointed an Inter-Ministerial Group to identify gaps in the existing regulatory
framework for deposit-taking activities and suggest administrative / legal
measures and also to draft a new legislation to cover all aspects of deposit
taking.


(iii)    The report of this
Inter-Ministerial Group was made public for public comments.  After detailed consideration a Bill to ban
Unregulated Deposits Schemes was introduced in the Lok Sabha on 18.7.2018. The
Bill was referred to the SCF on 10.8.2018. It was only after consideration of
the SCF report that the Bill was passed by the Lok Sabha on 13.02.2019.


(iv)   From the above it is evident
that a lot of thought has gone into the drafting of this legislation. It is
only because the Rajya Sabha could not pass this Bill, before the Parliament
was dissolved, that the Hon’ble President has issued this Ordinance on 21st
February, 2019. Let us hope this Ordinance is approved by both Houses of
Parliament after the elections.


(v)    Reading the provisions of the
Ordinance it appears to be very harsh. But considering the fact that many
ill-informed persons get lured by attractive schemes for deposits floated by
unscrupulous persons, the government has considered it necessary to enact this
legislation in order to protect the interests of small depositors. 


(vi)   An issue which requires
clarification is about the position of such Unregulated Deposits Schemes
started before 21.2.2019. There is no specific mention about the same. There is
also no provision for refund of money to depositors of such existing schemes
within a particular period. Let us hope that the government will issue
clarification in this matter. 


(vii)        Section 10 of
the Ordinance requiring every person carrying on business or profession of
receiving loans, advances or deposits to report to the Authority to be
appointed by the government in the prescribed form, is going to be an onerous
exercise. Whether the form is to be filed only once or every year on an ongoing
basis is not clear. This requirement and certain other procedural requirements
under the Ordinance are dependent on the rules to be prescribed by the
government. We have to wait for these rules which are likely to be issued
shortly.

Section 5(2), read with section 9, of the Act – Agency commission received by non resident outside India, for services rendered outside India, is not taxable in India.

2.      
TS-84-ITAT-2019 (Mum) Fox International
Channel Asia Pacific Ltd. vs. DCIT  A.Y.: 2010-11 Date of Order: 15th
February, 2019

 

Section 5(2), read with section 9, of the
Act – Agency commission received by non resident outside India, for services
rendered outside India, is not taxable in India.


FACTS

Taxpayer, a company resident in Hong Kong,
was a part of a group of companies, and was engaged in distribution of
satellite television channels and sale of advertisement air time for the
channel companies at global level.

 

During the year under consideration, Taxpayer
received income in the nature of agency commission for distribution of
television channels and sale of advertisement air time as an agent of the
channel companies. Having noted that the Taxpayer has entered into an
international transaction with its associated enterprises (AEs), AO made a
reference to the Transfer Pricing Officer (TPO) for the determination of the
arm’s length price (ALP).

 

The TPO while computing ALP noted that out
of the global commission received by the Taxpayer from the overseas channel
companies, commission fee received towards the services rendered outside India
was not offered to tax in India and only the commission fees for services
rendered within India was offered to tax in India. The TPO held that the entire
income including for services rendered outside India was taxable in India and
hence made transfer pricing adjustment to the total income of the Taxpayer. In
pursuance to the ALP determined by the TPO, the AO passed a draft assessment
order adding the transfer pricing adjustment to the income of the Taxpayer.

 

Aggrieved, Taxpayer appealed before the
Dispute Resolution Panel (DRP) and contended that agency commission received in
respect of services rendered outside India, and received outside India, is not
taxable in India u/s. 5 and 9 of the Act.

 

However, DRP rejected the Taxpayer’s
contention and held that by virtue of Explanation to section 9(2), entire
income is deemed to accrue or arise in India whether or not the non-resident
has a residence or place of business or business connection in India or the
non-resident has carried on business operations in India. Accordingly, DRP
upheld the adjustment made to the ALP by the TPO.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •   The conclusion of the DRP
    that section 9 being a deeming provision can bring to tax any income which
    accrues or arises outside India, is incorrect.
  •   As per Explanation 1 to
    section 9(1)(i), a non-resident whose business operations are not exclusively
    carried out in India, only such part of the income as is reasonably
    attributable to the operations carried out in India, is deemed to accrue or
    arise in India. Thus, on a complete reading of the provisions of section 9 of
    the Act, only such income which has a territorial nexus is deemed to accrue or
    arise in India.
  •  Moreover, provisions of Explanation to section 9(2)1  of the Act, is not applicable to the agency
    commission earned by the Taxpayer.
  •   It is a well settled position
    of law that agency commission paid to non-resident agents outside India, for
    services rendered outside India, is not taxable in India. Thus, agency
    commission paid to Taxpayer outside India, for services rendered outside India,
    is not taxable in India.